Fortive Corporation

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

Thank you, Pasha. Good afternoon, everyone, and thank you for joining us on the call. With us today are Jim Liko, our President and Chief Executive Officer, and Chuck McLaughlin, our Senior Vice President and Chief Financial Officer. We present certain non-GAAP financial measures on today's call. Information required by SEC Regulation G relating to these non-GAAP financial measures are available on the Investors section of our website, www.4div.com, under the heading Investors Quarterly Results. We completed the separation of our prior Industrial Technologies segment through the spinoff of Von Thier Corporation on October 9, 2020, and have accordingly included the results of the Industrial Technologies segment as discontinued operations. The results presented on this call are based on continuing operations. During the presentation, we will describe certain of the more significant factors that impacted year-over-year performance. All references to period-to-period increases or decreases and financial metrics are year-over-year on a continuing operations basis. During the call, we will make certain forward-looking statements within the meaning of the federal securities laws, including statements regarding events or developments that we expect or anticipate will or may occur in the future. These forward-looking statements are subject to a number of risks and uncertainties, and actual results might differ materially from any forward-looking statements that we make today. Information regarding these factors that may cause actual results to differ materially from these forward-looking statements is available in our SEC filings, including our annual report on Form 10-K for the year ended December 31, 2020. These forward-looking statements speak only as of the date that they are made, and we do not assume any obligation to update any forward-looking statements. With that, I'd like to turn the call over to Jim.

Thanks, Griffin, and good afternoon, everyone. We were very pleased with our second quarter results. As you can see on slide three, our performance once again highlighted the benefits of our strategy to provide differentiated, connected workflow solutions for our customers, creating a portfolio with enhanced resilience and long-term earnings power. During the quarter, we capitalized on accelerating point-of-sale trends across a number of our larger businesses, continued growth from our software offerings, and improving conditions across our key end markets. Against this backdrop, we delivered core revenue growth and adjusted operating profit margins that exceeded the high end of our guidance, driving exceptional earnings growth and pre-cash flow conversion. As we highlighted at our investor day on May 19th, we are building on the foundation of our advantaged hardware positions and expanding our software capabilities to address our customers' critical workflow needs and accelerate their ongoing digital transformation. In the second quarter, our SaaS offerings delivered low double-digit growth and we also drove significant improvement across our professional services offerings. We continue to see strong momentum at eMate, including increasing demand from its expansion into the food and beverage, pharmaceutical, and healthcare verticals. Gordian and the current both had strong quarters as they executed on opportunities provided by increasing demand from facility owner-operators and improvements in access to customer sites. Both companies are well-positioned to capitalize as customers focused on post-COVID return-to-work challenges and digital transformation priorities. Census also performed very well in the quarter as access to hospital customers improved, executing on strong demand for its SAS offerings among existing and new independent delivery network customers. Looking across the portfolio, we continue to be excited about our expanding offering of EHS workflow solutions, which are well positioned to meet the significant long-term sustainability requirements of our customers. ISC and Intellects performed well, capitalizing on strong, broad-based growth across end markets and key geographies. At the same time, we are excited with the early progress at EHS AI, where the company closed its largest deal to date in its first joint marketing campaign with Intellects and generated strong growth in its sales pipeline. Throughout the second quarter, we continue to apply the Florida business system across the portfolio to drive innovation, growth, and share gains. Deployment of our lean portfolio management tool set which significantly accelerates the efficiency and impact of R&D investments, achieved a greater than 40% increase in our on-time program delivery. The application of FBS and digital analytics in search optimization generated 25% growth in digital traffic from pre-pandemic levels across the portfolio. Meanwhile, the use of FBS growth tools has accelerated innovation at Fluke Health Solutions over the past 18 months and continues to drive excellent top-line performance. We have created good early momentum in our partnership with Pioneer Square Labs, including the recent spin-in of TeamSense, a provider of innovative workflow solutions to streamline communications with hourly workers. This marks the first business incubated at Pioneer Square Labs to be integrated into the Ford portfolio. While still very early, we are pleased with the progress thus far at TeamSense and are excited to develop additional technologies that accelerate safety and productivity solutions for customers within our core markets. In early July, we announced the acquisition of Service Channel. The transaction brings a differentiated, high-growth software business with an integrated service provider network and significant proprietary data assets to the portfolio, enhancing our ability to meet the evolving needs of facility owners around the world. Following the expected closing of the acquisition in Q3, we will have significant balance sheet capacity supported by our strong and resilient free cash flow generation. As we highlighted at our investor day, we see substantial runway across our $40 billion surf market for disciplined capital allocation to accelerate our strategy. Turning to a quick summary of the results in the quarter on slide four, we generated year-over-year total revenue growth of 26.7% as revenue strength exceeded the high end of our guidance. Adjusted operating margin was 22.2%, while adjusted earnings per share was 66 cents, representing a year-over-year increase of 53.5%. Given the outperformance for both top line and our adjusted operating margin, we delivered $282 million of free cash flow, which represented 118% conversion of adjusted net income. On slide five, we take a closer look at the intelligent operating solution segment. IOS posted total revenue growth of 31.2% in the second quarter. This included mid-20% core growth in North America, low 30% core growth in Western Europe, and low 20% core growth in China. Fluke's core revenue increased in the mid-30% range. Fluke also grew by mid-single digits on a sequential basis as it continued to see robust demand across its businesses, highlighted by growth at Fluke Industrial. Fluke Industrial generated share gains across a range of key channel partners and retail accounts as point-of-sale accelerated through the quarter. Fluke's broader II900 acoustic imaging product line also continues to perform very well, as revenue approximately doubled in the quarter on strong growth across both Western Europe and North America. Fluke Networks also performed well, driven by the recent launch of its LinkIQ product line, which continues to exceed initial expectations tied to office reopenings and network modifications. In Fluke Reliability, our efforts to accelerate performance-approved technique are gaining traction, as we took advantage of increasing demand for alignment and other services. while E-Mate also delivered another strong quarter. With the accelerated pace of orders that flew, we did see some backlog build due to supply chain responsiveness. Industrial scientific increased by mid-teens, driven by strong execution and instruments in rental, as demand from oil and gas markets rebounded and the business continued its expansion into new end markets. The company's INET offering remained resilient, increasing by mid-single digits, with net retention solidly above 100%. IntellX grew by high single digits in Q2, reporting a record revenue quarter. IntellX continues to leverage FBS and has driven improvements in lead generation and funnel conversion. Also in the second quarter, IntellX closed multiple deals for its enhanced ESG platform to help customers launch, scale, and optimize their sustainability programs and meet increasing demand for transparency on a growing set of critical non-financial reporting metrics. Accurrent grew by mid-single digits in the second quarter with low double-digit growth in its SaaS business. Accurrent generated strong sales and bookings for its Meridian solution for engineering document management and its maintenance connection CMMS offerings. The business also capitalized on the strong demand for its EMS event, workspace, and resource scheduling offerings as companies plan and execute their return-to-work strategies. The company continues to generate new customer logo wins and improving growth in recurring bookings. Importantly, Accruant also delivered improved performance in its professional service business, which generated mid-single-digit growth as customer site access continued to improve. Gordian increased by mid-teens, driven by low 20% growth in the procurement business and high teens growth in estimating. Gordian generated a record month for procurement revenue in June, with accelerating timelines for key projects across a number of large customers. This included increased project spend, by the New York City Department of Education and School Construction Authority. Moving to slide six, precision technology segment posted a total revenue increase of 25.1% in the second quarter. This included low 20% growth in North America, mid 20% growth in Western Europe, and mid-teens growth in China. Tektronix increased by approximately 30%, with another quarter of strong demand across its product businesses, including accelerating point of sale trends in each of its major regions. Both mainstream and performance oscilloscopes had a strong quarter with high demand for semiconductor, industrial manufacturing, and communications applications. Tektronix's service business again showed its stability and resilience, increasing by low teens. Tektronix continues to benefit from the accelerated focus on driving innovation, with Q2 new product introductions performing very well, including its family of automated test solutions for high-speed data transfer. In the second quarter, Tektronix held six regional innovation forum events, which stimulated the adoption of its TechScope platform, resulting in accelerated funnel creation for the company's broader hardware and software offerings. Sensing technologies increased by low teens in the second quarter, with growth driven by continuation of the broad market recovery. Sensing performed very well in China, with another quarter of mid-teens growth driven by demand for factory automation solutions. Elsewhere, Anderson Negla continues to make progress with its approval of its paperless process recorder IoT solution aimed at the dairy industry, with broader commercial rollout expected in the second half of the year. Sensing also continues to drive market share gains elsewhere across its portfolio, particularly at Cetra, led by its differentiated critical environment solution and strong demand across its HVAC customers. Taxi EMC grew in the low 20% range, with the business seeing some alleviation of the COVID-related shutdowns and approval delays that impacted shipments in previous quarters. Pax IMC continues to see good growth in the commercial space market with the resumption of launches by OneWeb, providing recurring revenue for smart controllers and initiators. Also, on July 20th, we were excited to watch the company's mission-critical technology ensure safe and reliable separation of Blue Origin's New Shepard capsule from its booster during its maiden voyage. Moving to advanced healthcare solutions on slide seven. Total revenue increased 21.8%, including 11% core growth. This included high single-digit core growth in each of North America, Western Europe, and China markets. ASP grew by high single digits in the second quarter, led by strong growth in Western Europe and China. ASP also realized improved growth in North America, highlighted by high single-digit growth in the U.S. Overall, ASP grew its consumable revenue high teens as the rate of elective procedures across most geographies continued to improve. While elective procedure volumes increased on a year-over-year basis, Q2 volumes came in a bit lower than expected at approximately 93% of pre-COVID levels, which was consistent with the Q1 exit rate. ASP also continued to expand its global installed base of terminal sterilization capital equipment, which grew at a 3.5% annualized rate in Q2. We expect this continued installed base expansion to provide an additional tailwind to consumable revenue as procedure volumes normalize going forward. Census increased in the mid-20% range with mid-teens growth in its census track SAS offering, as well as strong growth in its professional services business. Many hospital customers are now allowing access to vendors, which resulted in a significant increase in activity in the second quarter, particularly with integrated delivery networks. Fluke Health Solutions increased by low double digits, even as it lapped a sizable COVID-related revenue tailwind in the prior year. FHF saw high teens growth from its optimized and one QA software solutions, which benefited from accelerated growth of investments over the last 18 months. With that, I'll pass it over to Chuck. We'll take you through some additional details on our margins, free cash flow, and balance sheet. Thanks, Jim, and good afternoon, everyone. We delivered solid margin performance in Q2, driven primarily by strong fall through on our revenue outperformance. Adjusted gross margins were 57.3%, up 100 basis points on a year-over-year basis. This increase reflected 130 basis points of price realization as we delivered another quarter of solid performance managing price cost across the portfolio. Q2 adjusted operating profit margin was 22.2%, 170 basis points above the high end of our guidance, also driven by stronger volume and high associated fall throws. We reported 240 basis points of core operating margin expansion, including 570 basis points of core OMX at the iOS segment. Both Fluke and Tektronix delivered strong core operating margin expansion through disciplined application of FBS to drive sales conversion as demand accelerated across their end markets. At the same time, strong contributions from some of the acquired pieces of our portfolio, including ISC, Gordian, Census, and Landauer, also contributed to the margin outperformance across the segments. On slide 8, you can see that in the second quarter, we generated $282 million of free cash flow, representing a 118% conversion of adjusted net income. Free cash flow over the trailing 12 months increased 15% to $943 million. Today, our net leverage is approximately one times, and we expect net leverage to be around 1.2 times at year-end, including the funding of the acquisition of a service channel, but excluding any additional M&A. This gives us significant capacity to continue to deploy towards our key capital allocation priorities. Turning now to the guide on slide 9. Given the strong performance in the second quarter and the improvement in our outlook for the rest of the year, we are once again raising our 2021 guidance. For the full year, we now expect adjusted diluted net earnings per share to be $2.65 to $2.75, representing a year-over-year growth of 27% to 32% on a continuing operations basis. This assumes total revenue growth of 13.5% to 15%, adjusted operating profit margins of 22.5% to 23.5%, and an effective tax rate of 14% to 14.5%. It also assumes total revenue growth of 8.5% to 11% in the second half of 2021. We continue to expect free cash flow conversion to be approximately 105% of adjusted net income for the full year. We are initiating third quarter adjusted diluted net earnings per share guidance of $0.62 to $0.66, representing year-over-year growth of 24% to 32%. This assumes total revenue growth of 11.5% to 14.5%, adjusted operating profit margin of 21.5% to 22.5%, and an effective tax rate of 14% to 14.5%. For the third quarter, we expect free cash flow conversion to be approximately 105% of adjusted net income. With that, I'll pass it back to Jim for some closing remarks. Thanks, Chuck. Before we move to questions, I want to provide a quick update on our sustainability and inclusion and diversity efforts, which is shown on slide 11. During our Investor Day program on May 19th, we introduced an accelerated greenhouse gas reduction goal. which now targets a reduction of 50% in greenhouse gas intensity for scope one and scope two emissions by 2025 relative to our 2017 base year. During the second quarter, we also issued our 2021 sustainability report, which included Florida's second annual GRI index, first annual SASB index, and the 2017 to 2020 greenhouse gas emissions profile. During the quarter, we also became a signatory to the UN Global Compact, committed to alignment with the task force on climate-related financial disclosure by 2022, and announced our 2025 aspirational inclusion and diversity goals. We continue to make significant strides and are highly committed to accelerating our sustainability and inclusion and diversity progress in the coming years. I'd also like to take the opportunity to thank our team and all of our stakeholders for your support over the first five years of our journey as an independent company. Across all three of our strategic segments, we are expanding on strong established positions with offerings that address the critical workflow needs of our customers in markets with attractive long-term growth drivers. Our strong earnings and free cash flow performance in the first half of this year clearly demonstrated the benefits of this strategic focus and the momentum building in our portfolio. As we look ahead, we will continue to invest in expanding the capabilities of the Florida business system as we accelerate operating improvements and innovations to increase the value we offer to our customers. With strong free cash flow and significant M&A capacity, we are well positioned to pursue the key organic and inorganic growth initiatives that will drive consistent double-digit earnings and free cash flow growth in the years to come. With that, I'll turn it back to Griffin.

Thanks, Jim. That concludes our formal comments. Pasha, we are now ready for questions.

Ladies and gentlemen, as a reminder, if you would like to ask a question, please press star followed by the number one on your telephone keypad. We ask that you please limit your questions to one and a follow-up. We'll pause for just a moment to compile the Q&A roster. Our first question is from the line of Steve Tosa with JP Morgan.

Good afternoon, Steve. Hey, guys. How's it going? Good. Just a question on the AHS margin. I think the fourth quarter, just backing into kind of the fourth quarter guidance, shows... margins that are kind of into the, like, beyond the mid-20s into kind of even the high 20s, maybe just some rounding going on there, but at kind of the high end of the range, what's implied. Am I looking at that the right way, and what's kind of the source of that strength, if so?

Thanks, Steve. That's a good question, and I think you're calculating it right.

You know, above the mid-20s, pushing... You know, around 26%, 27% I think is the right zone. What's pushing that is as we move through time, you know, we're starting to see acceleration in our revenue as elective surgeries get better, but also seasonally there's more revenue in the fourth quarter. You put those two things together, and that's what really drives the health margins at the segment level up.

So is that any read, I guess, is that any read into next year? Or is it like, you know, highly unusual seasonality? You know, like the fourth quarter is just way stronger than the rest. I mean, is there a reason why that seasonality is so acute? Or, you know, can we think about that as maybe, you know, a bit of a jumping off point at some stage?

I don't think from just where the OP is going to be is the jumping off point, but I do think in terms of every year, you should expect the fourth quarter to be stronger. But we have the back half of the year going up by a couple hundred basis points in each of the quarters, and I don't think that there's anything anomalous about this Q4 going forward, but I wouldn't take that and multiply it by four. I think we've got to go back to know a couple hundred basis points of growth in q1 and q2 on what we posted this year steve i would just add that you know i just had that you know like last year we sort of had that 25 as an exit rate not saying it was going to be the rate for every quarter but that would be a good jumping off point in which to take margins to the next level i think you're seeing that the same thing i think it's it's it's a combination of the fps work the full year effect of the fps work the full the full year effect of all the work that we're doing to continue to integrate the business drive margins and, as Chuck said, consumable revenue coming up, too, as well. So I just think the business is in a good trajectory right now overall. And, you know, obviously a big part of that is ASP.

Right. That makes a lot of sense. And just one follow-up on the margin for the total company. Did you ultimately have some of that cost come back? I think we were thinking of it in kind of the $75 million range, like temporary costs, and then some of those investments that hit this quarter year over year. I mean, did you guys ultimately see that stuff come through?

We did. There's two things going on for Q2. There was the year-over-year. We had $60 million of snapback costs. We did that. And then plus we did another $15 million in investments, and that did show up in Q2 for sure.

Yeah, so that's like a core incremental on EBITDA of like, I don't know, I can back into something like 65%, 70% kind of core incremental. I mean, is that the right kind of math?

Well, it is. So the straight year-over-year incrementals for Q2 is 31%, stronger than the mid-20s we talked about. But, yeah, with, you know, our incremental gross margins are going to be in that 65% range. So, yes, that is the right math. I wouldn't expect that to fall through at that every quarter.

In the second half, we would expect, as we've been talking about, 40% is the right thing for this, the second half we have going forward.

Yeah, right. Gotcha. Okay.

Thanks a lot.

Thanks, Steve. Your next question is from the line of Jeff Sprague with Vertical Research.

Hey, Jeff. Hey, thanks. Good afternoon, everyone. Hey, Jim and Chuck, could you follow up a little bit on the POS comments? And I don't know if you have to kind of break it down, but Fluke and a couple other businesses. Are the sales we're observing here in the quarter, you know, trailing or outpacing PLS? And I just wonder if you have any color on what's going on with channel inventories, if other channels in any way caught up or, you know, this is a pretty good indication of what in demand is.

Yeah, we saw, you know, one of the things, Jeff, as obviously with the beat in revenue and the strength that we saw, particularly as it accelerated through the quarter, point of sale is an important target, as you're asking. You're exactly right. We saw good POS that continued to improve through the quarter. I think it will continue to improve. Obviously, a little bit of an easier comp in the quarter, but both at Fluke and at Tech, we saw, as an example, POS in the Americas, we saw in the 30% range, so better even than our sales, total sales in some cases. So very good position. We're also obviously making sure, given supply chain discussions around the world, we're making sure that inventories aren't up, that we're not seeing accelerated buying. We're using a new metric where we not only look at point-of-sale sales, But we also look at orders on hand to sort of understand are we seeing a leading situation or not. And we're certainly seeing things continue to be good. So, you know, hence we took the revenue guide up. Both Fluke and Tech are performing well, and, you know, I think we're in a good place. And we're certainly, particularly in the U.S. and Europe where we have the best data, we're certainly in a good place from an inventory position. We don't feel like we're in any situation building excessive inventory. Okay.

And I wonder if you could just take a moment on tech in particular and discuss what's going on in some of the new verticals you are trying to pursue. I think that's going to be an important part of making sure tech puts up the kind of growth you want to see over time, not just in cyclical rebound. So where are we at on that push? Some of these new verticals, maybe some color on what percent of tech sales these are now and how you see those progressing?

Yeah, you know, I think because we're feeling, as we said in the first quarter commentary and again this time, you know, we are seeing automotive data centers as two particular verticals that have continued to increase. I think on a percentage basis they're about the same simply because the total revenue is coming up. And obviously in places like Keithley, we still continue to see revenue in semiconductors. So I don't think we've necessarily moved the needle as a percent of sales, but on a total basis in terms of total dollars, we're certainly up. And as we mentioned in the prepared remarks, the advent of TechScope, which is sort of a software offering, is also, I think, helps users connect multiple scopes and multiple channels and really bring more data together effectively. is also accelerated in some new verticals as well. So I think just to answer your question specifically, I don't think we've seen a demonstrative difference necessarily in the percent of sales, but we have seen substantially greater sales in those verticals over time, and that should bode well for the future too.

Great. Thanks. I appreciate the call. Thanks, Jeff.

And next question is from the line of Scott Davis with Milius Research.

Hi, Scott. Good afternoon slash evening to everyone. But a couple things here. I mean, first of all, I mean, obviously you're getting operating leverage, but is price kind of in line with your cost increases? Are you still catching up a little bit on that? Or another way to say it is we're 130 bps up on price. Is that accelerating with prices? you know, through the year here.

Yeah. We're in a great shape on price-cost, Scott. First of all, as you said, 130 bps in the quarter in the hardware businesses in particular. We'll double that number in the second half. So we're in a very good position relative to price. As you know, we've gotten good price over the years, so this is a compounding effect. You saw the price read through as well on the gross margin improvement in the second quarter. So we feel very good. And really, you know, quite frankly, even though we are seeing a little bit of cost inflation, we're still going to be significantly net in a good shape relative to material cost reductions for the year. So material cost reductions will still be a profit improver for the year, even though we've seen a little bit more inflation than typical. we still are in a very good shape relative to price-cost, not only because of price, but also because we've done a nice job on the cost-reduction side as well.

Okay, that's super helpful. And then this is a little nitty-gritty, but just following up on Jeff's question on tech and oscilloscopes overall, I mean, the new markets that you're entering, is it with the same exact product, meaning kind of standardized product, just different channel, or do they have different – problems are trying to solve in an electric vehicle facility or data center that perhaps you've modified or changing or creating new products for?

Yeah, I would say on balance, they're the same base oscilloscope, the 6-series or the 4-series, but then there's a set of software that's specific to that vertical application. There might be a set of probes that is also different. And ultimately, there's really a solution around the challenges that they might have. As an example, power usage is a huge issue in data centers. It's a big problem in electric vehicles in a variety of places. So, you know, it might be a power consumption challenge, might be trying to do some different troubleshooting aspects of particular applications as well. So there's a suite of software and probes that typically go with that oscilloscope that is very much vertical specific.

Okay. Encouraging. Thank you. Good luck, guys. Thanks, Steve.

Scott? Your next question is from the line of Andrew Open with Bank of America.

Good afternoon. Hi, Andrew. Yes, I'll just continue to ask questions about tech. It does sound like very broad-based demand into electronics. How durable do you think the demand is here versus sort of more bounce back from COVID?

Well, there's certainly an aspect of the bounce back at COVID. So I wouldn't, you know, in any way, shape or form take away from that. But I think when you look at where the business has been historically, we're at an accelerated growth rate here over the last couple of years. So I think in that sense, we feel good about the overall growth rate this year. And we think it's certainly durable in the sense of services. As we recognize, services had a good quarter. We're doing some good strategic work to add to services the things we were just mentioning around new verticals. So, you know, the team has really got the mantra and the strategy to consider to continue to make the business less volatile, less cyclical, and really work towards some secular drivers that have more durable growth rate. And I think we're in a very good position relative to how we'll do that over time.

And a follow-up. So how should we think about the implications around the uptick in professional services? and improving site access for your SaaS businesses. You know, site access was a hurdle for your logos, right? But just trying to get a sense if now you're able to close deals and start onboarding new clients.

Yeah, we're still not where we'd like to be. And obviously, even the recent news over the last 24 hours is going to have – we'll have to look into. But I think we feel confident in sort of double-digit professional services growth in our SaaS businesses in the second half. So we see continued improvement in site access. We're starting to see customers start to really make decisions here at an accelerated rate. talked a little about that in the prepared remarks amongst all the software businesses. So, yeah, I think you'd say the second half we're in a much better place relative to services. And that's not just on-site services. It's also getting customers to accept remote services. So it's a combination of the good work the team has done to be able to deliver things more remotely as well as customer site access. Thanks so much. Thank you.

Our next question is from the line of Nigel Cole with Wolf Research.

Good evening, Nigel. Good evening, good afternoon to you guys. So just in answer to Jeff's question, I'm not sure if you actually address, you know, the absolute level of channeled inventories to your best sort of knowledge. And the spirit of the question is that, you know, obviously a lot of channels are pretty empty at this point. So, you know, any sense on where channeled inventories are going? you know, for tech and fluke and other products. And then, you know, kind of on top of that, it sounds like a dumb question given the kind of call you just put up, but did supply chain constraints gate your ability to supply during the quarter?

First of all, I think we're in a good place in channel inventories. I think in some cases, given the revenue numbers, both what we delivered in the quarter, over-delivered in the quarter, plus raising the guide for the full year, you'd say, well, we're definitely seeing better demand. Against that backdrop, we're not seeing an increase in channel inventories, nor would we see an increase in channel inventories. at least in the next 90 days through delivering the revenue that we have relative to the POS numbers we're seeing. So I think we feel good about end-user demand, and we feel good about the fact that we're not building inventory in some sort of oversaturation situation. So I think there's real demand out there, and I think we're fulfilling it. You know, Nigel, we're not oblivious in any way, shape, or form like our peers and pretty much all the companies in the world relative to supply chain constraints. We've seen those for sure. I think the fact that we've been building great lean manufacturing capability over decades in our businesses, our ability to respond to those things relative to the FBS tools like daily management and problem solving means we're fighting every day to secure jobs. secure material, and our ability to beat the revenue in the second quarter is a good demonstration of our success in that way. But I would also say we continue to see those challenges every day, and I would expect to see those challenges probably through the year at least. So I think we've been very successful thus far, but it is a daily battle. But given the work we've done over decades to build the kind of capability within our factories, I like our chances and continue to be successful. Great.

That's great news. And then I want to go back quickly to ASP margins. Sorry, AHS margins. A little bit weaker, lighter in the quarter, 2Q. Is that simply the mix of ASP? You know, does ASP carry a high contribution margin relative to the average there? And then that 27% margin yield guidance for 4Q, does that represent, you know, quote, unquote, normal mix in that segment?

Thanks for the question, Nigel. So, we really weren't lighter than what we expected. We're over the high end of our guide for Q2 on AHS margins, but I think you're looking at the comparison to last year. And so, There's a couple of things going on there. One, as we have been building out our supply chain, coming off the TSAs, that's incrementally put in, you know, starting last year at this time, more costs. So when you come back to the margins, that gives us a headwind on year-over-year margins. With that, there's a little bit higher freight as well, but there's more revenue to go along with it. So we're still driving OPEC. Also, we had a one-timer last year that inflated margins. That doesn't repeat this year related to just the transition off the TSAs. But, again, I think that we're right where we expected to be in Q2, and going forward we're going to see us, you know, start expanding again at 200 basis points from Q2 to Q3, and then Q3 to Q4, maybe even a little bit more than that. So consistent margin expansion. And, yes, the consumables have very high margins, and so is recovery. That really helps part of that story for sure. Okay.

Thanks, Ed.

All right.

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

Hi, good afternoon. Maybe just the first question around the, I think the AHS margins have been discussed a fair amount, but just wanted to touch on the revenue side of things. You took down the high end of the core growth guide for AHS for this year, kept the margins, as you'd said. So maybe help us understand, you know, what's driving that revenue reduction and how good you feel about the overall state of businesses such as ASP in terms of their market share and are they winning sort of their fair share of business?

Yeah, Julian, I'll take the second one first. I think we're installed basis up 3.5% year on year. We're in a very good place relative to equipment placements. We had another good equipment quarter after several, you know, four or five quarters in a row of continued increases in the installed base. So we feel very good about where we stand relative to the installed base. I think what we're really saying for the second half of the year, and I think if you look, you know, consistent revenue growth through the remaining part of the year, ASP will actually accelerate in growth through the remaining part of the year. But we did see, you know, a little bit of elective procedures coming down a little bit than we anticipated. As we said, we thought maybe we would end the quarter around 95. We ended around 93. So there's a little bit of an assumption that we'll probably not get to 100% by the end of the year. That has a little bit of impact. But I think we come back to the fact that we're taking share. And if things come back, we certainly would see improvements. and associated improvement. But I think we're just trying to be a little bit more consistent with what we've seen here recently relative to elective procedures. And so there's a little bit of a change. Obviously, we took the guide up in total up for the overall company, but maybe a little bit more conservative relative to where we think elective procedures might come in. And as you said, continued very strong margin increases like Chuck was just describing through the remaining part of the year through AHF and at ASP. Sorry for all the acronyms.

No worries. Thank you for that. And just on China, I think your growth went from close to 30% in Q1 to sort of mid-teens in the second quarter. So pretty consistent with a lot of the other indicators short cycle-wise in recent months there. But when you're looking at sort of Fluke and Tektronix in China, both have a very good presence there. How are you thinking about their growth in the second half in China specifically?

Yeah, I think very good. I think the answer is, you know, to be quick, Chuck and I did a review with all the China teams here a few days ago and feel very good about the second half, particularly at Fluke and Tech. You know, the comps play a little bit of a role here, but I think as we look on a two-year stack, as an example, we continue to grow well in China through the remaining part of the year. I think we've got mid-teens or something like that for the full year in China. And, you know, we feel good that we can continue to maintain good growth rates and really good market positions as we get into 2022 as well. Great. Thank you. Thank you.

And your next question is from the line of Marcus Mittermeier with UBS.

Good evening, Marcus. Hi, good afternoon. Hi, good evening. Very quick follow-up on pricing. The 130 basis points that you have, you said the target is to double that in the second half. Just to be clear, that's part of the guide, or should we add that on top?

Yeah, Marcus, the 200 and some basis points is really in our hardware businesses, particularly sort of fluke tech, sensing tech in particular, that I was associated with that number. So that's really a comparison of where really relative to price cost. I think our overall, you know, sort of our overall pricing for all of Ford of incorporating everything is probably closer to, you know, from the second quarter, probably up about 140 or, excuse me, about 40 or 50 basis points up from where we've been thus far in the first half. So the 200 is really to address the price-cost question, but the overall pricing is a little bit less than that. And we have built that into our guide. Yeah, and that's built into the guide. Yeah, thanks.

Okay. No, that makes sense because then the follow-up would have been sort of if you see any sort of issues around price, electricity, but that doesn't sound like it. Go ahead. Sorry. Yeah, and then the second question around sort of just the balance sheet. You know, after the service channel now, I think, you know, any change in priorities, I know that a few months ago you said or if the relative size between the various businesses matters, any sort of new thinking here where priorities are here for the second half of the year?

No, I think, you know, as we said in the prepared remarks, the balance sheet remains in very good shape and will be in very good shape to do other deals when those opportunities become available. So, you know, obviously we're going to continue to be – you know, focused on making sure we get good, strong financial returns. I think service channel deal is a good example of that, both a creative, you know, in 12 months, but also with a 10% ROIC in five years. So I think there's lots of those kinds of situations available to us in the second half. And so you never know if you're going to get a deal done, but I think we both have the capacity financially, as well as the capability to pull off another deal if an opportunity becomes available. So it's hard to predict those things. And and what happens, but we are busy and we feel confident that we could get a deal done if we had the opportunity.

Great. Thank you very much.

Thank you.

The next question is from the line of Andy Kaplowitz with Citigroup.

Good afternoon, Andy. Hi, Andy. So just focusing on the bigger picture with Gordian and Accruant again, you mentioned there's still a bit of noise in terms of the varying pace of return to work, especially lately, but you did mention the clients are accelerating work on key projects within Gordian. So does that give you better visibility into growth continuing to accelerate within the businesses? And can the improvement we've seen in state and local budgets and their stimulus give you an additional boost?

Yeah, so first of all, Gordian had a very good quarter. What we did see in June, and we mentioned this a little bit, is there was a little bit of budget clearing at the end of the fiscal year. And I think between stimulus and what's already we're seeing in projects, I think, you know, we feel confident we'll have a good year at Gordian for sure. So I think, you know, as we look forward to Gordian, not only in job order contracting but estimating and even facility assessments, we're seeing good business. And I think on the occurrence side, you're seeing, as we said, we're starting to see those back-to-work projects come back. People who are looking for hoteling solutions, we mentioned in the prepared remarks, our event and hoteling planning solution is sort of leads the way as people start to think about bringing people back to the office. So we saw that accelerate. We really like the professional services because in a lot of those situations, that's the first part of a current before we see the SAS revenue. We see those projects come in where we go in and help clients get started. So I think, you know, a number of places where we're seeing real opportunity is And, you know, I think we'll, you know, we really believe that those will continue. And as I said in a previous question, professional services being up double digits in the second half, you know, it's going to be real helpful to us, you know, sort of building that business here for not only this year, but obviously into next year.

It's helpful, Jim. And then you mentioned a nice rebound in industrial and oil and gas markets as ISC inflected. Is the recovery more a function of easy comparisons, or are you starting to see a relatively significant rebound at this point in the energy-related markets? And what do you see going forward for that business?

Yeah, I think we see continued improvement. I would say, you know, there was some easy comp aspect to the ISC number in the quarter. But one of the things I think we're really excited about is the work they've been doing over the last year and a half to sort of move the business into new markets outside of oil and gas. And we saw some success in that in the quarter as well. Building the business around different end markets, at the same time, they're starting to see instrument revenue and rental revenue come up, you know, which is really, I think, consistent with people coming back to work in oil and gas and projects coming back into those customers. So we think that continues to accelerate through the remaining part of the year.

Thanks, Jim. I appreciate it. Thanks, Danny.

Your next question is from the line of Dean Trey with RBC Capital Markets.

Hey, good afternoon, everyone. Hi, Dean. How are you? Doing real well, thanks. Can we just get updated? There was a plan that you would start these growth investments, $35 million in the second quarter. And I think early in the call, you called out a $15 million investment. Is that part of it? And what's the plan for the balance of these investments? Are they going into Fort and Pioneer Square Lab also?

So, Dean, we called out that we'd have $35 million. You're correct.

We had $15 million in Q2, which we did kick off and invest in Q2, and then you think of $10 million in each of Q3 and Q4. And then relative to maybe what we saw, I think – and the other thing I'd just call on, there's a couple of examples in the call. The II900 that we called out at Fluke and the 1QA at Fluke Health, those are both examples of investments – that we did 18 months ago that are now really paying off. So I think it's a good example of, hey, we give the operating companies money to accelerate product development for accelerated growth. And that's a good example of we're seeing the payback of some of those investments that we did roughly a year and a half ago. Relative to Pioneer Square Labs, as we said in the Q2 call, about half of that $15 million and half of that $35 million would be at the Fort and at PSL. We mentioned the spin-in of TeamSense in the quarter or in early July. You know, that's part of that investment is to fund TeamSense here as we spin that into the business. We're really excited about that opportunity. And then obviously the Ford investments, which we said were probably more like three or four years, you know, two or three years out relative to payback and return. And just to bring those numbers back, we thought it was about a $250 million growth opportunity for all of that work. And we still believe that that's true. We're probably hopefully, you know, planning to get 30 to 50 of that. And as we continue to build out the product lines and build out some of the ideas that We'll have greater granularity to that. But we're really excited about the work that we got done in the quarter, which is really going to be good work for us next year and in the years to follow.

Got it. And that's a nice lead-in for the second question about how do these spin-ins work? You know, with TeamSense, are there more in the pipeline? And what are the conditions that a startup is ready to be brought into Fortis?

Yeah, so each one has its own sort of particular set of metrics. We have a board that's made up of team members from Fortiv and team members from PSL. They sort of advocate for the business through a period of time prior to the spin-in. We fund that, and then we make a decision whether the business ought to be spun in if it's good strategically or really is helpful to us strategically. There might be situations where we actually go and get external funding from And then there are situations where we maybe wouldn't go forward. Right now we have three that we're funding. The one that we spun in, TeamSense. We have two others. We'll make some decisions here. And those decision criteria are individual to the businesses based on what they're trying to accomplish strategically. Generally has the number of end customers they have to solidify. There's certain goals around what they're doing with those customers from a product perspective. Is the product ready? And if we achieve those milestones, then we start to assess the potential opportunity. Pioneer Square Labs is really good, obviously, with their experience of bringing to us how we think that if we were to go for an external investment, as an example, how would that business do in that regard? So I think it's been a great experience. We're really celebrating 12 months of partnership here. And I was just with the senior team there at PSL a couple weeks ago to talk about the partnership and make sure it's really on good footing. And I think, without a doubt, we're in a very good place as an organization in which to continue to fund some of these things. We think, you know, if we've got great ideas, we'll fund them. But, you know, I think they also bring the process of killing ideas, and we've killed several ideas as well.

That's real helpful. Thank you.

Thanks, Dean.

Your next question is from the line of Josh Chobosinski with Morgan Stanley.

Hey, Josh. Hi. How are you doing, guys? How are you doing? Great.

Excellent.

So, Jim, you have a mix of cyclical, seasonal, and I guess some more stable businesses, so maybe the comps don't tell a lot here, but where do you think there's still room for, I guess, sequential growth that sort of ignores the comps, obviously, as we're still coming off the bottom? It sounds like maybe ASP is one of those, given that it's still kind of lifting off the bottom, and maybe 2Q, those electric procedures didn't show as much progress as you hope, but is there anything else where

We should still kind of keep an eye on sequential progression, maybe relative to comps or seasonality. Yeah, well, I think obviously, you know, with what happened last year with COVID, you've got to consider that. And I think you'd see as an example at Fluke and Tech as an example on a two-year basis, they're accelerating through the year. So I think in that sense, what we have implied in the guide is those businesses getting better over a two-year basis. So I think we feel good sensing maybe in that same boat. So I think we still see some good progress here in a number of places. And as you mentioned, we'll see ASP get a little bit better. Our SaaS businesses have been, you know, with 40% recurring revenue, we have a large part of the portfolio that did exceptionally well through 2020 and has continued to do well. And we called that out mostly the SaaS businesses that we have. But obviously, we continue to build our ARR portfolio. That continues to grow well. We'll have double-digit ARR growth at the end of the year for the full year. So I think we're accelerating the businesses that have been stable. And I think what you're starting to see is some of the businesses that have a little bit more cyclicality still have some room with them. And what we've seen is, I think, good margin progression with those businesses as we've seen the revenue come back. Got it. And then just on that strength and glory and the courage you have, I think it adds a lot of validity to the service channel deal that you've already announced. Anything else that either, you know, sort of a shift as a function of COVID or something else?

where over the last couple of years you said, hey, we liked this before, but gosh, this seems to even have more legs now, and maybe we should look for more externally. Anything else that sticks out in the portfolio? Yeah.

Well, I think the obvious one is just everything we're doing in EH&S. I think sustainability is becoming such an important topic for companies around the world, and not just large-cap. I mean, just about every company in the world now is trying to understand their carbon footprint. They're trying to understand how to action sustainability work, and we're just so well-positioned with Intellects, EHSAI, around those trends. I think it's hard to call out anything better than that, just given the massive amount of work and effort that's been going into sustainability everywhere in the world. So I think that's certainly a secular driver that, you know, we knew was good a few years ago when we bought into intellect, but I think every quarter we own that business, we realize that we have an even bigger opportunity. Yep, can't argue with that. Thanks a lot. Thanks.

Your next question is from the line of Cliff Ransom with Ransom Research.

Good afternoon, folks. After all these wonderful nitty-gritty questions, I want to get back up to 35,000 feet for a second. You know, you've taught me that it's the principles and the behaviors of lean that are important, and those rules don't really change. But can you talk a little bit about what lean taught you i'm sorry what covid taught you about lean and what your experience in the last couple of years with sas models has taught you about lean and then have a quick follow-up yeah sure well i think um cliff i wouldn't have thought that we could have virtualized some of our resources and still maintained a lot of the daily management things that we've done

It's just been incredible, and certainly with some of the supply chain things I was describing, our team's ability to collaborate, continue to do Kaizen events in many cases, certainly problem-solving events in some cases virtually. I would have never thought we could have done those at the level of quality that we're doing them today. So I think kudos to our FBS team that virtualized all of our tools, and I think that's certainly a great example of probably my own learning that these things can be virtualized and We've seen some great efforts here over the last year or so, year and a half in that regard. Relative to SaaS, I think there's really a couple things. You know this better than anyone. Problem solving is problem solving. Value stream mapping is value stream mapping. Every SaaS business has processes that are inefficient. Sometimes they're customer success. Sometimes they're product development. But I think fundamentally we find that those processes can be improved. And I think in a SaaS business, it's no different than any other business in terms of a culture of continuous improvement on everything you do, is a winning culture. So I think those are certainly things that we're seeing, and obviously what we're trying to show in our investor day is so many examples of where that's really playing out thus far.

How about you held my hand when I was trying to apply lean principles to transactional processes today, traditional transactional processes. When you took over Ford, have you said, look, we've got all the original divisions where the great pushes in lean came in the 80s and the 90s? And you said, I haven't got a business that I can't add another 150 basis points to. How do you feel about your progress of taking these lean principles and putting it into SINOP and new product development and accounting and accounting for lean as opposed to lean accounting.

Yeah, I mean, it's a lot of the same stuff. You know, we applied value stream mapping into the current business and significantly impacted DSO right away. And that was already a negative working capital business that we just made, I think we made better. So, you know, I think these transactional processes exist just as much in software businesses. And, you know, our teams are, you know, our Gordian, we called out Gordian several places who's applied these things all across the board and made great improvements. So, And we've certainly seen that. IntellX's operating profit is significantly above where it was when we bought the company. I could say that about all the software businesses. So we've found those, you know, pools of opportunity. They're sometimes in different places, but ultimately if we can teach the principles to the leadership teams of these businesses and encourage them and, quite frankly, support them, we tend to have real good success. Thank you so much. Thanks, Cliff.

Our next question is from the line of Joe Giordano with Cowan & Company. Hey, Joe.

Hey, guys. This is actually Rob Jameson in for Joe. Thanks for taking my questions. Hey, Rob. Hey, Rob. Hey. Just wanted to go back to ASP real quick. I know we've talked a lot about that with the elective procedures. Just wondering kind of what regions may be underperformed versus your expectations in the quarter and, you know, what regions might provide some upside in the second half that you kind of called out.

You know, it's mostly the U.S. Now, part of that's because it's our biggest business, our biggest region. So, you know, I would say most of it was in the U.S., a little bit in Europe. But, you know, I think for the most part, most markets outside of the United States were actually pretty stable. So we're, you know, because of the share that we have in the U.S. and we're probably a little bit more receptive to the COVID change, the elective procedure change than we are elsewhere. We can make a little bit more of our own luck in the other parts of the world, and that's what we did. So I think that really is where we stand. Relative to going forward, you know, as we said, we probably thought that we were getting closer to 100% by the end of the year. We're probably a couple hundred basis points different than that now where we stand for the second half.

Okay, that helps. And then just another one, and I know it might be a bit early for this question, but because service channel hasn't closed yet. But, you know, as you think about that rolling into the business and, you know, you talked a lot about Fort and the AI initiatives that you have at Investor Day. I'm just wondering, like, it looks like a good overlay, you know, for some of the services they provide as well, you know, from the matching service providers with customers and then the back end on the analytical side. Is that something that you're thinking about enhancing? And then, And I guess on the flip side, too, when you think about those AI technologies that you have inheriting from like ServiceNow from the analytical side, is that something you might be able to leverage across the rest of the organization through the forward initiatives, too?

yeah so so number one they have a scout product which is really their data analytics product we we definitely think we have an opportunity to accelerate some of the great things they were already planning to do with the fort so answer to that is absolutely that'll that'll be a real opportunity for us going forward it's a very small part of service channel today but we think it can be a real important part not only the revenue stream but of the customer capture and the ability to accelerate the network flywheel that we talk about between enterprise customers and the service network Relative to algorithms, the answer is yes. One of the principal roles of the fort is actually to retask algorithms, is to create algorithms that we can apply to the same business problems or the same growth opportunities within the business. Probably the place we're doing that the most is in our software businesses around customer churn predictive models. Once we get those models up and running, we can apply them to different customer sets within different businesses. different operating businesses. So we absolutely retask those algorithms, and that's a big part of the Fort's job is to maintain those algorithms and to continue to make them better as we get more and more data running through them.

At this time, that does conclude our Q&A session. I would like to turn the call back over for any closing remarks.

Thanks, Pasha, and thanks, everyone, for taking the time today. I think what you saw today with earnings was a really strong quarter. We continue, I think, to really work hard and diligent to really take advantage of the opportunities of a better market. I think you saw that with the guide and certainly saw that in the margin profile, and we're really excited about the work going on. A lot of hard work going on with our team every day, so I want to thank our team for all the hard work in the quarter and all the hard work that's going to continue through the year to take advantage of the opportunities of a growing market here. We're in a great place. Thanks for your time. Thanks for your support. We'll look forward to the follow-up calls and conversations that we have. Have a great rest of the summer for those of you who haven't taken a vacation yet, and we'll look forward to seeing you soon. Stay safe. Thank you.

This concludes today's conference call. We thank you for participating and accept your now disconnected lines.