Fortive Q3 2021 Earnings Call Transcript

Quartr
Provided by Quartr
October 27, 2021

There are 17 speakers on the call.

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 3rd Quarter 2021 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. Own keypad.

Operator

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.

Speaker 1

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's section of our website, www.fortive.com, under the heading Investors Quarterly Results.

Speaker 1

We completed the separation of our prior Industrial Technologies segment through the spin off of Von Tir Corporation on October 9, 2020, and have accordingly included the results of the Industrial Technologies 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. Call. All references to period to period increases or decreases and financial metrics are year over year on a continuing operations basis.

Speaker 1

Call. 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 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 forward looking statements is available in our SEC filings, including our annual report on Form 10 ks for the year ended December 31, 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.

Speaker 1

With that, I'd like to turn the call over to Jim.

Speaker 2

Thanks, Griffin, and good afternoon, everyone. Early in the Q3, 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 and 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 the backdrop of strong broad based demand. Strong execution and application of FBS help to generate 3 25 basis points of core operating margin expansion, along with very strong free cash flow despite widespread supply chain disruption.

Speaker 2

In the Q3, our software businesses grew by low double digits, supported by strong demand and improving net dollar retention. In total, we now have almost $750,000,000 of annualized software revenue across the portfolio Another differentiated high growth software asset to our Intelligent Operating Solutions segment. The Service Channel acquisition significantly enhances strategic position in the facility and asset lifecycle market, extending our leading suite of offerings 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 4, across Fortive, we continue to invest in product development to drive organic growth and enhance our competitive position. Many of our investments in organic innovation are focused on enabling digital transformation across our customer base.

Speaker 2

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 Fort 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, 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. This quarter, we announced a number of important additions and promotions to the senior leadership team, including the appointment of Illuminae Sherroya as President and CEO of Intelligent Operating Solutions the promotion of Tammy Newcomb to President and CEO of Precision Technologies and the promotions of Justin McElhadden and Bill Pollack to Group President roles within Ios.

Speaker 2

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 Illuminae and Tammy, as well as Pat Murphy now leading advanced 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 5. 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%.

Speaker 2

The strong adjusted operating margin performance helped us to deliver $252,000,000 of free cash flow, which represented 105 percent conversion of adjusted net earnings. On Slide 6, we take a closer look at the Intelligent Operating Solutions segment. IOS posted total revenue growth of 16.6% in the 3rd 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. Fluke's core revenue increased by mid teens with very strong demand trends continuing across its end markets and major geographies.

Speaker 2

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 Q3. Fluke Networks had a very strong quarter driven by innovations 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 Emate, 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 Q4 and 2022.

Speaker 2

Industrial Scientific revenue increased by mid teens as its instruments and rental business continued their strong recovery. 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. Intellect grew by mid teens and posted another record revenue quarter. Intellect is seeing solid FBS driven improvements in its upsell process to support higher net dollar retention data Moran, which enables intellect's customers to manage their full life cycle of risk identification. Accruent grew by low single digits in the 3rd quarter, while seeing strong bookings of greater than 20%.

Speaker 2

This booking strength was paced by continued demand for Accruent's Meridian Engineering Document Management and Maintenance Connection CMMS offerings. Accruent also continues to see strong demand for its EMS, event, workspace and resource scheduling solution to support emerging hybrid office models as 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 Q3, Gordian continued to see increasing project volume as well as higher average dollars per project.

Speaker 2

Gordian is also seeing success from its expansion into healthcare with significant demand for its facility solutions from hospital customers. 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 and 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 3rd largest mobile carrier in North America as they transform their facility management program. Moving to Slide 7. The Precision Technology segment posted a total revenue increase of 8.9% in the 3rd quarter with core growth of 7.7%.

Speaker 2

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 in demand with double digit order growth in the quarter. 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.

Speaker 2

Throughout the Q3, Tektronix did an excellent job deploying FBS countermeasures to navigate sustained supply chain challenges, while also delivering significant price realization. Even with the 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 3rd quarter. Sensing reported strong growth across each of its major regions with robust order momentum across key end markets. Cetra 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.

Speaker 2

Thanks for Dynapar had a very strong quarter by utilizing the FBS toolset to improve lead times and on time delivery to drive share gains with key OEM customers. Pacific Scientific EMC grew by mid single digit 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 8, 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.

Speaker 2

Western Europe saw high teens decline based on a difficult prior year comp at Invotec, partially offset by strong growth at ASP and Flukel. ASP grew by low single digits in the 3rd 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 the consistent financial results in the United States. In the U. S, the spike in COVID related hospitalizations led to a notable decline elective procedure volumes toward the end of the quarter, resulting in global elective procedures at approximately 88% of pre COVID levels for the period.

Speaker 2

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 installed base. Sensus increased in the low 40% range, highlighted by very strong growth in professional services and related hardware. Its SensiTrak SaaS offering grew mid teens as they continue to benefit from new customer additions, as well as good momentum with up selling and cross selling to existing customers. Sensus continues to have open access to customer sites and saw strong continued 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.

Speaker 2

FHS executed very well all 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 with a good early traction from software integration efforts with 30% growth year over year in Q3. Imitex declined by mid single digits, which is better than expected against the 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 expect 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.

Speaker 2

Thanks, Jim, and good afternoon, everyone.

Speaker 3

Strong pricing and successful value engineering to implement components PS execution and the continued The continued strength of our software businesses helped deliver adjusted gross margins Up 57.3 percent 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 excluding countermeasures enacted financial results in the face of ongoing supply chain challenges. We had strong margin performance across all of our segments, resulting in 3 25 basis points of core operating margin expansion. On Slide 9, you can see that in the Q3, we generated $252,000,000 of free cash flow, representing 105% conversion adjusted net income.

Speaker 3

Free cash flow over the trailing 12 months increased 22% to $991,000,000 Our current net leverage is approximately 1.6 times and we expect net leverage to be around 1.3 times at year end, excluding any additional M and 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 $0.70 resulting in a range of $2.70 to $2.75 for the year. This represents a year over year growth of 29% to 32% on a continuing operation basis. This assumes that total revenue growth of 14% to 14.5%, adjusted operating profit margins of 23% to 23.5% adjusted net income for the full year.

Speaker 3

We are also initiating 4th quarter adjusted diluted net earnings per share guidance of $0.74 to $0.79 representing year over year growth of 6% to 13%. This assumes total revenue growth of 6.5% to 8.5%, adjusted operating profit margin of 23.5% to 24.5% 12,000,000 of anticipated investments in strategic productivity initiatives that we expect to execute before the end of the year. For the Q4, we expect free cash flow conversion to be approximately 125% of adjusted net income. With that, I'll pass it back to Jim for some closing remarks.

Speaker 2

Thanks Chuck. We're very pleased with our performance in Q3. We worked diligently to counter measure 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.

Speaker 2

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

Speaker 1

to Griffin. Thanks, Jim. That concludes our formal comments. Alexander, we are now ready for questions.

Operator

Again, that is star 1 to ask a question. Please limit your question to 1 and one follow-up question. We have your first question from Scott Davis with Melius Research. Your line is open.

Speaker 4

Good afternoon, guys, and good evening, everybody.

Speaker 2

Hey, Scott.

Speaker 4

It's a pretty good quarter overall. I'm just trying to nitpick a little bit. If price up 2 20 basis points, Did that fully offset your cost, Jim? And is price still going up as you go into Q4 here to Offset kind of the deltas as costs continue to rise?

Speaker 2

Yes, Scott, thanks. I think number 1 is we've been ahead as you know, we've been in A really good position all year relative to price cost. And it's about prices. When you think about it, we really think about it in the big hardware businesses is Fluke, Tech and Sensing. And in that those businesses, we were over 300 basis points.

Speaker 2

So yes, and we'll see improvement from there in the Q4. So yes, so we're in good shape. You'll see the price in the software businesses in the net dollar retention. And so net dollar retention at 102 or so with some of our businesses even higher means we're also we're getting that price Number of the software businesses, it just doesn't show up in the metric the way you'd like it. But 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.

Speaker 4

Okay, good. And then Service Channel, you made some positive comments. And what is Is it more specifically that you like more perhaps today than when you close the deal?

Speaker 2

Well, I think, number 1, the team, I We didn't have full access to the entire organization when we were in the deal. So 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 1. We always said the product was great, so I don't think there's any surprise Other than the product is great and the solution is good.

Speaker 2

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

Speaker 5

Great. I'll pass it on.

Speaker 4

Thank you and good luck in 4Q.

Speaker 2

Yes. Thanks, Scott. Good talk to you.

Operator

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

Speaker 6

Thank you. Good afternoon, everyone.

Speaker 7

Good evening, Steen.

Speaker 6

Hey, just maybe start with Fluke. And 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.

Speaker 2

Yes, sure. I think we had a very, 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 going to be a little bit of a challenge. So orders were In the high teens, so we're really good shape on the order side.

Speaker 2

We build backlog, as you mentioned. I've been with the team a couple of times on the shop And they're doing some really good work to get on with many of the component challenges that they've had. But We're in a very good place with backlog and with the position of the business. I like where we're at. As we mentioned, from an innovation perspective in the prepared remarks, a number of examples of where I think we're really handling things well and we're taking market share.

Speaker 2

And of course, all that's also really driving strong margins there as well.

Speaker 6

Okay. And 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 Q4 to get a jump start on the coming year. So this $12,000,000 just to be clear, that was not in your prior guidance. Is that correct?

Speaker 3

That's correct, Dean. We've got some things going on with the ASP Day 2 Countries that we'd plan to get But hadn't been put into our guide. And then we've also got some things around facilities reductions that we were looking at reducing our footprint.

Speaker 6

Got it. And which segments would benefit from those from that spending?

Speaker 2

Yes, about half of it half of it's in iOS and the other half

Operator

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

Speaker 8

Thank you. Good afternoon, everyone.

Speaker 9

Hey, Jeff. Interesting answer to the prior question absorbing that. Also, is there some dilution from service channel In Q4 as you bed that down and any change of view of kind of that year 1 accretion, I think in the $0.04 to $0.05 range?

Speaker 3

So Jeff, this is Chuck. No change to the year one accretion in that around that $0.04 range. And actually it's coming in just as we expected, but in the Q4, we're going to get revenue with really not a lot of operating profit As it moves into profitability really in next year. So that's not different. And so inherently there is a little bit of dilution there in Q4.

Speaker 9

Great. Margins look good in spite of that. And then just on this Walgreens deal, Was that something in the pipeline already or is there some synergy that's already occurring with the Gordian or Accruent or some other part of Fortive.

Speaker 2

Jeff, I'd love to take credit for it, but it was in their funnel And the team did a great job executing on it. So I won't we'll take credit for when the synergies happen maybe next year. But right now, the team is we obviously, we saw it in the funnel when we did our due diligence. So we knew and I think their say due ratio of things they said they were going to 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.

Speaker 9

And is the answer to the Tech the same as the answer to the Fluke backlog, essentially, there's some supply backing up

Speaker 2

a little bit? Yes, I mean, it's we're not the 1st company to talk about it, what I understand. So I think at the end of the day, electronic components, 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 has continued to accelerate, it's a good news story here. This isn't just a supply constraint issue.

Speaker 2

It's really a demand acceleration standpoint. And with demand the combination of demand accelerating really has our teams work diligently on these things, but 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 Q4. Great.

Speaker 9

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

Speaker 3

Thanks, Jeff.

Operator

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

Speaker 7

Yes. Good evening. Good afternoon.

Speaker 3

Good evening, Andrew. Just a

Speaker 7

question on pricing. Just going back to the tariffs, I just remember that putting in pricing price cost What has changed inside Fortive to enable this kind of pricing power because I just recall like 3 years ago was More of a drag.

Speaker 3

Well, I think a couple of things. 1, 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, equal amounts of price and cost, we'll do that. In this case, what we've been doing is staying ahead That and getting as Jim mentioned in our hardware business, this is up to 300 basis points of price and we still are getting PPV and taking 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. Thanks.

Speaker 7

And just a follow-up question. Looking back, you turn out to be prudently conservative on your view on elective procedures relative to everybody else and frankly us. But where do you see elective procedures sort of going Over the next 3 to 6 months, what's the pace of improvement as you see it globally? Thank you.

Speaker 2

Yes, thanks, Andrew. What we saw, I think we ended Q3 at about 88%. Obviously, the Delta variant had impact in As the quarter progressed, we're assuming for the Q4 about the same, no real uptick. I suspect when we get 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 Q1, start to see some of those procedures coming back and we'll get to the first quarter once we finish the 4th, but specifically for the Q4, our assumption is things stay about the same as they are today.

Speaker 2

We're in a really good place at ASP. As we mentioned, we had not just a 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. On a continuous basis in 2022, we'll be in a really good position to take advantage of that.

Speaker 7

I'll leave it there. Thanks so much.

Speaker 2

Thanks, Andrew.

Operator

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

Speaker 10

Hi, good afternoon. Hey, Julien. Hey, maybe just the first question around the core growth guidance for Q4. So I think it's sort of plus 5 At the midpoint, you've probably got around 3 points of price in there. So it's sort of 2 points of volume growth.

Speaker 10

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?

Speaker 3

Sure. There's a couple of things. I think The way you're looking at it, 200 basis points is the price increase, 300 is specific to the hardware businesses, but so 200 overall, but you've got that about right. But when you look at on a 2 year stack, we actually think we're still expanding or growing increasing our growth rates in Q4 versus even Q3. So I think that's important.

Speaker 3

Also, I think as we noted, we'll get out the door right now isn't really reflective of the underlying demand of the businesses. And Julian, I'd just say

Speaker 2

a couple of things. 1, as Chuck said, The underlying demand on the orders for the second half is double digits. So very good order. 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 Q4 simply because while Tek had a little bit lower growth in the quarter.

Speaker 2

They had over 20% order growth. And so we will see China get back to mid single digit like growth in the 4th quarter. So We've seen good point of sale in China. So we're watching it carefully, certainly because of a lot of the headlines. But We had a good quarter.

Speaker 2

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 and in the 4th quarter should improve sequentially from the 3rd to the 4th.

Speaker 10

That's very helpful. And then margins, so you had very strong incrementals in Q3 year on year company. You're assuming something in the maybe mid-30s operating leverage, so very good, but a little bit lower. Is that just the sort of price cost and service channel coming in. Or is there anything sort of specific moving around in Q4?

Speaker 10

So

Speaker 3

our underlying assumption is 40% incremental. And I think when we print Q4, I think that's what we're seeing. Maybe when we get to the so not seeing any slowing there.

Speaker 10

Perfect. Thank you.

Speaker 3

Thanks, Julian.

Operator

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

Speaker 11

Good afternoon, guys. So just going back to the restructuring, I think you said $12,000,000 Chuck,

Speaker 3

about half

Speaker 11

of that in iOS, I think.

Speaker 12

The decision

Speaker 11

to do that, was that just because You've come in ahead of plan and so you just decided that a good idea to maybe do some investment here. And how should we think about this? Is this something that we can consider to be sort of a one timer? Or Would the intention be to do quite restructuring of this sort of magnitude in 2022, 2023 as well?

Speaker 3

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 As we go forward to them at the ASP realm. And I'd also say that as we come out of COVID, We're going to continue to evaluate our footprints here and see what we need going forward. Then that's probably going to be an evolving Thanks. So you could see that we could see that going forward, but it's not like we have a plan, we're going to do a certain amount each quarter. It's as we see what the situation is and we need to make a change, Then you're going to and then we'll tell you about it.

Speaker 2

And sorry, Nigel, the other part of it is we did some in the third within the business and sensing to do some factory relocation as well. So really in the second half, these are really ideas around the second half. And 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 businesses we have, we can take our footprint down. And so we're obviously going to take advantage of those opportunities as they come at us.

Speaker 11

Great. And then on accruance, low single digit growth versus mid-20s bookings. So obviously, a big disconnect there. Maybe just update us on how you see the revenue Some out accruance, I think there's a SaaS transition going on there. And maybe just touch on as well the net retention of 102, That's a year to date metric.

Speaker 11

Is that changing at all through the quarters? And what's your target around net retention?

Speaker 2

Yes. So relative to recurrent, you're right, we had a little bit slower revenue growth there, but we did have good bookings, really strong bookings and a couple of several what we call the growth businesses. We called those out in the prepared remarks, but really strong bookings relative to the performance in those businesses. So I think we're set up well for mid single digit in 2022. But you're right, we had a one time hit on revenue that occurred in the quarter, Couple of little churn events or mini churn events that we didn't anticipate.

Speaker 2

So certainly slowed it down a little bit in the quarter, but we think Because of the order strength, particularly around new logos, we are in a good position for next year. Relative to the 102, We're always going to have some businesses up and down relative to where that number is at. Service channel and eMate would Be our best performers on that metric as an example. Intellects would be pretty high. But we I would suspect we'll We'll get to sort of thinking about 100 basis points of improvement, 100 basis points to 200 basis points of improvement, somewhere in that range

Operator

We have your next question from Josh Pokrzywinski. JPMorgan Stanley. Your line is open.

Speaker 8

Hi, good evening guys.

Speaker 7

Hi, Josh.

Speaker 13

So just a follow-up question, not the nitpick on some of the like the margin differences here with the restructuring and then service channel coming in, but I just want to make sure I'm understanding this right. In intelligent operating, if we Sort of add back in that half of the slug of restructuring that goes there. It doesn't look like ex service channel, there's really much of a difference in margins in 4Q. Is there something seasonal there or supply chain that's sort of interrupting that or am I just sort of Put this under

Speaker 3

a microscope unnecessarily. There's just we're talking about some the highest Your planning sheet with you in detail and they'll be understand that. But we're seeing sequentially margin expansion and I think in all of our businesses.

Speaker 13

Got it. And then just in terms of kind of your specific Fortive flavor of supply chain, Maybe talk about like the 1 or 2 things would be particularly helpful. I know some folks are really focused on chips, others have Freight and airfreight or labor issues like what would sort of be kind of your top 1 or 2 things, Jim, that would be best Citi.

Speaker 2

Yes. Well, I can 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. It takes me back to some roots, I guess. Josh, I would say a couple of things. 1, Certainly in our businesses, but think of it as the most circuit board at Tektronix, which is incredibly complicated, has multiple semiconductors on it, has multiple all kinds of chip technology on a board like that.

Speaker 2

You're going to just have higher variability because of that. Fluke will be as true as well, and then sensing a little bit less. So From a just how that goes, that's how it would be. We are seeing mostly electronic shortages. And as I said in the previous comment mostly around availability.

Speaker 2

We're paying a little bit more to get things. So there's some premium freight involved in the inflation, very not a lot of labor. We have pretty low labor content in the company simply because of our decades of productivity initiatives. So we're seeing some labor inflation, but at the end of the day, doesn't move the needle as much. It's really about the material availability first and foremost.

Speaker 2

And given our gross margins on those products, it makes sense to even if we spend a few pennies more to get something in faster, Given the demand given the high demand we have right now and 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. And obviously, our 1st and foremost, we're taking care of customers. So 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.

Speaker 2

Our businesses put that on steroids a little bit in order to amplify The challenges and just given how well we countermeasure that really makes the difference. Appreciate it. Best of luck guys. Thanks.

Operator

We have your next question from Markus Mayer with UBS. Your line is open.

Speaker 14

Hi, Mark. Hi, good afternoon.

Speaker 15

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 word, obviously. And so once things hit your backlog, sort of how flexible are you to adjust price further if you have to?

Speaker 2

Well, number 1, I think what we do is in the big businesses where we sell into distribution, we limit the amount of buying that can occur at pricing. So if we have a price increase stated, we obviously have contractual terms, Marcus, And we will contractually make sure we work with our obligations to not necessarily something like that. So we're part of how we work with channel partners. We've been able in many OEM cases to reprice orders as well. So I think it really speaks having problems in their backlog with pricing.

Speaker 2

We have really good granularity around what that looks like and that's what gives us confidence to know that we'll continue

Speaker 5

to get

Speaker 2

the price here going forward and to know that our price costs will continue to improve.

Speaker 15

That's good to hear. And then maybe one as a 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. So if I look into 2022, What's potentially the bigger driver here?

Speaker 15

Because it seems like the equipment placing trends are actually quite positive as well. So if I get that and I get elective procedure recovery, sort of what sort of growth should we be dialing in here?

Speaker 3

Marcus, I think that you're right, our underlying business and placing units is starting to is continuing to We're very proud about that. I think electric surgery is coming back. It could be half of Quite a bit of the growth of it all springs back in 1 year. But I think we need to get closer to next year to really see what they Actually do in what month, but I do think that it's just to answer your question, if we have all came back at once, That'd be the bigger driver of the year for ASP and be quite a tailwind coming forward. But we're not calling that all Coming back at once in 2022, it will probably ramp.

Speaker 3

It's over some period of time.

Speaker 2

And I think maybe, Mark, it's one thing we know to be true over the last That's caused it to go a little bit sideways. So 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 get forward.

Speaker 2

And 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. So it's it probably doesn't snap back, But it certainly comes back over time, which Thank you very much.

Operator

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

Speaker 12

Hey, good afternoon, guys. Hey, Andy. So obviously, Fortive continues to have a really strong balance sheet. I think you said 1.3x leverage at So could you talk about the M and A environment out there? We've obviously seen a flurry of software focused acquisitions after your service channel acquisition.

Speaker 12

And 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 and would you lean toward continued focus on recurring revenue and or software related assets such as service channel?

Speaker 2

Well, Andy, as we said over the last few years, we've and you know that as we've talked to you, we remain very busy. And I think we're working on some hardware things. We're working on some software things to advance our What we do within workflows with customers. So 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.

Speaker 2

We're certainly going to lean in on recurring revenue. We think that's a good way to we Really think that's a strategy towards building a more durable, resilient Fortive over time. And so 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 revenue in those deals even when they were hardware. So we're going to continue to look for those opportunities, not exclusively, But probably the majority of the things we're doing is really going to have a passion for growth, but also with that idea Yes, that we can continue to build a more durable resilient growth rate.

Speaker 12

Thanks for that. And then maybe if I could follow-up with asking you about tech in sort of a different way. You've also had good momentum there and you talked about new product introductions this quarter. I know you've mentioned, that's continuing strategy of focusing on data centers, EVs. So is that where the momentum continues to come from?

Speaker 12

And is techs growth just maybe on a higher plane versus past cycles, given the sort of change in focus?

Speaker 2

Well, I think number 1 is it's more resilient because We had, I think, low digit growth in our service business, but just a resilient, durable base and foundation of revenue that we've built over time. So So number 1, 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 started with. We mentioned that in the prepared remarks. So 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 what I would call higher growth situation.

Speaker 2

And quite frankly, when we think about going forward, obviously, the semiconductor cycle is going to 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 ships or different components. And quite frankly, one of the things they need to do that is an oscilloscope. So We think there's also 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 and fundamentally that can often end up in a redesign. And certainly, we have the products and solutions to help people do that. So Well, it has a component of volatility to it, but we're I think the team has done a nice job continuing to drive technology and innovation towards higher growth, more durable revenue streams.

Operator

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

Speaker 3

Hi, John.

Speaker 16

Hi, everybody. How are you?

Speaker 2

Good.

Speaker 16

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 you're showing up. Just curious how you parse out that growth?

Speaker 3

No, I think that's a good question. Especially when you Look at our software businesses, you heard Jim mention a little bit of other where we also see price and great margin expansion. And we've got those businesses with their great growth and margins growing faster than fleet average. That's going to give you a lift as well. So 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.

Speaker 16

Great. And then you obviously highlighted both the internal and external promotions here.

Speaker 13

I was wondering if you could

Speaker 16

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?

Speaker 2

Yes, sure. Well, we're incredibly excited to have Illuminae 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.

Speaker 2

And he created an enormous digital data analytics capability at CoreLogic. So he really brings data centric approach to these businesses, which I think is a wonderful part of his leadership style. Obviously, Tammy'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 2 internal promotions, both of whom came with acquisitions.

Speaker 2

Justin and Bill were both both came to us with acquisitions, Justin with ISC, Bill with Gordian. And so 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 are additive to our leadership capabilities. So 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. And we're in a very good place relative to adding talent.

Speaker 2

On the healthcare side, we brought in some new real new talent from a healthcare standpoint at ASP to really give us even be additive to our healthcare So I think we've not only have been able to retain people through a very rigorous development process, but we've become a destination for talent. We've certainly been able to recruit some top notch talent. We mentioned Reed Simmons as our Head of Strategy in the Q2. 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.

Speaker 16

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

Speaker 3

Thanks, John.

Operator

We have your next question from Joe Giordano with Colin. Your line is open.

Speaker 14

Hey, guys. Thanks for taking my questions. Hey, Joe.

Speaker 6

Hey, so one of

Speaker 14

your competitors Was talking one of your competitors to tech was talking about having success in integrating like protocol analyzer capability into their scopes. So like connected devices, I see. Is that something that you're doing or is it something you think is worthwhile, just curious if that's an offering yet.

Speaker 2

Well, I think at the end of the day, 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. So I would say that our direction has been more Rather than adding additional measurement capability to some of the scopes, we've been really adding more solutions focus to really different probes, different software around the 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 the engineer in the application specific application that they're moving forward with.

Speaker 14

Okay. And then Jim, going into when you guys gave guidance last time, you knew elective you were appropriately cautious on elective surgery, Supply chain was bad then. I'm just curious like what are the big like the 1 or 2 single biggest like top line variances that will end up being realized versus what you thought last

Speaker 2

time. In the Q3? Yeah, like versus

Speaker 14

when you gave.

Speaker 2

Yeah, I mean, I think electives certainly were part of it. We thought electives were going to be we were conservative on electives, but we were They were lower than we anticipated. So you could probably think about maybe $10,000,000 of revenue that was They're just in the just there. And then certainly on the 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. We always said the September is a big month and we had several things that hit us in September that we didn't anticipate.

Speaker 2

So 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. And this isn't a story of the absence of challenges, but rather the ability to deal with them. And that's what we'll continue to do in the Q4. And 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.

Speaker 14

Can I just clarify one thing? The stuff that you couldn't get out supply chain. Is that because you couldn't I guess, can you break it down between stuff that you were able to manufacturer and the customer wasn't ready to take delivery and it's not sitting in inventory or it's stuff that you just couldn't get the components on your side to No,

Speaker 2

this is all us not getting components. We have demand picked up tremendously through the quarter. As we said, we had very strong orders, and we'll have strong orders through the rest of the year. So our demand profile is very good. Customers are Taking things as soon as we can get them to them in most cases.

Speaker 2

So this is not an inventory situation or anything like that. This is 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. Sure. Thanks, guys.

Speaker 2

Thank

Operator

you. We have your next question from Andrew Buscaglia with Berenberg. Your line is open.

Speaker 8

Hi, guys. I just wanted to ask on Advanced Healthcare as well. I mean, it doesn't seem like Yes, this will exactly be a snapback situation. You're facing some tough comps into the first half of the year. So The question is where I guess, FBS, but where Where we see some margin leverage.

Speaker 8

Like I guess what needs to happen to really see those margins pick up in kind of more muted first half maybe?

Speaker 3

Well, I think first in Q3, we saw some outstanding margin expansion in the Advanced Healthcare segment going from I think around 20% in Q2 to 23% of our adjusted operating profit. So we're seeing good margin expansion. And that's not just at ASP. Census had a really good quarter, so did Fluke Health. So we've got and our hardware placements there.

Speaker 3

And so you're seeing that already. What we're saying is it could have been better with the pifelactive surgeries And that's going to be a future advantage. But to be clear, we had good step up between Q2 and Q3 in Health. And from Q3 to Q4, We expect to do another 100 to 200 basis even with elective surgeries to staying where they're at right now.

Speaker 8

Okay, fair enough. And Chuck, maybe you can comment, I know M and A is definitely on the top of your minds with given where leverage is, but The stock is kind of getting cheaper here and kind of I've done a whole lot in the last year. What's your what are your thoughts on a buyback or Maybe choosing that as a different avenue for the cash.

Speaker 3

We remain very optimistic about the opportunity to deploy capital. We've said that we laid out that we had probably $5,000,000,000 in the 1st 3 years post separation with volunteer. We've done 1.2. It sounds like we're running way behind there. So we think we've got ample opportunity for that.

Speaker 3

And so we're not changing Our priority being M and A.

Speaker 8

Yes. Okay. Thanks, Chuck.

Operator

We have your next question from Steve Tusa with JPMorgan. Your line is open.

Speaker 5

Hey, guys. How's it going?

Speaker 2

Hey, Steve. How are you?

Speaker 5

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 4Q. I don't know if you did a better job on margins this quarter. Is there anything going on there?

Speaker 5

Is there a like is that elective procedures? And Can we think can we still kind of think about a potentially kind of high-twenty's margin as we look out into kind of next year?

Speaker 3

I think it's first of all, I think the 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 electric procedures being around 90% rather than the high 90s. That's Somewhere around $12,000,000 to $14,000,000 of 75% to 80% margin business. And so when you do that, That clipped off about 200 basis points margin expansion, but we're still expanding margins from Q3 to Q4. And we know that sooner The electric procedure is going to come back.

Speaker 3

So today's headwind there is tomorrow's tailwind. So but we don't the destination or going into those high 20s, That's still what we think is very possible. Nothing's changed about that.

Speaker 5

Got it. And then just heading into next year, You're exiting kind of 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 From an organic perspective, should next year be more in line with your longer term guidance in mid singles or can you maybe do a little bit better than that Given the headwinds you're kind of facing here in 3 and 4Q with the supply constraints.

Speaker 2

Well, it's safe to say that we're going to end the year in acquisition 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. But things are setting up pretty well. Orders are very strong.

Speaker 2

They're going to continue to be good in the 4th. There's a lot of variables out there. Obviously, there's still to be considered as we play out the rest of the quarter to give consideration to. But as Chuck just said, relative to how AHS is setting up, we certainly talk about the software businesses even where we had a little bit less growth at the current, we had good orders. So, we think we can continue to build on our net retention.

Speaker 2

So 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. So but we'll get there pretty soon. And obviously, I think if it plays out the way we think, we'll certainly have we'll be in our best backlog position that we've ever been in.

Speaker 5

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

Speaker 3

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.

Speaker 2

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.

Speaker 2

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.

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Earnings Conference Call
Fortive Q3 2021
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