Fortive Corp (FTV) — Q4 2022 Earnings Call Transcript

Thank you, Julianne, and thank you, everyone, for joining us on today's call. With us today are Jim Lico, our President and Chief Executive Officer; and Chuck McLaughlin, our Senior Vice President and Chief Financial Officer. We present certain non-GAAP financial measures on today's call. Information required by Regulation G are available on the Investors section of our website at fortive.com. Our statements on period-to-period increases or decreases refer to year-over-year comparisons on a continuing operations basis. 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 31, 2021. These forward-looking statements speak only as of the date that they are made, and we do not assume any obligation to update any forward-looking statements. With that, I'd like to turn the call over to Jim.

Thanks, Elena. Hello, everyone, and thank you for joining us. I'll begin on slide 3. Fortive had another quarter of outstanding operating performance in Q4, delivering 14% core revenue growth, 50 and 110 basis points of adjusted gross and operating margin expansion, respectively, 11% adjusted earnings per share growth, and 62% free cash flow growth, all ahead of the guidance we gave in October. Our strong purpose-driven culture is supported by our relentless focus on executing for customers and shareholders in 2022. The continued evolution of our portfolio within the markets we play is characterized by strong secular drivers, which powered 9% ARR growth in our software businesses and backlog expansion in our hard products businesses, contributing to record core revenue growth for the year. Our performance would not have been possible without the dedication of our 18,000 team members around the world. The team overcame continued supply chain and inflationary challenges, which will likely linger into 2023. We believe the power of the Fortive Business System is a key differentiator, contributing to more profitable growth, record gross margins, and free cash flow generation. As we look forward, we're excited to update you on the progress we've made on our multiyear targets and strategies that are driving outperformance at our upcoming Investor Day in May. Turning to slide 4. Even against the backdrop of a difficult macro in 2022, Fortive continued to validate the investment thesis that we have pursued since 2016, delivering core growth of 10% and 20% on a two-year stack basis, accelerating over the last few years. Our portfolio transformation has also driven approximately 1,000 basis points of gross margin expansion since 2016, which has translated into higher operating margins and provides further opportunity to improve margins in the years to come. We also delivered free cash flow growth of $1.2 billion, with margins approaching 21%, underscoring our ability to compound cash flow off a higher base, a key Fortive differentiator and value creation driver. In summary, we had said that 2022 would be a show-me year and we delivered strong results across all of our segments, which I will highlight in more detail on the next few slides, starting with Intelligent Operating Solutions on Slide 5. IOS grew core revenue by 13%, representing its third consecutive quarter of double-digit core revenue growth. We had good growth in all regions, with low double-digit growth in North America, mid-teens growth in Western Europe, and high 20s growth in China. Double-digit core growth in every workflow, combined with our rigorous application of FBS, drove 330 basis points of core operating margin expansion, more than offsetting inflation and FX headwinds. Looking at our performance drivers by workflow and connected reliability, look at low teens growth, supported by a strong backlog position and continued success with their new solar and calibration products serving the energy, renewables, and electric vehicle markets. POS remains strong in every region. However, we expect to see some slowing as supply chains continue to normalize. Strong end market demand drove double-digit EMEA SaaS revenue growth in the quarter, with record net dollar retention of approximately 106%. In EHS, revenue grew by high teens with strong contributions from both Industrial Scientific and Intelex. Industrial Scientific revenue grew approximately 20%, as strong demand was supplemented by record iNet expansion and higher instrument shipments following the resolution of key supply chain issues at the end of the third quarter. Meanwhile, Intelex posted another quarter of low double-digit SaaS growth. They have successfully deployed FBS initiatives to accelerate software implementations and create upsell opportunities for customers. Moving to facilities and asset life cycle. We had low double-digit growth in Q4. Vontier revenues once again increased double-digits as customer labor shortages and deferred facility maintenance continued to drive higher volume through the company's job order contracting platform. Accruent SaaS revenue grew by mid-single digits, despite a sizable headwind from end-of-life products. Accruent continues to see good success from its recent go-to-market focus in asset management and workplace solutions to enable mid-single-digit revenue growth in 2023. And ServiceChannel saw another quarter of double-digit revenue growth taking their full year growth rate to just under 50%. As a reminder, we are transitioning from a largely pass-through revenue base to a better long-term business model that includes more recurring SaaS revenue. This change will create a short-term revenue headwind in the first quarter. However, we expect ServiceChannel to remain a strong double-digit growth business in 2023 with above 20% adjusted operating margin. Turning now to Slide 6. Precision Technologies delivered another strong quarter of double-digit revenue growth in every business. Core revenues increased 20%, driven by high teens growth in North America and greater than 20% growth in both Western Europe and China. PT also delivered 240 basis points of adjusted operating margin expansion with higher volume, price realization and productivity more than offsetting inflation in FX. Some highlights for the quarter include: record quarterly revenues and operating profit at Tektronix, which continued to benefit from a robust backlog, driven by new product launches, share gains, and new entry in mainstream sold scopes. We saw orders slow in Q4 as expected as demand normalizes following the 40% growth we've seen over the last two years. Sensing Technologies had another quarter of mid-teens growth, driven by strong price realization across all businesses and continued demand in Qualitrol's utility and power business, offsetting industrial and semiconductor demand softening. The combination of Gems and Setra in 2022 also drove approximately 200 basis points of margin expansion and four working capital turns improvement. Pacific Scientific EMC saw high 20s growth in the quarter, facilitated by capacity expansion and improved materials availability. Moving now to slide seven in Advanced Healthcare Solutions. As expected, revenues increased 5% in the quarter, driven by broad improvement across all healthcare operating companies. By major region, mid-single-digit growth in North America reflected the benefit of our higher installed base and some improvement in hospitals, partially offset by a low single-digit decline in Western Europe and a high single-digit decline in China. The exit rate on China elective procedures was the lowest we have seen post-COVID, and roughly 30% of normalized levels. January 2023 volumes were roughly half of prior year levels, which was reflected in our Q1 outlook for the segment. In the fourth quarter, AHS segment margins were down 260 basis points, driven primarily by higher inflation, partially offset by favorable M&A. Notably, margins were up approximately 400 basis points versus Q3. Versus our fourth quarter guidance, margins were unfavorably impacted by additional transactional effects and lower margins at Fluke Health Solutions. As we look ahead, the team is starting to see traction on their pricing and productivity initiatives, which we expect will deliver margin recovery in 2023. Some other highlights of the quarter include; ASP finished the year with core revenue growth of 5% as capital share gains and consumable volumes more than offset COVID headwinds in China. Even with inflationary pressures, ASP ended Q4 with the strongest margins of the year and continued to deliver strong working capital improvements. While hospital profitability remains pressured due to labor and inflationary challenges, Censis continues to drive robust growth in its Setra SaaS offering in Q4 and for the year with mid-teens net new ACV and record cross-sell opportunities. Lastly, Provation is ahead on its return expectations, having contributed $0.10 to earnings in 2022. As customers continue to standardize our probation across their health systems, we are seeing accelerated SaaS growth, setting them up for a strong 2023. Turning to slide eight, the Fortive Business System is a powerful mindset that makes continuous improvement a way of life at Fortive. We drive deep engagement across our teams and hold them accountable for delivering on high expectations. As a reminder, in October, we brought together over 400 team members and our CEO Kaizen Innovent. Our most senior Fortive leaders, including our segment leaders and a number of our operating company presidents, collaborated to drive significant improvements in growth, margin, free cash flow, and breakthrough innovations across four operating companies: Fluke, ISC, Tektronix, and Censis. We're proud of the success our teams are having sustaining results directly attributed to this event, including, at Fluke, we reduced bold change over time by over 50%, eliminating stock-outs on critical plastic components and reducing past due backlog. At ISC, we applied lean conversion in the Fortive material system to improve quality output and turnaround time for iNet and rental customers, dramatically reducing the cost of repairs and product redesign. At Tektronix, we applied lean conversion to circuit board repair, increasing on-time delivery to 98% by altering material flow, installing 5S part management, and building standard work and documentation of our procedures. In Censis, we applied value stream mapping and transactional process improvement to identify the inefficiencies and waste, resulting in a 50% reduction in time to onboard new customers. With Kaizen activity accelerating in 2023, we expect significant results across in the year ahead. I'm incredibly proud of the work we have done in 2022 to deliver powerful results and continue our progress towards building a more sustainable future. We believe in taking a holistic approach to creating value that includes setting aspirational and actionable targets across each of our sustainability pillars. Leading Fortive today is a diverse Board and leadership team, with recent hires and promotions advancing our commitment to top talent and diversity. A strong and inclusive culture is core to Fortive’s mission, with inclusion and diversity as a critical component of FBS. Last year, we published clear goals to increase our diverse supplier spend, gender representation, by pack representation and senior leader diversity by 2025. We believe this has resulted in part to an increase in our employee engagement scores, up five points from pre-pandemic levels. Our progress also extends to how we protect the planet, which includes the early achievement of our 2025 greenhouse gas goal in the adoption of our new ambitious goal of 50% emissions reduction by 2029. It's our shared purpose that also pushes us to create innovative and sustainable products and services. Today, approximately 60% of our revenue is derived from products and services that enable more sustainable outcomes, aligned to the United Nations' sustainable development goals. We have award-winning products that promote sustainability for our customers. Lastly, the commitment to drive meaningful and sustainable outcomes that matter most to our stakeholders is reflected in our recognition for the fourth consecutive year as America's most responsible company. With that, I'll pass it over to Chuck, who will provide more color on our fourth quarter financials and our 2023 outlook.

Thanks, Jim, and hello, everyone. I will begin on slide 10, with a quick recap of our fourth quarter performance. We generated year-over-year core revenue growth of 14%. Acquisitions net of divestitures contributed 1.5 points of growth. FX headwinds were approximately four points. Turning to the geographies. We saw another quarter of double-digit core revenue growth in each of our major regions. North America revenue was up low double-digits with broad-based strength across our businesses, Western Europe revenue grew mid-teens, with volume contributions in hardware products and favorable pricing, partially offset by a decline in healthcare. In the fourth quarter, bookings growth slowed in North America and Western Europe as expected. Asia revenue increased high-teens, with low 20% in China, driven by robust growth in Intelligent Operating Solutions and Precision Technologies, more than offsetting a dramatic drop in elective procedures in China impacting Advanced HealthCare Solutions. Lastly, we saw a broad-based performance in our high-growth markets with mid-teens core growth. Turning to slide 11, we show operating performance highlights for the fourth quarter. Adjusted gross margins increased by 50 basis points to 58.3% as volume and strong price realization continued to demonstrate the value proposition of our products and solutions more than offsetting higher inflation. Adjusted operating profit margins expanded 110 basis points to 25.5%, up 230 basis points on a two-year stack basis. Adjusted earnings per share increased 11% to $0.88, reflecting a strong fall-through on higher volumes and productivity, partially offset by higher interest and tax expense. Normalized for tax earnings in the quarter were up 16%. Free cash flow was another standard. Strong year-end cash collections and the benefits of our FBS-driven working capital initiatives yielded $428 million of free cash flow in the quarter, taking the full year to $1.2 billion. Before turning to the guide, I wanted to provide some context on our 2023 outlook on Slide 12. We expect that 2023 will be another year of growth and margin expansion in each of our strategic segments supported by secular tailwinds, driving market expansion and new customer innovations. Our recurring revenue businesses at roughly 40% of sales are expected to benefit from the work we did in 2022 to increase demand generation and strengthen our go-to-market efforts, driving double-digit SaaS and license revenue growth. Elevated backlog in our hardware products businesses, particularly at Tektronix, is expected to de-risk moderating demand as order rates normalize in 2023. Further, the benefit of 2022 pricing actions is expected to carry over into 2023, driving another year of above-trend pricing realization along with increased sourcing and value engineering savings contributing to gross margin expansion. We also expect our productivity initiatives to yield strong incremental operating margins, including actions in the first half of the year to counteract the slowing macro environment. Project paybacks related to these initiatives are expected to average one year. We have included these benefits in our margins and earnings outlook for the second half, with carryover benefits into 2024. In summary, we believe our 2023 outlook reflects a more resilient revenue and earnings profile, as we expect to weather the evolving macro environment. Turning now to the guide on Slide 13. We are introducing 2023 guidance. Starting with the full year, we expect core revenue growth in the range of 3% to 5.5%. Our outlook reflects a year-over-year foreign exchange headwind of just under 1% on revenue. Adjusted operating profit is expected to increase 5% to 10%, with margins in the range of 25% to 25.5%. Adjusted diluted net EPS guidance of $3.25 to $3.40, up 3% to 8%, which includes higher interest and tax expense. And free cash flow is expected to be approximately $1.25 billion, representing conversion in the range of 100% to 105% of adjusted net income and a 21% free cash flow margin. For the first quarter, we anticipate core revenue growth of 5% to 6.5% with an FX headwind of 2.5%. Adjusted operating profit is expected to increase 4% to 9%, with margins in the range of 23.5% to 24%. Adjusted diluted net EPS guidance of $0.71 to $0.74, up 1% to 5%, which includes higher year-over-year interest and tax and free cash flow of approximately $170 million. Turning now to Slide 14. We are expecting a 48-52 split of revenue first half to second half, which reflects a step-up of approximately $120 million of core revenue growth, which when you compare to last year, it's less than half of the increase we saw in the second half of 2022. The step-up in 2023 is largely driven by acceleration in new products, a ramp in the growth rate of advanced healthcare as we lap China COVID lockdowns, and an increase in software and other recurring revenue streams. FX and interest account for abnormal earnings seasonality as FX becomes a tailwind in the second half of the year and interest expense is expected to decline as we pay down debt with available free cash flow as the year progresses, giving us a bigger than usual step-up in EPS first half to second half. In summary, our revenue outlook reflects a similar linearity profile to 2022 and while core growth decelerates first half to second half, it accelerates on a two-year stack basis. With that, I'll pass it back to Jim to provide some closing remarks.

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

Thanks, Jim. That concludes our formal comments. Julianne, we will now take questions.

Hey, good afternoon.

Hi, Steve.

Can you discuss the margin expansion for iOS sequentially from the first quarter through the full year and the key factors contributing to that?

Yes, Steve, it's Jim. A couple of things. We clearly have a role in this, and as we continue to progress, we will see improvements. As mentioned, there was slightly lower growth in the first quarter related to some aspects of the asset life cycle. We can discuss this further, but we expect margins to expand. Revenue is coming back in the software businesses, along with ongoing initiatives that will help drive gross margin expansion and improve productivity. I don’t anticipate significant changes from the first half to the second half, aside from the typical seasonal trends in growth. The realization of pricing and productivity initiatives will gain momentum as the year progresses. Those are likely the main factors contributing to revenue growth.

And then should we assume this excess $350 million backlog that that all obviously gets washed out this year? And then what's the pace of that being washed through?

Steve, this is Chuck. In our modeling, we do not expect everything to be resolved completely, but it really depends on the order rate. This is one reason we believe our forecast is quite strong. If the order rates decrease more than we anticipate, we could still manage it. The supply chain is improving, but it’s not fully fixed yet. It may seem like we can just turn everything on at once, but realistically, we would likely need to reduce it significantly.

Okay, great. Thanks a lot.

Thanks, Steve.

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

In the second half of 2022, we expect orders for those businesses to be relatively flat. There was a slight decrease in the fourth quarter, which aligns with our expectations. As we noted in the third quarter call, we experienced some orders in the first half that carried over into the second half, framing our current situation with the backlog where we anticipated it would end the year. As Chuck mentioned, the backlog helps offset some of the order slowdown we observed. We anticipate orders to remain similar in the first half for those product businesses, with the possibility of declines in both the first and second quarters. However, the backlog will alleviate several of those challenges. We expect to see a slight uptick later in the year, partly due to easier comparisons from the second half of 2022. For sensing, we don’t foresee significant growth throughout the year, while we expect some improvement in Tek. We believe Fluke will recover as well, typically rebounding more quickly.

Julian, I want to point out that we have a more manageable comparison in PT in Q1. So when you consider the dollar perspective, the changes aren't as significant as the year progresses. In fact, we anticipate that PT will show an upward trend in dollar terms each quarter.

Thanks. And when we look maybe within PT at Tektronix, maybe flesh out a little bit more what you're expecting. You've got that high-teens growth first quarter. The year is up mid-single. But I guess if I look at a lot of what's happened in, say, electronics, it feels like people are in kind of the teeth of the destocking right now and have been for three or even six months. So, I understand maybe you're protected a bit by the backlog in Tektronix. That means you have a sort of gradual descent through the year. Maybe just help us understand kind of where you see channel inventories in that business? And again, on Tektronix, it looks like the guide implies down revenue in the back half. Just wanted to kind of confirm a couple of things there.

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

That’s great. Thank you.

Thank you.

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

Yes. Scott, you got that right. We came in at, I think, $0.14 in 2022. And I would expect that, that would grow as you expected. We build on that $0.14 in 2023. Faster growth rates there, also more profitability in the first half in service channel and things. All that are going to give us a nice tailwind.

And Scott, to expand on the first quarter service channel topic, the SaaS revenues have been exceptionally strong for the business. However, we experienced slightly more pass-through revenue this year than we expected, which contributed to nearly 50% growth for the full year. This past year showed remarkable growth. We are transitioning to a more sustainable business model that includes less pass-through revenue, while the strength of our SaaS business remains consistent. Additionally, we are now offering a data analytics platform. We will navigate through this in the first quarter and part of the first half, but we anticipate a significant increase in profitability. We achieved our goals in 2022 in this area, and we will be in an even better position in 2023 due to the business model transformation we are implementing, which will fully impact our P&L throughout the year.

I find that helpful. Jim, you mentioned that the discretionary procedures in China ended the year at about 30% of normal, which seems quite surprising. Are you still observing that trend in January? I would expect that with the reopening, there would be a significant uptick in activity in the first quarter, but I'm not sure. Are you still seeing that kind of...

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

Okay. Well, best of luck. Thank you. I’ll pass it on.

All right. Thanks, Scott.

Hey, thanks. Good day, everybody. Hello. Hey, Jim, as you're well aware, right, there's a process going on out there for national instruments and a lot of speculation about your interest. I'm sure you're fairly limited on what you might want to say, but any color you could give us on your appetite for any deal at large or you've expressed interest in the past and hardware-related deals? Anything there make any sense for you?

Yes, we are aware of the company and the news surrounding it. While we cannot comment on any specific processes we may be part of, I can say that we have a long history with NI. I remember meeting Dr. T about 15 years ago, and we have partnered with them at Tektronix for quite some time. Our strategic approach regarding our opportunities involves a mix of large and small deals, encompassing both hardware and software. Our balance sheet is in excellent shape, providing us with the ability to pursue various ventures. However, we will remain disciplined and ensure that any opportunity we explore aligns with our strategic goals. Overall, we are in a favorable position regarding potential mergers and acquisitions, and we are proactively seeking opportunities in this area.

Great. Thanks for that. And then just totally shifting gears. Just back to kind of the inflationary pressures in AHS. At this point, do you have the cost and other actions in place to be neutral or better as we move through 2023? Maybe just put a little finer point on how you see kind of price cost and kind of the margin impact playing out over the balance of the year?

Yes. Specifically regarding AHS, we identified a few one-time challenges during the quarter. There are several factors positively influencing our outlook for 2023. Firstly, in North America, we experienced good growth and expect that trend to continue. While things may not be perfect, we believe they will improve, as we observed in the fourth quarter, which is beneficial for our margin structure. Secondly, we are beginning to see improved price realization as we move through the fourth quarter and into this year, with our initiatives starting to gain some traction. Additionally, our leadership team has fully embraced FBS, enhancing productivity. We also do not foresee further inflation at this time. Therefore, with no incremental inflation expected and our initiatives increasingly embedding themselves into the margin structure, we feel significantly more positive as we enter 2023, both in terms of market conditions and the necessary actions to enhance our business. Furthermore, we have increased gross margins in AHS and operating margins by approximately 130 basis points over the past two years, which puts us in a solid position despite the challenges we face. I consider this the launching point from where we stand today.

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

Thanks, Jeff.

Thank you, good morning everyone. How is everyone doing? This discussion is going to be quite positive, as you categorize them in that competitive group. I want to follow up on Jeff's question about the National Instrument news. What is your stance on issuing equity for a deal? Given the calculations we're looking at, your leverage could reach very high levels. I'm curious about the leverage ceiling you are willing to accept for the right opportunity, and would you consider issuing equity for the biopsy?

We've always aimed to maintain an investment-grade rating, so we wouldn't take any actions on any deal that could jeopardize that. In the past, we've utilized equity instruments such as mandatory converts, and we've always maintained that issuing equity is an option if needed. However, it hasn't been necessary up to this point.

Okay, that's helpful. And then just going back to the FY 2023 plan. How much of that $350 million surplus backlog are you sort of planning to eat into underpinning your plan? And then maybe just touch on the service channel SaaS transition. It seems like it's a very sort of discrete sort of intra-quarter, maybe first quarter event. These SaaS transitions tend to be kind of drawn out when we look at other companies. So, just curious why that would be so short-term?

I’ll address the first part. We expect to utilize about half of the excess backlog we mentioned in our guidance for this year. To clarify, this excess is still subject to constraints from supply chain issues, although we may benefit more if those conditions improve. Regarding the service channel question, I wouldn’t categorize it as a traditional SaaS transition. The SaaS revenue remains strong, with growth over 70% in Q1 of 2022, largely driven by pass-through revenue. For some of our customers, we have been passing through facility maintenance costs for services such as plumbing or electrical work, and we’re simply doing less of that now. Therefore, it’s not an ordinary SaaS transition, as we are replacing it with added benefits. That’s why we see it as a short-term transition, moving away from some one-time pass-through revenue from which we didn’t profit. Hence, it’s short-term rather than a typical conversion of traditional license revenue to SaaS revenue. The service channel is entirely a SaaS revenue company.

Right. Okay. Thank you.

Thank you.

Thanks.

Good afternoon, guys.

Hi Andy.

Jim, you and Chuck mentioned increased productivity initiatives planned in all segments that primarily benefits the second half of 2023. I think you already mentioned FBS in AHS, but could you give us a little more color around what the bigger initiatives are and maybe size these initiatives for us? And then if there's any sort of cost to undertake these initiatives?

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

Got it. And then Jim, can you give us more color into what you're seeing by region? It looks like Western Europe has continued to be strong for you. We've talked about China and AHS, but outside of AHS is strong. So what are you thinking for 2023? You talked about orders slowing in Western Europe and North America, but are that more a function of supply chain normalizing? Or are more of your customers are little cautious to start in 2023?

Yes, it's interesting. We've assumed for the last several months that customers would begin 2023 conservatively, considering the tech layoffs and the PMI situation. This forms our planning assumption regarding orders. We also have a good backlog situation to start. Regionally, North America should perform well and remain resilient since most of our software businesses derive the majority of their revenue from there, particularly in healthcare. Western Europe, on the other hand, may be weaker this year due to various factors, including supply chains normalizing and some overall weakness. China is expected to do well throughout the year, although healthcare in China may start weak in the first quarter but should improve over time. These insights shape our regional approach and planning assumptions moving forward. It is still early in the year, and there is much left to unfold, but this is central to our planning.

Appreciate it, Jim.

Thank you.

Hi, Josh. Hi. We do this every quarter. Morning, afternoon, sort of depends. I hope everybody is well. Not to beat a dead horse on this hardware backlog conversion and sort of what's in the guide but not, but I just want to be clear here, Chuck, on that comment that you only have about half of the excess backlog getting worked down. I don't know how fungible that backlog is even within something like Tek where it's a little bit more weighted. But am I to understand then that like orders on a volume basis could be down close to double digits. And you guys are basically still hitting the guide if you can work down that backlog fully this year, providing there's no like other governor in the way? Is that sort of a fair way to think about how that's calibrated?

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

And that's where I was going to add that it depends on the business, as you pointed out, and the backlog that remains intact matters in relation to how we manage our orders. This is certainly a factor. However, we should consider the additional portion that isn't planned to go out as a safeguard against any further decline.

Understood. That's beneficial. Relating to Jeff Sprague's question about price costs, if we take a step back to consider the overall impact on the supply chain, I suspect there were some frictional costs last year that may improve. However, you might also be reducing some inventories. Is there an offsetting absorption impact due to the absence of those frictional costs? How would you weigh these factors as a combined headwind versus tailwind for this year?

I believe that some spot buy costs will certainly decrease compared to 2022, but there are ongoing costs in the standards that will persist for a while. The key point is that we will continue to experience price challenges, yet we expect to improve gross margins in 2023 compared to 2022. As we have demonstrated over the past few quarters, we are not overly concerned about factory absorption. Our main focus will be on ensuring that several commodities, such as metals and plastics, decrease in price, although the bulk of our purchases are electronic components. It will take longer to mitigate some of the inflation we experienced this year in that area. Our approach is aggressive, and we’re committed to addressing these issues with our strong supply chain teams, though it may take some time. Throughout the year, we anticipate that gross margins will remain favorable.

Got it. Super helpful. Best of luck, guys.

Thanks.

Thank you. Good day, everybody. Can we put the spotlight on free cash flow by here? It looks like Fortive is the only company we've seen that is over delivered in the fourth quarter significantly above your 4Q average. And Chuck, you mentioned some working capital initiatives you could take us through that? But also, there was a reference about collections pulled into the fourth quarter from the first quarter. So what was the dynamic there?

We've been focused on improving our working capital across all of our operating companies throughout the year, which has been challenging as usual. However, we've made significant progress. While there were some strong results, I wouldn't say we were overly aggressive. We had a solid guidance, and our performance surpassed that slightly. Occasionally, we receive payments later than expected, and this quarter, about $20 million came in earlier than planned. Ultimately, these timing differences are beyond our control, depending on when checks are cut. Overall, we are very satisfied with our free cash flow performance throughout the year.

Yes, it came in at $107 million, which is right in the sweet spot for you all. Jim, you mentioned that you’ve seen some success in cross-selling. Can you share what's happening there? How is that being encouraged, how do you track cross-selling, and what opportunities do you see?

Yes, Dean, I think first, as you know, we've observed some new loan activity in a few areas. When things slow down at the beginning of the year, it tends to take a bit longer to secure new clients, often an extra 30 days. However, cross-selling and up-selling are opportunities we can pursue consistently. Our Presidents are very attuned to times like these when there's a bit more uncertainty about how the year will unfold. The teams are well-prepared to shift their sales strategy toward more cross-selling, which significantly enhances our net dollar retention. We've noted that some of our businesses are performing well above 105 in this regard, while we're currently at about 102. The key metric we focus on is net dollar retention. Early in the year, our emphasis is on securing those renewals, increasing gross retention, and boosting cross-selling and up-selling efforts. From a process standpoint, we have several tools at FBS that support these initiatives, and our customer success organizations are particularly focused on this at the start of the year.

That's really helpful. Thank you.

Thank you.

Thanks for taking my questions. Hi. I wanted to start just more macro and I think you know what you're talking about on the orders front is more just kind of backlog normalization as supply chain corrects. But as you go through that mean, how do you think about coming out on the other side? And how do you think that it's sort of soft-landing type of environment when we see sort of industrial production and we see PMI, so just in general, what you're seeing on kind of structural growth or outgrowth and kind of confidence that backlogs normalize and then the growth is there on the other side?

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

Got it. And then I think in the prepared comments, you mentioned some actions to counter some of the slowing. You're not sure what might be happening on the cost front, but anything that you could expand on there?

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

Great. Thank you.

Thank you.

Hey, everyone. How are you doing? I want to follow up on a couple of things regarding the orders. Specifically, let's focus on the hardware aspects in PT, Fluke, and Tek. What gives you confidence that orders in the second half of the year will improve? The revenue guidance indicates that you came out of the lowest point of the year. You mentioned that Fluke and Tek orders were up around 40% over a certain period. Is it reasonable to expect those orders to drop from plus 40 to more normal levels, or is there a chance for declines due to the rapid expansion over a relatively short timeframe?

In the first half, we expect to see some declines as mentioned earlier. However, point-of-sale performance remains strong. Specifically, Fluke's point-of-sale has continued to be solid. We anticipate some moderation as macroeconomic factors influence that number. It's important to note that we are comparing against high performance levels from previous years, so any decline might appear more significant than it really is. Nonetheless, it is not a major concern given both our backlog and our historical context. While we do expect some improvement in the second half due to favorable comparisons, we recognize that Sensing may face challenges throughout the year. We are aware of what OEMs are currently doing in sectors like industrial automation, especially in regions like China. Overall, we foresee slight improvement in Sensing, Fluke, and Tek in the latter half of the year, but we don't necessarily need a large upswing to achieve our targets. As discussed in previous questions, our backlog serves as a cushion against any larger than expected declines.

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

That's right. That's right. I mean we're really looking at some pretty significant growth rates over the last couple of years in orders that were much bigger than our revenue numbers because of the supply chain issues and the creation of a bigger backlog. And quite frankly, a bigger pass-through backlog, which we started to burn down as we've talked about throughout the day.

Okay. And then just one last question for me. You mentioned theoretical mergers and acquisitions earlier in the call. If you were in a situation where equity was part of the purchase, how would you evaluate your return expectations in those scenarios where equity is involved?

We want to emphasize that maintaining discipline will be key when it comes to mergers and acquisitions. Our return expectations remain consistent, aiming for a 10% return on invested capital for different types of deals. We will continue to adhere to this standard. The recent M&A activities, especially in the patient and service channel, have exceeded our initial expectations, showcasing the strong returns we can achieve. Additionally, past deals from five or six years ago, like those with Gordian, eMaint, and Landauer, are performing exceptionally well. We are in a strong position financially to invest, and our focus will remain on maintaining discipline regarding returns while strategically accelerating growth in areas where we can effectively do so.

Thanks guys.

Thank you.

Thanks.

Thank you, Leanne, and thank you all for joining us today. We truly appreciate your time, especially during such a busy week. What we expressed today reflects our pride in what we accomplished in 2022. We stated that 2022 would be a year of demonstration, and I believe the quarterly updates and annual figures highlight the strength of the Fortive Business System and how we leveraged the FBS tools for acceleration. We emphasized the importance of returning to in-person Kaizen events, which is crucial for our culture and our ability to perform well regardless of economic conditions. We aimed to showcase this revival of in-person events and provided examples of our efforts. As we enter 2023, we are excited to continue sharing our strategies in May. This year, you've observed in our guidance the ongoing enhancement of our portfolio and the robustness of our culture and business system. I extend special thanks to our 18,000 teammates globally who contribute to our success every day. Thank you all, have a wonderful day, and we look forward to the follow-up calls. See you soon and take care.