Operator:

Greetings, and welcome to the Fortive Corporation’s Second Quarter 2024 Earnings Call. At this time, all participants are in a listen-only mode. A brief question-and-answer session will follow the formal presentation. [Operator Instructions] As a reminder, this conference is being recorded. It is now my pleasure to introduce your host, Elena Rosman, Vice President, Investor Relations. Thank you. You may begin.

James Lico:

Thanks, Elena. Hello, everyone. Thank you for joining us. I’ll begin on Slide 3. Our second quarter results showcase strong execution across our businesses, allowing us to deliver earnings and free cash flow at the high end of our guidance with 90 basis points of adjusted operating margin expansion and 9% adjusted earnings growth, despite revenue at the low end of our guidance. Our performance continues to reflect our ability to adapt to the low growth environment and deliver differentiated financial results enabled by FBS-led innovation and productivity actions. Our leadership positions across durable growth markets are reflected in upside performance and Advanced Healthcare Solutions and continued momentum in Intelligent Operating Solutions positioning Fortive well for the future. As we look ahead, we are excited to see the acceleration of our innovation and new product launches, delivering more value for customers and sustained growth for Fortive. We are confident in our updated outlook for the year, reflecting strong growth in our recurring revenue businesses and continuing our track record of mid-single-digit through cycle core growth and compounding earnings and free cash flow by double-digits in 2024. Turn to Slide 4. I’ll provide an overview of our second quarter and year-to-date results, as well as what we’re seeing as we look ahead. Second quarter revenues were up 2% with flat core growth. Acquisitions contributed 3 points to growth, partially offset by a foreign exchange headwind. Strong operational execution contributed to record second quarter adjusted growth and operating margins, and earnings per share of $0.93. Year-to-date, we achieved 100 basis points of adjusted operating margin expansion and double-digit earnings and free cash flow growth on 3% revenue growth. Turning to what we are seeing across our businesses, Intelligent Operating Solutions and Advanced Healthcare Solutions continue their momentum, benefiting from durable and recurring revenue, as well as new product introductions aligned to secular growth drivers. This demonstrates the success of our capital deployment strategy in these segments, where we continue to focus our bolt-on efforts to further enhance growth. Across Fortive, our recurring revenue is now 42% of our portfolio growing low-double-digit year-to-date, we expect that pace of growth to continue in the second half. Government spending delays broadly contributed to revenue coming in at the low-end of our second quarter guide, primarily driven by delayed military and government R&D projects impacting Tektronix, as funding continues to be prioritized to production-related programs, and slower job order contracting growth at Gordian, as they lap government stimulus funding in 2022 and 2023. Orders of Precision Technologies were down in the quarter as expected and book-to-bill was stable at 1.0. Consistent with our prior outlook, we expect orders to return to low-single-digit growth in the third quarter. However, our updated 2024 revenue outlook does reflect a slower than expected recovery in certain end markets and PT in the second half of the year. We are offsetting lower revenue with new productivity actions and have reflected the delay in global minimum tax implementation and our tax rate guidance for the year. Chuck will cover the outlook for the rest of the year in more detail shortly. Lastly, our free cash flow performance continues to differentiate with industry-leading free cash flow margins allowing us to repurchase 2 million shares in the second quarter and continue that pace the remainder of the year. Turning to Slide 5, I will provide more detail on second quarter segment performance as well as our expectations for the full year. Intelligent Operating Solutions total revenue growth was 4% with core up 3%. Acquisitions were favorable, partially offset by an FX headwind. Adjusted operating margins were down slightly versus the prior year, although up approximately 400 basis points on a 2-year stack, with strong price realization and volume growth more than offset by growth investments. Additional highlights include, Fluke revenues were up low-single-digit plus, including mid-single-digit industrial products and double-digit ARR growth in the quarter, a strong proof point of our efforts to make the business more resilient. Fluke’s bolt-on acquisitions, Solmetric and Azima DLI, continued outperform contributing to Fluke’s growth in the quarter. EHS grew low-single-digit paced by recurring revenue contributions, including strong SaaS and iNet growth, partially offset by slower product sales at ISC. FAL grew mid-single-digit, or mid-teens on a 2-year stack, with continued normalizing growth at Gordian and lapping the wind down of pass-through revenue at service channel. FAL maintained its pace of high-single-digit SaaS growth, and we expect to see that reflected in accelerated core growth in the second half. For the full year, we expect the IOS to deliver mid-single-digit core growth, with approximately 100 basis points of adjusted operating margin expansion. Precision Technologies was down 1.5% in the quarter, with core decline of 6.6%. Acquisitions, net of divestitures contributed 6 points to growth, partially offset by FX. Adjusted operating margins were down slightly year-over-year, with lower core volumes almost fully offset by productivity benefits, favorable price, and M&A. Additional highlights include, Tektronix core revenues went down mid-teens as revenues normalized to bookings. We saw pushouts of large Mil-Gov projects in the Americas, and slower recovery in China, partially offset by mid-single-digit services growth. EA has seen large EV mobility and battery expansion projects push out, reducing its revenue outlook for the year to approximately $130 million. While sales cycles are longer for these large projects, EA has seen a doubling of the sales funnel on smaller run rate projects across industries, validating the go-to-market synergies with Tektronix and positioning the business well for 2025 and beyond. Sensing with down mid-single-digit in the quarter with continued strength in utility grid, food and beverage, and healthcare end markets more than fully offset by weaker industrial and factory automation demand. And lastly, Pacific Scientific delivered another quarter of mid-teens core revenue growth driven by robust demand. We finished Q2 with a stable one-to-one book-to-bill and are expecting revenue to return to growth in the second half. For the full year, we now expect PT growth down low-single-digit with adjusted operating margins approximately flat. Advanced Healthcare Solutions revenue growth was 3% with core growth of 5%, partially offset by unfavorable FX of approximately 2%. Adjusted operating margins expanded 260 basis points with strong volume, price realization, and productivity benefits more than offsetting growth investments. Additional highlights include, ASP Censis grew mid-single-digit, driven by double-digit consumables growth, enabled by the successful North American channel transition at ASP, and new doors and cross-sell expansion at Censis. Fluke Health Solutions was up low-single-digits with double-digit dosimetry services growth. Provation grew low-single-digits, lapping a large prior-year licensing win, while SaaS revenues up nearly 50% in the quarter. Given the strong first half performance, we now expect AHS full-year core growth to be at the high-end of mid-single-digit, with over 150 basis points of adjusted OMX for the year. Moving to Slide 6, several short-cycle industrial markets, served by our Precision Technologies segment, faced headwinds in the second quarter. We saw continued customer caution, weighing election and macro uncertainty, contributing to OEM and channel weakness, and further CapEx-related project delays. North American revenues were up slightly, benefiting from mid-single-digit growth at IOS, driven by strong industrial and software growth, mid-teens growth and healthcare consumables, and continued strength at PacSci, partially offset by lower Tektronix revenues. In Europe, we saw revenues normalized to bookings, with a mid-teens decline at PT, partially offset by low-single-digit growth in IOS and low-double-digit growth in healthcare. Core revenue in Asia was down low-single-digit, driven by slower government spending and distributor de-stocking in China. Japan was up mid-single-digit or better in all segments, and in India we saw slower growth, given election uncertainty, impacting project timing at Tektronix. Core growth for the quarter largely centered on our high growth markets, excluding China. These regions have now eclipsed China in size and account for approximately 14% of sales. Looking ahead, we expect improvement in core growth in the back half of the year, driven by favorable order rates, as well as continued strength in AHS and software. With that, I’ll turn it over to Chuck to talk through our updated third quarter and full year guidance.

James Lico:

Thanks, Chuck. I’ll continue on Slide 9. Our revised full year outlook yields double-digit adjusted EPS and free cash flow growth in 2024 and keeps us well on path to achieving our long-term targets. While we’ve seen both tailwinds and headwinds since we first issued those targets, you have also seen how we’ve adapted to the lower growth environment in 2024 and still raised our earnings guidance through the year. This is a testament to our culture of continuous improvement and our relentless focus on delivering for shareholders in any environment. We also still expect to generate over $8 billion in free cash flow in the next 5 years, which allows us to further accelerate earnings growth and shareholder returns through disciplined and accretive capital deployment. Our priority remains bolt-on acquisitions to existing growth platforms in areas of demonstrated strength, while also enhancing returns to shareholders. We continue to believe share repurchases are a good use of capital, and we expect buybacks in the range of 5 to 6 million shares for the year consistent with our recent track record. Further, we announced our first dividend increase in 2023 and plan to continue to grow our dividends in line with earnings and free cash flow. With a powerful combination of the Fortive business system and disciplined capital deployment, we think the best has yet to come with an opportunity to roughly double our adjusted EPS and free cash flow over the next 5 years. I’ll wrap up now on Slide 10. With a strong start to the year and track record of improved through cycle performance, our continued strategy to build a more durable company is playing out, as evidenced by our strong growth and recurring revenue businesses. We’re confident in the achievement of our revised 2024 outlook, which demonstrates the benefits of durable growth drivers and tailwinds from innovation investments, while de-risking the areas of protracted recovery. Our free cash flow generation continues to be robust, underscoring the differentiation of the Fortive business system and the compounding capability of our portfolio. By executing the Fortive formula for value creation, we are poised for higher returns on invested capital. The deals we’ve done since our inception continue to get better, and we remain disciplined on further capital deployment to enhance value creation. With that, I’ll turn it to Elena.

Operator:

Thank you. We will now be conducting our question-and-answer session. [Operator Instructions] Our first question comes from Scott Davis with Melius Research. Please state your question.

James Lico:

Hi, Scott.

James Lico:

Yeah, sure, I think really both. What we tried to highlight, and obviously we did last quarter as well, is to give a sense of, one, how FBS is really moving a portion of our sustaining engineering capability into innovation. That obviously has a long-term compounding effect, but we’ve been doing that for several years now. And I think some of the examples that we talked about that Chuck had in the prepared remarks are certainly evidence of better growth. Fluke’s durability here is certainly part of their engagement in our new product development process. We talked about the FDA approval on a product at ASP that takes a little longer in healthcare to really see that. So certainly on the gross margin front, because we’re pretty disciplined about making sure that products that we launch, if they’re replacing products, they replace them at better gross margins, which is really more value to the customer. And then you’re seeing also in a number of the places where we’ve got tailwinds relative to growth, part of that is certainly an innovation story.

Charles McLaughlin:

Yeah, Scott, this is Chuck. Well, clearly, we’ve already done some M&A, but we do include buybacks as part of our capital deployment. So we think that with the bolt-ons that we did in the fourth quarter and what we’re likely to do going forward, we still think that we have line of sight to that accretion 2025.

James Lico:

Yeah. Thanks, Scott.

James Lico:

Hi, Julian.

Charles McLaughlin:

So Julian, I’ll make a couple of comments first. What we’ve got in here is basically normal seasonality, maybe even a little bit less. I mean, you just look at the percentage in the first half versus the second half. And also, as you go forward from Q3 into Q4, obviously we’ve got a couple of – we’ve got IOS and AHS really showing up as we would expect, and then we’ve de-risked PT going through there. But we think that we’ve got a pretty reasonable breakout between both of those quarters in terms of the revenue.

Julian Mitchell:

That’s helpful. Thank you. And then just a follow-up looking out to the fourth quarter on Slide 12, so you have that a very hefty margin increase dialed in there sequentially going from 27% to 29%-plus. Yeah, when we look at sort of last year’s fourth quarter, I think the PT margin was flat if we’re looking at sort of some of those sequential moves, I guess, what gives us that confidence on that very large sequential increase? Is it all top-line? Or is there something coming in around cost savings anything else perhaps that’s really pushing up that that margin so much sequentially?

James Lico:

And that overall yearly incrementals at 60% we think shows pretty well, I think, it speaks to as we’ve said in the prepared remarks the proactive restructuring that we did at the beginning of the year. The continued productivity actions that we’ve taken throughout the years we’ve seen things, I think, gives us confidence in that sort of margin expansion if you think about first half of the year about 100 basis points of margin expansion in the first half. So, a really good launch point in which to get to and as Chuck described, the incremental is very similar to what we’ve seen in previous years.

James Lico:

Thank you.

Nigel Coe:

Thanks. Good morning, everyone. Or good afternoon.

Nigel Coe:

So, Chuck, I think you mentioned PT flats organically in 3Q. That’s obviously a big improvement from down to 7. I don’t understand the 2-year stack, but when we look at the sequential, I think it’s up 3% PT Q-over-Q, which again is unusual. So, I’m just wondering some of these delays you called out to military and government. Are you assuming that comes back in the third quarter? And then maybe on top of that, just talk about, what we’ve seen in the channel, sell-in versus sell-out. Are we seeing some big impacts right now?

Elena Rosman:

I would just add, Nigel, that on the inventory level, we do see distributor inventories are largely pretty normalized across all the regions, which does give us confidence in the order rates returning to growth in the second half.

James Lico:

Yeah, we don’t have a lot – we really de-risk the EA at this point. I think we’ve seen for a few quarters, we had always come into the year knowing that EV in particular would be low, but we did have a number of projects in the funnel that the customers were fairly confident that those would happen in the year. As we progress through the year, those have gotten pushed and pushed. And so we’ve decided to just mostly de-risk all of that out of the year. So we really, unfortunately, that’s not going to be in the year, but we still those orders have not disappeared. What we’re really seeing is we haven’t seen the step up in some of the other aspects, broader battery storage as an example. So, we’re really on track, we’re actually ahead of the game on our synergy opportunities in the funnel. So, we’ll see a little bit, certainly, that’s probably going to be a 25 aspect too. So, I think the net-net on all that is, Nigel is, we’ve de-risked the year, we continue to see the industrial logic of the deal, strategically, product, technology, all of those things, but certainly we’re putting in a little bit of a pause from a customer investment perspective and that’ll those – we continue to believe those will happen sometime in 2025.

James Lico:

Thanks, Nigel.

Stephen Tusa:

Hi, guys. How’s it going?

Stephen Tusa:

Can you just talk about just the industrial – more the industrial software parts of the portfolio, putting probation aside, what just broadly you’re seeing there? I mean, you mentioned a couple of businesses and their growth rates. What is the total growth rate for those businesses and any theme you’re seeing there on customer budgets, perhaps going to more direct AI applications as opposed to ones that are going to weave it in over time?

Stephen Tusa:

And then, lastly, you guys are doing a pretty good job of delivering on expectations, but looks like there’s a bit of upside needed in consensus to hit that your long-term target next year. When would you kind of reevaluate that the 450 number or act to get there whether it’s kind of paying down debt? Or like when would we kind of reevaluate that EPS target, because The Street right now is obviously comfortably below that not moving very much?

Stephen Tusa:

Great. Thanks a lot.

Operator:

Our next question comes from Jeffrey Sprague with Vertical Research Partners. Please go ahead with your question.

James Lico:

Hi, Jeff.

Elena Rosman:

Just on the core growth at tech, we now expect it to be down a low-double-digit in terms of revenue. Previously, we had expected it to be down mid-single-digit flow.

Jeffrey Sprague:

And then maybe just – I don’t have all the comps in front of me. I’ll dig them out after the call, but just then the progression into the remainder of the year for tech, you said orders are expected to be up. Will that convert relatively quickly to revenues? How would you expect the revenues to kind of play sequentially off this Q2 level?

James Lico:

We are seeing some longer-cycle aspects of the business that are setting up for order rates or shipments in the late part of the year and early part of 2025.

James Lico:

Thank you.

Deane Dray:

Thank you. Good day, everyone.

Deane Dray:

Hey, I want to circle back, it’s related to Steve’s earlier question, but we’re hearing more issues in the software side about risks of churn and disintermediation by some cheaper AI-enabled products. This has come up on other calls. Are you seeing any issues, and maybe specifically for Accruent and Service Channel? Thanks.

Deane Dray:

Great. That’s really helpful. And then one for Chuck. Maybe just give us some color and context around the lower tax guide for the second half. What’s driving that? Is that mixed? Is there anything one-off like a reversal of an accrual? Just if you could share that.

Deane Dray:

Thank you.

Operator:

Thank you. And our next question comes from Joe Giordano with TD Cowen. Please state your question.

James Lico:

Hi, Joe.

James Lico:

Yeah, I think we’re close to 185, 190-ish, I think, but that’s probably close. Some of that’s FX. I wouldn’t say relate to the party. But obviously, what we’ve seen is some things that are abnormal to what we’ve seen in the past. As an example, even last year when orders were tough, that Mil-Gov segment was really strong. We’ve got a multi-million-dollar repeat order that moved, that we did in the second quarter of last year, that has moved into the second half and we’ve cut in half. So that’s an unusual, we had real good line of sight to that. That’s a piece of the move. The other is we’ve typically seen, I think over 20 years, the Chinese government’s actions get traction. So I think those things maybe are a little unique to us but maybe not. So I think we’ve certainly been prepared for it from a cost perspective and that’s why you still continue to see the strong margin and EPS growth for the year. But I think at this point it’s appropriate getting into the year with 6 months left to take stock of where we’re at and that’s our story.

James Lico:

Well I take stock of what we’ve done over the last several years and we typically do one to two deals a year from a bolt-on perspective. But when you think about the recurring revenue that we have now 42% of sales growing in low-double-digits, all of that is acquired assets. So we’re really seeing the benefit and the resiliency of the acquisition strategy that we’ve had and now that we build these foundations those four bolt-ons that we did last year all into the workflows and growth platforms we have today. We think we’re seeing the benefit of that and so that those are real strong opportunities for us we’ll continue to do that. But, again, we’re going to be selective and while we remain busy on things. You’re not seeing a lot of deals transacted this year thus far, and I think that’s because you continue to see seller interests very often not aligned with buyer interests. And so, we’ll continue to be disciplined and we’re in a great position given the number of deals we did in 2023 to continue to work on those and make them a great part of life. We have the deals that were in 2019 and 2020 and 2021 that you’re seeing the benefit of play out in 2024 for us.

James Lico:

Thank you.

Jamie Cook:

Good morning. Thanks for the questions. One, just on your guide for Europe and for Asia, you maintained your core growth guide for both of those geographies, however, sales core growth deteriorated in the second quarter relative to the first quarter for both of those regions, they’re just trying to understand confidence level or is there recovery expected in the back half of the year? And then my second question, not to be nitpicky, but the IOS margins were down 20 basis points year-over-year. You still had core growth. You had positive pricing. You are maintaining your guide for the year, but was there any nuance in the second quarter that drove the margins down year-over-year? Thank you.

Charles McLaughlin:

Well, IOS margins are like 34% or so, down nominally with a little bit of mix, but on a 2-year stack, I think there are 300 basis points. So we’re very happy with those margins, and I would expect that you will continue to see that margin expansion continue at the normal rate in Q3 and Q4.

James Lico:

China got worse within the guide, for sure. The rest of Asia is a little bit better. So I think where we stand now, China is now just about 10% of our sales and our high growth markets back to China are now 14% of our sales. So we’re seeing good growth. We mentioned in the prepared remarks that India was a little slow in the quarter, but we see good India growth the rest of the year as one example. So we just think that the other parts of Asia will – we mentioned in the prepared remarks, that Japan was pretty good. So we think the other parts of Asia will hold up as they have in China, but we did, as part of our de-risking, particularly in PT, we did take China down for the year.

James Lico:

Thank you, Jamie.

Robert Mason:

Yes, good morning. Just wanted to see if you could comment on your pricing outlook for the balance of the year. A couple of your segments saw a step up. AHS and IOS saw a step up in pricing during the quarter and just how you’re thinking about pricing for the balance of the year?

Robert Mason:

And then just a follow-up around EA. I’m curious, Jim or Chuck, just how are you thinking about what’s possible, the potential in terms of capturing synergies, some of the commercial synergies you’ve talked about as you go into 2025. Yeah, against, if we end up at 130 in revenue this year and you talked about that funnel maybe doubling in smaller orders, what kind of contribution maybe we’d be thinking about?

Robert Mason:

I see. Thank you.

Operator:

And our next question comes from Andy Kaplowitz with Citigroup. Please state your question.

James Lico:

Hi, Andy.

Charles McLaughlin:

Yeah, Andy, this is Chuck. We see, first of all, we’ve got two segments, IOS and AHS, that are really on a good path into what we wanted them to be in 2025. And then, as you noted, we did productivity and cost savings out last year. And we’ll be doing more of that in the back half of this year. It’s not as dramatic, but to get onto the right glide path into that 2025 number. So we’ll alter spend less, not slow the rate of the spending in there and then take a little bit of cost out, particularly in PT.

James Lico:

Yeah, the ASP business has been on a good run for several quarters and, obviously, we had some noise with the North American channel transition and the exit of Russia and a number of things. When you look across now the last several years, that’s a good growth and we believe strongly that that’s the benefit of the business. We’re just now getting the innovation funnel going, right? We mentioned that the steam sterilization product that we just launched, which is a [seven second BI] [ph]. We’re in a really good place from an innovation front. We’ll start to get that innovation flywheel moving. The team has done a great job from a commercial success perspective. So we think ASP is an important part of the transition in health. And on the backs of Censis’ SaaS revenue growth, we mentioned on the prepared remarks that probation SaaS business was up over 50%. So we’ve got a number of good things. And obviously, we continue to improve the margins, the fall through as you described. And the previous question is good there. So we think we’re on a good run here. There’ll always be some puts and takes, but we feel good about it. We feel good about where we’re at. And the team is doing a really nice job from an execution perspective.

James Lico:

Yeah. Thanks, Andy.

Joseph O’Dea:

Hi, thanks for taking my question. Can you just sort of characterize a little bit what you’ve seen over the past 3 months when we talk about EA? I think on the sort of sensing side within PT, you also noted some softer trends in industrial and factory automation demand. Really, you’re trying to understand the degree to which, there were expectations for things to get a little bit better, and that just hasn’t happened as things push to the right, or the degree to which things kind of softened sequentially over the course of the quarter, and then what you attribute that to? So any color there would be helpful.

Joseph O’Dea:

Hi. Thanks a lot. I just thought you hated my question, but I’ll try again.

Joseph O’Dea:

No worries. Basically, I just wanted to understand trends over the course of the quarter. I think we see kind of the reset on expectations of EA, I think in prepared remarks he talked about within PT and the sensing side, a little bit of softer activity in industrial and factory automation. And so I wanted to understand whether what you saw over the course of the quarter was sequential softening? Or if it was more a matter of earlier expectations for things to get better, and that’s just kind of pushing out to the right? So, overall, just how you would characterize those trends over the course of the quarter?

Joseph O’Dea:

That’s helpful color. And then just related in the conversations you’re having with customers and as they sort of push things to the right a little bit what you’re hearing from them in terms of why are they doing that? What are they waiting for how much of it is kind of macro and election and interest rates or other things that they’re paying attention to and waiting on some spending as a result?

Joseph O’Dea:

That’s helpful. Thank you.

Operator:

Thank you. And there are no further questions at this time. I’ll hand the floor back over to Jim Lico for final comments. Thank you.

Operator:

Thank you. And this concludes today’s conference. All parties may disconnect. Have a good day.

Operator:

Good day. My name is Dennis, and I will be your conference operator today. At this time, I would like to welcome everyone to Fortive Corporation's First Quarter 2024 Earnings Results Conference Call.

Elena Rosman:

Thank you, Dennis, and thank you, everyone, for joining us on today's call. With us today are Jim Lico, our President and Chief Executive Officer; and Chuck McLaughlin, our Senior Vice President and Chief Financial Officer.

Charles McLaughlin:

Thanks, Jim, and hello, everyone. We're pleased with our Q1 performance, including 3% core growth, reflecting better-than-expected performance in all 3 segments. Total revenue growth of 4% included the benefits of acquisitions, partially offset by approximately 1 point of unfavorable FX.

James Lico:

Thanks, Chuck. I'll wrap it up on Slide 13. The strong start to the year and an enviable track record of improved through-cycle performance, our transformation execution and strategy to build a more durable company is playing out. However, our strategy is reflected in the continued momentum of positive core growth over the last 14 consecutive quarters, even as demand slowed in select end markets. And the strength of our execution and dedication to FBS is reflected in 15 consecutive quarters of adjusted operating margin expansion, delivering more value to customers.

Operator:

Your first question is from the line of Julian Mitchell with Barclays.

James Lico:

Yes. Julian, thanks for the question. I would say a couple of things. What we saw in the quarter was a book to bill -- I'd start with the sort of high-level. We saw book to bill of about 1, and we anticipate that book to bill as well in Q2. So we're starting to see the orders come back. Obviously, shipments, not yet. Probably on a revenue basis, probably PT is lower, Q2 will probably be the low point.

James Lico:

Yes. Relative to the revenue guide, obviously, what we saw in the quarter, a little bit stronger than we anticipated for Q1. We feel good about that on the backs of health strengthening. We've had several good quarters now at Health, that's a mid-single digit for the year, and we feel good about that. IOS, similarly, good strength there. We stood out in a number of places. Fluke has been very resilient as we talked about. PT is down a little bit.

Charles McLaughlin:

Julian, the interest expense came down primarily because, since the last time we guided, we went out and put a euro bond in place. And so that came in better, like 3.7% coupon. So that's the major change. That roughly offsets the impact -- OP impact of the FX.

Operator:

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

James Lico:

No, Jeff, we'll get that -- we'll be moving back to high single. We had a really big comp at Gordian in the first quarter. I think they were plus 25% a year ago. So ARR growth for that was about high single digits, it was roughly 9%. So good ARR growth that supports sort of high single-digit growth for the year.

Charles McLaughlin:

Yes, Jeff, a couple of things. FX, it pushed EA's revenue down a couple of million. And then divestiture, about $5 million, with the agreement to separate some of the Invetech business that shows up on that line. So I think he is impacted by those 2 things, down about $7 million.

Operator:

Your next question is from the line of Jamie Cook with Truist Securities.

Elena Rosman:

Yes. So Jamie, just on the prior guide, yes, the $30 million has come out of the PT revenue from Invetech. And then to your point, there's probably another 2% that's come out due to FX. Some of that is obviously for EA as well as the core business. So that $2.3 million is the midpoint of the PT revenue guide as you pointed out.

Elena Rosman:

Yes. No change to the expectation of margins for PT.

Scott Davis:

A couple of questions. So first, just if we want to start with M&A and kind of mark-to-market your pipeline, is there -- should we -- or could we assume that the EA type of deal is -- and valuation range is kind of the type of stuff that you guys are looking at in '24? I'm sure it's a wide range of properties, but trying to just narrow that down a little bit? And perhaps just a little bit of a mark-to-market on how that pipeline looks.

Operator:

Your next question is from the line of Deane Dray with RBC Capital Markets.

James Lico:

Well, yes, I think where we showed on the slide in high-performance compute and in data center expansion, the chips that are going to go into data centers, as an example, next generation. We got an 8-digit order from a Keithley as an example for that in the quarter that will ship later in the year, with some semiconductor manufacturers in Taiwan.

Deane Dray:

Great. Those are real specific data points, so I appreciate your sharing. And then as a follow-up, and I might have missed it in your answer to Julian's question, but the weakness in Tektronix you referenced, what was the delayed customer R&D in the U.S.? Is that just -- is it product cycle related? Is there anything related to worries about the election that's starting to read through some hesitation in orders?

Operator:

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

Elena Rosman:

Yes. Steve, Tektronix' book to bill was 0.95 in the quarter. For PT, Sensing and Tek combined is 1.0, and for hardware products overall was 1.0. And then we talked about Tektronix revenue being down mid-single digit in the quarter. Our expectation would be that Tektronix revenue for the year will be down mid-single digit, but that's always been reflected in our outlook for the year.

Elena Rosman:

Yes. I'll just really quick on the numbers for EA, and I'll let Jim comment on the acquisition overall. We had expected revenues for EA for the year to be, call it, $190 million, $195 million. That's come down. It's probably closer to $180 million to $185 million. Part of that is foreign exchange, and part of that is some push out of larger projects in the year.

James Lico:

Yes. Steve, I would say a couple of things. One, as we said in the prepared remarks, we -- one of the things that's really evident and certainly have been around the world, not only with the U.S. view of this, but China, India, a number of other places, we clearly see a great product that customers really like. So I think, as we start out, we really affirmed the fact that the product and the technology is really, really strong.

James Lico:

Yes, I'm not -- forgive me, I'm not sure what that number is, but it's probably in the, I guess, in the $10 million-ish range or something like that.

James Lico:

Yes.

Andrew Kaplowitz:

Jim, just in AHS. I know you did well in the quarter, and maybe you talked about some potential upside there. You did mention maybe some Provation headwinds still. Is there anything that's still holding you back at all from even better performance, with the understanding that it was quite good in the quarter?

James Lico:

Well, I think, number one, I think the first quarter affirms what we're able to do, right? With the growth rate that we had in the quarter, we still drove strong EPS growth and strong free cash flow growth. Our guide demonstrates that.

Nigel Coe:

So I hate to like retread. Ground has been trod on already. But -- so Elena, you mentioned Tek down mid-single digits. That was in the plan from day 1, down mid singles in 1Q. I'm just curious why things wouldn't get better in the second half of the year just given the comps? And therefore, my question really is, in second quarter, is Tek down sort of high singles, maybe a bit worse than that, some PT down maybe mid-singles? Just thinking about how we should think about the way this comes through the year?

Nigel Coe:

Okay.

Elena Rosman:

I think the other thing to consider, right, is that Tek did continue to grow revenues throughout all of last year.

Charles McLaughlin:

Nigel, this is Chuck. I wouldn't expect that to be the case. I think there's a little bit of timing here. But as we move through the year, we expect that probably in PT, we had, I think, 1% to 2% and gradually going up as we move through the quarters.

Nigel Coe:

That's great. And sorry, a quick one on EA. The 1Q seasonality for kind of the full year, is this a business that typically has a weak 1Q and then a back half loading in the plan?

Operator:

Your next question is from the line of Joe O'Dea with Wells Fargo.

James Lico:

Well, I definitely think we're outperforming the market. And I think Fluke's done a great job. When you look at a number of things, obviously, an outstanding global franchise presence in every -- pretty much every country of the world. Team does a great job on the innovation front. We had 4 new product launches just in the first quarter alone. Our eMaint business is doing really well. So our Fluke reliability growth -- eMaint was up 17% in the quarter.

Joseph O'Dea:

And then I also wanted to ask on ASP. I think consumables in North America was up 7% in the fourth quarter, just looking for what you saw in the first quarter and as you're sort of on the other side of the transition through go-to-market, how that's coming together to drive some of the consumables demand?

Operator:

Your next question is from the line of Joe Giordano with TD Cowen.

James Lico:

Well, I think number one is we're more tied to the maintenance of those than we are to the construction of them. So in many respects, it's what's out there today. And so that's number one. Number 2 is, I think when you look around the world, certainly take a global view of solar, too, and you have a very good global opportunity. I would say the same thing about electrification.

Joseph Giordano:

Okay. And then just curious, with the numbers on EA lowering the top line a little bit, is that business still like 40-plus EBITDA margins at the lower revenue rate?

Operator:

Today's final question will come from the line of Andrew Buscaglia with BNP Paribas.

Charles McLaughlin:

Andrew, I think the -- a couple of things to think about. We generally think about incrementals at around 40% in the base case. So that's probably a good place to start. When you're talking about the step up as we move through the year, we've got the top line with 48% of the revenue in the first half and 52% in the second half. So there's always this upward trajectory in terms of seasonality from the first half to second half, and that drives through more volume. And that's the biggest key to expanding the margins.

Andrew Buscaglia:

Okay. And staying with -- just touching on AHS. The distributor transition is definitely helping you guys. Can you talk a little bit more about that business as we progress through the year? I think -- yes -- I think with the way that your incrementals have been strong there. Can you talk a little bit more about how that continues there -- as sustainability there?

Operator:

This concludes the question-and-answer session. I will now turn the call back over to Jim Lico for closing remarks.

Operator:

This concludes Fortive Corporation's First Quarter 2024 Earnings Results Conference Call. Thank you for joining. You may now disconnect.

Operator:

My name is Kristina and I will be your conference facilitator this afternoon. At this time, I would like to welcome everyone to Fortive Corporation's Fourth Quarter and Full Year 2023 Earnings Results Conference Call. [Operator Instructions] I would now like to turn the call over to Ms. Elena Rosman, Vice President of Investor Relations. Ms. Rosman, you may begin your conference.

James Lico:

Thanks, Elena. Hello, everyone and thank you for joining us. I'll begin on Slide 3. Fortive delivered outstanding operating performance again in 2023 through our proven formula for value creation. Our transformed portfolio of businesses delivering consistent through-cycle performance reflecting a more durable company with mid-single-digit core growth in 2023 despite a mixed macro environment. Strong execution by our teams drove another year of record margins with adjusted gross margins now approaching 60% and adjusted operating margins nearing 26%. Throughout 2023, we focused on unleashing the full power of FBS, reflected by record participation in KAIZEN events, including our largest ever CEO KAIZEN week. The results of these KAIZEN's were tremendous, including an average of 50% productivity and 50% lead time conversion improvements. Our industry-leading free cash flow generation funded accretive capital deployment, including our best year executing on bolt-on acquisitions, accelerating our growth strategy across all 3 of our segments. We also opportunistically bought back shares and increased our dividend, enhancing shareholder returns. In summary, we remain committed to our strategy and its success is evident given the consistency of our results which I'll highlight on Slide 4. We built Fortive to drive growth, drive progress and drive value. Reflecting on our evolution, we made significant steps again in 2023 towards our vision of a premier company. This includes 5% core growth and 160 basis points adjusted operating margin expansion. The benefits of our portfolio transformation are reflected in our progress to date, averaging rule of 35 [ph] performance over the last 5 years. FBS is driving commercial success as we expand into new growth markets, speed innovation cycles and maximize investment returns across our 3 operating segments. For example, in 2023, we saw a 33% increase in our revenue attainment on new product launches. Many of these new products are contributing to the approximately 60% of our revenues that positively impact climate, health and safety concerns and aligned to the U.S. sustainable development goals. Our operating companies are seeing a greater than 20% acceleration in software development time through the use of Gen AI, improving our ability to deliver more value to customers. Our culture of innovation, learning and continuous improvement is contributing to gains in our industry-leading employee engagement scores, a critical component of our sustained success. Lastly, our acquisition performance contributed to our record free cash flow in the year, underpinned by industry-leading net working capital performance and accelerated returns on invested capital. On Slide 5, you see how our portfolio is strategically positioned to increasingly benefit from secular growth trends. Every day, we are helping our customers harness the power of emerging automation and digitization technologies streamline crucial workflows and embrace the energy transition. Some highlights in the fourth quarter include

James Lico:

Thanks, Chuck. I'll start this wrap up on Slide 13. I am incredibly proud of the contributions of our 18,000 team members to make 2023 another record year for Fortive. Over the last couple of years, our success executing our strategy to build a more resilient company reflects our strong foundation and enduring principles that underpin our unique and compelling culture. We talked about the operating rigor and leverage of FBS tools to innovate and drive growth across our segments. In addition to higher core growth, the deals we have done are contributing to our multiyear track record, including strong performance again in 2024. Since 2019, we are sustaining 7% revenue growth, delivering 120 basis points of adjusted operating margin expansion per year, driven predominantly by higher gross margins compounding earnings and free cash flow double digits; we have cut net working capital as a percent of sales nearly in half, building 50% more free cash flow per dollar of revenue. This is a testament to our portfolio transformation and the power of FBS fueling our current and future success and with a $60 billion served market, we have substantial runway to accelerate growth organically and inorganically. This brings me to Slide 14 and how we drive differentiated performance and value creation for our shareholders. With a consistent and compelling 2024 outlook, including 6% to 8% total growth and over 100 basis points adjusted operating margin expansion in every segment. We are on track to our 2025 target of $4.50 of earnings and $1.6 billion of free cash flow. We are confident in our ability to differentiate our performance and believe our outlook is appropriately balanced, remaining agile to deliver for customers and shareholders should the environment differ dramatically. As we showed at our 2023 Investor Day by executing the Fortive Formula, we expect to roughly double our earnings per share and generate more than $8 billion of free cash flow over the next 5 years. Our M&A funnel remains strong and our acceleration of capital employment as demonstrated in 2023, further positions Fortive as a higher growth cash flow compounder and a premier company delivering exceptional value to shareholders. With that, I'll turn it back to you, Elena.

Operator:

[Operator Instructions] Our first question comes from the line of Steve Tusa from JPMorgan.

James Lico:

Yes, Steve, it's Jim. I think, number one; I would differentiate Fluke and Tek here. I think we certainly saw, we saw mid-single-digit growth at Fluke in the quarter. We saw growth in orders, point of sales in the mid-single digit around the world. So I think we're seeing the real benefits of the number of transformation things that we've done from an innovation perspective, also with some of the M&A work we've done and in good shape. And I would say Tek, Tek was low single digits in the quarter but quite frankly, off a 20% growth comp in Q4 '22. So still saw some good performance there. We felt really good about the quarter they produced as well. And certainly, the year that Tektronix had is unprecedented a record year, as we said in the prepared remarks. So as we go into the next year, I think it's -- I think, more of the same at Fluke. We've really seen some resilience and durability activity that we've talked a lot about over the years, playing out there. We probably have a quarter. They're about their fifth quarter of negative bookings. And obviously, we've been working off backlog there. And we would anticipate that book-to-bill there turns positive and probably Q2. So we feel good. North America was really good for tech, where a little bit of slowing that we saw within China as we talked a little bit about our China growth in total and Chuck's prepared remarks. But obviously, part of that Tek's one of our bigger businesses in China. Part of that story is the Tektronix there. So I'll pause there and you've got a follow-up, I'll certainly cover.

Charles McLaughlin:

We're thinking about 2% to 3%.

Nigel Coe:

Good afternoon, just like on the reclass of Invetech to PT, it's a small business, it seems like margins are relatively depressed maybe 6% to 7% margin. Just wondering, I think, Chuck, you went through some of the logic about just maybe talk about what this achieves this class? And maybe just in terms of the importance of this ASP rather AHS acceleration, kind of like how is that benefiting sort of the outlook for AHS because were you assuming that Invetech recovers? Just trying to think about AHS on a like-to-like basis here?

James Lico:

Yes. Nigel, I would just add, we called out in the slide materials that Invetech was a headwind in the quarter for health care to the tune of about 280 basis points. That's probably the largest year-over-year headwind that Invetech has seen. I wouldn't expect the size of that to continue but probably still in the 1% to 2% [indiscernible] continued to be in health care throughout 2024. But that's now reflected in PT.

James Lico:

Well Nigel, I would say, number one, yes, we're definitely fully through it. So you saw the benefit of that. I think as we said in the prepared remarks, consumables in North America were up about 7%. Consumables around the world, we're up about 4%. So good performance there. We think mid-single-digit guide for ASP for the full year is a good number. Certainly opportunity to go and on the margin front which we're going after. We were just with the team last week. We actually had them with, we had our Board meeting there and we have the team there for an operating review, highlighting the level of innovation. I talked about in the prepared remarks. We now have a new set of consumables around steam sterilization that are going to now be in the U.S. and Asia that are certified. So a number of opportunities here to continue to improve the growth. Those are obviously all in Consumables which obviously have higher fall-through. So you like the guide here overall held up 125 basis points in margin expansion mid-single-digit growth. We think that's a great launch point. It certainly certifies I think a lot of the things we've been saying about the direct North American strategy and certainly more broadly around the strategy at ASP and how health will just be a real durable grower for Fortive in '24.

Julian Mitchell:

I just wanted to check on the sort of margins in the first quarter. So I realize it's not a big sequential decline in sales but you've got a very heavy sort of sequential step down in margins there in Q1, 100% or so kind of drop-through. So is that reflecting maybe something on mix in any of the businesses in the first quarter versus the fourth? I'm just trying to understand maybe on Precision, in particular, how their margins are starting out the year in Q1?

James Lico:

Yes. And I would just say that guide represents record operating margins in the first quarter for Fortive. So I think when you just look at, we do have some expenses that start back up at the beginning of the year, obviously, salaries and some of those things. There's a little bit of that. But at the end of the day, if you just step back, record, that will be a record first quarter for, in the history of Fortive.

James Lico:

Yes, a couple of things. I think when you look at our history in terms of double-digit EPS growth and the compounding free cash flow, I think, it's not an enormously to get to that $450 million. That's why we put those numbers out there a year ago and we reiterated them in the guide and on the presentation. So we obviously feel good long way away, a lot can happen but we feel good about it. I think relative to the M&A market; we just closed a quarter where we did basically 5 deals -- between including kind of closing in the early part of January. So it's across the board in every segment, a variety of different sources from private equity to private ownership, founder-led companies good breadth across a number of our workflows. So we feel really good about the M&A environment and we just demonstrated really good progress against the M&A environment. EA is starting off really well. And where we start -- we now think that's going to be accretive in the year, only right after closing it. So we've seen really good things there. So, I would say the -- what we've done, we're really proud of that work, good work that set us up well back to your comment about '25 would the EA and those other deals are going to be helpful in '25 for sure. And quite frankly, when you look at the environment that we're in right now, probably a little bit better. Certainly, we've demonstrated that and we want to continue to, as always, as you know, Julian, we're always busy and we're excited about the opportunities that are in front of us but we're also incredibly excited about the teams that have just joined Fortive.

Jeff Sprague:

Just a couple for me. Just back on ASP and the Consumables growth, 7% sounds pretty healthy. Is there some kind of I don't know, kind of channel fill in the direct model that had to happen, as you looked from distribution to direct, there something abnormal about that number? What are you expecting for consumables growth in the U.S. for 2024?

Jeff Sprague:

And then just on EA, obviously, then didn't own it in Q4 but any color on how it grew in Q4? And can you just be a little more specific on what you expect for growth in 2024, again, to be in M&A but kind of the underlying growth in the business in 2024?

Jeff Sprague:

And just I'm sorry, a little quick housekeeping one, too. Just the design piece of Invetech, is that a divestible business? Or are you just winding it down? And how big is that piece?

Operator:

Your next question comes from the line of Deane Dray from RBC Capital Markets.

James Lico:

Yes. I think to the second part of your question, mid-single-digit POS growth at Fluke around the world in the fourth quarter. So, good solid growth. Down from the double digit we've seen for a while. But still, I think that would be, that we take that number pretty solidly. A little bit of destocking at Tek in the U.S. Single-digit millions but a little bit and some in China, maybe more broadly. I would say that that's, we now think China is likely to probably not grow in the year that's embedded in our guide and some of that is going to be just, I would say, less destocking than it is just conservativeness on the part of the Chinese distributor and Chinese channel partners to sort of see how the macro evolves out there over the year. But again, that's embedded in our guidance.

James Lico:

Probably down low single for the year. So that would be our anticipation at this point. A couple of things there. Just starting what we've seen thus far is customers -- a little bit more conservative, as I mentioned. As you know, Deane, we've talked about this over the years. You really don't know China until you see March, you get out, you get to after the Chinese New Year, see how channel partners and customers are going to unfold for the year. We've seen more conservativeness up to this point, in the year. So our anticipation is that the year sort of progresses. We had a really tough comp in the first quarter in China. We had great growth in China last year in the first quarter but we would anticipate for the full year that China would probably be down about low single digit.

Charles McLaughlin:

So Dean, a couple of things to unpack there. When we got EA and they just come with 40% incremental margin. I think the 100 basis points is about core growth that it adds to Tek, is what we called out. We would expect the volume growth that there's, do they go from 40% to 41%? Yes, that wouldn't be super surprising for them. But I think that was more about the impact on core growth for everyone for at Tek. And then on the sales force, I think Jim can give a...

Operator:

And your next question comes from the line of Andy Kaplowitz of Citigroup.

James Lico:

Why don't I take the first part of that. Yes, Fluke help will probably be in the mid-single-digit range for the year, so pretty close to the segment growth, maybe a little bit less in the first quarter and a little bit better, or first half and a little bit more in the second half. So but they are through some of the things that you described as well.

Andy Kaplowitz:

That's helpful, guys. And then maybe just a little more color on price versus cost expectation in '24? I know you said price Chuck but one of your industrial peers report today and reported quite rocky results in terms of its handling of the global supply chain. It seems like Fortive is handling supply chain quite well. Pricing obviously remains sticky. But could you elaborate a little bit what you're baking in for price versus cost and how you would rate the predictability at this point of the global supply chain?

James Lico:

Yes. And I would just add the proof points. Our gross margin expansion over the last several years has been very consistent. I think that speaks to our ability to manage the situation, not just on the price side but on the cost side and our working capital continues to get better and as we noted, as a percent of sales. So we're doing that while not having to have significant increases in working capital. In fact, our working capital is getting better. So we, I think what we'll see this year Andy, just to add on to that is that our teams have done a really nice job. We were just with all of our teams, a couple of weeks ago and they're doing a really nice job on design savings as well. So not only on the negotiated savings but also looking at design, what we call our value engineering effort. And our value, I think we'll have a, right now, our plans for value engineering would be, our cost reductions out of value engineering will be at a record in '24 when we deliver on that through the year. So a number of things we're doing to continue to stay ahead of price cost knowing that probably price wasn't going to be able to stay at those levels that we had over the last few years. We've always been a good price company. So we'll continue to get our fair share. But I think what we're also trying to do is really push our teams hard on the opportunities on the cost side as well.

Scott Davis:

I'm not very good at the Star 1 thing. It's a skill, I guess. But anyways, the, a lot of questions have been answered but I'm kind of curious on ServiceChannel and proVation. If you combine those deals, combined, they're pretty darn important to the kind of long-term growth story. But pretty dilutive the first year and change. But where do you think you'll be in 2024 versus a deal model and those things combined, will you be back in the positive on those things? And I would imagine the compound, right? I mean the growth is so -- it should be high enough, the margin is high enough that the returns on capital kind of go through kind of hockey stick at some point. Are we there yet when you think about 2024?

Scott Davis:

Kind of I guess kind of my point and perhaps you can do this after is that when you announced those deals, it was, I think that the language Jim used at the time is you'll be really happy we own these assets someday just given the growth rates. So I'm just kind of curious if you feel the same way?

Scott Davis:

Yes, that makes a lot of sense. Just real quick guys. Does Invetech get worse before it gets better? Just partially just given Sprague's question on kind of the wind down or the sale of the design business but put these things you're selling into some pretty tough markets. But does that end up getting a little bit worse before it gets better in '24? Are we already there?

James Lico:

I would say, Scott, embedded in the PT core growth outlook for Q1, there's about a 1% headwind to core growth in PT due to Invetech.

Operator:

And your next question comes from the line of Rob Mason from Baird.

James Lico:

Yes. We feel really good about it, Rob. I think when you look at not only maybe starting with '23, we had really good growth in '23. We'll have high single-digit software growth in '24. So when we look at the ARR numbers, they're good. Obviously, we're just talking about ServiceChannel and proVation in the previous question. But I think across the board, [indiscernible] going to have high single-digit growth. So we feel good about where it's at. I think it's a testament to the strength of how FBS is really adding value and it's a testament to those businesses. and the work they're doing. We didn't talk a lot about AI but we'll start to see as we get into late '24 and '25, so some of our Data Analytics and AI solutions are also going to help the growth rates there. So we're in a very good place. And I think the strategy is playing out the way we anticipated which is those businesses would have more durable, higher growth rates and ultimately, that would benefit Fortive not only on the growth side but on the margin front. We certainly saw that in '23, you absolutely see that with our double-digit EPS kind of numbers that we'll show in '24.

James Lico:

Yes. Well, in Sensing, we're about 6 quarters of negative order rates. So we don't anticipate to see the overall over rate start to change the book-to-bill there probably in and around 1, in the second half, for sure, probably starting in sometime in the second quarter. So we start to see things move. We didn't talk about it but number, maybe more broadly about Sensing. One of the things we saw in the fourth quarter was rather than get 12-month blanket orders which we would typically get with OEMs. We got 3-month [indiscernible] orders. So we will see that those orders pick up probably in the second half. So that's the state of the world. Relative to the semi index and where it's at, we're starting to see the green shoots of customers that are starting to talk about orders and our businesses that are maybe in the earlier stages there, a little bit of Setra, a little bit in our KEITHLEY business at Tektronix. they're starting to see customers talking about the second half of this year. So, we would -- I would think that just overall, we'll start to see some things. We're not anticipating a big step up there. We'll let the [indiscernible] patterns determine that. But we do anticipate at least seeing some of that turn in the second half of the year.

Andrew Obin:

Yes. Just maybe and I don't know if, when you were talking before Sensing, you were specifically referring to Sensing or Tek. But maybe just to confirm, what's happening with Tek book-to-bill? And what kind of exit rate are we at a Tek right? Just sort of if you look at the peer orders, Keysight, NATI, you still have orders down, let's call it, mid-teens. So to understand correctly, we're thinking that based on the feedback we're getting on the comps, revenues will be up low to mid-single digits next year, right? Is that the right framework?

Andrew Obin:

And where are we on book-to-bill, sorry?

Andrew Obin:

Got you. And just a broader question because it's certainly been a weird '23 and it seems like '24 is going to be strange as well. But I think at your Analyst Day and it's just sort of going back to Julian's question, you did outline the '25 target but you also outlined longer-term targets, right? And if you look at '25 target with sort of, I think, CAGR is 12.5% and longer-term targets, 13.5%, right? We printed 9% EPS growth last year. This year, target is 9% to 12%. I told to get there, there's cushion here, right? Invetech is out of the way. We're probably going to do some M&A. But from your perspective, what needs to sort of go back to normal change from a macro standpoint, what's the biggest lever that needs to change, right, to sort of get back "normal" where you guys can sort of accelerate EPS growth from what we've seen last year. And what we're sort of guiding to this year? Or is that all just M&A? Sorry for an extensive question but yes.

Andrew Obin:

And if I could just squeeze in one more. Should we start to think about Fortive as increasing dividends annually and some framework around share buybacks, maybe offsetting share issuance as long as we're there?

Operator:

Your next question comes from the line of Joe Giordano from TD Cowen.

Charles McLaughlin:

First of all, we look at our ROICs and go back to looking at where the revenue needs to be. Margins start to upgrade on probation as talked about and we're running ahead of where we thought we'd be on the top line. So maybe talk off-line exactly what the original assumptions were. But that's where we know we're at for both of those deals. And so we're on track or ahead of where we thought we'd be a couple of years in. I think the, so I think that's as simple as I can put it.

Charles McLaughlin:

And just to clarify, this came up earlier but the combined ROIC and certainly for proVation is already in the mid-single digit for '24-range.

James Lico:

Well, I would say, certainly, hardware deals is something we've been doing for 20 years in there's, to use your muscle framework. There's a lot of muscle around that. You saw that in, even with some of the COVID challenges in ASP, our continued ability to do things like really improve the free cash returns on the business because of working capital. So I would certainly say that that's, those are things that we've done for a long time. But I think and this is really one of the reasons why we put it on the slide, is that we've really built tremendous capability around software, FBS for Software. And we didn't talk about it but we've now got an FBS suite of AI tools which are really helping drive innovation drive commercial activities for the Software broadly but also for the Software businesses. So we've really, I'm really proud. I said it in the prepared remarks around how the FBS in and of itself is getting better. And that really means more broadly. It's really, it is, I think what we're really proud of is the fact that if you look at the Fortive's portfolio today, FBS needs as much to a Software business or a Healthcare business or a Traditional Industrial business. FBS may mean different tools. It may mean different applications but the rigor and discipline is exactly the same.

Joseph O'Dea:

First question just related to the price volume composition of organic and implying volumes kind of flat to up 1% for the year. And I'm trying to understand where kind of the upside risk might sit on the volume side and whether the embedded assumptions are more sort of moving sideways and there can be some upside risk on maybe easier short-cycle comps in the back half of the year? Or just how you've thought about that volume piece of the equation and if there's anything embedded within that as things getting better over the course of '24.

Joseph O'Dea:

Okay, makes sense. And then on the productivity front, can you just talk about the margin contribution you anticipate from productivity in '24 and the degree to which that's kind of carryover from '23 actions or additional actions to drive kind of more productivity gains in 2024?

Joseph O'Dea:

Meaning actions you've already taken and so that's just carrying into '24.

Operator:

And I'll now turn the floor back over to Jim Lico for closing remarks.

Operator:

Thanks. Thank you. And this does conclude today's conference call. You may now disconnect.

Operator:

My name is Krista, and I’ll be your conference facilitator this afternoon. At this time, I would like to welcome everyone to the Fortive Corporation Third Quarter 2023 Earnings Results Conference Call. [Operator Instructions] I would now like to turn the call over to Ms. Elena Rosman, Vice President of Investor Relations. Ms. Rosman, you may begin your conference

James Lico:

Thanks, Elena. Hello, everyone, and thank you for joining us. I’ll begin on Slide 3. In the third quarter, we continued to see the benefits of our portfolio strategy with core growth and margin expansion in all segments. Third quarter core revenue growth was 2.5%, tempered by specific headwinds in health care and slowing in parts of Sensing in China. Strong execution by our teams drove substantial improvement in gross and operating margins, earnings and free cash flow. Adjusted gross margins expanded by 160 basis points to 59.7%. Adjusted operating margins increased by 150 basis points to 25.9%, and adjusted earnings per share grew 8% and free cash flow increased 25% to $384 million. As you can see, our strategy is delivering results with enhanced portfolio positions, innovative new products and dedication to the Fortive Business System, allowing us to consistently perform despite a mixed macro environment. As we look ahead, our attractive funnel of bolt-on and adjacent M&A opportunities across our three segments and five connected workflows are expected to drive upside in 2024 as exemplified by the acquisition of the EA Elektro-Automatik as well as three other bolt-ons in the quarter. Turning to Slide 4. We wanted to highlight how the year is playing out relative to our initial expectations and begin to frame our thinking for 2024. Beginning on the left, hardware product orders were stronger in the first half of the year as traction on new product launches and leveraged to secular drivers provided more backlog to buffer the normalization of supply chains. Hardware product orders were down mid-single digit, which we believe reflects continued solid demand with orders up over 20% on a 3-year stack basis in the third quarter. Point-of-sale trends in North America and Western Europe have remained healthy even as channels normalized, while we did see slowing specifically in China and parts of Sensing in the quarter. Software and services continue to demonstrate their resilience with high single-digit growth across our facilities and asset life cycle, environmental health and safety and perioperative customer workflows. The health care environment continues to improve. Core growth in the third quarter was constrained by the clearing channel inventory in ASP and continued weakness in the bioprocessing market in Invetech. Turning to the right-hand side of the slide, we are delivering 2023 performance ahead of our initial expectations coming into the year with mid-single-digit core growth with adjusted operating profit margin incrementals over 60%, delivering nearly 2x the margin expansion planned in the year. And we are accelerating our capital deployment in the quarter with robust free cash flow and ample firepower to fund attractive M&A opportunities. Further evidence that our strategy to create a more durable growth company is working is highlighted on Slide 5. Our innovation and portfolio strategy continues to build on leadership positions in our connected workflows benefiting from customer investments in key megatrends, including automation and digitization, the energy transition and the need for productivity solutions contributing to our improved through-cycle performance. We have several good examples across Fortive, including

James Lico:

Thanks, Chuck. I’ll start to wrap up on Slide 14. Consistent with 2023, we believe we will see sustained core growth and robust margin expansion and free cash flow growth in 2024 despite the evolving macro environment. What continues to differentiate Fortive is our ability to deliver mid-single-digit through-cycle growth, reinforcing our portfolio durability and the power of FBS to deliver strong margin expansion. The consistency of our execution reflects the strength of our product vitality and alignment to high-growth secular trends, continued solid customer demand in the buffer of excess backlog, adding to a resilient growth profile. In health care, we expect a continued modest pace of industry recovery to drive stronger growth and incremental margins as we lap discrete 2023 headwinds. Lastly, in software and other recurring, our efforts to increase demand generation and strengthen our go-to-market capabilities is expected to drive strong SaaS and license revenue growth in 2024. This brings me to Slide 15 and how we drive differentiated performance and value creation for our shareholders. As we finalize 2023, we are demonstrating another year of strong execution, delivering record gross margins, operating margins and free cash flow. The sustained results underscore the power of the Fortive Business System to relentlessly drive continuous improvement throughout our portfolio. As we showed at our Investor Day in May, by executing the Fortive formula, we expect to roughly double our earnings per share and generate more than $8 billion of free cash flow over the next 5 years. Our acceleration of capital deployment, as demonstrated this quarter, further positions Fortive as a higher-growth cash flow compounder and a premier company delivering exceptional value to shareholders. With that, I’ll turn it back to Elena.

Operator:

[Operator Instructions] Your first question comes from the line of Julian Mitchell from Barclays. Please go ahead.

James Lico:

Yes, good morning Julian, it’s Jim. And I think when you look at it, you’re right. When we look at kind of where we’re at now, we’re back to where we were. And I think that at high single digit, I think, for the year for Tek. I think we’re -- really what we saw, and you sort of answered it in the question is probably a little bit more of a step down in China. We obviously have good strength in China on a 2-year basis. I think in the third quarter -- I think we’re like 30% on a 2-year stack. But I think what we saw in China was a little bit of inventory, a little bit cautiousness on the part of a number of distributor and direct customers all around China, not really necessarily industry-based, maybe more broad-based. I would call it more caution than anything. That’s probably the single biggest aspect to it. We did have some push-outs a little bit from a couple of large orders that we saw as well. But I would say the big Pareto [Ph] bar on that conversation related to Tek is really what is really China. The good news on it and what we’ve seen, as you know, over the last several quarters with PMIs where they’ve been, semiconductor index down, a number of factors that would suggest that some -- we’re coming in -- we were coming into what we’ve been calling normalization. I think we’ve been consistent in that regard. We’ll see Tek get a little bit better in orders in the fourth quarter than they were in the third. And our 90-day funnels actually look better now than they have been. So I think point of sale in a number of places, North America and in Europe, as an example, we’re good and will probably continue to be pretty good. We actually -- China POS was actually decent in Q3 as well. So if I would just stay high centered on Tek, I’d say high [indiscernible] China trend third quarter probably at the low point in many respects, will start to get a little bit better as we get towards the end of the year.

James Lico:

Yes. I think what we’ve been talking about strategically around PT has been that we thought -- we’ve done a lot of work in Tek to try to move that growth rate, make it less cyclical. Our service business, as an example, in the third quarter, was up 3%, which is, I think, a good environment relative to sort of stabilizing the business a little bit. We haven’t done as much work in Sensing. We’ve called that a low single-digit business. And as you know, we’ve had double-digit growth there here for a couple of years. So we anticipated that normalization there. I think what we’ve seen over the last sort of 60 to 90 days is what I would call more slowing. And so the PT number really in Q4 is really around Sensing. Some of that’s China, some of that’s some direct OEMs that have sort of pushed out blanket orders into 2024. Typically, some of that is our lead times coming down. Some of that, I think, is a little bit of slowness. We talked about it on the second quarter call, automation, principally in Europe, that continues. HVAC U.S. and Europe, also a little slower. And then as I mentioned, China. So that really is the PT story in the fourth quarter relative to kind of the change in the guide.

James Lico:

Yes. I mean, we’ll get out of guiding for 2024. But I do think we’ll see mid-single digit, for sure, maybe just to sort of characterize what we saw from an ASP perspective. Obviously, this channel transition, we called out about $10 million. It was about $6 million more than we anticipated in the third quarter. And some of it is really why we have the strategy to go direct. It was really about the lack of visibility we really had on natural demand. When we take out those sort of adjustments for channel inventory in the second and the third, what we see is on a 2-year stack, mid-single digit growth in the second, third and fourth. So we really see more consistency. Obviously, some noise there we would prefer not to have as well. But I think where we stand into the fourth quarter, the channel situation behind us, we feel good about that. We feel good about the work the team has done. Obviously, a little bit more -- we’re not proud of a little bit more noise than anticipated. We’ll certainly take that. But where we stand today, I think, is in a much better position strategically, should set us up well for 2024. And quite frankly, that when you see the margin expansion in health in the third, 200 basis points, we’ve talked about that margin continued improvement. I think even on a little bit less revenue, we had good margin expansion. So really, when you look at it kind of a good walk into Q4 and certainly sets us up for what we think will be a much better 2024.

James Lico:

Thank you Julian.

Stephen Tusa:

Hi, guys. So just on the hardware backlog you guys have talked about in the past, where do we stand on all that, the 1 that was like $350 million at one point? What’s the status of the hardware backlog?

Stephen Tusa:

And then what happened at Invetech? Can you just maybe discuss a little more of the drivers of that business for the quarter?

Stephen Tusa:

One last one for you. Does this feel recessionary to you? And are you guys -- do you have a playbook for costs, if so?

Stephen Tusa:

Great. Thanks a lot.

Operator:

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

James Lico:

Yes, it’s a couple of things. I think number one is we’ve seen slowing in Tek orders for a few quarters now. And so some of it is comp. You’re right. We started to see some slowing. The two and three year stacks are still really strong, so we’re working off a level of order -- just raw order dollar numbers that are still very, very good, quite frankly, unprecedented in the history of the company over the last few years. So in that sense, it really -- there is much of a comp issue. We started to slow in the fourth quarter of last year. So yes, that’s it. And then there’s a little bit of -- we think China maybe get a slightly better, it was pretty dramatic in the quarter, but even in -- we’ve seen some early signs that maybe that gets a little bit better. I wouldn’t call it good. I’d just call it a little bit better. So we had some order push from Q3 to Q4. We think we’ll see those things as well. So the majority of it is comp. We’re not counting on a big step-up improvement. But we are seeing some things that might suggest things might be a little bit better, and that’s reflected in how we’re talking about it.

Charles McLaughlin:

Hey Jeff, this is Chuck. No, we don’t have anything baked into Q4. We’re done shipping to the distributors. And if there’s some -- we’re confident that we work through everything. It was bigger than we had visibility to, which as Jim mentioned a few minutes ago, is why we wanted to make this -- one of the reasons we want to make this change. We wish we’d been able to size it properly out of the gate. But as I said, that’s why we make the change. But nothing in Q4. And so we -- what we are going to see is ASP to be in mid-single digit in Q4.

James Lico:

Yes. We experienced a network infrastructure disruption from what we’re calling a cyber-incident in the quarter. We talked about some costs to mitigate that, roughly $0.01, around $5 million that’s in the guide. That’s what we called out. We did have some downtime in some North American facilities. Those are back up and running. We definitely think we can mitigate that. We’ve mitigated the issues relative -- we have first contained the issues. We’ve mitigated them. We’ve completed the investigation. We’re implementing the final remediation measures. So we don’t believe this incident has a material impact on the quarter. So that’s where we stand.

Operator:

Your next question comes from the line of Deane Dray from RBC Capital Markets. Please go ahead.

James Lico:

Yes. There’s not a lot of product overlap, Deane, you’re right, but there is a bunch of application overlap. We’ve talked about the power market at Tek for a number of and how that’s really been driving growth even in the quarters we were just describing, we continued to see strength. And that’s really been on the backs of our mainstream oscilloscopes and probes and our sourced measuring units. And almost in every one of those applications is also an EA-type product, if you will. So we will 10x their go to market. They were mostly direct in Germany and parts of Europe, mostly with distributions in countries around the world. We’ll 10x that with our own go-to-market from a capability, both direct and channel capability. We think that’s a tremendous leverage point. It is at the call point we’re at and we see a lot of those applications relative to seeing EA right there in many cases or, in many cases, seeing others and understanding that we can be a partner to EA in that regard relative to the go-to-market. So we feel good about the synergies. It’s obviously a very good business. It’s had very strong growth. It’s got software like growth and software-like margins. And we think we can really help accelerate the continued market expansion of the product lines.

James Lico:

Yes. I mean, I think when we look at Fluke POS, as an example, in North America is probably the best place to think about the U.S. economy. It played out pretty consistently, although point of sale came in pretty consistently. We got to look at 2-year stacks because as we fulfill backlog over the last 12 to 18 months, it does in some respects, distorted a little bit. But by and large, pretty consistent. I think when we looked at China, it was probably a little slower as we got -- as we went through. But I think we have a good understanding of where that was and that kind of thing, and that’s broadly China, not just Fluke. So I would say that’s how anticipate it. Tek, on the other hand, was their order growth was actually better in September than it was through the early part of the quarter. I would say, though, we did see a little bit later in the month. And so there was maybe a little bit of a dynamic where in a few places. But I think that’s really what -- the biggest change in really how we think about the second half, though, is really coming back to less, maybe really specific OEM customers within Sensing in those markets I described and China. I think those are the 2 big changes that we really saw.

James Lico:

Thank you.

Andrew Obin:

I guess a question on PT and the decision to sort of buy EA. I think for years and we’ll have Tek. But it was like one of the acquisitions back at Danaher, this is the one that didn’t go well. And there were questions and all of a sudden, there’s a lot of attention being paid to it, right? Press report at NATI, clearly, you’re making a bet here with EA. Can you just talk about the evolution of the company’s thinking about sort of Tek and how you’re thinking about the business overall? Where this is all of a sudden a key area for capital deployment? And what it is you’re seeing two, three years down the road that gets you excited?

Andrew Obin:

And just a follow-up on just software, but specific, I guess, facility and asset life cycle, right? We sort of slowed down to high single digit growth. And I apologize if I missed it, but what were the key headwinds that sort of took it down from double digits to high single digits? And how much visibility do we have on this business reaccelerating into year-end and into 2024? Thank you.

Andrew Obin:

So 10%-plus is still a good place hold for this business long term?

Andrew Obin:

Thanks so much.

Scott Davis:

Good morning, everybody. I got disconnected earlier so if someone asked this question, I apologize. But can you be -- can you clarify on this channel adjustment going direct? Is there a margin payback? I would imagine you capture some of that margin that distributors were getting, but are we going to see that in the numbers? Or did you have to add costs in proportionately to that change?

Scott Davis:

Okay, good. And when you guys think about kind of your pricing strategy, and I imagine it’s dynamic by SKU, but is this new world we live in one where you can go out every January 1, you think, with some sort of placeholder price increase and capture it in the marketplace? Or is that not how to think about it?

Scott Davis:

Super helpful. Best of luck for the rest of year, guys.

Operator:

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

Charles McLaughlin:

Nigel, why don’t I take the first one? I think there is a little bit -- I wouldn’t say $0.02 impact on FX in the fourth quarter. I think it’s probably a little less than one. But there is some effects just to close that one out. And you did note there is $0.01 in corporate cost for the remediation or efforts on the site.

Nigel Coe:

No, no. I’m just curious if you were like taking down ship inventories in particular, but...

Nigel Coe:

No, that’s right. Yes. And then my follow-up question, I think this is a quick one. I thought Slide 14 was a good slide showing the variability in revenue growth, but ultimately, around a mid-single-digit type of growth rate. And 2024 was sort of to that. So I’m just curious, does the same thing, as we frame 2024, does the same apply to incremental margins? And the spirit of the question is you’re coming off a really big year for incrementals. So I think we’re north of 60%. Does that mean that 2024 might be sort of below natural levels? Or are you confident you can build on 2023 margins in the 40%, 50% range, perhaps?

James Lico:

And Nigel, relative to core growth, I think hopefully, that slide is helpful because what we were trying to articulate is what we really said is mid-single digits through the cycle. So after a couple of years of 10% like growth, we would anticipate having a little bit of normal -- we’ve been talking about this for three quarters. We have a little bit of normalization. We talked about that consistently about that in the second half of the year. We’re seeing that mostly very, very consistent with what we talked about. I think a little bit of difference in Sensing, a little bit of difference in China relative to what we talked about. But again, I think we’re seeing that normalization here in the second half of the year. And I think that’s very consistent with how we would look at a mid-single-digit grower through the cycle. And as Chuck just mentioned, the fact that we’ve been prepared for things means we’ve been able to drive really good margin expansion even with some slowing in the second half of the year because of our preparation and because of how we run the business.

James Lico:

Thank you.

Andrew Kaplowitz:

Good morning everyone.

Andrew Kaplowitz:

So I think one of the keys for ASP as you go into Q4 2023 and 2024 is consumables coming back and being relatively strong. I think you’ve talked about underlying elective procedures improving. I would surmise that’s the case in the U.S. and I guess in China at this point. But what is your visibility into the consumables ramp-up, and if anything, would stop ASP from recording the stronger consumables demand?

Andrew Kaplowitz:

Yes. No, that totally makes sense. And then maybe just shifting gears, Jim, could you talk a little bit more how you’re thinking about M&A now? After the announcement of VA and you had the three small bolt-ons, how are you balancing thinking about the higher rates environment in terms of your own M&A strategy? And should we expect a higher tempo of M&A from Fortive over the short to medium term?

Andrew Kaplowitz:

That’s great, Jim. And Chuck, just to sort of follow up on my first question. You don’t need a consumables ramp up to make your Q4 margin, right? You already have it. It’s just the other thing getting better?

Andrew Kaplowitz:

Got it. Thanks guys.

Operator:

Your next question comes from the line of Joe Giordano from TD Cowen. Please go ahead.

James Lico:

Well, I think embedded in what the comment Chuck just had about consumables is number one, obviously a little bit of noise, but we had COVID for several years, and that certainly created a lot of noise given the fact that it was a regional situation, we were kind of behind in the U.S. for a while and then China and all that. I won’t reiterate all that. You know it. I think where we stand today and what Chuck just described is as you sort of look through kind of these onetime channel situation, which we really believe was the right thing to do strategically, we’re seeing that growth now. And I think the 200 basis points of margin expansion in the third quarter in the segment really speaks to the fact that ASP’s margins are starting to get up better because the rest of the margins in the segment are very strong. So we feel good about the launch point relative to how we’ve just described it. And 2024, as I said earlier in the year, 2023, the health care market would be a little bit better. It wouldn’t be great but it would be better and 2024 would be better than 2023 and 2025 would be better than 2024. So we continue to think that -- we continue to see that. So that’s what gives us the confidence. And again, I understand, given the fact that this inventory situation in the third quarter was a little bit more than we anticipated, but -- and so obviously, that puts some skepticism in the nature of the question. But I think as we stand here today with what we’ve got going, we saw good equipment growth, high-growth markets. Growth in the quarter was 10%. So I think we’ve got other parts of the world in better shape, and now we’ve got -- we needed to get North America in a better shape. That’s really been the drag on the business in the last few years. And we feel that we needed to do the channel change in order to make that happen. And that’s now behind us, and we walk into the fourth quarter and into 2024 with a number of those things behind us.

James Lico:

Yes. Yes, a couple of things. Number one is just remember, we created about we’ve created $300 million over -- that $330 million is an excess backlog number, not a backlog number. So in a couple of years, we created $330 million just to -- and we said then we naturally deplete -- under normal circumstances, we would deplete backlog in the second half of the year. That’s pretty natural. We had said that was likely to get us from $330 million to $200 million. We now think that’s about $125-ish million, call it, $100 million to $150 million, maybe because I don’t think we can be super precise here. And so it’s call that about somewhere in the neighborhood of $50 million to $100 million difference. We think some of that already got pushed into 2024 and some of it probably is inventory corrections mostly in China. And it’s really the Sensing story that I talked about earlier in the call. So hopefully, that reconciles a little bit of that for you from a numbers perspective.

James Lico:

Thank you.

Joseph O’Dea:

Hi, thanks for taking my questions. I wanted to start on the just kind of inventory rationalization. And could you explain a little bit more kind of the differences between Fluke versus Tek and Sensing? And so what -- I think you’re seeing it in Fluke as well, but it seems like you’re seeing it in ways which it isn’t surprising. And so whether that’s a function of there were longer lead times in Tek and Sensing that led to more forward buying, whether that’s more tied to the end mark they’re serving? Just trying to understand why they might be marching down a little bit of different paths in terms of managing through some of the destock effect.

Joseph O’Dea:

I’m talking about inventory.

Joseph O’Dea:

That’s helpful. And then I wanted to ask on EA and just how to think about the revenue growth potential and incrementals there over the next kind of five years, what you’re thinking about to get to that kind of ROIC target. I mean, it seems like we’re looking at maybe solid double-digit revenue growth and some really strong incrementals and the 10x go-to-market is pretty compelling. But maybe any details there in terms of kind of what you see for that revenue growth over the next number of years?

James Lico:

And I would just add, that’s obviously a lower growth rate than they’ve anticipated. We think there’s upside opportunity as well, given the synergy and the go-to-market expansion. So we like the business, and we look forward to continuing to talk about it in the near term.

James Lico:

Thank you.

James Lico:

Thanks, Krista, and thanks, everyone, for taking the call. We appreciate the time and energy and enthusiasm of the questions. We obviously have some -- we’ll have some follow-up with many of you and we look forward to that. I think what you saw in the quarter, obviously, a few changes on the revenue line. But I think what we’ve tried to say from day one is that we see some normalization in the second half. We saw that maybe a little bit more in the third than we anticipated. But what we also said is that we’ll continue to drive margins and continue to set the business up for long-term sustainability and success. I think the margin expansion you saw the free cash flow, the number of deals that we did that was very consistent with the strategy we’ve outlined. We think we continue to set up for 2024. Well, we’ll obviously get to a guide here in the next few months. We look forward to finishing the year out here strongly. We’ll see you on the road, and we look forward to taking your follow-up. Thanks, everyone. Have a great day.

Operator:

My name is Rob, and I will be your conference facilitator this afternoon. At this time, I would like to welcome everyone to Fortive Corporation's Second Quarter 2023 Earnings Results Conference Call. [Operator Instructions]. I would now like to turn the call over to Ms. Elena Rosman, Vice President of Investor Relations. Ms. Rosman, you may begin your conference.

Jim Lico :

Thanks Elena. Hello, everyone, and thank you for joining us. I'll begin on Slide 3. Our second quarter results once again demonstrated the durability of our portfolio, and the strength of our execution, allowing us to deliver higher core growth, margins, earnings, and free cash flow. Core revenue growth of 5.5% reinforces that our strategy is working, building leading positions across our customers' critical connected workflows with performance reinforcing the resilience of our transformed portfolio. We also delivered record margins in the second quarter, expanding adjusted gross margins by 250 basis points to 59.5% and an adjusted operating margin by 190 basis points to 26%. We're converting more revenue to earnings and more earnings to cash, with 9% growth in adjusted earnings per share and free cash flow in the quarter. Our ability to consistently drive off performance is directly tied to our culture of continuous improvement and dedication to the port of business system. Our mandate this year to unleash FBS, which is driving record productivity from Kaizen activity across the enterprise, and increasing our confidence in our raised outlook for the year that we believe further positions Fortive for accelerated compounding in 2024 and beyond. Turning to Slide 4. I wanted to provide an update on what we are seeing and what we are expecting over the course of the rest of the year. Starting with health care, industry recovery is on track as labor and productivity challenges continue to moderate. We are seeing traction on our pricing and productivity initiatives, yielding sequential growth and profitability in the second quarter. We expect further improvement in AHS in the second half with higher core growth and operating margins. We also continue to drive growth in our software and services businesses with SaaS revenue up mid-teens on strong enterprise growth and bookings. Hardware products have also been running ahead of expectations as traction on new product launches and leveraged to secular drivers are helping to provide more backlog to buffer the normalization of industrial demand. As we sit here today, we now expect to have over $200 million of excess backlog heading into next year, well positioning us for 2024. Our strategy to create a more durable growth company is working. Our recurring revenue businesses are expected to accelerate first half to second, led by higher software and consumables growth. Combined with favorable pricing and discrete productivity initiatives, we now expect over 125 basis points of adjusted operating margin expansion for the year. Lastly, our robust free cash flow and low leverage profile provides further flexibility to accelerate compounding with an attractive funnel of M&A opportunities aligned to our workflow strategy. Turning to Slide 5. Our success in the quarter demonstrates our ability to leverage our domain expertise and hardware and accelerate software and data analytics across our five customer connected workflows, where we are enabling progress in a number of high-impact fields. All benefiting from customer investments in automation and digitization, the energy transition and the need for productivity solutions to address labor, manufacturing, inflation and regulatory challenges globally. For example, solar energy is one of the fastest-growing renewable energy sources worldwide. From the grid to hybrid and backup systems connected reliability solutions are ensuring the maintenance and efficiency of critical infrastructure, enabling the energy transition and IoT expansion. Environmental health and safety solutions are safeguarding workers and enabling customers ESG reporting and compliance. Our leading facility and asset life cycle software applications are improving asset performance, optimizing workplaces and accelerating customer productivity efforts. Our innovations in the product realization workflow are solving customers' toughest technical challenges, the speed breakthroughs in a wide range of applications including helping to increase the proliferation of electrified and connected devices and advance the democratization of high-performance compute and AI-driven data analytics as well as in the perioperative loop, where we're helping health care providers deliver exceptional patient care more efficiently, with industry-leading clinical safety and productivity solutions. In summary, we are seeing strong customer success on new product launches, highly aligned to these secular trends where our innovation funnels remain focused, which I'll take a moment to discuss further on Slide 6. As we highlighted at our Investor Day in May, our FBS growth tools are accelerating innovation cycles to drive share gains and maximize R&D returns to create and sustain our competitive advantage in a number of exciting new areas. For example, we highlighted new product launches at Fluke to accelerate the distributed energy strategy and penetrate the high-growth EV storage equipment market with new testing tools that ensure technicians safety and asset performance. At Gordian, our unique planning tools, RS means data and technical expertise helped the California County optimize their infrastructure resulting in millions of yearly cost savings and a significant reduction in project completion time lines. Tektronix is providing performance scopes and wave form generators to help customers develop quantum computing to advance AI applications, including a large aerospace and defense customer win in the quarter. Provation's latest cloud-based documentation software is saving physicians roughly 16 hours per month in documentation and reporting which is why Provation continues to be the provider of choice with accelerated win rates and apex adoption. Lastly, Intelex leverage lean portfolio management to expand its foothold in environmental accounting, compliance and reporting. Accelerating the launch of its new ESG corporate reporting solution. Fortive is committed to innovation across all aspects of the company. And this quarter, we received two notable recognitions for our innovative sustainability efforts. In May, USA Today and Statista have named Fortive, one of America's climate leaders in 2023. This award recognizes us as a leader in greenhouse gas emissions reductions and singled out Fortive as a top emissions reducer among more than 2,000 companies nationwide. And in June, Fortive was selected as a finalist for the 2023 World Sustainability Awards in the profit with a purpose category which recognized as companies that link revenue generation to sustainability. We're incredibly proud of our culture of innovation and continuous improvement and how that not only shows up in the solutions we deliver for our customers but also in the positive impact we are making around the world. I'll now provide more details on each of our three segments, beginning with Intelligent Operating Solutions on Slide 7. IOS grew core revenue by 4%, driven by good growth in most regions. Strong FBS driven execution resulted in 420 basis points of adjusted operating margin expansion. Driving operating margins to a record 33%. Looking at our performance drivers by workflow and connected reliability, Fluke core revenues were up slightly, lapping the Shanghai recovery last year with mid-single-digit orders growth in the quarter. Fluke margins expanded by more than 300 basis points year-over-year, driven by productivity initiatives and solid price realization, eMaint saw record quarterly bookings, fueled by the continued success of the new X5 CMMS product launch. EHS revenues grew by high single digits with record iNet growth at ISC and strong SaaS momentum in Intelex. Further, Intelex saw strong bookings for its new ESG corporate reporting solution. Moving to facilities and asset life cycle. We had low double-digit growth in the second quarter, driven by mid-teens SaaS growth. Gordian had strong growth and operating margin expansion in the quarter as more customers utilize their job order contracting platform to procure and manage their large infrastructure projects. [Inaudible] is seeing sustained improvements in win rates and good growth in their streamlined portfolio, supported by FBS-led innovation and pipeline generation efforts. Service channel had an acceleration in growth and profitability as planned, driven by strong SaaS bookings and resulting take rate as customers leverage the service channel network to maximize their cost savings to large retail customer is already $2 million ahead of their $14 million cost savings goal in 2023 after taking advantage of the automation capabilities of the platform, powerful testament to the secular drivers underpinning the FAL workflow strategy. Turning now to Slide 8. Precision Technologies continued its momentum with another strong quarter with 8% core revenue growth and 190 basis points of adjusted operating margin expansion reflecting volume and price benefits more than offsetting inflation in FX. Some highlights in the quarter include record second quarter revenue at Tektronix with orders better than expectations and strong point of sale in all major regions. The team delivered mid-teens growth, which was over 20% on a two-year stack basis in the second quarter. Tektronix is executing on robust backlog and power and digital test and measurement solutions and delivering outstanding margin, operating margin expansion. As orders continue to normalize, we anticipate Tektronix growth will moderate to mid-single-digit levels in the second half, and we expect we will end the year with elevated backlog levels again heading into 2024. Sensing technologies came in better than expected, up slightly driven by strong price realization across all businesses and continued broad strength at Qualitrol. Lastly, Pacific Scientific EMC reported a strong sales quarter with mid-teens growth as it benefits from strong customer demand and Kaizen activity to improve manufacturing capacity and operational execution to deliver on record backlog. Moving now to Slide 9, in Advanced Healthcare Solutions. Core revenues were up 4% in the second quarter as the industry continues its modest pace of recovery. Consistent with expectations, adjusted operating profit margins contracted by 60 basis points year-over-year. The benefits of sequential volume, price and productivity drove operating margins higher by 180 basis points versus the first quarter. China electric procedures remained at normalized levels throughout the quarter, only slightly trailing global rates, allowing for double-digit growth. Our outlook continues to assume that electric procedures remain close to pre-COVID levels in all major regions. Some highlights for the quarter include, ASP/Censis had mid-single-digit core growth, driven by capital expansion at ASP and double-digit SaaS growth at Censis. ASP saw sequential growth in consumables as planned and U.S. channel transition to direct is on track, contributing to sequential price benefits, driving margins higher, a trend we will expect will continue through the rest of the year. Supply chain constraints are largely resolved, yielding good growth at Fluke Health Solutions and Provation had another great quarter with mid-teens core revenue growth, driven by Apex SaaS adoption and new logos. With that, I'll pass it over to Chuck, who will provide more color on our second quarter financials and our 2023 outlook.

Jim Lico :

Thanks, Chuck. I'll start to wrap up on Slide 13. At our Investor Day in May, we highlighted our progress executing our strategy over the last several years, building on our strong foundation and enduring principles that underpin our unique and compelling culture. Talk about the operating rigor and leverage of FBS growth tools to innovate and enhance leading positions across our three segments and five connected workflows contributing to outstanding fundamental financial performance. Since 2019, we have doubled our core growth rate and delivered more than 100 basis points of adjusted operating margin expansion per year, driven predominantly by higher gross margins. We've driven double-digit earnings, annual earnings per share growth, converting working capital as a percent of sales, nearly in half, allowing for us to run our businesses more efficiently and contributing to more than double free cash flow generation over the period. We are now generating 50% more free cash flow per dollar of revenue, which is a testament to our portfolio transformation and the power of FBS, fueling our current and future success and with a $60 billion served market, we have substantial runway to accelerate growth organically and inorganically. Wrapping up on Slide 14, the combination of portfolio work we have done, the rigor of the Fortive Business System and the development of leadership capability around the world is driving better-than-expected growth and operating performance in 2023 despite a continued evolving macro environment. As a result, we've raised our outlook for the year. And as we look ahead to 2024 and beyond, we are confident in our ability to accelerate our progress. With a high-quality portfolio of desirable brands, segment strategies favorably aligned to sustainable secular trends, industry-leading margins and free cash flow and best-in-class execution. Fortive is poised to deliver exceptional earnings and free cash flow compounding in the years to come. Our attractive funnel of bolt-on and adjacent M&A opportunities across our three segments, five connected workflows drives upside, making Fortive a more durable, high-growth cash flow compounder and a premier company delivering exceptional value to shareholders. With that, I'll turn it back to Elena.

Operator:

[Operator Instructions] Your first question comes from the line of Jeff Sprague from Vertical Research.

Jim Lico :

Hey, Jeff, it's Jim. A couple of things. One, I think it was better than expected. As we mentioned in the prepared remarks, we've seen some slowing in some places, obviously, or maybe more moderating for sure, places like China as an example, but we're seeing some acceleration in investments from places like aerospace to defense customers. So the book-to-bill -- I think our orders were down about 10% in the second quarter. But to put it in some context, it's up, those orders are still up 30% from three years ago. So we're still seeing good demand here. And the backlog is actually above our expectations. We've talked about that excess backlog, and that backlog today is above expectations to what we thought going into the year. So anyway, I'll stop there and if you have any follow-up.

Jim Lico :

Yes. We're really pleased with the performance of ASP in the quarter. As we said, we had really strong capital placements which bodes well for the rest of the year and obviously into the future given the consumables. Our project, what we call Elevate is on track, and it certainly was a headwind in the second quarter, but nothing that we didn't plan for. So I think when you look at it mid-single-digit growth, even better than that ex Russia, exit out of Russia. So really a strong performance from a growth perspective in the quarter, and we think really as we kind of play out the rest of the year, we're going to see continued performance there just given the work we've done and given that headwind from elevate ], really, there's a little bit in the third, and then it really goes away completely in the fourth.

Steve Tusa :

Hye, guys. Just wanted to follow up on the AHS question. It looks like the margin was tweaked lower just adding up the quarters. I think like maybe 50 basis points below that 24% you had talked about at your Investor Day. Maybe just a little bit of a more shallow recovery in second half, but still earning strong in the fourth quarter. Just curious, as we kind of look out to next year, on the way to that 30% margin, I just wonder obviously reaffirm that. And do you like step up to more of a linear move from what you thought this year would be and kind of capture that next year in the margin? Or are we just kind of like a little bit of a shallower inflection on the way to that 30%? I'm just trying to figure out if '24 is kind of like a more linear year considering '23 is a little bit below expectations?

Steve Tusa :

Yes. I guess my question was more along the lines of like is next year -- should we view next year as kind of a plot in a linear, from a linear perspective on the way to that 30%? Or is it -- does what happen this year kind of make that target more back-end loaded to maybe '25, '26, '27 type time period. That was my question is '24 more of a nice recovery year early on? Or is it more back-end loaded to that 30%?

Steve Tusa :

Yes, totally. And then just one last one. Where is the $350 million today? You had $350 million of excess you say it's going to be $200 million or something at the end of the year. Where is the 3 -- where is that number today at the end of the 2Q?

Steve Tusa :

All right. I'll round that up to $350 million.

Scott Davis:

Good morning out there, Jim and Chuck and Elena. The IOS margins up 400 basis points on pretty limited volume is impressive, of course. But -- what -- is that sustainable? I mean, it sounds like it's sustainable given your guidance and such, but will -- is there any risk that some of that price cost spread that you're capturing right now perhaps goes the other direction on you in the next 12 months or so?

Scott Davis:

Okay. That makes sense, Jim. Now I want to just follow up on Steve a little bit here on this one. But the comment on the Slide, I just lost the Slide, but that said pockets of industrial slowing. Can you parse out what part of that might be inventory destock versus kind of real sell-through demand that could be leaking a bit?

Operator:

Your next question comes from the line of Deane Dray from RBC Capital Markets.

Jim Lico :

Yes. A couple of things, Deane. So as Chuck said, we've got about -- the excess backlog is higher than we anticipated at the start of the year. It's about $330 million. We'll probably get that down in the $200 million range by the end of the year. And it's -- I would call it, it kind of depends. But if we were to think about half of that excess is at Tektronix, that's relatively flexible and has been -- I wouldn't say within a month, it's necessarily flexible because it does have some supply chain aspects to it. But it's -- in the sort of 90 days kind of time frame pretty flexible. Sensing a little bit less, depends on some of the OEM customers, so and Fluke pretty flexible. So I would say that's kind of where it stands. And that's why we think it is a good insurance policy relative to slowing, and that's what you saw in the second quarter, right? You saw us get a little bit more backlog out. EMC was a little stronger as well than we anticipated. And so those are places where we think we can use the backlog in a way that sort of prevents any near-term challenges. And also maybe just to add on to the Scott question because I didn't answer the destocking piece. We're really not seeing a lot of destocking or de-booking, very little, pretty much around our normal numbers, which is pretty small. We see some rescheduling of backlog on the OEM side in Sensing. That's why Sensing is a little slower in the second half than maybe the rest of the portfolio but we really haven't seen destocking. We haven't asked distributors really not asking to cancel orders or anything like that. That's been pretty minimal to the point. That's why we think the backlog remains flexible.

Jim Lico :

Yes, it's a little bit of a comp thing on the Japan side. We'll still see, I think, high single-digit growth in Japan, the remaining part of the year, but certainly a little bit of a comp side in Japan. India, no, we've seen good growth in India. We're seeing I think we're getting some benefit of some of the reshoring and some of the investments that are going -- the sort of foreign direct investments that have been going into India here over the last 12 months. We benefit from that. Our big companies like Fluke and Tek and ASP are seeing the benefits of that, but even more broadly in some of the rest of the portfolio. So we think India is going to be probably 20% the rest of the year. Those are smaller regions in some like Western Europe, so they can move a little bit more on a big chunk of business, but we like the demand dynamics right now in India in particular.

Andrew Obin:

Hey, how are you guys? I was going to ask AI question, but I was made fun of. So I'm going to ask something else. I'm going to keep beating down this dead horse with inventories. In the revenue breakout, and maybe this is not the best way of looking at this, but I think revenue through distribution was down 13% year-over-year this quarter. So how do you think just inventory levels among your distributors because I think our data shows that actually people continue to build inventory in the channel. And I know you've sort of talked about it quite a bit.

Andrew Obin:

No, I appreciate this. And just a question on Fluke and Tek. I remember being in China in 2018 when sort of Chinese CapEx hit a wall and that these businesses were hit in reverse with all these mega projects in the U.S., right, how much visibility do you have related to specifically Fluke and Tek to these projects? When would you expect to get orders and does it structurally change the growth rate for these businesses over the next couple of years? Thanks.

Operator:

Your next question comes from the line of Josh Pokrzywinski from Morgan Stanley.

Jim Lico :

Yes. I don't -- we don't have a lot of exposure to commercial buildings really in the sense of traditional in FAL. So I think maybe we have commercial customers or maybe 5% of sales or something like that. So it's not a big driver. What we are seeing is, quite frankly, on the positive side, at Gordian is a lot of deferred maintenance. And what Gordian Solutions and quite frankly, what we see in FAL is taking advantage of deferred maintenance and seeing the opportunity for deferred maintenance, improving project time line. So that's really been a big growth driver for FAL, and I think it really played out in the quarter, and we think it plays out certainly in the second half. So I think that leads to some of the infrastructure improvements that not only is going on in state and local, but also in the commercial industry, just more broadly. What we're seeing from customers really in FAL also is the fact that people want to understand the capital in this time of return to work and how are my real estate assets working, particularly with things like retail customers, they really want to understand their investments, and we really do -- our solutions are really oriented towards understanding that how to bring facilities costs down. So really, in some respects, the reassessment that people are doing around their commercial infrastructure, to some extent, is a growth driver for us and that we sell software that really helps them bring that together and really helps them understand their expense, what they're spending and where they're spending it and how they might take opportunities to save money. We talked about in the prepared remarks about a customer that is ahead of schedule on a $14 million cost savings because of our solutions. So quite frankly, I think a number of the sort of noise that's in the commercial real estate market that I think your question is really orient at in many respects is, to some extent, a driver for us because of the solutions we have.

Jim Lico :

Yes. I think when we see a little bit of that is at Tektronix, where our lead times have come down and it does create a little bit of a pause. That was embedded in our guide. That's why we thought orders would be the way they were. So yes, to some extent, we're seeing that as lead times moderate and you don't need to order something 18, 20 weeks in advance, you can now order at 6 to 8 weeks in advance. There is some moderation. But that's really what's been embedded in our guide from the first places. We've made some assumptions around that. And by and large, that's come into play the way we thought. At Fluke, a little bit less so because our lead times have been always pretty good. So I think to the extent we're seeing any of that, it's really a Tektronix. And as I said, we've embedded that as we give you sort of the book-to-bill dynamics and we give you some of the order growth rate, it's really embedded in those kinds of numbers.

Julian Mitchell:

Thanks a lot. Good morning. Maybe just wanted to circle back to AHS as people seem very focused on that one given the history and so forth. So if I look at the second half it looks like you're assuming sort of $30 million, $40 million of profit step up, I think, half-on-half in AHS and maybe sort of $50 million or so step up from the top line there. And obviously, last year, we had a more stable half-on-half performance. So is the delta on the top line this year, a lot of that is the elective procedures element? And then when we look at the profit step-up with that, is it sort of just normal leverage plus some of that distribution channel shift and maybe some cost savings? Any sort of color as to that half-on-half move.

Julian Mitchell:

That's very clear, Chuck. Thank you. And then maybe switching Tek. I don't think capital deployment has come up much on the call yet. I think the buyback did sort of get going again in the second quarter after a quiet six months or so. And clearly, on M&A, it's been quiet for 18 months given the -- partly given the tough M&A backdrop. But we get lots of questions around whether there's been any change in view fundamentally about M&A or some of the types of deals? And then also, is there more of an effort now to balance M&A with buybacks in terms of cash usage. So just any sort of thoughts on that given that buyback spend in Q2.

Jim Lico :

Yes, Julian, I would say we've been very busy this year. As you point out, it's been Provation, since we did Provation. But I think where we stand today its activity is actually pretty good. And we've seen some things transact in the market lately that wouldn't suggest prices have come down necessarily. But there are some pockets of that. And our bolt-on activity is very busy right now. But we remain disciplined, there's a number of processes that have failed given some sellers lack of desire to sort of get pricing into what we think is the appropriate frame. So we'll remain disciplined around the opportunities. But we do think there's a number of things out there that are possible. And we'll continue to work through them. And with the work we do and the diligence we do and we look forward to when those things get done. We don't have a burning time clock of getting something done for the sake of getting something done as you well know, we'll remain disciplined and there are opportunities for us, I think, in the back half of the year to do that.

Andy Kaplowitz :

Hey, good morning, everyone. Jim, can you give us more color by region and especially what's going on China and Europe. Obviously, China has become more of a concern recently and maybe your, but I think you already did say China is one of those pockets of industrial weakness, and that will continue to decelerate moving forward. But Could you give us more details regarding how China and Europe are reflecting your guidance moving forward?

Andy Kaplowitz :

Got it. So you can make fun of me, I'm going to ask an AI-related question, but I'm going to ask it in the context of precision you talked about some of the verticals fueled by geopolitics and investment in AI and compute. And I think PacSci you had guided much lower for the quarter than you actually reported. So I think you talked about A&D inflecting. Maybe you can talk about the inflection you saw in PacSci. Was it AI-related? What's going on there? And what does it mean for the future?

Operator:

Your next question comes from the line of Nigel Coe from Wolfe Research.

Jim Lico :

Yes. So I would say a couple of things. In the quarter, a little bit better than we anticipated, really around Sensing. As we said, we overdelivered in Sensing, and I think that brings the number up where we probably are getting the most price, if you will. Relative to health care, it will accelerate a little bit in the second half just because of Elevate and the channel mix change that we have, that will probably be more true in the fourth and then third, but we will see that. And yes, we're continuing to see price and upselling, cross-selling, our net dollar retention, as an example, has continued to improve, and we're getting some opportunities to really push more price and that sum of the story of the margin improvements in 2Q and IOS is really the good work we've done. The leader in the clubhouse that net dollar retention is service channel, I think we're at almost 115% now. I think it just gives you an example of us continuing to push the opportunity for really value. I think it's -- on the software side, it's really about value and the value you bring. And if we can continue to have those features that we can go cross-sell and upsell, we didn't talk much about it on the question around AI, but AI does present us an opportunity over time to create more features and opportunities within our software business to improve net dollar retention. We've seen that in Censis as an example with the AI launch that we had with them in the second quarter. So we do think there's plenty of opportunity for net dollar retention to really continue to go up, Nigel. And that's really where we'll see the price component of what we do in our software businesses.

Jim Lico :

Yes. I think when we, we probably, if anything, such a strong first quarter there. When we look at the mid-single-digit growth in the first half, at Fluke, we really feel good about that number. And yes, there's a -- I would say the industrial business has got a little bit of slowing there, but the calibration business and other components of the business are accelerating. So all up, I think the mid-single-digit number on the back of such a good first half last year, I really think speaks to the strength of Fluke. The second half will look similarly in terms of about mid-single digits for the second half, and that's really on the backs of even higher growth last year in the second half. So in many respects, kind of an acceleration from a two-year stack. So overall, we like the trajectory in the business. You're right. There's a couple of places pockets of things we're continuing to watch. We continue to watch the PMI and industrial production. But I think the team has been executing well, a number of good technology launches. We had -- the eMaint business is performing really well so. So we've built some things that are into the portfolio over time, as you well know, trying to make Fluke less cyclical, more tied to secular drivers, and we believe that will continue to play out here in the second quarter. We've got a number of new product launches that could take advantage of those opportunities as well. So if there is some slowing in the marketplace, we think that can be -- we've got a number of actions out there that we think can countermeasure some of the potential slowness.

Joe Giordano:

Hey, good morning, guys. Again, I want to just on the short cycle stuff. One, I just want to make sure I understand, Fluke flattish this quarter, it accelerates in Q half in the second half? I just want to make sure I understood that. And then on Tek, you mentioned earlier, orders were down 10%, but still up 30% from three years ago. Like that's obviously very positive. But at the same time, does it like scare you in a way that like what's the right or not like the normal level for a business like that? Because if we're talking about 350-ish of excess backlog going to $200 million and half of that is Tek, it's like $75 million of excess revenue delivery versus orders in the second half alone, which is pretty significant. So I just want to understand like where these businesses exit the year and what it means for comps into next year from like a 4Q starting point?

Joe Giordano:

And then just a follow-up on margins. Like if I look at your Slide 16, obviously, a big ramp in all three segments from 1Q to 4Q. And I just want to kind of -- if you can frame out maybe how much of that variance from 1Q to 4Q is like normal seasonal? And how much is like a new jumping off point from the fourth quarter level into next year?

Operator:

And your next question comes from the line of Joe O'Dea from Wells Fargo.

Jim Lico :

Well, I would say relative to just the transition itself, the biggest impact, I think we ought to think about the biggest impact is in the second quarter. There's some impact in the third and that sort of equates itself out of the number by the fourth quarter. So that's kind of the sort of the sequential aspects of the impact of it. We think that benefits -- I think we talked about this, it benefits margins from the perspective of, we think we get better price. And so in that sense, it has a margin impact as well. I also think it has a growth impact, and this will probably be more a late Q4 in the '24 impact. And we still need to see it, but the direct aspects of our terminal sterilization, which is our a really strong business for us allows for us to accelerate the sterilization cycles that go on in our equipment, meaning that we can, now that we're direct, we have much more contact with customers and our application engineers will be more directly working with customers on the sort of efficacy of accelerating sterilization into other products that might be in the sterilization lab. That should have impact on growth over time. So not only in terminal sterilization, but also in our biological indicator business. So we feel that there's a real -- there is a growth in this as well. We think there's a customer satisfaction in this as well. And I think to some extent, the reason why our capital numbers were better in the second quarter was because customers are starting to understand that they're going to have a better opportunity to really have ASP salespeople, ASP application engineers in their hospitals every day helping them out. And so I think it's a margin and growth story. It certainly is going to -- has already started to play out, I believe, on the capital side, plays out on the consumable side in the second half and certainly into '24.

Jim Lico :

Yes, I think, well, here's what we're seeing. I mean I really if we, as we started the year, we thought there'd be some slowing in the year just because of the moderating aspects of some of our businesses and maybe some economic impact in pocket. We really have seen -- we really haven't seen much of that in the first half of the year. But embedded in our guide is still some aspects of thinking that there's going to be some economic impact. Obviously, PMIs in the world, some of the portfolios still have some ties to industrial production. We've been able to mitigate all that because of the strong strategy around secular drivers and the recurring revenue parts of the business that have played out exceptionally well. So we'll continue to -- that was a book-to-bill of 1.0, which included, by the way, Fluke orders as well on that overall book-to-bill. So I think where we stand today is in a much better position. As we said, the excess backlog number is more robust than we anticipated as we go into the second half. And I think that bodes well for the three things we talk about going into the year. If there were some concerns around the macro that we would have the strong backlog, excess backlog, as I described, software and recurring revenue and the self-help work that's going in AHS. And I think what you saw in the second quarter is all that manifesting well.

Brett Linzey:

Hi, good morning, all. Yes, thanks for taking the question. A lot of ground has been covered, but I just want to come back to price. Clearly, advanced here in the industrial cycle and seeing some softness in some of those hardware businesses, how are you thinking about the ability to take more price or hold the ground on price should the macro develop more weekly here, particularly within Sensing.

Operator:

And this concludes our question-and-answer session. I will now turn the call back over to you, Jim, for some final closing remarks.

Operator:

This concludes today's conference call. Thank you for your participation. You may now disconnect.

Operator:

Thank you for standing by. My name is Brent, and I will be your conference facilitator this afternoon. At this time, I would like to welcome everyone to Fortive Corporation's First Quarter 2023 Earnings Results Conference Call. [Operator Instructions]. I would now like to turn the call over to Ms. Elena Rosman, Vice President of our Investor Relations. Ms. Rosman, you may begin your conference.

James Lico:

Thanks, Elena. Hello, everyone, and thank you for joining us. I'll begin on Slide 3. We had a strong start to the year, delivering better-than-expected revenues, margins and earnings in the first quarter. At 9% core growth, we're demonstrating strong execution of our strategy, building leading positions across our customers' critical connected workflows. Our ability to deliver strong growth and continued margin expansion is directly tied to our culture of continuous improvement and dedication to the Fortive Business System. As a result, we expanded adjusted gross and operating margins by 80 and 100 basis points, respectively, taking margins to a first quarter record expectations for further merger and expansion this year and into the future. Free cash flow in the quarter reflects our normal seasonality as well as the timing of China collections that pushed into April. Overall, our teams have done an excellent job managing working capital in a more challenging supply chain environment as seen by our outstanding performance in 2022. By harnessing our unique competitive advantages and strong execution capabilities, we are confident in our outlook and are raising and narrowing our full year 2023 guidance. Turning to Slide 4. I wanted to provide an update on what we're seeing and what we expect over the course of 2023. Starting on the left in the current environment, hardware product orders were better than expected, down mid-single digit and backlog was more resilient with a book-to-bill of 1.0 in the first quarter. Our software businesses continue to see good growth benefiting from strong customer value propositions, driving double-digit growth in our SaaS revenue streams. While industry challenges remained in our Healthcare segment due to China, consumables growth in March reaffirmed recovery is underway. We expect momentum to continue and accelerate growth and profitability throughout 2023. Moving to the right-hand side of the slide, we are seeing traction on our new product launches, favorably aligned to secular drivers including Fluke's latest family of solar tools and Tektronix' leading power and electronic test systems, together with continued software strength and recovery in healthcare, we expect to sustain core growth in the second half. Combined with favorable pricing, cost savings and discrete productivity initiatives that span all segments, we expect over 75 basis points of margin expansion in the year. Lastly, we expect robust free cash flow growth again in 2023 which together with our very strong balance sheet, gives us confidence that our attractive M&A funnel will provide opportunities to enhance earnings and cash flow compounding in the future. Turning to Slide 5. We want to take a minute to remind you of all the work we've done to transform our portfolio and create focused segment strategies favorably aligned to a number of strong secular trends, has resulted in a more resilient Fortive with enduring growth and further margin expansion opportunities. As a result, today, we have a stronger collection of businesses with a more diversified end market mix and durable recurring revenue profile that includes leading healthcare and software franchises. Together with our enhanced innovation capabilities, we have focused our portfolio around multiyear megatrends, including automation, digitization, the electrification of everything and improving healthcare trends to name a few, all to reduce the overall cyclicality of our businesses and provide more tailwinds for growth by expanding into new markets. As a result of these megatrends, we see continued growth across our portfolio. including the more durable software and services businesses as well as the nonrecurring portion, given the sizable amount of backlog, some of our product businesses are working through, while continuing to see resilient demand. Finally, our portfolio quality is reinforced by the substantial improvements we've made in gross and operating profit, working capital and free cash flow as a percent of revenue, driven by the rigorous application of the Fortive Business System. Turning to Slide 6. FPS is a powerful mindset that makes continuous improvement a way of life at Fortive to drive deep engagement across our teams and hold them accountable for delivering on high expectations. With Kaizen activity accelerating, we saw significant results across the portfolio, including material improvement in delivery and past due backlog reduction in our hardware products businesses by improving planning and reducing part shortages with the Fortive material system. Board of software system deployment in our SaaS companies, including service channel, a current information is accelerating delivery of software features to customers, driving customer value and resulting in higher renewal rates and pricing gains. Our record gross margins in the first quarter were driven by a significant expansion of Kaizen events in the quarter, approximately double the number the prior year, setting us off for improved performance throughout the year. Turning to Slide 7. Fortive made sustainability a priority since its founding. It is inextricably linked to our company's shared purpose, values and business strategy, which you'll read more about in our upcoming 2023 sustainability report to be published in May. This year's report will further highlight how our commitment to sustainability is grounded in our culture of Kaizen, leveraging the power of FBS innovate products and services that enable more sustainable outcomes. We'll also hear how our team has strengthened our responsible sourcing initiatives, ensuring robust review of the labor and given rights practices across our supply chain and how our strong and inclusive culture is creating a community where everyone belongs, which is positively reflected in our latest employee engagement and inclusion, diversity and equity performance. In summary, we are accelerating progress towards a more sustainable future for Fortive and our customers as well as the environment and the communities in which we operate. We invite you to review our report next month. I'll now provide more details on each of our 3 segments, beginning with Intelligent Operating Solutions on Slide 8. IOS grew core revenue by 10% as our connected workflow strategy drove better-than-expected performance in the quarter. The segment saw a good growth in all regions with mid-single-digit growth in North America and Western Europe, and mid-40% growth in China, lapping prior year shutdowns. Solid core growth in each workflow and strong FPS driven execution resulted in 300 basis points of operating margin expansion, taking operating margins consistently above 30%. Looking at our performance drivers by workflow. In Connected Reliability, Fluke core revenues grew by low double digits with mid-single-digit orders growth in the quarter and point of sale remained positive in all regions. Fluke is benefiting from lean portfolio management, driving record revenue attainment and Fluke's new product launches, including the SMFT 1000 solar tester, which are benefiting from strong demand in the energy, renewables and electric vehicle markets. Elsewhere at Fluke, eMaint posted another record quarter with strong double-digit growth. We are seeing accelerated customer adoption of the X5 CMMS system with enhanced connected worker capability also closed the largest deal on record with a strategic enterprise customer. EHS revenues grew by mid-single digit with both Industrial Scientific and Intellect providing solid contributions. Industrial Scientific saw strength across all product lines, including iNET and orders growth outpaced sales driven by new product launches and cross-sell activity. Intelex posted another quarter of strong SaaS growth with low double-digit ARR growth. Moving to facilities and asset life cycle. We had high single-digit growth in the first quarter, driven by high single-digit SaaS revenue growth. Customers continue to shift larger projects to Gordian's job order contracting platform, while the wind down of endo-light programs are occurring, and the business model change and service channel lowered core growth, revenues exceeded expectations in [indiscernible] as customers continue to seek more productive and digitized solutions to optimize their facilities management. For example, a large worldwide retailer is migrating multiple manual processes to the [indiscernible] real estate management platform at Acron and a large enterprise customer is leveraging service channels automation services to save hundreds of thousands of dollars of mismatched invoices. Turning now to Slide 9. Precision Technologies delivered another quarter of strong double-digit core revenue growth or revenues increased 14%, driven by a high single-digit growth in North America, low double-digit growth in Western Europe and high 30% growth in China. PT also delivered 190 basis points of adjusted operating margin expansion with higher volume and strong price realization more than offsetting continued inflation and FX. Some highlights of the quarter included greater than 20% core revenue growth at Tektronix. Orders were better than expected, benefiting from bookings growth and electric vehicle testing programs. This and strong point of sale in all major regions drove double-digit growth across its product businesses in the first quarter, which continued to see good demand for recently introduced entry-level and mainstream stopes. Sensing Technologies reported low single-digit growth as expected, driven by another quarter of strong price realization across all businesses and continued broad strength of Ultra. Pacific Scientific EMC reported a second consecutive quarter of greater than 20% growth as the business continued to deploy FBS to improve operational performance. Moving now to Slide 10, in Advanced Healthcare Solutions. Core revenues are flat as the improvement in electric procedure volumes outside of China was offset by some supply chain challenges at Fluke Health Solutions and the expected headwinds in China elected procedures and the wind down in Russia. By major region, North America was up slightly, and Western Europe grew mid-single digits, offsetting a high single-digit decline in China. China elected procedures were covered in March, exiting the month at approximately 90% of normalized levels. Our outlook continues to assume that China electric procedures return to normalized levels in the second half of 2023. In the first quarter, AHS adjusted operating margins declined 260 basis points as a result of FX headwinds, supply chain challenges at Fluke Health, lowering contribution margins and higher-than-expected inflation. Some highlights in the quarter include we exited March with stronger ASP consumables growth, reaffirming recovery post COVID is underway with sales outpacing the market in most regions. Double-digit growth at Census was driven by a Censo [indiscernible]. Censis is also seeing strong demand for its AIT productivity platform and continues to drive productivity improvements through the application of FBS tools, which have accelerated the time from bookings to revenue. FHS saw solid demand for equipment orders and dosimetry services despite continued supply chain strengths that stalled equipment shipment. Lastly, Provation continues to perform very well with another quarter of double-digit growth driven by its Apex SaaS offering. Apex has seen continued high customer demand with substantial Q1 orders and a greater than 3x average revenue uplift from license migrations. Following a strong start to the year, we continue to expect the probations growth will accelerate through 2023 supported by customers looking to further standardize our formation across their health systems. In addition to our remarks on the first quarter performance, we thought it would be helpful to provide more detail on our expectations for the AHS segment for the remainder of this year. The headline is that we expect sequential improvement in both revenue and adjusted operating profit margin as we move through the year. Specifically on revenue, we expect favorable price in addition to the recovery of electric procedures in China resolution of supply chain challenges at Fluke Health Solutions and normal healthcare seasonality to drive higher volumes over the course of the year. As a result, we expect core growth will go from low single digit in Q2 to mid-single digit in the second half of the year. On margins, in addition to the uplift from higher volumes and favorable price, we see compounding tailwinds from the benefits of the productivity initiatives taking second half margins to approximately 25%. Go-to-market changes in ASP consumables in North America will improve performance and enable closer connection to our customers to better serve their needs, transitioning from a primarily distribution model to direct to the customer. All these actions will have carryover benefits in the years to come, positioning us for accelerated growth and profitability as the general healthcare environment continues to improve. With that, I'll pass it over to Chuck, who will provide more color on our first quarter financials and our 2023 outlook.

James Lico:

Thanks, Chuck. I'll now start to wrap up on Slide 15. Our team is thrilled to be back in New York for our first in-person Investor Day since 2019 to be held on May 25. We are looking forward to highlighting our progress, executing our strategy and the results that has yielded over the last 7 years, building on our strong foundation and enduring principles that underpin our execution capabilities. We will showcase how our businesses have leveraged FBS tools to innovate, take advantage of the secular tailwinds, accelerating progress across our 5 critical customer workflows. This has translated into relevant product innovations helping to solve our customers' toughest safety, quality and productivity challenges and contributing to sustained strong growth for Fortive. In the spirit of setting high expectations, we will set long-term targets. Looking out 3 and 5 years, culminating with the evolution of our strong free cash flow, supporting us ample opportunities to further accelerate our strategy. We are actively fueling our future success by building on the transformation progress and learning that has taken place since our inception, unlocking future value for Fortive. Wrapping up on Slide 16. The combination of portfolio work we have done and the productivity initiatives we are implementing in the first half of 2023, prepare us for the continuing evolving macro environment and set us up for differentiated performance again in 2024. As you saw in today's press release, we're also continuing to build on our exceptional leadership culture for the Fortive of the future by expanding Tammy Newcombe's responsibilities to include the Advanced Healthcare Solutions segment in addition to our current role as segment leader of Precision Technologies succeeding Pat Murphy, who will retire at the end of the year. As you heard today, FBS is more robust than ever with powerful new capabilities to bring breakthrough innovations to market for our customers faster and drive enhanced business results. The evidence of this is reflected in our strong financial performance, including our free cash flow, the currency we use to measure our success. These factors culminate in the powerful formula for value creation, enabling Fortive to make a real difference in the world and deliver exceptional value to shareholders. With that, I'll turn it back to Elena.

Operator:

[Operator Instructions]. Your first question is from the line of Julian Mitchell with Barclays.

Charles McLaughlin:

So Julian, I'll take the first part of that. Productivity, we probably expect to do about $10 million in the first half, and that generally has a 6-month payback. So we'll probably see a like amount in the second half there, annualized is going to be a little -- obviously, a little bit bigger.

Julian Mitchell:

That's helpful. And then just switching back to the overall product hardware orders. You said those were down about mid-single digits in the first quarter. Is there any sort of interesting movement as you go sort of month to month? And any clues on how you're thinking about the second quarter. And if we look at the Precision Tech business specifically, and I suppose, Tektronix in it. You've had cautious comments perhaps from some companies who might be peers in recent weeks, have you seen anything shift in the market outlook for Tektronix or product hardware within PT?

Operator:

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

Charles McLaughlin:

Jeff, I'll take the first part of that. There's 3 main things that happen in health in Q1. You mentioned about Fluke health supply chain, that was a hit. FX strengthening dollar is -- it shows up more here in one of our more global businesses. So that was a part of it. And then also just thinking about the mix effect of lower consumables from China as we had COVID really hit maybe a little harder than we thought there in the first part of Q1. Those 3 things are the main reasons we came in short versus our guide for in the health sake.

Jeffrey Sprague:

And then totally shifting gears, just PT strategically, right? If I don't know if you're going to end up commenting specifically on NATI, right? But it looks like you were there at or near the alter. You haven't deployed capital there really actually since Danaher bought Tektronix, really, right? and maybe you're on the verge of doing your biggest deal ever by an order of magnitude. So I just wonder if you could frame that up for us what your thinking is or was and maybe the strategic direction of that particular segment in business over time.

Operator:

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

James Lico:

Well, I think it's certainly the solution that we feel really good about. I mean I think our talent development process. And if you go back a lot of years, you'd see us ebb and flow a little bit relative to those jobs as well as the jobs below that and Group President and operating company presidents. Our talent development is in, I think, in really a good place. Every one of our group presidents was internally promoted. 80% of our current operating company presidents were internally promoted. So I think when we really feel good about the structure, it's not just what we have at the segment level, but it's within those group presidents and operating company presidents, and we've, quite frankly, never been stronger in that regard. It gives us degrees of freedom to do some things throughout the leadership structure. I would also say that when you sort of look at it, it's pretty balanced from an operating profit perspective and from a just contoured market standpoint. So if we look at the split of responsibilities, yes, 2 segments to 1 segment. But when we look at a served market, ILS has half the served market, profitability is pretty close that ebbs and flows with deals. So I think we're in a very good place relative to the structure that we came to. But in part, it's not just the most senior job. It's also the quality of folks that we have across the board. We had all of our presidents in last week for our quarterly leadership summit with them, and I couldn't be more proud of the work they're doing and quite frankly, where we stand relative to the quality of leadership at the operating businesses.

James Lico:

Well, I think -- you broke up a little bit, but I think at the end, I think we got it. So I think when we look at the 3 segments we have today, the quality of businesses we have, the execution that's going on, we feel good. So I think, certainly, the Nate process, if you will, ending with Emerson doesn't really change the market structure. We feel good about what we're doing at tech and we'll continue to run the play there that we think is really good. And that's obviously a part of our success right now is the strong execution that we've had at Tektronix over the last several years.

Scott Davis:

I know there's just so much you can say about NATI, but it was, I think, as Greg said, kind of a pretty darn big deal versus kind of your history, is there anything that we should be taking away as far as your willingness to make bigger bets? Was this kind of a one-off unique? I know the gross margin structure was pretty attractive. But I think historically, you guys have generally looked at assets coming out of PE or pieces of assets coming out of bigger companies, but not necessarily looked at buying other public companies is really a big part of the M&A strategy. Has that changed at all, Jim and Chuck or is this -- or should we not read too much into this.

Scott Davis:

Fair enough, Jim. And just to clear something up. What was the Fluke Health supply chain issue? I don't recall hearing an explanation on that.

Operator:

Your next question is from the line of Andrew Obin with Bank of America.

Charles McLaughlin:

Andrew, I'll take that. The biggest thing is really what happened last year. It's really the comp. If you remember, Shanghai was shut down at the end of Q1 and a lot of that revenue showed up in Q2. So when you -- if you adjust for that comp actually Q1 and Q2 look pretty similar from what we're doing this year. If you interrogate on the 2-year stacks, you actually start to see some acceleration even into the second half. Yes. So you're right. We think came in on balance better than we expected in Q1, and we're optimistic moving forward.

Charles McLaughlin:

I'm also saying look at the first half this year versus the first half last year, there was a lot of revenue missing in Q1 that showed up in Q2. So it's really a tough comp. But if you look at that, you really see that shutdown that happened in the last week of Q1 of last year is really what explains most of what you're talking about.

James Lico:

Yes. We -- you did hear it right, we're at about 3x right now. We would expect the early migrations to be maybe slightly a little bit higher than maybe what the downstream ones. But we're actually ahead of the game on new bookings relative to the SaaS. So that's good. So we're all up, just probation, things are better. We thought '22 was better than expected and we started the year off well. So we are seeing a little bit of extended discussions with customers, I would say. And maybe more broadly, there are certainly in the software world. There's a little bit more funnel activity, things sitting in the funnel a little bit longer just given maybe how typical start of the year, but we still have good confidence in the projections we have for what we have in software. We had a very good ARR quarter, and we feel good more broadly about software in general.

Joshua Pokrzywinski:

Just going to dig in a little bit on implied second half for PT, especially with the backlog holding up really well here in the first quarter. It looks like volumes would be kind of flat, maybe even down. Now I know the comp gets a little longer there, but just trying to triangulate the book-to-bill still being good with the basically kind of no growth second half.

Joshua Pokrzywinski:

Got it. That's helpful. And then just on the order intake. Again, I know you're surprised that the book-to-bill was won in the quarter. But any sort of rightsizing of the order book as lead times start to improve a little bit, customers basically just saying, look, I still want everything, but now that it's not as urgent, was there any kind of air pocket pushout that you see as a function of that?

Operator:

Your next question is from the line of Deane Dray with RBC Capital Markets.

James Lico:

Yes, it's a great question. I think number one is, if we take Fluke in the industrial business, we don't have a huge amount of excess backlog in that business. Point-of-sale remains strong. And I think what we're seeing is just continued good execution from the Fluke team. The back -- the sort of backlog protected on that slide is mostly a Tek and in sensing. And in Tek, I think it's we don't anticipate that excess even burning down this year, Deane. So I would say in some respects, we're probably going to run with excess backlog in perpetuity. And I think in both cases, it's really about the secular drivers that exist that we've really tried to build the business around. We're seeing better performance as an example, in Western Europe. And I think that's really because of the sustainability, electric vehicles, the power -- a lot of the grid upgrades, some of those things, those investments are very much happening in Europe, and we're taking advantage of those opportunities. So we like the durability, if you will, of the backlog. Some of it is excess, and that's why we call it that way. And some of it is a little bit of in precision relative to what it will be like long term. But we do see when we interrogate that backlog on a pretty regular basis, we like the durability of it, the resiliency of it pretty because of the secular drivers that we listed on the right side of that page. So we think we're in a better position for the year because of the strategic moves we've made over the last few years relative to those secular drivers.

Charles McLaughlin:

Yes, Deane, this is Chuck. We had about 4.5% price in Q1. Much of that is carryover. But we continue to be active at we still got inflation coming out. So maybe it won't be as high, I would expect that inflation is going to moderate from the rate set increases from last year, but there's still inflation coming out. And so we'll still be deploying price as we go through the year.

Operator:

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

James Lico:

Yes. I think any time we get a new leadership into a role like that, Nigel, we see a new set of eyes and that always is a good thing. When we hired Olumide a few years ago, I think we got a new set of eyes on IOS, and you're seeing that quality of performance play out in IOS right now. He's brought some new skill sets to the role has done some things over the last year that you've had health that are definitely sticking and Tammy will bring the same thing. That's the expectation. And I think we benefit from sometimes those new perspectives.

James Lico:

I would say, regardless of the process, our strategic thinking around tech has been very focused on the secular drivers, not to bear too much repeating on that. But it's been around changing the vertical focus, as you know, well, and that's played out. And some of that has been innovation efforts that we would certainly look to add to if opportunities become available. So we would never say never to -- but that doesn't really change anything that relative to what's been going on in the external environment. That's why we do strategic plans every year. That's why we really kind of come with a different emphasis every year. And we feel good about the strategy at tech and to the extent that we've got bolt-on opportunities there as well as any of the other businesses that we have, we're always going to be looking at those opportunities to accelerate strategy into the markets. As an example, we would power is a good example. We would love to do more in power. If we found an M&A opportunity that is that, we would certainly look at it. [indiscernible] is a good example, although it was a few years ago. It's really extended our ability to do some things relative to power and we're bearing the benefits of the fruits of that work today.

Andrew Kaplowitz:

Jim, can you talk a little bit more about what you're seeing by region? I know you mentioned you expect China to slow a bit, but it's continued to be really strong for Fortive. I think -- last quarter, you said Western Europe might grow a little more slowly, but you just mentioned some secular trends holding up well in Europe. So you would you say these trends are proving more durable than you originally thought? And do you see an extended CapEx cycle in the U.S. from trends such as electrification and onshoring?

Andrew Kaplowitz:

Helpful Jim and I wanted to ask an AHS question maybe in a different way. You mentioned China letter procedures at 90% in March. Maybe a little bit faster improvement from where you started the quarter and you did mention overall consumables better in March. I know Invetech is still somewhat weak, which I think is still somewhat difficult comparisons versus during the pandemic. But do you think by the second half of '23 that maybe normalization from the pandemic actually happens, whether it's improved staff in at your customers, better consumables for you or improve [indiscernible] just the market around you change.

Operator:

Your final question comes from the line of Joe Giordano with Cowen.

James Lico:

I think it holds up pretty well. I think, number one, there's a couple of big pieces in there, right? Consumables at ASP is a big piece. iNet our EMC businesses in there, which is long-term contracts. So we've got a number of -- and of course, broadly defined services, so though it should hold up well. And we feel good about -- it held up very well in the first quarter as an example with really good growth. So you combine that with software and then even the healthcare hardware. We've got a good portion of the portfolio that we think is really resilient. You combine that with roughly 25% of our hardware nonrecurring, which is backlog protected, we feel pretty good. And as I mentioned earlier, the secular drivers in the entire product side also provide some -- another good insurance policy here. So we're -- we've really run the playbook that we've talked about so many times. We're prepared for a number of scenarios. We took some restructuring earlier productivity initiatives earlier in the year, as you know. We've upped that as well. So we feel like we're building scenarios around what could happen. It's hard to predict the future. But the portfolio was developed many -- over the years, in most cases, to deal with a lot of these challenges, and we think we're well prepared for.

James Lico:

Yes. I think the first half doesn't change all that much. Chuck kind of talked about that a little bit. But I think you think about derisking the second half. It's a little bit of derisking. And if things continue to play out as positive as they have, there might be some opportunity. But I think right now, let's see how things play out. But as we said on a 2-year stack, the hardware business, the product businesses do get a little bit better given the tougher comps in the second half. But where we stand today, I think we -- I think most people would be envious of the start that we had for the year, and we feel good about that.

James Lico:

Thanks, Brent, and thanks, everyone, for taking the time today. We know it's a busy schedule for all of you. We appreciate the questions. We certainly appreciate the interest. I hope from the words from Chuck and I, you heard as well as the prepared remarks, and hopefully, the presentation was helpful was helpful as well. We're off to a good start. We feel good about it. There is certainly some uncertainty out there in a number of ways. We feel well prepared for it. We'll look forward to the follow-up questions, I can give you more color on that to the extent we can be helpful. We're really looking forward to sharing our story more longer term at our investor conference. We think it's an opportunity for us to really demonstrate a lot of the things we've talked about today relative to how that plays out, the strength of -- in addition to not only the strength of the financials, but also the strength of the strategy, which really continues to help us. We had a great 2022. We think it's also going to help us post a good '23. We look forward to seeing you soon. Thanks, everyone. Take care.

Operator:

My name is Julianne, and I will be your conference facilitator this afternoon. At this time, I'd like to welcome everyone to the Fortive Corporation's Fourth 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. [Operator Instructions] I would now like to turn the call over to Ms. Elena Rosman, Vice President of Investor Relations. Ms. Rosman, you may begin your conference.

Jim Lico:

Thanks, Elena. Hello, everyone, and thank you for joining us. I'll begin on slide 3. Fortive had another quarter of outstanding operating performance in Q4, delivering 14% core revenue growth, 50 and 110 basis points of adjusted gross and operating margin expansion, respectively, 11% adjusted earnings per share growth, 62% free cash flow growth, all ahead of the guidance we gave in October. Our strong purpose-driven culture is supported by our relentless focus on executing for customers and shareholders in 2022. The continued evolution of our portfolio within the markets we play is characterized by strong secular drivers, which powered 9% ARR growth in our software businesses and backlog expansion in our hard products businesses, contributing to record core revenue growth for the year. Our performance would not have been possible without the dedication of our 18,000 team members around the world. Team overcame continued supply chain and inflationary challenges, which will likely linger into 2023. We believe the power of the Fortive Business System is a key differentiator, contributing to more profitable growth, record gross margins and free cash flow generation. As we look forward, we're excited to update you on the progress we've made on our multiyear targets and strategies that are driving outperformance at our upcoming Investor Day in May. Turning to slide 4. Even against the backdrop of a difficult macro in 2022, Fortive continue to validate the investment thesis that we have pursued since 2016, delivering core growth of 10% and 20% on a two-year stack basis, accelerating over the last few years. Our portfolio transformation has also driven approximately 1,000 basis points of gross margin expansion since 2016, which has translated into higher operating margins and provides further opportunity to improve margins in the years to come. We also delivered free cash flow growth of $1.2 billion, with margins approaching 21%, underscoring our ability to compound cash flow off a higher base, a key Fortive differentiator and value creation driver. In summary, we had said that 2022 would be a show-me year and we delivered strong results across all of our segments, which I will highlight in more detail on the next few slides, starting with Intelligent Operating Solutions on Slide 5. IOS grew core revenue by 13%, representing its third consecutive quarter of double-digit core revenue growth. We had good growth in all regions, with low double-digit growth in North America, mid-teens growth in Western Europe and high 20s growth in China. Double-digit core growth in every workflow, combined with our rigorous application of FBS, drove 330 basis points of core operating margin expansion, more than offsetting inflation and FX headwinds. Looking at our performance drivers by workflow and connected reliability, look at low teens growth, supported by a strong backlog position and continued success with their new solar and calibration products serving the energy, renewables and electric vehicle markets. POS remains strong in every region. However, we expect to see some slowing as supply chains continue to normalize. Strong end market demand drove double-digit EMEA SaaS revenue growth in the quarter, with record net dollar retention of approximately 106%. In EHS, revenue grew by high teens with strong contributions from both Industrial Scientific and Intelex. Industrial Scientific revenue grew approximately 20%, as strong demand was supplemented by record iNet expansion and higher instrument shipments following the resolution of key supply chain issues at the end of the third quarter. Meanwhile, Intelex posted another quarter of low double-digit SaaS growth. They have successfully deployed FBS initiatives to accelerate software implementations and create upsell opportunities to customers. Moving to facilities and asset life cycle. We had low double-digit growth in Q4. Vontier revenues once again increased double-digits as customer labor shortages and deferred facility maintenance continued to drive higher volume through the company's job order contracting platform. Accruent SaaS revenue grew by mid-single digits, despite a sizable headwind from end-of-life products. Accruent continues to see good success from its recent go-to-market focus in asset management and workplace solutions to enable mid-single-digit revenue growth in 2023. And ServiceChannel saw another quarter of double-digit revenue growth taking their full year growth rate to just under 50%. As a reminder, we are transitioning from a largely pass-through revenue base to a better long-term business model that includes more recurring SaaS revenue. This change will create a short-term revenue headwind in the first quarter. However, we expect service channel to remain a strong double-digit growth business in 2023 with above 20% adjusted operating margin. Turning now to Slide 6. Precision Technologies delivered another strong quarter of double-digit revenue growth in every business. Core revenues increased 20%, driven by high teens growth in North America and greater than 20% growth in both Western Europe and China. PT also delivered 240 basis points of adjusted operating margin expansion with higher volume, price realization and productivity more than offsetting inflation in FX. Some highlights for the quarter include

Jim Lico:

Thanks, Chuck. I'll now wrap up on slide 16. In summary, I'm incredibly proud of the contributions of our 18,000 team members to make 2022 a record year for Fortive and further differentiate our more resilient financial profile. As we turn the page on 2022, that resiliency will be on display again in 2023 as our outlook reflects an expectation for slowing growth as customer demand normalizes after two years of robust double-digit hardware product orders, but it also reflects the benefits of the investments we have made to accelerate strategy, strengthen our market position, scale our software revenues and develop new innovations that are solving our customers' toughest safety, quality and productivity challenges. As you've also heard today, we are seeing the benefits of our continuous improvement culture, unleashing the power of the Fortive Business System to deliver more profitable growth and strong free cash flow, again in 2023, allowing us to compound returns through disciplined capital deployment. When taken together, this creates a powerful formula for value creation 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.

Operator:

[Operator Instructions] Our first question comes from Steve Tusa from JPMorgan Chase. Please go ahead. Your line is open.

Jim Lico:

Hi, Steve.

Jim Lico:

Yes. Hey, Steve, it's Jim. A couple of things. One, obviously, we play a role in that. And -- so as we continue to progress, we'll see that. As we noted, some of the asset life cycle, a little bit lower growth in the first quarter. We can talk about that, but that -- those margins will expand. So, the revenue coming back certainly in the software businesses there as well as just continued progression of -- a lot of the actions that we've got price will continue to be a helpful piece of this driving gross margin expansion along with our productivity initiatives. So, I don't think we've got anything dramatic from the first half to second half in terms of anything that you wouldn't normally see seasonally in terms of growth, price realization, productivity initiatives get more traction as you go through the year. Those are probably the big drivers outside of just normal revenue.

Chuck McLaughlin:

Steve, this is Chuck. Actually, in our modeling, no, we wouldn't expect that all gets washed out based -- but of course, it depends on the order rate. It's one of the reasons why we think that we've got a pretty resilient forecast here. If the order rates moderate beyond where we think they're going to be, we could still do it. It's really still -- we've got -- supply chain is getting better. It's just -- it's not resolved. So it sounds like we can just flip the switch and get it all out. But we would -- we'd probably cut it in half.

Jim Lico:

Thanks Steve.

Julian Mitchell:

Hi. Good afternoon. I just wanted to start with some more detail on the product hardware orders. So I think those were up mid-single digit Q3. It sounds like they're up maybe low single Q4. And then you've got this slowdown commentary. And then also on slide 14, you talked about orders improving through the year. So is the way to think about that, you're trying to say that orders, I don't know, ended last year up low single, maybe they're down in the first half, grow in the second half? And then that's what informs the PT organic sales guide, because if I look at that on slide 17, you're starting the year up double digit. The year as a whole is up low to mid. So you're implying the organic sales in the year flat or down. Is that just, kind of, the orders flowing through with a six-month lag? Is that how we're thinking about it?

Chuck McLaughlin:

And Julian, the only thing I'd just remind you is we have an easier comp in PT in Q1. So when you start -- when you look at $1 standpoint, it's not as dramatic as you move through the year. In fact, I think from $1 standpoint, we'd expect that it would -- there would be an upward trajectory in PT each quarter sequentially.

Jim Lico:

Yes. Well, number one, I think, on the back stuff, as we said in the prepared remarks, 40% order growth over the last couple of years. It's obviously a little bit higher growth rate than what we'd normally expect for Tek. So, what you start to see in the full year, it’s a moderation or a normalization back to that mid-single-digit growth. I would say when you think about customers, very much playing out the way we anticipated in terms of moving the business. The business just doesn't have as much of influence from consumer electronics anymore, where you're seeing a lot of that distortion with the things we've talked about in terms of power, data centers, industrial IoT, all of those drivers are really driving the business much more today than ever before, making it more resilient. So, I think those are all the things we've described that I think really continue to have the business. It does dissolve a little bit, but it moderates off of really, really large numbers. So I think mid-single-digit growth for the year is what we're calling out here. It could be a little bit better. We'll still end the year with a decent backlog, as Chuck was just describing a couple of questions ago. So, I think when we look at the business for the year, very healthy channels have almost no inventory. So we continue to see good point-of-sale strength. And some of that is just fulfilling past due to some extent, but there really isn't a channel inventory situation whatsoever. And so I think we're in a good place. Orders will slow a little bit, but some of that is just the big heavy comps that we've sort of had over the last couple of years. So we think we're in a good place, and we think we'll exit 2023 in a good place as well.

Jim Lico:

Thank you.

Scott Davis:

Hey, Jim and Chuck and Elena. I hope you guys are well. If I look back at my notes, I think you said, the service channel probation would be like $0.12 accretive in 2022. It sounds like maybe that came in a couple of pennies better. Is that accretion step-up meaningfully in 2023? We think just given the growth rates of those businesses that would be a nice tailwind for you. But I know you did make some comments on the SaaS adjustment on service channel, though as an offset.

Jim Lico:

And Scott, just to maybe add on to the first quarter service channel thing, as we talked about in the prepared remarks. This is really -- the SaaS revenues continue to be incredibly strong in the business. But we did have a little bit more pass-through revenue in the year than we anticipated. That's why we grew the business almost 50% on a full year basis. So really strong growth this past year. But we'll move to a better business model, which is a little bit less pass-through revenue and a much -- but the strength of the SaaS business has been there all along. We've now got a data analytics platform that we're offering as well. So we're really going to, kind of, get through that in the first quarter and a little bit in the first half, but the profitability really does raise considerably as well. We got what we needed in 2022 in that regard. We'll be an even better place in 2023, simply because the business model transformation that we intended to do is really start going to hit the -- full hit of the P&L through the year.

Jim Lico:

Yes, I mean you got it exactly right. December, in particular, was really low. I think that speaks to the strength of AHF, quite frankly, on the revenue line is we were able to weather that storm because of the strength of other regions of the world. We talked about the 5% growth that we had in the segment. So we think, we're about probably 50% in January, so about half of where we were a year ago. But you're right, it's going to ramp. We're seeing some of that improvement. A couple of weeks ago, we think was the low point. But it's now picking up to 70 in a week, but we should see continued improvement. Again, on the other side of the Chinese New Year holiday, we'll get a better view of things, as we always do. But we anticipate that this will continue to improve throughout the year, as China just kind of gets back to normal, and we certainly started to see that.

Jim Lico:

All right. Thanks, Scott.

Jim Lico:

Hey, Jeff.

Jim Lico:

Yes. So, I think, number one, we obviously, know the company and have read the news. So you're exactly right. We wouldn't comment on any process that we'll be involved in or not involved in, particularly a public one. But I would say this. I mean we've known NI for a long time. I can remember meeting Dr. T 15 years ago or so. So we know them well. We partnered with them at Tektronix and have for a long time. So I think what we've said strategically about all of our funnel was there was a balance of large, small deals, hardware and software. So we can -- the balance sheet is an incredible place right now, as you know. So we're in a great place to do things. But we're going to be disciplined. We're going to make sure that every situation we approach, we approach it strategically, how well that accelerates, what we want to do, and I'll leave it at that. But I think more broadly around M&A, we're in a very good place relative to our opportunities ahead of us. And we'll -- we certainly are playing offense in that regard.

Jim Lico:

Yes. So I think, more specifically around AHS, we called out a couple of kind of onetime headwinds in the quarter. We -- I think there's a number of things that are working in our favor relative to the 2023 year. Number one is North America. We had good growth in North America and anticipate that will continue -- we're not necessarily calling everything getting perfect in North America, but we do believe it will get better. And we saw that in the fourth quarter, and that's a good thing for our margin structure. And then number two, to your point, we're seeing a little bit more price realization in the fourth and into this year. Things are starting to get a little traction. We've talked about that on the call that it just takes longer, and we're starting to see that. And then finally, productivity. The team has -- that leadership team has really adopted FBS, and they've really embraced a number of things to really drive productivity. So, we don't see the additional inflation either as well. So the combination of we don't see incremental inflation at this point and we have those actions getting deeper and deeper into the margin structure, if you will, through the year. So, we feel like we're in a much better place starting here in 2023, both from a market and obviously, the kind of actions that we need to continue to make the business better. And I would just kind of ask, but we have grown gross margins in AHS -- operating margins about 130 basis points over the last two years. So, despite those challenges, we're in a good place. I call that the launch path from where we are today.

Jim Lico:

Thanks Jeff.

Jim Lico:

Hi Nigel.

Chuck McLaughlin:

Nigel, it's Chuck. We've always felt we want to maintain an investment-grade rating. And so we wouldn't do anything that -- on any type of deal that would jeopardize that. I've pointed out in the past, we've done equity instruments, like the mandatory convert. And we've always said that in situations where we want to do something, equity has never been off the table. It just hasn't been needed at this point.

Chuck McLaughlin:

Nigel, I'll take the first part. We would expect to take of the excess backlog that we're talking about probably up to half of it is included in the assumptions for this year in this guide. But to be clear, this is what we consider excess. And that's still -- we get more out if supply chains get better. So there's a little more there, but it's still constrained by supply chain throughout this year. But getting back Nigel on the service channel question, I wouldn't think of it as a SaaS transition. The SaaS revenue has continued to be good. It's just -- we grew the business well over 70% in Q1 of 2022 and so with a large amount of this just pass-through revenue. And so if you think about it, we have a customer. Some of our contracts have. We're passing through a number of amounts of the facility maintenance costs that they have pain plumbers or electricians. We're just doing less of that. And so it's really not a SaaS transition in the traditional sense. That we're replacing that solution, though with some other added benefits. And so we -- that's why it's a short-term transition. It's really kind of going from losing some of this one-time pass-through revenue and quite frankly, we didn't make any money on. So I would see it as that, and that's why it's short-term as opposed to sort of a conversion of what you'd see traditional license revenue to SaaS revenue. We're not going to see that. This is -- service channel is 100% SaaS revenue company.

Chuck McLaughlin:

Thank you.

Operator:

Our next question comes from Andy Kaplowitz from Citigroup. Please go ahead. Your line is open.

Chuck McLaughlin:

Hi Andy.

Chuck McLaughlin:

Yes, Andy, the first half, we'd expect to put up $20 in $25 million to $30 million of cost. See cost to get after some of these structural things. Some of them are looked up, a few of those, but there'll likely be some outside of the U.S. Maybe there are some regions that we want to convert to a dealer approach rather than a direct approach, and I'm thinking here in our health margins. We've always thought that there was cost that we needed to improve our go-to-market there. And we're just getting after that.

Jim Lico:

Yes, it's interesting. I think we've always thought for the last several months that customers would inevitably start 2023 out a little more conservative just given we've seen some of the Tek layoffs and some of those things, the PMI and where it is. And so that's number one. That's number one. That's kind of a planning assumption from an order perspective. Now we also knowing that we had -- we're starting here with a good backlog situation. I would say, if you think about it regionally, Andy, obviously, North America is going to be pretty good and pretty resilient, given the fact that we have most of our software businesses have the predominance of their revenue streams in North America. And I mentioned the health care, particularly ASP North American story. So, North America is going to be pretty resilient I would say that Western Europe and Europe more broadly, probably a weaker area for the year, just given a number of things. Some of that is supply chains normalizing a little bit back to normal. Some of it is just a little bit of weakness as well. China is going to be good all year. Healthcare will be weak in China in the first quarter because of the actives but should continue to get better through the year. So that's kind of the regional play, and that's sort of our planning assumptions going forward. I think it's still early days. Obviously, a lot of the year to play out here. But that was -- that's sort of fundamental to our planning assumption.

Jim Lico:

Thank you.

Jim Lico:

Hi, Josh.

Chuck McLaughlin:

Yes. I mean, that's not what we're seeing here in there. But what we are seeing is reason we can't get the backlog down more, it's more supply chain constrained we've got so much material is the way I'm thinking of it. So if orders go down $10 million more, that doesn't necessarily change our revenue guidance. That's what you say. I would agree with that.

Jim Lico:

And that's where going -- yes, I was just going to add that it's -- as you said, it depends on the business as you pointed out, a little bit more backlog intact. So it does matter where the orders go down relative to how we can make it off. So that certainly is part of it. But we ought to think of that extra -- the half that isn't planned to go out as an insurance policy, again some additional decline.

Jim Lico:

Well, I would take it this way. There are some spot buy costs that probably go away from 2022, for sure. But there are some embedded costs in the standards that are going to be with us here for a while. I think the real thought is we're going to have price cost like we have been, we grow gross margins more in 2023 than we did in 2022. So in that sense, I think we're going to be as we've shown over the last several quarters, the media had -- we're not too worried from a factory absorption perspective. If that's -- if you're going in that direction, we won't worry about that. We'll really be focused on is making sure a number of commodities are down or will be lower, things like metals, plastics, but the majority of our buy is electronic components. And that will take a little bit longer to sort of wean ourselves from some of that inflation that we saw this year. So, we plan to -- I think we're super aggressive in that regard. We'll get after everything. We have great supply chain teams, but it will take a little while. But I think you're going to see that throughout the year as the gross margins continue to look good.

Jim Lico:

Thanks.

Jim Lico:

Hi, Dean.

Chuck McLaughlin:

Yes, a couple of things we have always have a lot of work as you know, working at our working capital across all of our operating companies is the focus that we've had all year long and it's been -- it's been a challenge. It is -- it always is, but we've really done a great, ASP actually was a stand up there. So I think that's really what we were talking about there. But they weren't building ones. We had a couple of really good place. I wouldn't say pulling so much is really thinking about it as just some time. We thought we had a really, we did have a really strong guide, and we came in a little stronger that. There could be -- sometimes you just get your on receipts, sometimes they come in a little late and show up in Q1, this time, I'm probably think maybe $20 million came in a little early. You really can't do much about that. It's just whether sometimes when they cut the check before New Year's or after -- that's -- but we were very pleased with our free cash flow performance all year along.

Jim Lico:

Yes. Dean, I think number one is, as you -- I know you know when we've seen a little -- in a couple of places, we've seen new loan book. When things get a little slow, particularly starting the year out. New logos maybe a little bit harder to grab on to as people maybe take a month or so to maybe an extra 30 days to close the business. But cross-selling and up-selling is something you can do every day. And so our Presidents are very much tuned in times like this where maybe things are a little bit more -- there's a little bit more ambiguity out there as to how the year is going to play out. The teams are really conditioned to really move the sales motion to more cross-selling and that really drives our net dollar retention. We talked about it in a couple of individual places we've got over -- we've got a number of businesses that are well over 105 now, we're about 102. So the metric we really used to drive that is cross -- is net dollar retention. And so what we're really pushed on early in the year is get those renewals, drive gross retention up and then drive the cross-selling and up-selling as well. So, I think we're well -- from a process perspective, FBS has a number of tools that support those efforts, with customer success organizations. That's a big focus for us here at the start of the year.

Jim Lico:

Thank you.

Jim Lico:

Hi, Joe.

Jim Lico:

Yes. Joe, I think it really goes back. It will have an opportunity to really give a lot of this detail on our Investor Day in May. But I think what we really think about this is really how we move the growth rate on long-term through the cycle growth rate to mid-single-digits. So we got two really strong years of growth 10% average in the last two years. That's on the backs of a number of things we've done from a portfolio perspective and just demand has been better than historically. But as we get into 2024, and we normalize around the kind of things that we would see. We certainly would continue to see that mid-single digit as a number on the backs of continued stabilization of the macro for some of our product businesses obviously continued improvement in our healthcare businesses and just the strength of success that we've had in software. And those sort of combination pillars are really are going to be what really drives that mid-single-digit growth rate. As we said, as things normalize here, hopefully sooner rather than later.

Jim Lico:

Well, yes, I think as Chuck described, it's really kind of across the segments. And it really deals with a number of things. Certainly, looking at certain product lines that maybe are a little slower than over the next few years, we closed a couple of rooftops, continue to do some things on the lease front as we continue to consolidate our real estate footprint. So a number of those things are really what we're talking about. It's an accelerated rate, given kind of after a couple of years of 10% growth, we've may be more focused on the growth, maybe a little bit more focused on supply chain. But now as things start to normalize here, we're back to getting after some things, and in the traditional sense, we want to be ahead of those things, and that's really what we're talking about.

Jim Lico:

Thank you.

Operator:

Our last question will come from Joe Giordano from Cowen. Please go ahead. Your line is open.

Joe Giordano:

Hey, guys. Hey, how are you doing? I just want to follow-up a couple of things on the orders here. Particularly, let's strip out like the AHS and look more on the hardware stuff in PT and Fluke and Tek. What gives you confidence that orders in the second half of the year start to get better? I guess like just the revenue guide suggest that you exited kind of the lowest point of the year. And you said, Fluke -- Tek orders were up like 40% over a period of time here. So, like is it just going from plus 40 to normal levels? Is that like reasonable or like could you see declines in orders because of the magnitude at which they expanded over felt relatively short time?

Joe Giordano:

Okay. So, you're saying it's more of a dollar thing. I mean more of a comp mask think than dollars, I guess?

Joe Giordano:

Okay. And then just last for me. You talked about, I guess, theoretical M&A on the call so far. But if you were -- in a theoretical situation where equity was a component of a purchase, like how do you think about what your return hurdles would be in scenarios like that where equity is part of it?

Joe Giordano:

Thanks guys.

Operator:

We are all out of time for questions today. I would like to turn the call back over to Jim Lico for closing remarks.

Operator:

This concludes today's conference call. Thank you for your participation. You may now disconnect.

Operator:

Good day. 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 [Operator Instructions]. I would now like to turn the call over to Ms. Elena Rosman, Vice President of Investor Relations. Ms. Rosman, you may begin your conference.

Jim Lico:

Thanks, Elena. I'll begin on Slide 3. We had another quarter of outperformance with 12% core revenue growth; 80 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. Third quarter also demonstrated continued success launching a number of new products and solutions that solve our customers' toughest safety, quality and productivity challenges. 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. 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 million on revenue and $0.11 on EPS for the year. Despite these headwinds, we are driving higher growth and operating margins by leveraging FBS 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. 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 of the secular tailwinds accelerating progress across our five 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. 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 health care solutions for the perioperative loop keep clinicians and patients safe, serving over 5,000 customers, including all the top US 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’re also aligned to our sustainability mission by helping our customers accelerate safety, good health and well being, advanced industry and customer productivity, utilizing new and more efficient clean energy resources and drive reductions of our customers' greenhouse gas emissions. 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 on 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. 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 in the quarter include