Fortive Corp (FTV) — Q2 2023 Earnings Call Transcript

Thank you, Rob, and thank you, everyone, for joining us on today's earnings 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 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 31, 2022. These forward-looking statements speak only as of the date that they are made, and we do not assume any obligation to update. 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. Our second quarter results once again demonstrated the durability of our portfolio and the strength of our execution, allowing us to deliver higher core growth, margins, earnings, and free cash flow. Core revenue growth of 5.5% reinforces that our strategy is working, building leading positions across our customers' critical connected workflows with performance reinforcing the resilience of our transformed portfolio. We also delivered record margins in the second quarter, expanding adjusted gross margins by 250 basis points to 59.5% and an adjusted operating margin by 190 basis points to 26%. We're converting more revenue to earnings and more earnings to cash, with 9% growth in adjusted earnings per share and free cash flow in the quarter. Our ability to consistently drive performance is directly tied to our culture of continuous improvement and dedication to the Fortive Business System. Our mandate this year to unleash FBS, which is driving record productivity from Kaizen activity across the enterprise, and increasing our confidence in our raised outlook for the year that we believe further positions Fortive for accelerated compounding in 2024 and beyond. Turning to Slide 4. I wanted to provide an update on what we are seeing and what we are expecting over the course of the rest of the year. Starting with health care, industry recovery is on track as labor and productivity challenges continue to moderate. We are seeing traction on our pricing and productivity initiatives, yielding sequential growth and profitability in the second quarter. We expect further improvement in Advanced Healthcare Solutions in the second half with higher core growth and operating margins. We also continue to drive growth in our software and services businesses with SaaS revenue up mid-teens on strong enterprise growth and bookings. Hardware products have also been running ahead of expectations as traction on new product launches and leveraging secular drivers are helping to provide more backlog to buffer the normalization of industrial demand. As we sit here today, we now expect to have over $200 million of excess backlog heading into next year, well positioning us for 2024. Our strategy to create a more durable growth company is working. Our recurring revenue businesses are expected to accelerate from first half to second, led by higher software and consumables growth. Combined with favorable pricing and discrete productivity initiatives, we now expect over 125 basis points of adjusted operating margin expansion for the year. Lastly, our robust free cash flow and low leverage profile provides further flexibility to accelerate compounding with an attractive funnel of M&A opportunities aligned to our workflow strategy. Turning to Slide 5. Our success in the quarter demonstrates our ability to leverage our domain expertise in hardware and accelerate software and data analytics across our five customer connected workflows, where we are enabling progress in a number of high-impact fields. All benefiting from customer investments in automation and digitization, the energy transition, and the need for productivity solutions to address labor, manufacturing, inflation, and regulatory challenges globally. For example, solar energy is one of the fastest-growing renewable energy sources worldwide. From the grid to hybrid and backup systems, connected reliability solutions are ensuring the maintenance and efficiency of critical infrastructure, enabling the energy transition and IoT expansion. Environmental health and safety solutions are safeguarding workers and enabling customers' ESG reporting and compliance. Our leading facility and asset lifecycle software applications are improving asset performance, optimizing workplaces, and accelerating customer productivity efforts. Our innovations in the product realization workflow are solving customers' toughest technical challenges, speeding breakthroughs in a wide range of applications including helping to increase the proliferation of electrified and connected devices and advance the democratization of high-performance compute and AI-driven data analytics as well as in the perioperative loop, where we're helping health care providers deliver exceptional patient care more efficiently, with industry-leading clinical safety and productivity solutions. In summary, we are seeing strong customer success on new product launches, highly aligned to these secular trends where our innovation funnels remain focused, which I'll take a moment to discuss further on Slide 6. As we highlighted at our Investor Day in May, our FBS growth tools are accelerating innovation cycles to drive share gains and maximize R&D returns to create and sustain our competitive advantage in a number of exciting new areas. For example, we highlighted new product launches at Fluke to accelerate the distributed energy strategy and penetrate the high-growth EV storage equipment market with new testing tools that ensure technicians' safety and asset performance. At Gordian, our unique planning tools and technical expertise helped a California County optimize their infrastructure resulting in millions of yearly cost savings and a significant reduction in project completion timelines. Tektronix is providing performance scopes and waveform generators to help customers develop quantum computing to advance AI applications, including a large aerospace and defense customer win in the quarter. Provation's latest cloud-based documentation software is saving physicians roughly 16 hours per month in documentation and reporting, which is why Provation continues to be the provider of choice with accelerated win rates and apex adoption. Lastly, Intelex leverages lean portfolio management to expand its foothold in environmental accounting, compliance, and reporting. Accelerating the launch of its new ESG corporate reporting solution. Fortive is committed to innovation across all aspects of the company. And this quarter, we received two notable recognitions for our innovative sustainability efforts. In May, USA Today and Statista named Fortive one of America's climate leaders in 2023. This award recognizes us as a leader in greenhouse gas emissions reductions, and singled out Fortive as a top emissions reducer among more than 2,000 companies nationwide. In June, Fortive was selected as a finalist for the 2023 World Sustainability Awards in the profit with a purpose category which recognized companies that link revenue generation to sustainability. We're incredibly proud of our culture of innovation and continuous improvement and how that not only shows up in the solutions we deliver for our customers but also in the positive impact we are making around the world. I'll now provide more details on each of our three segments, beginning with Intelligent Operating Solutions on Slide 7. IOS grew core revenue by 4%, driven by good growth in most regions. Strong FBS-driven execution resulted in 420 basis points of adjusted operating margin expansion, driving operating margins to a record 33%. Looking at our performance drivers by workflow and connected reliability, Fluke core revenues were up slightly, lapping the Shanghai recovery last year with mid-single-digit orders growth in the quarter. Fluke margins expanded by more than 300 basis points year-over-year, driven by productivity initiatives and solid price realization, eMaint saw record quarterly bookings, fueled by the continued success of the new X5 CMMS product launch. EHS revenues grew by high single digits with record iNet growth at ISC and strong SaaS momentum in Intelex. Further, Intelex saw strong bookings for its new ESG corporate reporting solution. Moving to facilities and asset lifecycle. We had low double-digit growth in the second quarter, driven by mid-teens SaaS growth. Gordian had strong growth and operating margin expansion in the quarter as more customers utilize their job order contracting platform to procure and manage their large infrastructure projects. Sensing is seeing sustained improvements in win rates and good growth in their streamlined portfolio, supported by FBS-led innovation and pipeline generation efforts. The service channel had an acceleration in growth and profitability as planned, driven by strong SaaS bookings and a resulting take rate as customers leverage the service channel network to maximize their cost savings. A large retail customer is already $2 million ahead of their $14 million cost savings goal in 2023 after taking advantage of the automation capabilities of the platform, which is a powerful testament to the secular drivers underpinning the FAL workflow strategy. Turning now to Slide 8. Precision Technologies continued its momentum with another strong quarter with 8% core revenue growth and 190 basis points of adjusted operating margin expansion reflecting volume and price benefits more than offsetting inflation and FX. Some highlights in the quarter include record second-quarter revenue at Tektronix with orders better than expectations and strong point of sale in all major regions. The team delivered mid-teens growth, which was over 20% on a two-year stack basis in the second quarter. Tektronix is executing on robust backlog and power and digital test and measurement solutions and delivering outstanding margin operating margin expansion. As orders continue to normalize, we anticipate Tektronix growth will moderate to mid-single-digit levels in the second half, and we expect we will end the year with elevated backlog levels again heading into 2024. Sensing technologies came in better than expected, up slightly driven by strong price realization across all businesses and continued broad strength at Qualitrol. Lastly, Pacific Scientific EMC reported a strong sales quarter with mid-teens growth as it benefits from strong customer demand and Kaizen activity to improve manufacturing capacity and operational execution to deliver on record backlog. Moving now to Slide 9, in Advanced Healthcare Solutions. Core revenues were up 4% in the second quarter as the industry continues its modest pace of recovery. Consistent with expectations, adjusted operating profit margins contracted by 60 basis points year-over-year. The benefits of sequential volume, price, and productivity drove operating margins higher by 180 basis points versus the first quarter. China electric procedures remained at normalized levels throughout the quarter, only slightly trailing global rates, allowing for double-digit growth. Our outlook continues to assume that electric procedures remain close to pre-COVID levels in all major regions. Some highlights for the quarter include, ASP/Censis had mid-single-digit core growth, driven by capital expansion at ASP and double-digit SaaS growth at Censis. ASP saw sequential growth in consumables as planned and U.S. channel transition to direct is on track, contributing to sequential price benefits, driving margins higher, a trend we will expect will continue through the rest of the year. Supply chain constraints are largely resolved, yielding good growth at Fluke Health Solutions and Provation had another great quarter with mid-teens core revenue growth, driven by Apex SaaS adoption and new logos. With that, I'll pass it over to Chuck, who will provide more color on our second quarter financials and our 2023 outlook.

Thanks, Jim, and hello, everyone. I'll begin on Slide 10 with a quick recap of our second quarter revenue performance. We generated year-over-year revenue growth of 4% with core growth of 5.5%. FX was a 90 basis point headwind to growth. Turning to the geographies. North America revenue grew high single digits with growth in all three segments. Western Europe revenue was essentially flat in the quarter, following mid-teens growth the prior year. Asia revenue grew mid-single digits with over 20% growth in Japan and India and low single-digit growth in China. We saw strength in healthcare in China. As expected, however, growth was muted by COVID reopening tailwinds that benefited the hardware products revenue in the second quarter of 2022. Looking ahead, we continue to expect China growth to moderate in the second half as we lap outsized growth in prior years. Turning to Slide 11. We show operating performance highlights in the second quarter. As Jim mentioned earlier, adjusted gross margins increased 250 basis points to a record 59.5% driven by volume, FBS initiatives, and strong price realizations that more than offset higher inflation. Adjusted operating profit margins expanded 190 basis points to 26%, another Fortive record, reflecting higher gross margins and productivity initiatives that have started to gain traction in the quarter. Adjusted earnings per share increased 9% to $0.85 despite higher year-over-year interest and tax expense. Free cash flow was $300 million, which reflects approximately 100% free cash flow conversion. A testament to our working capital efficiency enabled by the Fortive businesses. Turning now to the guidance on Slide 12. We are raising our previous 2023 guidance to reflect the outperformance in the second quarter. Starting with the third quarter, we expect core growth of 3.5% to 4.5% and with revenues reflecting our normal linear profile and adjusted operating profit margins are estimated to be up over 100 basis points year-over-year. Adjusted earnings per share are expected to be in the range of $0.82 to $0.85 in Q3 and reflect a 17% estimated effective tax rate. Our fourth quarter guidance assumes a seasonal uplift in all segments with core revenue growth of 3.5% to 4.5% year-over-year and strong margin expansion, reflecting the cumulative benefits of our productivity initiatives. Adjusted EPS is expected to be in the range of $0.94 to $0.97, up 7% to 10%. For the full year 2023, we have raised our core revenue growth to be in the range of 5% to 6%. Adjusted operating profit is now expected to increase 10% to 11% with margins higher in the range of 25.5% to 26%. We are increasing our adjusted diluted net EPS guidance to $3.36 to $3.42, which includes an approximate $0.06 headwind from higher interest and tax expense versus the prior guidance. Free cash flow for the year is now expected to be approximately $1.26 billion. This represents conversion of 105% of adjusted net income and 21% free cash flow margin as well as over 30% growth on a two-year stack basis. With that, I'll pass it back to Jim to provide some closing remarks.

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

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

Hey, thank you. Good day, everyone. Can we just drill a little deeper into tech? Just want to clarify what you said about orders. So orders decelerate but were stronger than expected. And I guess you're talking about backlog being pretty healthy. So are you actually running at a book-to-bill above 1 in tech?

Hey, Jeff, it's Jim. A couple of things. I think it was better than expected. We've noticed some slowing in certain areas, particularly in places like China, but we're seeing an increase in investments from sectors like aerospace to defense customers. Our orders were down about 10% in the second quarter. However, to provide some context, those orders are still up 30% compared to three years ago, indicating good demand. The backlog is also higher than our expectations, which we had discussed earlier. It's above what we anticipated at the start of the year. I'll stop there, and if you have any follow-up questions, feel free to ask.

No, I'll switch gears to AHS now. Regarding the channel distribution shift, I’m not sure if you consider it a challenge, but there might have been some risk of any issues during the transition this quarter. Is that accurate? Moving forward, do you expect things to go more smoothly for the rest of the year?

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

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

Yes, Steve, this is Chuck. The adjustment in our guidance this year is primarily due to Invetech performing slightly below our expectations in Q2. Looking ahead, we recognize the sequential improvements you mentioned, which are influenced by the decline of COVID, our productivity initiatives, and increased pricing. Although we are not providing specific projections for next year, we anticipate continuing support from these factors, including COVID and pricing. We expect margin expansion to be above the usual mid-single digits and 75 basis points. While we won't reach a 30% margin next year, we will continue to make progress and experience strong margin growth as electric procedures recover, which we believe will provide ongoing support for an extended period.

I was wondering whether we should see next year as a straightforward progression towards the 30% target, or if this year's events will push that goal further into '25, '26, or '27. Is 2024 expected to be a solid recovery year early on, or will it be more weighted towards achieving that 30% later on?

I don't believe the growth is back-end loaded; it's not structured that way. I anticipate we'll see significant progress. The current trajectory shows that operations like Provation, Fluke Health, and the Censis segment of our sterilization business are already delivering over 30% operating profit. The growth path for ASP is the key focus. Additionally, I believe our performance this quarter regarding placements will boost consumable sales in 2024. I think we've made a solid advancement in the second quarter concerning health margins, though I don't want to overstate things.

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

So about $330 million. We still have about $330 million of excess at this point.

Good morning, Jim, Chuck, and Elena. The IOS margins are up 400 basis points on relatively limited volume, which is impressive. However, is that sustainable? It seems sustainable based on your guidance, but is there a risk that some of the price-cost spread you’re currently experiencing might reverse in the next 12 months?

No, I think there are a couple of factors at play. As you mentioned, it highlights the strength of our efforts in IOS as we continue to accelerate, particularly with the acquisitions we made several years ago. FAL performed exceptionally well, as did our EH&F, resulting in margin improvements from those businesses. Fluke had a slower quarter but remains strong for the year and has historically contributed positively to margins. While you may not see 400 basis points every quarter, which is likely ambitious, it demonstrates the progress we've made over the past few years to enhance the entire segment. The second quarter provided a good indication of the segment's potential.

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

Yes. I think there are a couple of things to note. In the PT segment, the book-to-bill ratio for the year is about 1.0, which is better than we anticipated. Year-to-date, we expected it to be around 0.9, but we're currently at 1.0. This indicates that orders have been stronger than we anticipated, leading to better revenue growth. Specifically, in Sensing, some areas are performing very well. Qualitrol is executing effectively, and we expect Anderson-Negele to do well throughout the year, along with parts of the Sensing sector. However, we are observing a slowdown in industrial businesses, especially in Europe among automation customers. There is also a slowdown in sectors like HVAC with some OEM clients, particularly on the OEM side related to Sensing, and parts of the semiconductor business are also showing this trend. This slowdown was something we had initially anticipated, and it aligns with what we are currently seeing and expect to continue in the second half of the year.

Thank you. Good day, everybody. Wanted to circle back on this concept of the excess backlog, and I know you just sized it. But just be interested, I know there's the implied earnings visibility that you get from elevated backlog, but can you share with us some thoughts about the flexibility within the backlog? Like let's say, something happens, whether it's supply chain or customer readiness, how much flexibility do you have to immediately just draw down the next in line on the backlog and have that kind of seamlessly flow through to the P&L? Because when we hear excess backlog, we immediately think there's flexibility, but sometimes it may not be as flexible based upon customer timing and so forth. But any color there would be helpful.

Yes. A couple of things, Deane. As Chuck mentioned, our excess backlog is higher than we expected at the beginning of the year, currently at about $330 million. We anticipate reducing this to around $200 million by year-end. It largely depends on the situation; if we consider that half of this excess is at Tektronix, it is quite flexible, although it's not immediately flexible due to some supply chain factors. However, it should be fairly adaptable within a 90-day timeframe. The flexibility in Sensing is somewhat less, depending on specific OEM customers, while Fluke remains quite flexible. This is essentially the current landscape. Our excess backlog acts as a safety net against any potential slowdowns, which was evident in the second quarter when we managed to release more backlog, with EMC performing stronger than expected. These factors indicate that we can utilize the backlog to navigate any short-term issues. Regarding the question from Scott about destocking, we are not observing significant destocking or de-booking; it remains close to our usual levels, which are quite low. There has been some rescheduling of backlog on the OEM side in Sensing, which accounts for a slower second half relative to the rest of our portfolio. We have not encountered requests from distributors to cancel orders—it has been quite minimal. Therefore, we believe the backlog continues to be flexible.

All right. On behalf of Scott, I'll thank you for the destocking answer. And then my follow-up, just any color on the excess of 20% in India and Japan. Is that a comp issue? Is there anything specific on the business side you call out?

Yes, there is a bit of a comparison issue with Japan. However, I believe we will still achieve high single-digit growth in Japan for the rest of the year, despite this comparison factor. In India, we have observed strong growth. We are benefiting from the reshoring and foreign direct investments that have been flowing into India over the past year. Major companies like Fluke, Tek, and ASP are experiencing these benefits, and it's evident across a broader range of our portfolio. We anticipate that India's growth will be around 20% for the remainder of the year. Smaller regions, like parts of Western Europe, can show variability based on significant business changes, but we are optimistic about the current demand patterns in India, in particular.

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

I view demand as closely tied to inventory levels in the channel. As demand has slightly decreased from the significant figures we've seen over the past couple of years, there are some areas where we might notice an increase in inventory. However, as I mentioned earlier, this isn't a widespread issue. In the U.S. and Europe, particularly with Fluke and Tek, we have good visibility into inventory levels. The channel inventory data mentioned in our filings also reflects what we observe in average selling prices and the Sensing division, giving us a comprehensive view of the channels, including international partners. We are effectively managing our approach to demand creation and are still witnessing strong point-of-sale activity. This is helping to fulfill backlogged orders, with customers waiting for their orders and receiving them in a timely manner. Point-of-sale growth remains robust, albeit with Fluke showing some mixed results; it's more about moderation than a significant decline. We experienced mid-single-digit growth in point-of-sale for Fluke during the second quarter in the U.S., with even better growth reported in China and a decent performance in Europe. As demand moderates, we expect some sectors may see a slight increase in channel inventory, but we have solid processes in place to monitor this and implement demand creation strategies. Additionally, we anticipate a strong second half for innovation and product launches, which presents another opportunity to stimulate demand where there may be excess inventory.

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

On the technology front, we are beginning to gain clarity. Even in some semiconductor sectors where growth has slowed a bit, we've had discussions with customers across various product lines regarding investments for 2024. The positive aspect is that companies in tech are leveraging opportunities in power, aerospace, and defense to mitigate some of the slowdown. That's encouraging and could bode well for 2024, although it's still early to predict with certainty. Regarding Fluke, the focus will be less on the timing of when facilities are constructed and more on ensuring those facilities operate efficiently. We may be a few years away from realizing some of these opportunities. While new manufacturing plants present initial benefits during the construction phase, when electrical contractors increase their purchases of Fluke equipment, the true potential will come once those facilities are operational, and maintenance teams begin to develop further opportunities. We might be a bit distant from that potential, but in the meantime, we are witnessing strong underlying trends at Fluke in areas like power, solar, and the sustainable investments we mentioned earlier, which continue to represent solid prospects for us.

Hi, folks. Just wanted to follow up on FAL and with some of the, I guess, changes going on in the construction markets, so maybe a little bit of mix divergence, more manufacturing, a little less in some of these commercial or warehouse verticals. Anything that you guys are seeing across your customer base that gives you any kind of cyclical impulse, whether this business is countercyclical, more procyclical? I guess this is maybe one of the first real construction cycles since you guys have owned some of these assets. Like anything that you would just point out cyclically that you guys are noticing it seems like your business is doing well, but anything would be helpful.

We don't have much exposure to traditional commercial buildings in FAL, with commercial customers accounting for about 5% of our sales. This isn't a major driver for us. However, we are observing a positive trend at Gordian with a significant amount of deferred maintenance. Both Gordian Solutions and FAL are focusing on this deferred maintenance, which is helping to improve project timelines and has emerged as a key growth driver for us. We believe this trend will continue into the second half of the year. The infrastructure improvements occurring at the state and local levels, as well as in the broader commercial sector, are notable. Our customers in FAL are particularly interested in understanding their capital investments as they return to the office, especially in retail. They want insight into how their real estate assets are performing, and our solutions are tailored to help manage and reduce facility costs. Consequently, the reassessment of commercial infrastructure is driving growth for us due to the solutions we provide.

Got it. Makes sense, seems what the numbers say as well. And then maybe just shifting gears. We've seen a few folks thus far this earnings season have maybe a bit more of a reaction from customers from lead times normalizing, so not necessarily a destocking or a change in point of sale. But are your lead times across some of the hardware businesses improving more materially here in 2Q? And is there sort of a customer impulse reaction to that?

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

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

Hi, Julian, this is Chuck. There are a few points to discuss. I believe your figures for the first and second halves are generally accurate. Normal seasonality, particularly in the fourth quarter, influences much of what we're seeing. Additionally, Q1 was quite low due to COVID and the associated procedures in China, leading to a lower performance in that quarter. However, Project Elevate and the shift in our dealer strategy should increase our revenue in Q4, as well as our profit. We're also increasing prices throughout the year, which contributes to our outlook. These factors, combined with the productivity initiatives we implemented earlier in the year, have significantly helped us. We anticipate a 65% increase from the first half to the second half based on these developments, including seeing higher sales of consumables in Tek now. I'll pause here to check if I've covered everything.

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

Julian, let me take the buyback, and then I'll pitch it over to Jim to talk about M&A. We remain opportunistic with our buyback. I think we, Q1 is our lowest cash flow in the quarter, and we didn't do any there. But we'll be opportunistic as we move forward when we think that we're undervalued and see an opportunity. So I think that's going to continue to be the case. I think from a capacity standpoint, what we're doing here doesn't change anything about when you look at the 3 to 5 years where actual capacity. So we've got plenty of capacity.

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

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

We've had a strong view on North America, and we expect that to continue in the second half, likely in the mid-single-digit range. Looking at the two-year growth in North America, the numbers are quite positive, around the mid-teens. We're confident in our position in North America, which is significant since most of our software businesses are located there. This contributes positively to our North American growth rate, along with the efforts of our ASP team. In Western Europe, we anticipate growth to remain roughly flat. The region has experienced strong performance for some time, with mid-teens growth noted for the second quarter. We expect this trend to continue into the second half of the year, possibly increasing slightly. While we're seeing good traction in some areas, we also notice a slowdown among some industrial OEMs, particularly in Sensing, which is reflected in our guidance for the second half. Regarding China, we've maintained consistent growth over the past six months, with four exceptional quarters. We expected the market to take a breather in the second half, a sentiment we expressed back in February, and we still hold that view. Our guidance reflects a low single-digit growth expectation for China in the second half, although the two-year growth is accelerating, showing high teens to low 20s. While the business is performing well, it is starting from a large base. As for high-growth markets, particularly in India, we believe there are several opportunities in the second half. However, since these markets are smaller, their growth rates can fluctuate a bit. Nonetheless, we’re optimistic about some prospects in the high-growth markets going forward.

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

Yes, I believe there are two key areas where we have observed customer investments. First, we are seeing significant investments in quantum computing and research and development organizations that are focusing on opportunities for AI. It's important to have the necessary hardware to fully realize the benefits of AI, and Tektronix is making strong contributions in that area. Secondly, EMC is more related to geopolitical factors rather than AI specifically, as it aligns with their historical business focus. They have a substantial backlog, which we do not count in our hardware backlog because it looks promising. However, we have faced some challenges with supply chain capacity. Although we were able to deliver more in the second quarter than we expected, we’re still working through those issues. Looking ahead to the second half, we have opportunities to improve further, but we'll have to monitor how that develops. The improvements we've made are encouraging, but we want to ensure they are sustainable, especially with our supply chain at EMC. Demand for EMC products is currently at an all-time high.

Hi, guys, good morning. So I think we've covered AI, so let's move to price. So you're one of the few companies actually seeing better price Q-o-Q, I think, 50 basis points better, if I'm not mistaken, maybe a bit more than that. So just curious, it seems like you're still pushing price, especially in AHS. So what is your perspective on how pricing looks in the back half of the year, especially within AHS, is there still more runway in healthcare? And then I'm just also quite curious as well, how pricing looks across software and services?

I would say a couple of things. In the quarter, we performed slightly better than expected, particularly in Sensing, where we exceeded our goals. This improvement has positively affected our pricing. Regarding healthcare, we anticipate some acceleration in the second half, particularly because of Elevate and changes in our channel mix; this will likely be more evident in the fourth quarter than the third, but we will monitor that. We're also seeing price increases and opportunities for upselling and cross-selling. Our net dollar retention continues to rise, indicating that we're finding ways to increase prices, which reflects the margin improvements we experienced in the second quarter. The service channel is a major factor, currently nearing 115% net dollar retention, showcasing our efforts to maximize value. On the software side, delivering value and enhancing features are key. As we expand our offerings, particularly with AI, we see potential to improve net dollar retention further. For example, the AI launch with Censis in the second quarter has already shown promising results. We believe there are significant opportunities to continue increasing net dollar retention moving forward, which will also reflect in our software pricing strategy.

Okay. That's great. And then moving on to Fluke. The flat revenues, it sounds like units down mid-single digits. I think you called out China comp has been quite tough there. But are there any other pockets of headwind that you call out? Just curious because this is to canary in a coalmine.

Yes, we had a very strong first quarter. Looking at the mid-single-digit growth in the first half for Fluke, we are quite pleased with that. While the industrial business has seen a slight slowdown, the calibration business and other parts of our operations are accelerating. Overall, I believe the mid-single-digit growth reflects the strength of Fluke, and we anticipate similar performance in the second half, benefiting from the higher growth we experienced last year during that time. In many ways, it's an acceleration from our two-year stack. We appreciate the positive trajectory of the business. There are a few areas we are monitoring closely, especially the PMI and industrial production. However, the team has been executing well, and we have had several successful technology launches. The eMaint business is doing particularly well. We have been working on making Fluke less cyclical and more aligned with long-term trends, and we expect to see this continue in the second quarter. We have several new product launches that could capitalize on emerging opportunities. If there is any marketplace slowdown, we believe we have effective strategies in place to mitigate potential impacts.

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

Yes. Let me clarify my comment about Fluke. In the first half of this year, we were seeing mid-single-digit growth, and we expect that to continue in the second half as well. So, from that perspective, there won't be any acceleration. While there may be some fluctuations between quarters, we anticipate that the performance in the first half will be similar to the second half. However, because we saw stronger growth in the second half of last year, the two-year comparison shows some acceleration. I hope that helps clarify my Fluke comment. As for Tek, we have always recognized that various parts of the business have been developing over time. Additionally, as lead times decrease, it will affect orders. It's encouraging to see consistent strength in point-of-sale activity worldwide, reinforcing our belief that the demand is genuine and sustainable. This is why we view the excess backlog as a safeguard against any potential slowdowns. I think that addresses your questions.

Hi, everyone. Thanks for taking my questions. First, just one related to a comment around channel distribution in AHS. And I think you talked about how still have a headwind in the third quarter, headwind goes away in the fourth quarter. I guess I'm curious about the tailwinds associated with this and what that looks like. And I don't know any framing around kind of the cost headwinds you've seen so far, but then as you sort of reach that transition point, how long you think it takes to then sort of reach the more elevated margin target opportunity that you have there?

I would say that the most significant impact of the transition will be felt in the second quarter. There will be some effects in the third quarter, but by the fourth quarter, things should balance out. We believe this transition will enhance margins because we anticipate improved pricing. Additionally, it will likely contribute to growth, particularly in late Q4 of 2024. We are optimistic about our terminal sterilization business, which enables us to speed up the sterilization cycles in our equipment. Being more direct will enhance our interactions with customers, allowing our application engineers to better assist them with the effectiveness of accelerating sterilization in other lab products. This should positively influence growth over time, not just in terminal sterilization but also in our biological indicator business. We see potential for customer satisfaction to increase as well. We observed improved capital numbers in the second quarter, likely because customers recognize that they will have better support from ASP salespeople and application engineers in their hospitals daily. This transition is both a margin and growth opportunity. We believe it is already starting to reflect on the capital side and will manifest in the consumable side in the second half of the year and into 2024.

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

I believe that our ability to maintain pricing is strong. The quality of our franchises and the investments we've made in innovation support this confidence. We view this as a means of creating value for our customers while getting compensated for it. This perspective is evident in various aspects we previously discussed. We are optimistic about maintaining our prices, though we may not achieve the same rates as we did in 2021 or 2022. Historically, we have been effective price leaders compared to many companies, and there's no reason to think that we won't continue this trend into 2024 and 2025.

Thanks, Rob, and thanks, everyone, for the time today. Hopefully, you get a sense of the excitement in the second quarter and the conversations we had. I think as we look into the second half, the raise of our guide really speaks to the confidence that we have out there despite probably some noisy things. Our strategy is playing out the way we anticipated, and we're excited about that and we look forward to sharing some of the details with you as we get through the follow-up calls and a number of things that we'll be doing here in the third quarter. Between now and then, have a great summer. Thanks for everyone. We look forward to your follow-up questions and take care.

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