Q3 2022 Fortive Corp Earnings Call
Good day My name is Dennis and I will be your conference facilities facilitator today.
At this time I'd like to welcome everyone to the 14th Corporation's third quarter 2022 earnings results Conference call.
All lines have been placed on mute to prevent any background noise. After the speakers' remarks, there will be a question and answer session. If you would like to ask a question during that time simply press Star then the number one on your telephone keypad. If you would like to withdraw your question Press Star one again.
I would now like to turn the call over to MS. Elena Rosman, Vice President of Investor Relations. Mr. Rossman, you may begin your conference.
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.
Was that certain non-GAAP financial measures on today's call information required by regulation G is available on the investors section of our website at Www Dot, Florida Dot com.
Our statements I'm curious if your rate increases or decreases refer to year over year comparisons on a continuing operations basis.
During our call we will make forward looking statements, including statements regarding your body for developments that we expect or anticipate will or may occur in the future.
We're looking statements are subject to a number of risks and actual results might differ materially from any forward looking statements that we make.
Information regarding these risk factors is available in our SEC filings, including our annual report on Form 10-K for the year ended December 31st 2021.
These forward looking statements speak only as of the date that they are made and we do not assume any obligation to update any forward looking statements.
With that I'd like to turn the call over to Jim Lico.
Thanks, Elena I'll begin on slide three.
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 Florida 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.
Our 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 the best in class returns for Florida and for a long time to come.
Turning to slide four we are delivering 2022 at the high end of our initial outlook. We set back in February reflecting continued strong momentum as we move 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 are.
Our supply chain measures across the portfolio continued 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 <unk> 11 on EPS for the year.
Despite these headwinds we are driving higher gross 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.
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 five we just finished our annual strategic plans for each of our operating companies.
Even more excited about the depth of our strategy to take advantage of the secular tailwind is accelerating progress across our five critical customer workflows.
Our solutions for managing facilities and assets, environmental health and safety and measurement and collective 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 healthcare solutions for the perioperative loops keep clinicians and patients safe serving.
Over 5000 customers, including all the top U S hospitals as well as hospitals around the world.
Each workflow is well positioned to benefit from durable business models that underpin our vision and strategy to build a stronger collection of businesses with industry, leading profitability and free cash flow margins.
They also aligned to our sustainability mission by helping our customers accelerate safety, good health and wellbeing advance industry and customer productivity, utilizing new and more efficient clean energy resources and drive reductions of our customers' greenhouse gas emissions.
Today over 60% affordable 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 service channel acquisition, which became core in mid August .
By region growth was broad based with low double digit growth in North America mid teens growth in Western Europe , and low twenty's growth in China.
Double digit core growth in every workload drove 345 basis points of core operating margin expansion more than offsetting inflation and incremental FX headwinds.
Some other highlights for the quarter include at Fluke demand remains solid with double digit point of sale growth in each major region.
Using FBS voice of the customer and product development tools Fluke launched a breakthrough platform serving the renewables market that reduces the time to test solar installations by as much as half. This kit combines multiple fluke hardware tools with a software platform and has been awarded industry recognition for its safety and time saving features.
EHS had low double digit revenue growth as it continued to see the benefits of share gains and efforts to diversify its customer base.
Industrial scientific saw greater than 20% increase in bookings with strong Ina and instrument bookings in both Europe , and the middle East and <unk> had another quarter of mid teens SaaS revenue growth.
Moving to facilities and asset lifecycle.
<unk> revenues were up double digits once again with the business continuing to drive accelerated penetration of projects flowing through Guardians job order contracting platform with an expanded set of customers.
Current saw strong software demand with its SaaS offerings growing low double digit current also continued to utilize FBS tools to improve its annual recurring revenue profile with recent kaizen is focused on driving price and improved customer retention.
Finally service channel had another exceptional quarter with strong double digit revenue growth and high teens growth in SaaS and some customers face mounting cost pressures. They are increasingly turning to service channel to help them outsource their facility maintenance work, reducing their third party contractor costs as.
As a result, we are reinvesting a portion of their upside into transitioning customers to our more profitable SaaS managed service offering to continue to drive profitable growth.
Turning now to slide seven and precision technologies, which delivered core growth ahead of expectations in every business.
Core revenues were up 19% with double digit growth in all our major regions driven by continued investment in the industrial power and energy semiconductor and medical end markets.
<unk> also saw a 280 basis points of adjusted operating margin expansion with higher shipments and strong price realization more than offsetting inflation and FX headwinds.
Some highlights in the quarter include seven consecutive quarters of double digit orders growth in tektronix fueled by a number of new entry in mainstream scope product launches.
As a result trailing 12 month orders are now greater than $1 billion.
Our teams are diligently applying FBS to countermeasure supply chain constraints to deliver on this record level of demand.
<unk> benefited from another quarter of volume growth and strong price realization, while supply chain constraints continue to limit output <unk> book to Bill was greater than one with strong demand and quality of our utility and power business.
<unk> Pacific scientific EMC saw improved material availability and capacity expansion across key production lines driving double digit revenue growth in the quarter.
Moving now to slide eight advanced healthcare solutions total revenue increased 3% in the third quarter with core revenue decline of 1% as continued supply chain constraints limited growth at ASP, and Fluke health solutions, resulting in lower than expected core growth in the quarter.
Mid single digit growth in Western Europe was more than offset by low single digit decline in North America, and a mid single digit decline in China, we saw sequential improvement in core growth at ASP.
Is there supply chain shortages constraining capital equipment growth started to ease in late September .
Electric procedures improved to the low 90% range, excluding China, while rolling Lockdowns kept electric procedure rates around 70% of pre COVID-19 levels there.
Hff's core segment margins were down almost 400 basis points stemming from lower volumes and FX headwinds in the quarter as well as the recognition of a bad debt reserve and in the tech.
As you can see the team is diligently deploying pricing and cost controls offset these headwinds, which we expect will deliver margin recovery in the fourth quarter.
Some other highlights for the quarter include an acceleration of new hospital bookings at sensus and double digit growth in their sense attract SaaS subscription revenues for.
Probation SaaS offering is also seeing good demand from customers looking to further standardize on probation across their health systems.
Lastly, we completed the sale of Fluke health therapy physics product lines, which will be adjusted from core growth going forward with annual sales just under $20 million.
Turning to slide nine Florida business system continues to be a differentiator for us, enabling our business to drive innovation and profitable growth I am excited to share that we just completed our annual CEO kaizen events accelerating our culture of performance.
We brought together our most senior leaders, including our segment leaders in many of our operating company presidents with a total of 2018 and over 400 team members driving significant improvements in gross margin and free cash flow and breakthrough innovations.
Part of how we do kaizen is what sets us apart is the deep engagement of our leadership and teams as well as the achievement of our high expectations.
Some highlights include the teams of fluke identified gross margin opportunities, resulting in margin expansion through freight cost reductions and value engineering opportunities at ISC linked conversion kaizen realized a 20% to 40% improvement in productivity across four product lines and improve the lead time for <unk> quotes by 80%.
And time to market for newly developed software by 75%.
Our teams reduce the average test time by more than 25% on a highly constrained production process and tektronix and sensus implemented kaizen, yielding a two <unk> improvement in productivity and reduce time to onboard new software customers.
These results on our continued example, how FBS is driving results in Florida.
With that I'll pass it over to Chuck who will provide more color on our third quarter financials, and our updated 2022 outlook.
Thanks, Jim and Hello, everyone.
I'll begin on slide 10, with a quick recap of our third quarter performance, we generated year over year core revenue growth of 12%.
Acquisition benefits were as expected contributing approximately four points of growth offset by higher than expected FX headwinds in the quarter.
As a reminder, the service channel acquisition became part of our core growth in mid August .
Turning to the right side of the slide we saw double digit core revenue growth in each of the major regions.
North America revenue was up low double digit with mid teens growth in software Western Europe revenue grew mid teens with favorable contributions from each segment.
Asia revenue increased in the low 20% range with mid 20% growth in China, driven by robust growth in precision technologies.
Partially offset by a decline in healthcare.
Lastly, we saw high teens revenue growth across our high growth markets on slide 11, we show operating performance highlights in the third quarter.
Adjusted gross margins increased 80 basis points to 58, 1% as volume and strong price realization continued to demonstrate the value proposition of our products and solutions.
Adjusted operating margins expanded 160 basis points to 24, 4% up 440 basis points on a two year stack basis.
Adjusted earnings per share increased 20% to 79.
Reflecting strong fall through on higher volumes, partially offset by higher interest expense <unk>.
Free cash flow was another standout at $307 million, reflecting approximately 108% of adjusted free cash flow conversion.
Turning now to the guidance slide 12, and the outlook for the remainder of the year.
For the fourth quarter core revenue growth is expected to be approximately 11% at the midpoint and adjusted operating profit margins are still anticipated to be up at least 100 basis points year over year.
Adjusted earnings per share are expected to be in the range of 80 to 85.
In Q4, representing year over year growth of four 7% or 10% to 13% normalized for a low tax rate in Q4 of last year. This reflects an incremental <unk> <unk> headwind from currency movements not contemplated in our prior outlook.
For the full year 2022, we are narrowing and raising our adjusted earnings per share outlook to $3 10 to.
The $3 13 to better reflect operational performance in the third quarter, partially offset by FX headwinds.
Tax rate is expected to be approximately 14, 5% for the year.
Lastly, we anticipate that free cash flow will be seasonally strong in the fourth quarter and we continue to expect full year free cash flow of $1 7 billion and conversion to be approximately 105%.
Turning to slide 13, I wanted to update you on our strong credit and liquidity positions.
Early in the fourth quarter, we amended our $2 billion revolving credit facility extending the maturity out to 2027.
The amended credit facility utilizes a sustainability feature whereby pricing varies depending on our achievement of our recently published commitment to reducing our absolute scope, one and two greenhouse gas emissions by 50%.
We also added a new $1 billion delayed draw term loan, giving us the financial flexibility to refinance the $1 billion term loan coming due in December with a pre payable where we can delever with available free cash flow without penalty.
We are now Levered at roughly two times on a net debt to EBITDA basis, with an average debt maturity of five years.
Three 2% weighted average interest rate.
The proactive moves we've made to strengthen our balance sheet combined with our robust free cash flow generation also gives us ample capacity to invest for growth and compound returns through disciplined and accretive capital deployment.
With that I will pass it back to Jim for some preliminary color on 2023 and closing remarks.
Thanks.
Thanks, Chuck turning to slide 14, we wanted to share some initial thoughts on 2023.
Starting with the hardware products business.
Which include Fluke Tektronix and sensing technologies backlog across these businesses are roughly double pre pandemic levels and the secular trends I mentioned earlier are driving market expansion and development of new innovations, where we have a strong right to play as.
As a result that gives us increased confidence in our ability to grow through a potential decline in new customer orders in 2023 or.
Our software services and other recurring revenue businesses, including facilities and asset lifecycle, environmental health and safety probation and others are expected to benefit from enhanced market positions driving double digit growth in our SaaS and license revenue streams at.
At the same time, our healthcare businesses, excluding software are 70% recurring with consumables and services on the capital side, we expect supply chains to normalize while the overall pace of recovery in hospitals will continue to be slow given the labor and productivity challenges likely to continue into 2023.
While we haven't completed our planning process for next year. We are confident the work we have done to build a more resilient revenue and earnings profile will enable us to outperform the evolving macro environment.
Lastly on slide 15, we are demonstrating the results of our successful portfolio transformation, yielding higher cash compounding power, having nearly doubled free cash flow over the last three years.
Our sustainable competitive advantages are evidenced in our ability to outgrow the attractive markets, we serve and deliver workflow innovations that solve our customers' most critical safety quality and productivity challenges.
The third quarter demonstrated our team's continued success launching a number of new products and solutions generating compelling investment returns and adding to our ability to continue to compound results.
Lastly, our ability to raise our earnings outlook for the year. Once again in the face of continued headwinds speaks to the power of the Florida business system, and our culture of Kaizen, which is all about finding a better way.
We have a strong culture of setting high expectations and through the rigor discipline and the unrelenting efforts of our teams we are delivering strong results.
When taken together this creates a powerful formula for value creation.
With a high quality portfolio of desirable brands favorably leverage to sustainable secular trends industry, leading margins and free cash flow generation and best in class execution, enabling Florida to outperform in almost any environment.
With that I'll turn it back to you later thanks Dan.
Concludes our formal comments Dennis we are now ready to take questions.
At this time I would like to remind everyone in order to ask a question simply press Star then the number one on your telephone keypad will pause for a moment to compile the Q&A roster.
And your first question is from the line of Deane Dray with RBC capital markets. Please go ahead.
Hey, Thank you good day everyone.
Hi, how are you doing real well. Thank you Barb can we start with that.
The comment on 23 regarding the positioning on the hardware backlog.
Two times historical.
Can you parse out how much of that is reflecting incremental demand versus supply chain inefficiencies and where your doctor few quarters back you don't typically see a big backlog and fluke, but our lead times normalizing and so I just wanted to get a perspective on how that hardware backlog looks.
Heading into 'twenty three.
Yeah, Deane I think as we said we continue to we'll take backlog down a little bit in the fourth quarter, which I think is the first quarter, we've done that in quite a while.
Order demand remains very robust so if I were to look at it that backlog I would say a good chunk of it will be.
At Tektronix, which we think is more is mostly demand.
And a number of places and lead times are out so we feel very very good about the backlog fluke fluke is lowering backlog from where they were.
They are.
And their lead times have come down a little bit. So if I were to think about it most of the sensing backlog I think is really advanced orders for 23. So if you think about it probably parses out to protection of longer lead times of protection kind of getting in line. If you will.
Which makes it I think pretty certain probably half of that is at least half of that is that number and the other half was good demand.
Throughout mostly a tech but in other places as well so with that I mean, that's why I think our confidence in the backlog is much higher than than maybe what others might think just because I think we.
We really examined it pretty deeply and feel good about the opportunity to deliver that in 'twenty three.
Appreciate that color and a follow up for Chuck can you break out the <unk>.
The year over year margin decline and advance healthcare solutions, just kind of how much is supply chain price cost or is that bad debt included if you could size that thanks.
Are you talking about Youre talking about the third quarter specifically, yes.
Yes, so when you look at year over year the biggest.
The first thing is the bad debt at AMETEK.
Is pushing.
$5 million reserve, we still hope that we.
We haven't given up on collecting that and gain some back to that but thats an accounting reserve.
Good good management there.
I think that there is year over year. There is we've got FX and.
And inflation that's probably.
100 basis points.
That's causing us a problem and then really just lack of growth.
The supply chain the.
The rest of it is supply chain and fluke health it a little bit in our biological indicators today ASP.
Well I'm, sorry, what was that last one.
Biological indicators that ASP.
It's.
Literally a plastic violet.
When you think about the <unk> go through the sterilization process to calibrate the effectiveness of our sterilization cycle.
Got it appreciate it thank you.
Thanks Dean.
Your next question is from the line of Josh <unk> with Morgan Stanley . Please go ahead.
Hi, good morning, guys.
Hey, Josh.
Jim maybe just.
Kind of closed out some that Deane was asking about in terms of the backlog I mean, we're hearing supply chain getting better pretty quickly here across a whole different host of verticals and product lines. It doesn't really look like <unk> guidance in iOS has significant amount of backlog reduction or are there some <unk>.
<unk> about seasonality orders or something else going in there, but all of that extra backlog. I mean is that something that you should be able to work down over the next couple of months and.
Would you prefer to keep more backlog in this business versus just kind of get it all out the door in a quarter or two for for that excess.
Well I think first it starts with customers and obviously, we're doing everything to take care of customers.
Fluke specifically.
And more broadly, but flip specifically pointed sales very strong as we said in the prepared remarks, it's double digit across all regions. So so point of sales good right now so we obviously want to take.
Take out take advantage of those opportunities.
Say, Josh so I would characterize the supply chain is broadly getting better but at the end of the day, it's down to a few hundred components around <unk> that still have very very long lead times like in the $50 60 week kind of timeframe. So while broadly with that number of components has gone down dramatically.
A number of components that are keeping our lead times out there now we're more used to it its more in our cycle. So but that's why we suggested in the prepared remarks that supply chain constraints, probably continue into 'twenty, three and I think thats pretty well documented around the electronics supply chain world. So.
We will take down a little bit of backlog here, but we will I think the robustness of what we do relative to Fps as those continued improvements help helping us and Thats why you see strong growth in iOS in the fourth quarter, but obviously as we as we said in Dean's question will still go into the year with what I would call.
A nice sized backlog in which to mitigate any potential short cycled challenges that might be out there potentially.
Okay. So there won't be a quarter, where you like blow out a $100 million all at once because supply chain gets better.
Some of these tailor it won't be I think I think we feel just that that <unk>.
Supply chain situations, just not that robust in that sense.
Got it and then just following up on Tech I mean performance in the quarter was pretty exceptional I know you guys have talked about kind of the.
Virtuous product redesign cycle that everyone's going through based on new chip availability.
Wondering how much is that determining kind of the go forward visibility intact versus maybe you have some residual backlog that could be electronics facing more susceptible as the economy slows.
Yes, I think one thing we've said from.
Since the inception afforded us that we were going to work diligently to improve the growth rate of tektronix and to reduce the cyclicality and so.
<unk> has exposure to cycles in the past and I think.
Pretty well, we've talked a lot with you and others about the fact that we've made good progress in that regard what we're really seeing and we said in the prepared remarks around the seven consecutive quarters of growth is really of the secular drivers playing out the innovation cycle that has been such a great success at Tektronix really hits the market at the right.
Time relative to the kinds of things, whether it's the power challenges in the EV market or in Iot.
Everything becoming digital requiring a hardware backbone infrastructure all of those dynamics are secular in nature and are going to continue to be part of the investment cycle I think.
Over the next several years now part of the business will still be exposed to some of the macro potentially but I think the backlog and the work we've done around innovation matched to the secular drivers is ultimately going to make it growth here and more durable for sure.
Great. Thanks, I'll leave it there.
Thanks.
Your next question is from the line of Steve Tusa with Jpmorgan. Please go ahead.
Hi, Steve.
Hey, How's it going.
Yes.
Good.
Just on the on the I guess the follow up to Dean's question on the fourth quarter at IHS.
It looks like Youre still growing core but margins are down maybe thats for extra something like that.
Can we get a bridge kind of to the fourth quarter there for IHS margins.
Yes so.
When you look at it.
Biggest thing is a little bit of FX, but I'd say.
More in IHS in fourth quarter around inflation there.
Yet.
It takes longer to get pricing.
In the health segment, and so I think inflation.
A little bit ahead of us there. Unlike maybe the rest of our portfolio, where we have been able to be ahead and we're headed in total and that's probably the biggest thing.
The recent were down in the fourth quarter.
I guess why wouldn't that have been hitting you already.
I don't know over the last like 18 months.
Of inflationary pressures YY is that hitting you know in the fourth quarter.
Well I think the.
It has been hitting us, but FX has also accelerated.
And it's hitting us a little bit more as well, Steve I think the other part of that is.
With the volumes that we ship in healthcare because the predominance of the revenue being in consumables and service.
We have we were able to mitigate some of those supply chain and expenses for a longer period of time than.
Then we were in some of the other businesses. So as Chuck said, we're seeing a little bit more inflation. Most of this all predicted most of the many of these things and will ultimately we're continuing to improve margins here at health. So we feel like is with mid single digit growth in the fourth quarter and into next year, we're going to.
We'll start to see some of these improvements playing out.
What's the carryover level of price you guys have into next year.
If you just snap the line today.
For total company.
It didn't do anything different while the first half is probably a lot like the second half of this year, so probably plus.
4% to 5%.
And we might last a few things there.
We would expect to continue to deploy price to offset.
With inflation throughout the year so.
It might be a little less than this year, but that's just a theory, we have to wait and see what inflation is we're committed to being ahead on our price cost.
Got it and one last one any loosening up of the acquisition environment.
Jim anything looking a bit more attractive here.
Yes, I think for sure I think the.
Sure.
I think we've been patient and a number of situations here over the last several months.
But youre starting to see I think probably more on the <unk>.
Maybe not as much on the private equity side, but may be up but certainly elsewhere on the other parts of the private markets certainly some public things that.
But we're starting to see so yes, I think we feel we obviously youre going to be disciplined it's a noisy environment as we all know and will probably continue to be and that should continue to make.
<unk>.
Given the fact that we do work on these things throughout the throughout the cycles.
We feel confident we can we'll be able to deploy some things that can certainly accelerate what we're trying to do in 2023.
Great. Thanks, a lot.
Thanks, Steve.
Your next question is from the lineup Julian Mitchell with Barclays. Please go ahead.
Hi, Hello.
Maybe just.
Just a first question around the hardware business.
Just trying to understand exactly what's going on in orders I think orders in holiday were up 9% in Q2 year on year.
It sounds like they were up more.
Maybe low mid single digit Q3, and then as the point that then down in Q4.
And that's helping to explain the backlog.
Reduction that's taking place.
And if there's any difference to call out between.
Hardware orders trends that iOS versus PT at the moment.
Julian.
Afternoon Chuck.
I think you've got the bookings right in Q2, and Q3 and in Q4 the rate slows, but it doesn't go negative.
But in a normal Q4, what happens is we.
We would normally expect sales to exceed bookings and then take take backlog down and I think that's what we've got modeled in there but that doesn't mean, our orders are actually negative.
In Q4, I think the other thing Julien as you know as we started the year. We had always said really consistently that the second half orders would be slower than the first we saw orders much better than the first half. So some of that as we talked about was a little bit of things that we saw were coming in a little earlier because of lead times and things like that.
So partly it quarter by quarter.
Little bit dangerous just because of the strong demand we had stronger demand in the first half and I think that really speaks to the strength of what Chuck just described of how we're really we're really obviously saw very strong third and we're going to continue to see a strong fourth so I think it just speaks to the orders are played out almost.
Better than we thought for the full year for sure and I think it puts us as we as.
As we talked about puts us in a great position for 'twenty three.
Thanks, very much and then my follow up just on the healthcare segment.
You took on slide 14 about a modest pace of recovery there.
Ex software piece in 2023.
I guess I'm really trying to think about the overall healthcare business from him I think this year, you're guiding for just under 2% core growth.
For the year.
With a very big a decent step up again in Q4, when you're thinking about next year.
What's the sort of framework for healthcare growth I think it's tended to come in a bit below what people had hoped for various reasons in the last two or three years.
We think in coal growth is similar to this year is just under 2% next year is that a chance to do better than that.
Yes, I think first of all what we're trying to sort of frame for 'twenty three as we think the hospital market is going to be better in 'twenty three in 'twenty. Two I think it's pretty well documented if you look at some of the public hospitals. As example in the U S. Certainly the challenges obviously with Covid in the first part of the year and some of the labor challenges that they've had we think that.
We've studied it pretty deeply we certainly think that the market will be good next year and we think mid single digit is possible, we're going to see that in the fourth and we think thats possible leading into the year. So so it won't be back to what I'll call normal I think we're still determining what the new normal is but I think as we look.
From Q3 to Q4, it gets better it gets better it probably Q4 to Q1. So I think we're pretty I don't want to be bullish necessarily in the overall situation.
And total Pollyannish Lee if you will but I think for sure the market is going to be better in 'twenty three than it was in 'twenty two and as we look out. We just finished our strategic plans with all of our healthcare businesses 24 looks better than 23. So I think obviously COVID-19 wasn't that far away. When we really think about it it feels that way a little bit but.
It was only four or five months ago. So.
As I think we continue to see step through some things and as we said really what we saw.
From a revenue perspective, what it played out as we said if it hadn't been for a couple of supply very specific supply chain challenges. So I think in general we have we have some confidence in the outlook here.
Great. Thank you.
Thank you.
Your next question is from the line of Scott Davis with Melius Research. Please go ahead.
Hey, good afternoon guys.
Hi, Scott.
I wanted to ask about probation ex just since we're talking about healthcare does.
Do you think that business will be kind of ripping on labor shortages, but at the same time, we think it's maybe hard to do installs when you have labor shortages too. So how does the how does that what drives that business, how does that kind of ebb and flow with with the issues that are going on today.
Yes.
Got on around around productivity.
I think the the.
Productivity and value proposition that comes in the GI suite is very very positive and we talked about the SaaS numbers in the prepared remarks being very strong we've seen a little bit of delay on the sales funnel.
Scott from the standpoint of just taken a little longer to implement so some of our services revenue is a little slower than than it had been but we're probably we're very bullish on the business as the value proposition is very specific and very very much in right in the sweet spot.
Of what challenges hospitals in afcs are saying, so we secured a very large order with a large government entity that that's going to take a little while to implement but but I think just speaks to the breadth and strength of recognition of the value proposition. So yes, we think that business is going to continue to ask.
<unk> got a few few challenges that we've got to work through because some of those labor challenges that hospitals are just.
Kind of the folks in sterilization labs or whatever Theyre also in some of the it organizations, but I think when you start to look over the next 612 18 months, we feel we feel really strongly about the business and its obviously still on track from a profitability and returns perspective, So we feel really good about it right now.
Okay. Good and then follow up earlier question on M&A, you had an interesting response, which perhaps was different than what you've said in the past where you mentioned publix.
Now just to be clear are you talking about pieces of public companies you could potentially take.
Or are you talking about potential public to private or public to public I'm sorry.
Opportunities, which is not necessarily something you guys have done a lot of in the past.
Yes, I would say first of all.
When you look across.
Just public valuations being more in the zone.
Certain places so I think it really is more a general comment relative to that but we're certainly eyes wide open and whatever opportunities are available and we.
We've got obviously a really are.
A very specific set of places, where we think theres great investment opportunities, but we're also patient relative to those situations. So.
As you know well I never want to predict what we do.
For lots of reasons, but but we feel good about where the environment is going to be going here over the next several months.
Fair, Okay best of luck. Thanks, everybody I appreciate it thanks, Scott Yeah, great tuck in.
Your next question is from the line of Jeff Sprague with vertical Research partners. Please go ahead.
Hello, Good day, everyone.
Hi, guys doing.
Great.
Just a little kind of geographic walk here, if we could.
First first on China.
Do you think the strength here is kind of reflective of just the <unk>.
<unk> down.
<unk> or <unk>.
I don't think youre expecting 20% organic growth to continue necessarily but it does seem extraordinarily strong so just what's driving that.
What are you expecting here in the next quarter or two.
Well, we've had so much strength in China over the last three or four years I mean, I think it really does speak to the how we built the businesses over there.
Pretty independent China manufacturing and design for the market.
There is a little bit of a bounce there so thats I think thats definitely true.
But our outlook still is pretty good.
And I think obviously healthcare as we said in the prepared remarks.
IOS and PT were good iOS, obviously, a little or healthcare a little slower just because of the COVID-19 lockdown. So I think as we look out we still continue to see a good growth opportunity. There, we'll see that in the fourth quarter, we should see it next year some of that backlog, obviously that we described in the previous <unk>.
Conversations includes China as well so so we think this can be a good market here.
Certainly for the next several quarters as we look out on.
And how about western Europe .
Any signs of cracking there.
It's.
For obvious reasons, we're continuing to put a real microscope on everything we do over their point of sale remained pretty good. So I think when we look across some of the things that would typically tell us we had good healthcare.
I think it was our best region for healthcare. So I think at the end of the day, we continue to think Western Europe , probably has hit some snarls here, but but if you look at the size that we would typically look at still holding up there pretty well, but I would anticipate it's hard to believe that just given some of the challenges they've got.
That there isn't some some issues certainly in dollars and 23 and it's part of our scenario analysis.
And maybe just the last one sort of on that kind of thinking about scenarios.
Obviously, theres a lot of mix, even within the segments, but at a high level.
How would you have us think about decremental margins, if we were to.
Get into kind of.
You know call it a moderate recession environment, where youre, putting up negative maybe mid single digit type organic growth.
Well I think I think.
If we got to negative excellent negative growth you can probably expect what we did during 2020.
Our up and down we try to manage it to the same level, but keep in mind that we've got a really strong elevated backlog position and while we expect slowing we also.
It might not be your base case, but we've always said we manage to that.
Down Decrementals I think it's part of our as we look at our playbook to Scott.
Sorry, Jeff.
To Scott's question around how we should think about all of this I really think that when we look at broadly our solutions and Scott got to the probation question, but if you look broadly across the portfolio.
Everything we do pretty much today is around productivity improvements whether it's the probation example, we were talking about or or what we do at service channel like we talked about in the prepared remarks, how we're bringing innovation and design cycle times down with our Tektronix solutions, what we talked about the prepared remarks around solar.
Fluke, we're really focused on saving money for customers with our solutions because of our workflow strategy and so I think to Chuck's point.
We certainly are scenarios across the board of what could happen relative to the macro but I'd be remiss, if I didn't sort of think about what we've really built in these workflow strategies is really to be to be there for customers. If their toughest with their toughest challenges and I think we're certainly seeing that in a number of places.
Where our orders are very very strong because.
The reality is is that customers are going to need to save money and in the future I think it's going to be more important and our solutions really play play well to those challenges.
Alright, thanks for that perspective.
Okay.
Your next question, Jeff in the lineup.
Next question is from the line of Andrew <unk> with Bank of America. Please go ahead.
Yes, hi, good morning.
Good morning, how are you doing.
I'm doing great I guess, if I'm warning it's afternoon now.
Good morning for you though.
So when you guys talked about 23 hour Polk and I. Appreciate it's very very initial how should we be thinking about the pricing.
We frame 'twenty three I think price was six points in the third quarter. So how much momentum do have go into next year.
Well.
Momentum perspective, obviously, we will have more price in the second half than we did the first half.
Of this year, so I think thats, the starting point from a momentum perspective as Chuck said before we don't we don't take some of that lightly we're continuing to look at where situations, where we would continue to get more price.
So I think I think we think the pricing envelope for next year certainly in the first it's hard to have a 12 month outlook by every quarter.
The price rate itself.
He will not be as high as it's been this year, but our ability to retain price while at the same time getting additional price I think still still is there. So are probably stay away from a specific number until we kind of get closer to the guide and how we see the fourth quarter play out, but I think we still as we've talked about we think we can.
Can get more price in the software businesses, we think theres still some more price to get the healthcare businesses. So so theres still opportunity within the portfolio.
To accelerate some things while at the same time continuing to do the things that we've done so well over the last.
Several several quarters.
Got you and just a slightly different question.
There were all these restrictions imposed.
Imposed by the by the administration on China semiconductor production I think there was a headline today that SK hynix is like thinking to pull out of China.
How do you how should we think about businesses like tech.
Keathley in China, and I know.
Even business like Fluke will have exposure to just sort of a regular day to day Capex in China have you guys been able to quantify or do any sort of initial assessment of the potential impact of the restrictions. Thanks. So much.
Yeah. So first of all as you know.
<unk> exposure broadly through Florida is is still pretty small so.
We're certainly aware of what's going on there.
Given the current regulations, we feel comfortable that that's not a huge impact.
Relative to customers, we typically don't sell under production Fabs, we tend to be more in the innovation cycle. Some of the some of that work that maybe that gets shut down or moved out of China gets moved to other places we should benefit from that whether it be the U S. Whether it would be back into Korea or other parts of the world.
We benefit from some of those changes over time as we see those play out we need to continue to evaluate what.
What we see and what happens in China from those regulations, which are still pretty new I think what you know to be true is that we've continued to countermeasure challenges in China and still be successful over the last three years, we've had good growth over there. Despite export controls that started several years ago and some of the other things we've lost close to 28 customers at <unk>.
Over the last few years because of export control. So we've weathered a number of these things as they have been applied and I think we'll continue to do that as we see fit and depending.
Depending on reactions that come back from China will react to those as well. So I think we understand what's going on there today, it's obviously a.
A very fluid environment, we'll continue to watch it but I think one thing that's been true over the last several years is our ability to be successful despite.
Be able to play within the rules and do the things necessary to continue to build business more broadly around the world. Thanks.
Thanks, so much.
Thanks, Andrew.
Your next question is from the line of Nigel Coe with Wolfe Research. Please go ahead.
Thanks.
Hello, and thanks for the question.
Hi, Nigel.
Hey, guys. So yeah look.
Obviously lots of impressive growth rates across the portfolio So SME with.
Gordon accruing up high teens and iOS.
So it seems like Thats really clicking now, but we don't really expect.
These businesses to grow high teens, maybe but slow and steady so just wondering to.
To provide a bit more breakdown on what was driving that growth you mentioned pricing in software, but just wondering what's driving that strong growth rate maybe.
Maybe talk about net retention there as well.
Yeah. Thanks, Andrew for the question, what we really as we've said with the addition of service channel and the combination of service channel.
Gordian and accruing into the one business that we really call facility and asset lifecycle really a very strong quarter, we'd always said that we're going to have some self help happening you'd occurring over time and we saw good steps forward in that regard. So I think that business is very good we service channel is really a great value proposition.
Four facilities managers, we're transitioning that business.
As well as we mentioned in the prepared remarks, where we're trying to take some of the pass through revenue and turn it into longer term SaaS revenue. So.
We've executed well net dollar retention as you pointed out is improving so that is inevitably probably now our fourth biggest business and we're pretty pretty quickly be probably moving up the scale in that regard just because of its impressive growth rates. So I think it's been a great addition to the portfolio, we still have great profitability opportunity in the business.
Gordian certainly firing on all cylinders.
So I think we feel like we feel very good about it lots of work to still do.
But I think we really feel good about what's that and you heard that in the prepared remarks, I think longer term as we are.
Certainly see those opportunities to still be there.
Consistent with some of the comments I made about value propositions and productivity really our solutions really give customers better view of their facilities better view of their assets.
They can reduce cost how they can reduce investment and obviously pretty much everybody in the world is think of that way. These days so.
That value proposition is going to continue to resonate well into 'twenty three for sure.
Okay. So it sounds like you're starting to see the revenue synergies from put together three businesses okay.
And then.
Going back to Tektronix and understand the chip and everything feckless second themes, but you are adding store the amount of prototypes healthy. This year I think you've launched the two series.
Mid year and Theres been other launches this year, so I'm wondering.
Have those new product families that had a disproportionate impact on growth rate from here.
Yes.
I would say the bank incredibly successful, but two series just launched and really launched in the third quarter.
Sure.
Around the world and it is exceptional and I think it really that is a product along with.
The new beef the version of our six series two big launches. The six series just won our innovation awarded at Florida last week.
We're still seeing early days of those innovations to be honest with you. So are our capability. There is just only increasing with with the value proposition of those products. Most of our success in the quarter really was more was more broad based in that so.
We still think we're in the early days of some of those successes.
And.
More broadly the innovations that we've really been doing over the last 12 months to 18 months are still continuing to help from a success perspective.
Okay I'll leave it there thank you.
Alright, Thanks Nigel.
Your next question is from the line of Andy Kaplowitz with Citigroup. Please go ahead.
Good day got Andy.
You said, Jim you said you examine demand very deeply at some of your shorter cycle businesses and you mentioned point of sale is still very good at fluke, obviously, we've begun to see some.
Some destocking more consumer facing businesses in other companies, but it seems like you're suggesting that your short cycle industrial channel inventories in reasonably good shape, but maybe you could just elaborate on that.
Yes, sure point of sale of both Luca Tech has been good as we as I was mentioning before.
<unk> inventories have been at all time lows for the better part of a year now.
So we feel we don't feel like there is destocking risk.
Just given given lead times, we really while orders have been strong as you well know our revenue has been accelerating so we feel we look at the combination of backlog and an inventory in order to make sure that things are not out of whack, there and we feel good about that little bit of elevated inventory at fluke.
From a few years ago, but not anything reset but point of sale really.
And our lead times sort of.
Just the math there would suggest that that's nothing more than a little bit of elevated lead times, we're going to watch pass more than anything.
And that continues to be strong so.
Certainly, we're keeping a watchful eye on it but as we sort of snap the line right now what we're seeing.
So far things look still look pretty good.
So we're not in any way shape or form thinking that that the whats happening around the macro more broadly and certainly into next year wouldn't influence that and Thats why I think we're keeping a close watch on that pretty much every day and every week.
That's helpful. Jim and then Chuck you've continued to generate basically spot on cash flow versus your own expectations.
Conversion when most a lot of your peers have faltered too to an extent we know much of the good performance is likely coming from Fps, but why haven't you incurred.
Bigger inventory build of receivables build as your core growth has been higher and do you see conversion continuing at this rate in 'twenty three.
Well first I'll take the easiest 1% to 105% for the year is the convert the REIT conversion rate for this business I think there's two things that are really helping us here.
Most obvious one is FBS.
And it really tough supply chain environment, thats, not only helping us get products out the door, but mitigating the impact that inventory is having on this we do have elevated inventories from where we would normally be but I think thats certainly.
We've done very well maybe versus some of our peers I would theorize because of Fps.
The other pieces.
Our.
The addition of these software businesses that will taken in whole at negative working capital and so the.
Free cash flow generation from the software businesses is incredibly stable and I think that that's an element that we're very.
Playing out as we expected, but very happy with.
And then Chuck just real briefly just given the changes on your balance sheet should we knowing that there is some floating rate debt should we think about higher interest expense in 'twenty three how do we think about that.
I think I think because we are delevering.
We'll give absolute guidance going out, but I don't think it's a huge headwind at this point.
Great.
Even though the rates are going up but our debt is coming down overall.
Overall, our debt level is really very low we would expect to be.
Well, we're at two <unk> net leverage now and going down between now and the end of the year.
Thank you.
Today's final question will come from the line of Joe Giordano with Cowen. Please go ahead.
Hey, guys, Hi, gentlemen, give me into.
Two quick ones from me.
When we think about the elective volumes and let's just focus on North America.
For this.
We haven't really had by coby lockdowns or anything for a long time now is there some risk that maybe the bar to go in for an elective surgery has just changed and like like we're trying to get back to a level that like you did the level anymore.
That is a possibility.
No I mean, I think at the end of the day when you look at where we've been on elective here lately. We've got we've been pretty close to the close of the pain here. So China has obviously its own story, but when you look at the U S. We've been pretty much spot on and what we thought so.
I think that's where we see it today it is COVID-19 wasn't that long ago and labor productivity.
Labor and labor challenges do restrict we have a number of customers that are not running all of their own cars right now, but would like to so I think youre going to continue to see that as an improvement over time and fundamentally thats going to be as I mentioned a few questions.
Questions before about how do we see the 23 hospital market. We think it we think it starts it improves off of this year 'twenty two is probably the low point from a combination of all kinds of challenges the financial challenges that occurred that sort of cropped up in 'twenty, one and 'twenty two the labor challenges and Covid, So 'twenty twos.
Probably the low point in that regard and we continue to see things put pull up here over the next.
23.
Fair enough and just to be clear I wasn't talking about your ability to forecast where electives, whereas I just meant like as a country what do elective is actually yes.
I think they will.
They are just going to continue to improve a little bit, but not theyre not going to go from nine.
92 to 100 to 105 or 110, right away, but theyre going to progressively move up through <unk>.
I suspect over the next several quarters.
Okay, and then just last like we've been hearing from some companies that while the order environment is still pretty good but like behaviorally, maybe maybe customers are being a little bit more measured about saying, yes to things.
So are you seeing any sort of like incremental behavioral shifts or like the bar to accept projects or anything like that is moving somewhat higher are taking longer to.
To get to the end of the line.
Yes, I think we talked a little bit because we are seeing in a few places where funnel sales funnels are extending a little bit where we met a closed business I'm just going to pick a number 60 days, maybe thats moved to 70 days or 75 days. So so we are seeing sales funnels to close business move out a little bit that's in software and hard.
We're a little bit so.
So yes, we are seeing a little bit of that but we've not losing business I think in a number of places where we saw things extended that was.
Caught our eye.
In no situation that we lost any business. So so it's really just it comes down to maybe customers stretch their dollar a little bit and Thats why.
The point I made around our value propositions is so important because I think we're going to stay at the high at the high at the top of the list of things to do.
With our customer base simply because of the value proposition and our ability to save money and the return profile that you get from an investment in the workflow solutions that we've developed over the last five or six years. So it doesn't mean, it's going to happen exactly like we think it is from a timeframe perspective, but we're not we're not seeing things fall out yet, which I think is good news for <unk>.
We ended at <unk> 23 for sure.
Thanks, everyone.
This concludes the Q&A portion of today's call I would now like to hand, the call back to Jim Lico for any closing remarks.
Thanks, Dennis and thanks, everyone for taking the time today, we know you have a busy schedule today and this week.
Hopefully you heard from Chuck.
Our remarks on the Q&A as well as our prepared remarks, we're really proud of the quarter. We just had I think it demonstrates the power and the resiliency of the portfolio I think the gross margin and operating margin expansion and free cash flow.
It accelerated organic revenue, it's just demonstrative of the power of what we're building here and we're really excited about what's going on obviously a lot of noise out there both from a macro perspective and geopolitical we understand that we're not oblivious to that in any way shape or form we're preparing scenarios for that we will continue to see how things.
Play out here in the fourth quarter, and we will look forward to talking to you through the quarter and obviously into 'twenty three as we get ready for our guidance in the new year. So thanks, everyone for the time good luck.
This week and we'll look forward to talking to you all soon thank you.
This concludes for the Corporation's third quarter 2022 earnings results Conference call. Thank you for joining you may now disconnect.
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Yes.
Okay.
Okay.