Fortive Corporation

and I'll be your conference facilitator this afternoon. At this time, I would like to welcome everyone to the Fortis Corporation Third Quarter 2023 Earnings Results Conference Call. All lines have been placed on mute to prevent any background noise. After a 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 Ms. Elena Rossman, Vice President of Investor Relations. Ms. Rossman, you may begin your conference.

Thank you, Krista, and thank you everyone for joining us on today's call. With us today are Jim Leeko, 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 Regulation G are available on the investor section of our website at fortif.com. Our statements on period-to-period increases or decreases refer to year-over-year comparisons, unless otherwise specified. During the call, we will make forward-looking statements, including statements regarding events or developments that we expect or anticipate will or may occur in the future. These forward-looking statements are subject to a number of risks, and actual results might differ materially from any forward-looking statements that we make today. Information regarding these risk factors is available in our SEC filings, including our annual report on Form 10-K for the year ended December 31st, 2022. 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, Elena. Hello, everyone, and thank you for joining us. I'll begin on slide three. In the third quarter, we continued to see the benefits of our portfolio strategy with core growth and margin expansion in all segments. Third quarter, core revenue growth was 2.5%, tempered by specific headwinds in healthcare and slowing in parts of sensing in China. Strong execution by our teams growth substantial improvement in gross and operating margins, earnings, and free cash flow. Adjusted gross margins expanded by 160 basis points to 59.7%. Adjusted operating margins increased by 150 basis points to 25.9%, and adjusted earnings per share grew 8%, and free cash flow increased 25% to $384 million. As you can see, our strategy is delivering results with enhanced portfolio positions innovative new products and dedication to the ford of business system allowing us to consistently perform despite a mixed macro environment as we look ahead our attractive funnel of bolt-on and adjacent m a opportunities across our three segments and five connected workflows are expected to drive upside in 2024 as exemplified by the acquisition of ea electro automatique as well as three other bolt-ons in the quarter Turning to slide four, we wanted to highlight how the year is playing out relative to our initial expectations and begin to frame our thinking for 2024. Beginning on the left, hardware product orders were stronger in the first half of the year as traction on new product launches and leverage to secular drivers provided more backlog to buffer the normalization of supply chains. Hardware product orders were down mid-single digit, which we believe reflects continued solid demand with orders up over 20% on a three-year stack basis in the third quarter. Point-of-sale trends in North America and Western Europe have remained healthy, even as channels normalized, while we did see slowing specifically in China and parts of sensing in the quarter. Software and services continue to demonstrate their resilience, with high single-digit growth across our facilities and asset lifecycle, environmental health and safety, and perioperative customer workflows. The healthcare environment continues to improve, Core growth in the third quarter was constrained by the clearing of channel inventory in ASP and continued weakness in the bioprocessing market in Inditex. Turning to the right-hand side of the slide, we are delivering 2023 performance ahead of our initial expectations coming into the year with mid-single-digit core growth with adjusted operating profit margin incrementals over 60%, delivering nearly 2x the margin expansion planned in the year. And we are accelerating our capital deployment in the quarter with robust free cash flow and ample firepower to fund attractive M&A opportunities. Further evidence that our strategy to create a more durable growth company is working is highlighted on slide five. Our innovation and portfolio strategy continues to build on leadership positions in our connected workflows benefiting from customer investments and key megatrends, including automation and digitization, the energy transition, and the need for productivity solutions contributing to our improved through-cycle performance. We have several good examples across Fortin, including providing customer software solutions to digitize and automate processes and deliver customer success in AI-driven ecosystems. Probation is partnering to enable real-time AI in the GI workflow, contributing to their strong win rates and accelerated mid-teens growth in 23. And in the third quarter, Fluke added Azima DLI, a bolt-on acquisition accelerating their AI-enabled predictive maintenance capabilities with vibration analytics and remote condition monitoring. Fordham is also helping to solve our customers' toughest energy transition challenges with breakthrough innovations. Fluke and Qualtrol are both benefiting from strong demand in solar EV storage equipment and the build-out and modernization of electric grid infrastructure. In addition, Fluke acquired Solmetric to further solidify their leadership position in the fast-growing distributed energy market with high-precision solar test and measurement products. In this environment, our customers are putting a premium on productivity. ASP is launching new sterilization monitoring products, broadening their leading position in biological indicators, allowing customers to reprocess surgical instruments with greater speed and efficiency. Further, Gordian acquired NSR, a natural extension of their pre-construction workflow, which provides cost data that will allow them to expand job order contracting in the UK. Turning to slide six, we are pleased to announce our agreement to acquire EA Electro Automatique, enhancing our leading position in advanced electronic test and measurement solutions. EA specializes in the high power segment of the market that serves a number of growing end markets, including data centers, energy storage, e-mobility, grid modernization, and hydrogen power alternatives. EA expands Tektronix's addressable market and complements and diversifies their offerings in the fastest-growing areas of the power market, solving for power density and efficiency challenges and creating a more sustainable and electrified world. With an estimated $175 million of revenue and low 40s operating margins in 2023, EA is expected to be accretive to our growth and margins. Tektronix's global scale, including a 10x increase in go-to-market resources, accelerates EA's global market expansion. Further, the Forta business system will be a valuable tool in achieving commercial, manufacturing, and operational synergies, creating unparalleled value for customers and shareholders. As a result, we are targeting an attractive double-digit return profile in year five in earnings accretion that ramps as we de-lever given our robust free cash flow. In summary, the acquisition of EA reflects our commitment to more durable and higher growth and ability to drive higher returns for Fortiv for years to come. Turning to slide seven. Fortiv Business System continues to be a differentiator for us, enabling our business to drive innovation and profitable growth. We recently completed our annual CEO Kaizen Week. This event is a hallmark for demonstrating our culture of continuous improvement and our ability to deliver outstanding results in our operating companies in one powerful week. As always, we bring together our most senior Fortiv leaders including our segment leaders and many of our operating company presidents, with a total of 41 teams and over 500 team members, driving significant improvements in growth, margins, free cash flow, and breakthrough innovations. Some Kaizen highlights include, at ISC and Qualtrol, their events realized 100% to 125% improvements in productivity, service channel reduced their time to onboard new customers, and probation had a 2x improvement in the conversion of marketing leads. both enabling more and faster ARR growth. Tektronix deployed a co-pilot leveraging AI to bring technical expertise to customers and internal automation to significantly improve their efficiency and customer experience. And Fluke Health Solutions had breakthrough results in dosimetry reporting, reducing customer response time by more than 50%. In summary, this year's event continued to emphasize the power of the Florida business system and the breadth of applications across our portfolio, driving sustained results. I will now provide more details on each of our three segments, beginning with intelligent operating solutions on slide eight. iOS grew core revenue by 4%, with good growth in most regions. Margins continued to benefit from our portfolio evolution with high margin software growth, as well as price realization and productivity benefits, driving 230 basis points of adjusted operating margin expansion. Highlights in the core are included. Blue core revenues were up low single digit, as solid core demand and MPI traction buffered expected channel normalization. EMA continued its strong performance with another quarter of double-digit revenue growth. Luke secured a number of wins in secular growth markets, including a sizable calibration order from an aerospace and defense customer. Luke also continues to see success with new product introductions, with the recent launch of MECQ, a first-to-industry acoustic imager for diagnosing mechanical failures. EHS revenues grew mid-single-digit with double-digit INET growth at ISC and another strong quarter for SAS and Intellect, with over 50% growth in ACV customer bookings in the quarter. In addition, Marathon Petroleum, our largest INET and Safer Systems customer, recognized Industrial Scientific with their Corporate Exceptional Partnership Award. Facility and asset lifecycle revenues grew high single-digit, driven by continued strength in SAS. Fortian continues to drive market penetration, as more customers utilize their job order contracting platform to procure and manage their large infrastructure projects. The current security agreement with Xavier University provided facility management software, which included cross-selling with Gordian, and Service Channel launched several innovations for both subscriber and provider software releases, contributing to strong overall growth. Turning now to slide nine, Precision Technologies reported 1% core revenue growth and adjusted operating margins of 26.5%. spanning 60 basis points, reflecting strong price realization and productivity benefits. Some highlights of the quarter include electronics is executing on robust backlog in power and digital test and measurement solutions and delivering low single-digit core growth and outstanding operating margin expansion. This included over 20% revenue growth in North America, reflecting continued customer investments to solve the proliferation of new power design challenges for batteries, EVs, and industrial applications. Tech orders continued to normalize off a 40% two-year stack at the end of 2022. Double-digit order declines at tech were greatest in China. However, we did see weekly patterns improve sequentially as we moved through the quarter. Further, we expect continued lead time improvement and channel normalization with orders returning to growth in the coming months as customers continue to prioritize investments in semiconductor advancements, AI-enabled compute, and electrification of everything. Sensing Technologies saw another quarter of strong orders and revenue growth at Qualtrip. This included a meaningful deal in the quarter from a large U.S. utility customer for full transformer asset monitoring solutions. Elsewhere in Sensing, slowing in China was reflected in lower-than-expected orders and revenue growth. Lastly, Pacific Scientific EMC reported another quarter of double-digit sales growth as it benefits from Kaizen activity to improve manufacturing capacity and operational execution to deliver on record backlog. Moving now to slide 10, an advanced healthcare solution. Core revenues were up 2%, reflecting improved underlying sterilization demand, partially offset by higher than expected U.S. channel inventory in ASP. For the third quarter, the total impact resulted in $11 million in less revenue, impacting AHS core growth by over 300 basis points and adjusted operating margins by almost 200 basis points. Elsewhere, high growth markets saw revenues of high single digits driven by robust growth in Latin America as well as good growth in Asia. Adjusted operating profit margins increased by 200 basis points year over year. We are seeing traction on pricing actions as well as the benefits of the productivity initiatives reflected in higher margins. Additional highlights in the quarter include Census continued to grow its subscription revenue with its CensusTrack SaaS business increasing mid-teens. benefiting from continued traction in both new logo expansion and cross-selling opportunities as customers standardized on their leading instrument tracking software solution. Fluke Health Solutions' revenue increased slightly as high single-digit growth in its corridor symmetry business was partially offset by project timing. We also saw continued market weakness at Invatec, accounting for approximately half of the slower-than-expected growth in the segment in the third quarter. Lastly, probation had another quarter of excellent growth, over 20%, driven by continued APEX SaaS adoption and new logo success. Previewing the fourth quarter, the ASP channel transition is now complete, and we expect growth to accelerate in AHS. This includes the initial ramp of ASP's recently launched portfolio of steam sterilization monitoring products, which will further build over several quarters as they expand their global reach. We continue to expect margins to ramp in Q4 and 2024, driven by consumables growth, price realization, productivity actions. With that, I'll pass it over to Chuck, who will provide more color on our third quarter financials and our 2023 outlook, starting on slide 11.

Thanks, Jim, and hello, everyone. We generated year-over-year core revenue growth 2.5%, which included a single-digit growth in North America. As Jim mentioned, we saw 20% growth in Tektronix and acceleration in our software and recurring revenue which more than offset moderation in some of the sensing businesses. Western Europe revenue was up slightly as growth in software was offset by normalizing growth in hardware products. Asia saw continued strength in India, up mid-teens, and Japan up high single-digit, which was more than offset by low double-digit decline in China. We had anticipated growth in China would slow in the second half as we lapped outside growth in prior years. For example, Tektronix was down over 20% in China in the quarter. However, it was still up 20% on a two-year stack basis. We also saw continued slowing in sensing given the current macro environment, while AHS grew high single digit as electric procedure volumes improved in the quarter. Turning to slide 12, we show operating performance highlights for the third quarter. Adjusted gross margins increased 160 basis points to a record 59.7%. On a two-year stat basis, they are up an impressive 240 basis points, driven by the benefits of our portfolio evolution, the continued application of FVS initiatives, and strong price realization. Adjusted operating margins expanded 150 basis points to 25.9%, or 300 basis points over the last two years, reflecting higher gross margins and the benefits of the productivity initiatives we executed earlier this year. Adjusted earnings per share increased 8% to $0.85, despite higher year-over-year interest and tax expense. Earnings are up 30% on a two-year stack basis, and free cash flow was $384 million, reflecting a 25% increase over the prior year and over 50% growth the last two years, as we continue to grow earnings and effectively manage working capital. Turning now to the guide on slide 13 and the outlook for the remainder of the year. For the fourth quarter, we are adjusting our range to reflect caution around the macro in China and delayed recovery in the tech. Core revenue growth is expected to be in the range of 1.5% to 3%. Adjusted operating profit margins are anticipated to increase by approximately 150 basis points. And adjusted diluted earnings per share are expected to be in the range of 92 to 95 cents, representing 5 to 8% growth, and includes $5 million of one-time additional corporate expense related to the remediation plans following a cybersecurity incident in early October. We also plan to proactively fund an incremental $35 million of productivity initiatives in the fourth quarter, which are excluded from our adjusted EPS outlook. with accreted benefits expected in 2024. Finally, we expect free cash flow of $415 million, representing conversion of approximately 125% of adjusted net income. Turning to the full-year recap, we are reiterating the midpoint of our earnings guidance for 2023, which is coming in at the high end of the outlook we set at the beginning of the year. Things have largely played out as we expected, with some upside driven by secular tailwinds driving market expansion, new customer innovations, resiliency of roughly 40% of recurring revenue, elevated backlogs, and carryover pricing in our hardware products businesses, buffering moderating demand as order rates normalize throughout the year. As a result, we have core growth and margin expansion in each of our segments. Core growth for the year for 40 is now expected to be approximately 5%, with adjusted profit margins anticipated to increase approximately 150 basis points. Adjusted diluted earnings per share is now expected in the range of $3.37 to $3.40, having raised our guidance twice in the year, and we continue to expect free cash flow of $1.25 billion, representing a conversion of 105% of adjusted net income and 21% free cash flow margin. With that, I'll pass it back to Jim to provide some closing remarks. Thanks, Chuck.

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

Thanks, Jim. That concludes our formal comments. Krista, we are now ready to take questions.

As a reminder, if you would like to ask a question, please press star 1 on the telephone keypad. Your first question comes from the line of Julian Mitchell from Barclays. Please go ahead.

Oh hi, good morning. Maybe just wanted to start with the precision business, just how the guidance sort of has moved around at Tektronix. So it seemed like the test and measurement market was getting worse a few months ago and you raised the Tektronix revenue guide for the year and now it's come down. So maybe just help us understand, was it simply China suddenly getting very bad in late Q3 that caused such a revision. And, you know, maybe give us some context now with that PT segment being down organically in Q4, what sort of history tells us the duration of that sales downturn should be for the PT segment?

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

Thanks.

And then any broad thoughts on sort of PT overall? You've got down organic sales this quarter. How quickly are you assuming that flips positive?

Yeah, I think what we've been talking about strategically around PT has been, you know, that we thought we've done a lot of work in tech to try to move that growth rate, make it less cyclical. Our service business, as an example, in the third quarter was up 3%, which is, I think, a good environment relative to sort of stabilizing the business a little bit. We haven't done as much work in fencing. We've called that a low single-digit business. And as you know, we've had double-digit growth there here for a couple years. So we anticipated that normalization there. I think what we've seen over the last sort of 60 to 90 days is what I would call more slowing. And so the PT number really in in Q4 is really around sensing. Some of that's China. Some of that's some direct OEMs that have sort of pushed out blanket orders into 24. Typically, some of that is our lead times coming down. Some of that, I think, is a little bit of slowness. We talked about it on the second quarter call. Automation, principally in Europe, that continues. HVAC, U.S. and Europe, also a little slower. And then, as I mentioned, China. So that really is the PT story in the fourth quarter relative to kind of the change in the guide.

Thanks a lot. And just one very quick follow-up, healthcare. You know, it's been a sort of a litany of issues for a few years. Once we get through the channel transition, which it sounds like that's finished, you know, do we get back to sort of mid-single digit plus growth in 24? Is that the sort of natural entitlement as you see it without any one-time changes?

Yeah, I mean, we'll get out of guiding for 24, but I do think we'll see mid-single digit for sure, maybe just to sort of characterize what we saw from an ASP perspective. Obviously, this channel transition, we called out about 10 million. It was about 6 million more than we anticipated in the third quarter. And some of it is really why we have the strategy to go direct. It was really about the lack of visibility we really had on natural demand. When we take out those sort of adjustments for channel inventory in the second and the third, what we see is on a two-year stack, mid-single digit growth in the second, third, and fourth. So we really see more consistency. Obviously some noise there we would prefer not to have as well. But I think where we stand into the fourth quarter, the channel situation behind us, we feel good about that. We feel good about the work the team's done. Obviously a little bit more, you know, we're not proud of a little bit more noise than anticipated. We'll certainly take that. But where we stand today I think is in a much better position strategically, should set us up well for 24. And quite frankly, when you see the margin expansion in health in the third 200 basis points, we've talked about that margin continued improvement. I think even on a little bit less revenue, we had good margin expansion. So really, when you look at kind of a good walk into Q4, it certainly sets us up for what we think will be a much better 24.

Great. Thanks so much.

Thank you, Julian.

Your next question comes from the line of Steve Tusa from JP Morgan. Please go ahead.

Hi, Steve. Hey, guys. How's it going? Great. So just on the hardware backlog you guys have talked about in the past, where do we stand on all that, the one that was like 350 at one point? What's the status of the hardware backlog?

Yeah, I think he tried to take us up last quarter from 330 to 350, but I think, Steve, it's come down. I think that's a fair statement. You know, we sort of said we might end the year in the 200 range-ish. We thought, and that's what I said in the second quarter, we think that's maybe more between 100 and 150-ish. depends on how the order rate. Some of that is just blanket orders that pushed into 24. So it doesn't necessarily mean as dramatic as that number. But we'll still walk into with an excess backlog of over $100 million. So not as much as we anticipated. And that's principally in sensing. A little bit of tech really in China, related to China, the conversation I just had around the answers to Julian's questions. But I think where we stand today is still with 100 million plus of backlog. That doesn't include EMC, which obviously has a very, very high backlog. So I think we still have an insurance policy going into 24.

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

Yeah, you know, that business is really mostly high centered on design, engineering, and manufacturing for the diagnostic and bioprocessing market. Certainly, you've heard over certainly the last couple days how that's taken a step down to some extent. We thought our guide, you know, I would own this one. We thought the second half guide was sort of bottom for us. And I think as it turned out, it was not bottoming a little bit more, you know, more. We think now we've taken that down to where we think that is. But certainly we were, you know, we're certainly a little bit overzealous. It's not our core healthcare market. As you know, the core healthcare market really centered around hospitals. But I think where it stands today, the engineering resources, we've certainly seen some customers sort of push projects into 2024. That's what the guide reflects.

One last one for you. Does this feel recessionary to you? Do you have a playbook for costs? if so?

Yeah, I mean, I think, you know, Steve, thanks for the question, because I think at the end of the day, it really, I don't know yet if this is recessionary in full. I think four quarters of PMI being where it's been in a number of other indexes around, you know, industrial production and some of those things having been slow. I think we've seen pockets of that, and that's been reflected in some of the order rates that we've described over the last couple of quarters. But I think if we come back to the original guide of the year, we're on that number. We prepared for flowing in some places. That's why margin expansion was so good in the second and the third quarter, following on a little bit less revenue. As we said in the prepared remarks, we've upped our productivity view of a little bit. And again, maybe a little bit of abundance of caution, but to be prepared for any environment. And we still think next year can be good. I think, you know, as we said, a number of the things that have played out in strategy, software was really good in the quarter. It continues to be strong. Our services businesses continue to be good. You saw Fluke in better shape, I think, than maybe if we were in a recession and their point of sale is pretty good. So I wouldn't call it necessarily yet, but I think there's pockets of things and we'll be prepared for it. Great. Thanks a lot. Thank you, Steve.

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

Thank you. Hey. Hello, everyone. Hey, can we just kind of maybe come back to tech first? So orders are down in the quarter, but you're expecting them to inflect positively in Q4. Just maybe elaborate on what's driving that, or is that just the comps now moving the other way? What kind of visibility do you have on improving orders at tech?

Yeah, it's a couple of things. I think number one is we've seen slowing in tech orders for a few quarters now. um and so some of it is comp you're right we started to see some slowing um the two and three year stacks are still really strong so you know we're working off a level of order you know just raw order dollar numbers that are still very very good quite frankly unprecedented in the history of the company over the last few years so in that sense it really there is much of a comp issue we started to slow in the fourth quarter of last year so yeah that's it and then there's a little bit of we think you know china maybe gets a slight slightly better it was pretty dramatic in the quarter but we you know even in you know we've seen some early signs that maybe that gets a little bit better i wouldn't call it good i just call it a little bit better so um we had some order push from q3 to q4 we think we'll see those things as well so um the majority of it you know is comp we're not we're not counting on a big step up improvement

and uh but but we are seeing some things that might suggest things might be a little bit better and that's reflected in how we're talking about it and on this um inventory realignment and asp so you misjudged it a bit in q3 like what is your kind of visibility that um you know you you totally understand what's in the channel and we don't have some additional hangover into q4 or maybe there's some hangover baked into your q4 numbers still

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

And maybe just a quick one. This cyber issue, is this totally wrestled to the ground, or do we have some kind of open-ended issue we're dealing with there?

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

Yeah, that's where we stand. Great. Thank you. Thank you.

Your next question comes from the line of Dean Dre from RBC Capital Markets. Please go ahead.

Thank you. Hi, everyone. Can we start with the EA acquisition? One of the things that struck me in the release is you talked about how you want to leverage the Tektronix franchise. And maybe just kind of elaborate on that. Is it distribution? You know, looking at their products, there's a lot of kind of similarities in terms of benchtop, but it doesn't seem to me there's a lot of product application overlap, and maybe I'm wrong there. So how does the leveraging the tech franchise play out here?

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

Great. That's good to hear. And then just as a follow-up in some of the themes about what are you seeing that might be recessionary or not, two areas I'd be interested in hearing, the typical Fluke, sell-in versus sell-through, how that is the cadence there, and then broadly the cadence for the quarter. If you broke out revenue growth or orders, how did it play out in the quarter by month, and did you exit in a more deteriorating fashion or not?

Yeah, I mean, I think when we look at Fluke POS as an example, and North America is probably the best place to think about the U.S. economy, it played off pretty consistently, although point of sale came in pretty consistently. We've got to look at two-year stacks because, you know, as we fulfill backlog over the last 12 to 18 months, it does in some respects distort it a little bit, but by and large, pretty consistent. um i think when we looked at china it was probably a little slower as we got as we went through um but i think we have a good understanding of where that was and that kind of thing and that's broadly china not just uh not just fluke so i would say that's how anticipated tech on the other hand was you know their order growth was actually better in the in the in september than it was through the early part of the early part of the quarter. I would say, though, we did see a little bit later in the month. And so there was maybe a little bit of a dynamic where in a few places. But I think, you know, that's really what the biggest change in really how we think about the second half, though, is really coming back to less, you know, maybe really specific OEM customers within sensing in those markets I described and China.

I think those are the two big changes that we really saw. Great. Thank you. Thank you.

Your next question comes from the line of Andrew Obin from Bank of America. Please go ahead.

Hey, how are you? Yeah, just I guess the question on PT and the decision to sort of buy EA, you know, I think for years and I, you know, we love tech, but, you know, it was like one of the acquisitions back at Danaher. This is the one that didn't go well. and there were questions and all of a sudden there's a lot of attention being paced to it, right? Press reported Natty, clearly you're making a bet here with EA. Can you just talk about the evolution of the company's thinking about tech and how you're thinking about the business overall, where this is all of a sudden a key area for capital deployment and what it is you're seeing two, three years down the road that gets you excited?

Yeah, thanks, Andrew. I would say number one, when you look at the returns of tech from back a while ago, those returns are good now. Yeah, we had a little bit of challenge in the early days. That's exactly right. But that's a little bit of old tape. The returns now are good. And I think we feel good about the business. And I think the performance in the business over the last several years and the profitability that's come with that has been very good because of the strategy of getting out of some businesses that were much more volatile, the video business being one of them, but a few others, getting into more services, which give us the higher attach rate and less volatility. And you've seen that play out over the last couple of years. I think as a large business within the company, we've been very specific, and I think we've been very deliberate in terms of our narrative that the power market was a very good market for us. It had good trajectories relative to secular drivers around electrification. That's not just EVs. Sometimes people think of that as mobility. That's much more around storage. It's much more around the use of renewable energy and the challenges that that brings to the grid. The challenge it brings to data centers, the challenge it brings on storage. And we've had exceptional success in those markets over the last few years. We talk about that relative to our own success as the mainstream oscilloscope line and that platform and the success that that's had. So a natural extension of that is what we see at EA. And that's an opportunity for us to have a high-value bolt-on. It accretes. Immediately to Tektronix's growth rate and profitability. And I think investors hopefully will, I think, and we've had good, it's interesting, I've had industry people that I've known for decades tell me over the last 48 hours what a great deal that is. We obviously got to continue to talk to folks about it to help them understand the company. But I think when you see it for what it is financially and what it is strategically and the fact that we can get the kind of returns that we've described, I think it's a very good addition to tech. And we're excited about it. And we're excited about not only what it happens in 24, but quite frankly, what it really brings to the business. And we've talked a little bit about this. But, you know, as we highlighted our 2028 targets for EPS and free cash flow, EA gets us about 30% to about 40%, actually, of the M&A EPS target. So when you look at that, at a multiple that we're trading at today, so we feel really good about the deal, and we feel good about the opportunity to really bring that team on. It's an outstanding team, and we think it'll be a great addition to Tektronix.

And just a follow-up on just software, but specific, I guess, facility and asset lifecycle, right? We sort of slowed down to high single-digit growth, and I apologize if I missed it, but what were the key headwinds that sort of took it down from double digits to high single digits, and how much visibility do we have on this business reaccelerating into year end and into 24? Thank you.

Yeah, I think Fowl is in great shape. It's a great story relative to IOS margin expansion that we had. We've had a great year to date in IOS margin expansion, and Fowl is a great part of that story. We had a little, I would call it a little bit of slowing at Gordian, but that is really not slowing. It's just really, we had an exceptional first half. And so it's a little bit of moderation more than anything, but I wouldn't read anything into it. That business has never been as good a shape as it is right now. So I think at the end of the day, Service Channel is on a great trajectory. We talked about a number of the good things that are going on at Accruant. I wouldn't read anything into FAL other than we feel really good about it. It's, you know, we're in a good place. It's going to be a good setup for 24.

The business is really humming along. So 10% plus is still a good placeholder for this business long term.

Yeah, I think we've said high single to low double, and it might move around. You do have a little bit of non-recurring service business in that, a little bit that plays out every once in a while. You get a little bit on the comps. But yeah, I mean, it's going to be that way in the 9%, 10%, 11% probably. You can dial that in for strong success in the years to come.

Thanks so much.

Your next question comes from the line of Scott Davis from Milius Research. Please go ahead.

Hey, Scott. Good morning, I should say, everybody, Jim, Chuck, and Elena.

Good morning.

Can you guys hear? Oh, okay, good. I got disconnected a little earlier. So if someone asked this question, I apologize. But can you clarify on this channel adjustment you know, going direct. Is there a margin payback? I would imagine you capture some of that margin that distributors were getting, but are we going to see that in the numbers, or did you have to add costs in, you know, proportionally to that change?

Scott, it is Chuck. Yeah, there's a margin component to that. It's about 7% on the revenue that was going through the North America distributor. And you will start to see that show up in price in Q4.

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

No, I think, you know, whether it's, you know, we probably have several dates. If I were to think about the hardware businesses, which have obviously had unprecedented price over the last few years, but we will continue to have good price. We think about it as value capture more so than price. We think about our innovation capability, and if we can bring on higher innovation, ultimately we'll be rewarded for that from a gross margin perspective. You know, I think our gross margin trajectory over the last few years is really is not only a good testament to FBS, but it's also a good testament to innovation and our ability to launch products that have tremendous value. So I think the pricing environment is going to be better going, you know, in 24 than normal. But I would say I wouldn't say it's better than 23. I would just say it's better than normal. And we would anticipate continuing to look for those pricing opportunities. You'll see that a little bit on the software side and built into net dollar retention. And then, you know, our pricing metric that we often talk about is really more related to the hardware businesses. But as Chuck mentioned, we'll get a little bit more price in healthcare. We've been getting more price in healthcare over the last few quarters. We think that'll continue as well into 24. So a number of things that we feel optimistic about. We're not in a guide scenario just yet for 24, but we are optimistic we can continue to get price.

Super helpful. Best of luck for the rest of your guys. Yeah, thanks, Scott.

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

Thanks, guys. Good morning. Good morning. So just look, on this 4Q, just mathematics here, look, obviously a penny on corporate with the cyber. Seems like maybe a penny or two on FX. Just maybe just confirm that move in FX. about a penny or two on 4Q. But I'm just curious on Texas Instruments, you know, there's obviously, you know, pretty weak forward guidance from them. And I think we're trying to all figure out, you know, whether this is deterioration in short cycle demand or whether, you know, consumers of chips like yourself are just destocking. You've been obviously holding buffer inventory and destocking. So any perspective you have on that, Jim, would be helpful.

Nigel, why don't I take the first one? I think there is a little bit, I wouldn't say two cents impact on FX in the fourth quarter. I think it's probably a little less than one, but there is some effects. Just to close that one off. And you did note there is a penny in corporate cost for the remediation or efforts on the side.

Hey, Nigel, a little bit, I think I caught your question on TI and a little bit about inventory in the channel and things like that. I didn't tear apart everything they said, but I did read a little bit about it. I would just say from a Tektronix perspective, broadly around maybe components and kind of the market, if you will, I think the biggest place we saw some level of inventory correction was in China. We do track inventory levels embedded in our guide as some lowering of inventory in China over the next couple quarters. We are, I wouldn't say we're at elevated inventory levels as demand comes down a little bit, lead times come down. We are managing with individual channel partners relative to inventory. But I think in general, we feel like we're in a pretty good place with the guide of where that all sets up. Obviously, the biggest decision in that is really where the demand goes. But we think we've dialed in the kind of demand. The order projections that I was describing earlier in the call really embedded a number of those things into those regional complexities into how we're talking about Tektronix. So if that's the answer, let me know. But if I missed it, let me know.

No, no. I'm just curious if you were like, taking down chip inventories in particular, but... Oh, I was looking down our inventories.

Yeah.

Yeah.

You know, the one thing about us, and you know this because our working capital performance has been so good, we really didn't build a lot of inventory into the company. We certainly will be taking, you know, actions on inventory given we, you know, our revenue guide for the fourth quarter is a little different than it was. So we're certainly working on that. But in terms of, you know, having big inventories on our own, we haven't necessarily been building big inventories. You know, that's the benefit of lean manufacturing, quite frankly. Sorry about that. It's not a really good question.

No, that's right. Yeah. And my follow-up question, I think this is a quick one. I thought 514 was a good slide showing the variability in revenue growth, but ultimately around a mid-single-digit type of growth rate. And 2024 is sort of recoupling to that. So I'm just curious, does the same thing, as we frame 24, does the same apply to incremental margins? And the spirit of the question is we're coming off a really big year for incrementals. I think we're north of 60%. You know, does that mean that 24 might be sort of below natural levels or are you confident you can build on 23 margins in a 40, 50% range perhaps?

Now, a couple of things to think about as 23 margins are very good and normally we'd think about 40% incremental and I think it's been 60 that has to do with more with the productivity. things that we did earlier in the year, and then you saw us do some more. So, no, we would always expect 40% incrementals, you know, moving forward. And then it'll be a little bit more elevated because of the actions that we're taking right now. So, we will build on what we've done here, and we would expect them to be, you know, elevated from what they would be because of the actions that we're taking year in and

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

That's great. Thank you.

Thank you.

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

Good morning, everyone. Hey, Andy. So I think one of the keys for ASP is you go into Q4 23 and 24 as consumables coming back and being relatively strong. I think you've talked about underlying elective procedures improving. I would surmise that's the case in the US and I guess in China at this point. But what is your visibility into the consumables ramp up and if anything would stop ASP from recording the stronger consumables demand?

Well, so Andy, a couple of things, you know, just from electric procedures. Generally, exiting Q2, we thought we were at 95% around the world. A little bit slowed in China because of the anti-corruption stuff, probably at 90%, but definitely improving around the world. We do have this inventory adjustment transition in North America. But when you look through that, the actual consumables growth is already there. It's there in Q2 and Q3. when you understand how the customers are using our products. And that's where when Jim talks about the two-year stack, we're up 8%, 9% from Q2, Q3, Q4, rather consistently when you just take that one thing out. So we think we're already seeing that in what's actually getting used at the hospitals. Let me stop there and see if that made sense.

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

Well, I think, you know, Andy, it's really, you know, when we were in our, when we had our investor day in May, what we tried to outline was the opportunities in front of us. And what I think what I tried to really try to communicate then and consistently is really around the fact that we were active, that we, you know, I think I said the second quarter call, I thought we'd get some things done in the second half. But maybe I had, you know, I probably had four of the five cards already drawn at that point. But, you know, I think we've been busy. We've been active. We've been looking for unique situations. I think everybody was looking for a step down and massive price differences. We've seen a number of peer companies pay robust prices. I think what we've been able to do is find those unique situations. Those three bolt-ons were unique situations, places like Azema where we've had a long-term relationship with them and a little bit of a partnership. Solmetric, which is a solar tool company. These are unique things that we're able to do that are really product extensions with high ROICs. And as I was mentioning earlier in the call, EA is really very similar. It's a business we've known for a while. We've known it in the market. They actually are well-known amongst all test and measurement players for their technology and their ability to sort of play in the really good high-growth applications. And so I think we'll continue to look for those opportunities that are there, and we think they are. We'll continue to do that, but we'll also do that within the context of looking for strong returns, and that's what you'll see. And I think what makes this I think what we've been trying to talk about is that we would demonstrate these things. They're hard to plan out. So sometimes they come in bunches like they did this quarter. But we will remain active. But we'll be looking for those opportunities that are, I think, very similar to what we've seen this quarter, which is unique situations where we really have an opportunity to get high returns.

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

Yes, that's exactly right. Got it. Thanks, guys. Thanks, Annie.

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

Hey, guys. Thanks for taking my questions here. Hey, Joe. I want to start on AHS. Like, you know, if I look back, right, like going back to 2018, the average growth, Is something like, you know, high 2% range and this year is going to be kind of maybe a little bit below that. So I know there's a lot of different things and you're certainly not the only people to get kind of surprised by what's going on in healthcare now. I mean, that's pretty much everybody, but. Like, what makes us really confident modeling forward that the entitlement is like, missing will digits plus 1 that's really only happened 1 time since 18 despite portfolio changes there.

Well, I think it's embedded in what the comment Chuck just had about consumables is number one. You know, we've obviously a little bit of noise, but, you know, we had COVID for several years, and that certainly created a lot of noise, given the fact that it was a regional situation. We were kind of behind in the U.S. for a while, and then China and all that. I won't reiterate all that. You know it. I think where we stand today and what Chuck just described is, as you sort of look through kind of these one-time channels situation, which we really believe was the right thing to do strategically, we're seeing that growth now. And I think the 200 basis points of margin expansion in the third quarter in the segment really speaks to the fact that ASP's margins are starting to get up better because the rest of the margins in the segment are very strong. So we feel good about the launch point relative to how we've just described it. And, you know, 24, as I said earlier in the year, 23, the healthcare market would be a little bit better. It wouldn't be great, but it would be better. And 24 would be better than 23. And 25 would be better than 24. So We continue to think that we continue to see that. So that's what gives us the confidence. And again, I understand given the fact that this inventory situation in the third quarter was a little bit more than we anticipated. And so obviously that puts some skepticism in the nature of the question. But I think as we stand here today with what we've got going, we saw good equipment growth. High growth market growth in the quarter was 10%. So I think we've got other parts of the world in better shape. And now we've needed to get North America in a better shape. That's really been the drag on the business in the last few years. And we feel that we needed to do the channel change in order to make that happen. And that's, you know, that's now behind us. And we walk into the fourth quarter and then 24 with a number of those things behind us.

Fair enough. And then just last for me on the hardware backlog that you talked about. I think you said like, what, it was 350 or so last quarter, probably ending around 150-ish, give or take at the end of the year. So, you know, I guess rough numbers, we're talking like Order is under revenue by like 100M a quarter right now. And then we exit the year. That's a pretty small percentage of like the total business there. So, like, we need to see

when did dollars have to like dollars of orders rather than percentage of orders have to start inflecting before like the revenue catches to the catches down to the orders yeah well yeah a couple things number one is just remember we we created about we've created 300 million dollars over three that 330 is an excess backlog number not a backlog number so in in a couple years we created 330 just just to and you know we said we'd end the we naturally deplete under normal circumstances you know, we would deplete backlog in the second half of the year. That's pretty natural. We had said that was likely to get us from 330 to 200. We now think that's about 125-ish, call it 100 to 150, maybe, because I don't think we can be super precise here. And so it's, call that about, you know, somewhere in the neighborhood of 50 to 100 difference. We think some of that already got pushed into 24% And some of it probably is inventory corrections, mostly in China. And it's really the sensing story that I talked about earlier in the call. So hopefully I've reconciled a little bit of that for you from a numbers perspective.

It does. Thank you. Thank you.

Your next question comes from the line of Joe Odia from Wells Fargo. Please go ahead.

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

Yeah. Joe, are you talking about inventory or backlog?

I'm talking about inventory.

Okay. Well, I don't think we had a big inventory correction here. um if i if i i might have miscommunicated that but i think what what we're really saying the backlog answer i just had is really the story relative to our order rate um and i would say most of that in fencing is not really inventory as much as it is it could be inventory but it's really oh it really is much more oems really pushing out i think it's much more of a demand issue than an excess and in specific verticals the majority of that backlog reduction which you could think of that as the the order kind of order is changing is really in three specific verticals, as we talked about, one being in sort of automation, industrial automation, mostly with Europe OEMs, semiconductor, really two equipment companies that we supply, HVAC kind of on a global basis in China, and a little bit of medical with some specific customers. So that's really the big change in our excess backlog number that I was just suggesting to Joe, and that's really mostly at sensing. A little bit of tech, A little bit at fluke, but really a big story. And relative to inventory and channels, what I was trying to suggest is, yeah, a little bit at tech relative to China. But in North America and Europe, we still had pretty good POS. And I would anticipate that if demand, you know, demand's really normalizing a little bit more. So if we continue to see that, we'll see some normal changes in inventory as lead times come down. But we don't anticipate at this point anything dramatic.

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

Yeah, Joe, we think it's going to be low double digit over the next five years. Really strong incrementals here. We've got some other examples of that, about 60% fall through. That gets us, I think we talked about or Jim mentioned earlier, with 20% of our next five-year free cash flow, we're going to get 40 cents of EPS out in 2028. That's the math that we've given out.

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

Thank you. Thank you.

Thank you. I will now turn the call over to Jim Lico for closing remarks.

Well, thanks, Krista. Thanks, everyone, for taking the call. We appreciate the time and energy and enthusiasm of the questions. We obviously will have some follow-up with many of you, and we'll look forward to that. I think what you saw in the quarter, obviously a few changes on the revenue line, but I think what we've tried to say from day one is that we see some normalization in the second half. We saw that maybe a little bit more in the third than we anticipated. But what we also said is that we continue to drive margins and continue to set the business up for long-term sustainability and success. And I think the margin expansion you saw, the free cash flow, the number of deals that we did, that's very consistent with the strategy we've outlined We think we continue to set up for 24. Well, we'll obviously get to a guide here in the next few months. We look forward to finishing the year out here strongly. We'll see you on the road, and we'll look forward to taking your follow-up. Thanks, everyone. Have a great day.

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