Fortive Corp (FTV) — Q4 2023 Earnings Call Transcript

Thank you, Kristina, 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 represent 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 the 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 the actual results may differ materially from any forward-looking statements that we make here 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, 2023. 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'll turn the call over to Jim Lico.

Thanks, Elena. Hello, everyone, and thank you for joining us. I'll begin on Slide 3. Fortive delivered outstanding operating performance again in 2023 through our proven formula for value creation. Our transformed portfolio of businesses delivered consistent through-cycle performance, reflecting a more durable company with mid-single-digit core growth in 2023 despite a mixed macro environment. Strong execution by our teams drove another year of record margins, with adjusted gross margins now approaching 60% and adjusted operating margins nearing 26%. Throughout 2023, we focused on unleashing the full power of FBS, reflected by record participation in KAIZEN events, including our largest ever CEO KAIZEN week. The results of these KAIZEN events were tremendous, including an average of 50% productivity and 50% lead time conversion improvements. Our industry-leading free cash flow generation funded accretive capital deployment, including our best year executing on bolt-on acquisitions, accelerating our growth strategy across all three of our segments. We also opportunistically bought back shares and increased our dividend, enhancing shareholder returns. In summary, we remain committed to our strategy, and its success is evident given the consistency of our results, which I'll highlight on Slide 4. We built Fortive to drive growth, drive progress, and drive value. Reflecting on our evolution, we made significant steps again in 2023 towards our vision of a premier company. This includes 5% core growth and 160 basis points adjusted operating margin expansion. The benefits of our portfolio transformation are reflected in our progress to date, averaging rule of 35 performance over the last five years. FBS is driving commercial success as we expand into new growth markets, speed innovation cycles, and maximize investment returns across our three operating segments. For example, in 2023, we saw a 33% increase in our revenue attainment on new product launches. Many of these new products are contributing to the approximately 60% of our revenues that positively impact climate, health, and safety concerns and align with the U.S. sustainable development goals. Our operating companies are seeing a greater than 20% acceleration in software development time through the use of Gen AI, improving our ability to deliver more value to customers. Our culture of innovation, learning, and continuous improvement is contributing to gains in our industry-leading employee engagement scores, a critical component of our sustained success. Lastly, our acquisition performance contributed to our record free cash flow in the year, underpinned by industry-leading net working capital performance and accelerated returns on invested capital. On Slide 5, you see how our portfolio is strategically positioned to increasingly benefit from secular growth trends. Every day, we are helping our customers harness the power of emerging automation and digitization technologies, streamline crucial workflows, and embrace the energy transition. Some highlights in the fourth quarter include: in IOS, Fluke's new family of Multi-product Calibrators are providing the broadest workload coverage across some of the fastest-growing markets. The recent bolt-on in RedEye is helping to transform customers' digital experience with a modern centralized hub for engineering document management, solidifying our Accruent's leading position in that market. In PT, Tektronix is harnessing the power of open-source software with the first release of its Python Native Drivers to help our customers automate their instruments and accelerate their testing types. Together with EA, which closed in early January, Tektronix is expanding its addressable market, adding complementary performance solutions to their best-in-class electronic test and measurement suite serving the fastest-growing areas of the power market. In AHS, Landauer is helping customers reduce energy usage, waste, and carbon emissions with their new Digital Dosimetry Solution. And ASP launched their new sterilization monitoring products in North America and Asia, helping customers achieve greater efficiency and assurance as they work to keep up with rising clinical demand. Turning to Slide 6 and a spotlight on M&A performance; our two most recent large deals provide an excellent example of the Fortive flywheel for value creation and action. In 2021, we accelerated our segment strategies with the acquisitions of ServiceChannel and proVation information. These two world-class software offerings are creating compelling value for our customers. And Fortive, having fully embraced the power of FBS to drive double-digit ARR growth and significant margin expansion. For example, ServiceChannel exited 2023 with adjusted operating margins in the mid-20s, up from breakeven when it was acquired. And proVation delivered 112% net dollar retention in its GI solutions, up approximately 8 points from the Censis acquisition. The execution of our disciplined acquisition strategy, strengthened by the value FBS creates, is a critical component of how we achieve sustained results over time. You see that reflected in their industry-leading net dollar retention as our innovation and customer-centricity tools are helping them retain and grow their existing base. Turning to Slide 7; our ability to deliver differentiated results enables our world-class business system. Across Fortive, we leveraged FBS to better understand our customers, accelerate innovation, expand market share profitably, improve operations, and forge the leadership skills we need for the future. One of the best things about FBS is that we never stop improving it. As our portfolio evolves, we are expanding the toolset and capabilities that allow us to set and deliver on high expectations, as you just saw in the ServiceChannel and proVation examples. In 2023, our center of excellence for software data and AI expanded its capabilities to further support digital transformation and drive innovation, next-gen products, and productivity across Fortive. Core to our success is how our leaders immerse, teach, and lead from the front with FBS. Together, they make KAIZEN the way of life for our 18,000 team members, reinforcing our strong culture of inclusion where everyone's contribution matters. Looking at the chart on the right, what is unique and differentiated about Fortive is the breadth of results that are compounding over time. Since 2019, we have sustained our target of mid-single-digit through-cycle core growth. We have delivered outstanding margin expansion above our annual commitments. We have converted more revenue to income, growing adjusted EPS at a 14% compounded rate and converted more income to cash, compounding free cash flow at an average of 19% over time. With that, I'll turn it over to Chuck to provide more color on our fourth-quarter financials and our 2024 outlook, starting on Slide 8.

Thanks, Jim, and hello, everyone. We ended the year with a high level of performance, generating earnings growth of approximately three times revenue. Core revenue growth of 3% in the quarter reflected an acceleration in IOS and Healthcare, partially offset by anticipated slowing in Precision Technologies. We achieved record margins in the quarter and full year, driven by the strength of our brands. Earnings per share of $0.98 reflects operational beat at the midpoint, with earnings up 11% year-over-year. Free cash flow was $413 million, down versus the prior year as expected and up 56% on a two-year stack basis. For the year, core revenue growth was 5%, exceeding our initial outlook of 4%. Adjusted gross margins expanded by 180 basis points to 59.5%. Adjusted operating profit grew 11% and margins expanded by 160 basis points. Adjusted EPS of $3.43 grew 9%, and we delivered on our free cash flow forecast of $1.25 billion, which represents 32% growth on a two-year stack. Turning to Slide 9; I'll now provide highlights on the fourth-quarter performance of each of the three segments, beginning with Intelligent Operating Solutions. Q4 core growth was 6%, reflecting continued momentum across this segment, with stable POS trends in all regions and new logos and customer bookings contributing to strong ARR growth. Adjusted operating margins expanded 300 basis points to 34.2%, driven by margin expansion in all businesses, accretive software mix, price realization, and productivity initiatives. Overall, we have seen better durability in Fluke throughout the year, given the benefits of innovation and customer adoptions in key growth verticals. Environmental Health and Safety continues to see strong high net growth at ISC and double-digit SaaS growth at Environmental Health and Safety. Facilities and asset lifecycle experienced double-digit core growth throughout most of 2023, driven by continued strength in SaaS, contributing to record margin expansion. Moving on to Precision Technologies. Core revenues in the quarter were slightly ahead of expectations, down 1%, driven by lower Sensing revenues more than offsetting growth in Power, Food, and Beverage, and Aerospace and Defense market. Adjusted operating margins expanded 270 basis points to 29%, enabled by favorable pricing and productivity benefits funded throughout the year. Additional highlights include Tektronix, which had a record year with 9% core growth, up 25% on a two-year stack basis, reflecting the benefits of our focused innovation and vertical markets growth initiatives. While Sensing Technology revenues were down low single digits in 2023, they were up low double-digit on a two-year stack and ended the year with a return to growth in 2 of our 4 businesses. Now on to Advanced Healthcare Solutions. Q4 growth was 3%, driven by an acceleration to mid-single-digit growth at ASP, excluding Invetech, AHS core growth would have been approximately 6%. Adjusted operating margins expanded 160 basis points to 25.7%, driven by flow-through on consumables, price realization, and product additional highlights include. At ASP, we are through the North American channel transition from indirect to direct, driving 7% consumables growth in the quarter. Our software businesses continued their pace of double-digit SaaS growth with new logo success at Censis and proVation. We expect to sustain this momentum in 2024. Turning to Slide 10; you can see total growth in the fourth quarter of 4% was driven by expansion in the core with minor contributions from FX and bolt-on acquisitions. By regions, we had mid-single-digit revenue growth in North America, driven by growth in all segments, including stronger growth in consumables, benefiting AHS. Western Europe revenue was up slightly as growth in software was offset by normalizing growth in hardware analytics. Asia saw continued strength in India and Japan; however, this was more than offset by high single-digit decline in China. As a reminder, we anticipated growth in China would be down as we lap outside growth in prior years. Turning now to Slide 11; we're introducing 2024 guidance, starting with the full year. We expect growth of 6% to 8%, with core revenues up 2% to 4% and acquisition contributions of approximately $215 million. Adjusted operating profit is expected to increase 10% to 13% with margins of approximately 27%. Adjusted diluted EPS guidance of $3.73 and $3.85, up 9% to 12%, includes a $0.13 headwind from higher interest expense associated with funding of the EA acquisition. The effective tax rate is expected to be approximately 14.5% to 15%, in line with the average of the last two years, reflecting the benefits of the EA acquisition. Free cash flow is expected to be approximately $1.38 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 revenue growth of 3% to 5%, with core flat to up 2%, driven by the continued momentum in our IOS and AHS segments, partially offset by a low to mid-single-digit decline in PT. Adjusted operating profit is expected to increase 6% to 10%, with margins of approximately 24.8%. Adjusted diluted EPS guidance of $0.77 to $0.80, up 3% to 7%, includes a $0.04 headwind from higher year-over-year interest, and free cash flow of approximately $180 million, reflecting normal seasonal variation. Moving to Slide 12 and the outlook for 2024 by segments. You can see we expect positive growth and operating margin expansion in each segment in 2024, supported by our alignment with secular tailwinds, new product introductions resulting from our robust innovation efforts, the continued resilience of our software and other recurring revenue businesses, the expected delivery of the remaining approximately $100 million of excess backlog in our hardware products businesses, another year of FBS-driven execution, and the carryover benefits of the productivity initiatives that we executed in 2023. By segment for the year, we are planning IOS to continue its momentum with mid-single-digit core growth and another 100 basis points of margin expansion. Key drivers include stable demand and NPR traction in the hardware products and continued ARR growth supported by strong 2023 SaaS bookings. We are planning for PT revenues to be up 10% at the midpoint in 2024 with core growth up slightly, reflecting the benefits of the EA acquisition and normalization of orders in hardware and products businesses in 2023. We expect EA to be accretive to adjusted operating margins in 2024. Together with the benefits of our productivity initiatives, we expect PT margin expansion of over 100 basis points. The remainder of Invetech includes product revenues that align more closely to our automation businesses in Sensing. For comparison purposes, we have provided pro forma segment results for 2023 in the appendix. In AHS, we are planning mid-single-digit core growth, with operating margin expansion of over 125 basis points driven by volume, price realization, and productivity. We expect acceleration in the growth at ASP driven by their improved channel position, NPIs, procedure volumes, and new logos and SaaS migrations are expected to drive continued software growth in Healthcare. Before opening it up for questions, I'll pass it back to Jim for closing remarks.

Thanks, Chuck. I'll start this wrap-up on Slide 13. I am incredibly proud of the contributions of our 18,000 team members to make 2023 another record year for Fortive. Over the last couple of years, our success executing our strategy to build a more resilient company reflects our strong foundation and enduring principles that underpin our unique and compelling culture. We talked about the operating rigor and leverage of FBS tools to innovate and drive growth across our segments. In addition to higher core growth, the deals we have done are contributing to our multiyear track record, including strong performance again in 2024. Since 2019, we are sustaining 7% revenue growth, delivering 120 basis points of adjusted operating margin expansion per year, driven predominantly by higher gross margins compounding earnings and free cash flow double digits; we have cut net working capital as a percent of sales nearly in half, building 50% more free cash flow per dollar of revenue. This is a testament to our portfolio transformation and the power of FBS fueling our current and future success, and with a $60 billion served market, we have substantial runway to accelerate growth organically and inorganically. This brings me to Slide 14 and how we drive differentiated performance and value creation for our shareholders. With a consistent and compelling 2024 outlook, including 6% to 8% total growth and over 100 basis points adjusted operating margin expansion in every segment. We are on track to our 2025 target of $4.50 of earnings and $1.6 billion of free cash flow. We are confident in our ability to differentiate our performance and believe our outlook is appropriately balanced, remaining agile to deliver for customers and shareholders should the environment differ dramatically. As we showed at our 2023 Investor Day, by executing the Fortive Formula, we expect to roughly double our earnings per share and generate more than $8 billion of free cash flow over the next 5 years. Our M&A funnel remains strong, and our acceleration of capital employment as demonstrated in 2023 further positions Fortive as a higher growth cash flow compounder and a premier company delivering exceptional value to shareholders. With that, I'll turn it back to you, Elena.

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

Just the kind of trend in the shorter-cycle businesses, Tektronix and Fluke, maybe just an update on where you stand, book-to-bill how the revenue did this quarter, and then how you're thinking about how the year plays out next year?

Yes, Steve, it's Jim. First, I want to distinguish between Fluke and Tektronix. We experienced mid-single-digit growth at Fluke during the quarter, with growth in orders and point of sales globally. This reflects the positive outcomes of our innovative transformations and recent M&A efforts. For Tektronix, growth was low single digits this quarter, but this follows an impressive 20% growth comparison from Q4 '22, so we still saw solid performance. The year for Tektronix has been remarkable, marking a record year as mentioned in our prepared remarks. Looking ahead, I believe Fluke will continue the trend we’ve seen, as we've noticed consistent and durable activity there. However, we have experienced about five consecutive quarters of negative bookings, and we are working through the backlog. We expect the book-to-bill ratio should turn positive around Q2. North America performed well for Tektronix, although we noticed some slowing in China, which we addressed earlier in our discussion. That’s part of the Tektronix narrative as well. I'll stop here, and if you have a follow-up, I’ll be happy to discuss further.

Yes. And then just how much price do you assume in the guidance for 2024?

We're thinking about 2% to 3%.

Good afternoon, just like on the reclass of Invetech to PT, it's a small business, and it seems like margins are relatively depressed, maybe 6% to 7% margin. Just wondering, I think Chuck, you went through some of the logic about just maybe talk about what this achieves this class? And maybe just in terms of the importance of this ASP rather AHS acceleration, kind of like how is that benefiting sort of the outlook for AHS because were you assuming that Invetech recovers? Just trying to think about AHS on a like-to-like basis here?

Thanks for the question, Nigel. I'll take the margin question first. We're talking about the business expanding 125 basis points, but that's on a like-for-like basis. If you really look at where we ended with Invetech, we're up probably 200 to 250 basis points, but the business is generating margin expansion of 125, and that's what we've got in the guide. I think the rationale for switching it is the event design engineering piece just isn't as big as we thought it would be, and it's not really moving forward. The part that is now the majority of this business really fits better in Sensing.

Yes. Nigel, I would just add, we called out in the slide materials that Invetech was a headwind in the quarter for healthcare to the tune of about 280 basis points. That's probably the largest year-over-year headwind that Invetech has seen. I wouldn't expect the size of that to continue but probably still in the 1% to 2% range to continue to be in healthcare throughout 2024. But that's now reflected in PT.

Okay. That's helpful. And then maybe just on the transition ASP consumables. Just confirm that's now fully behind us. There's no lingering impact there? It sounds like it is. But maybe I think we can see the clear sort of margin benefits that we should see coming through from capturing that distributor margin. But maybe talk about the opportunities to drive better growth and having that direct customer connection, what do you see as a potential for revenue benefits?

Well, Nigel, I would say, number one, yes, we're definitely fully through it. So you saw the benefit of that. I think, as we said in the prepared remarks, consumables in North America were up about 7%. Consumables around the world were up about 4%. So we think mid-single-digit guidance for ASP for the full year is a good number. There is certainly opportunity to go and on the margin front which we're going after. We were just with the team last week. We actually had them with, we had our Board meeting there, and we have the team there for an operating review, highlighting the level of innovation. I talked about in the prepared remarks. We now have a new set of consumables around steam sterilization that are going to now be in the U.S. and Asia that are certified. So a number of opportunities here to continue to improve growth. Those are obviously all in consumables, which obviously have higher fall-through. So you like the guidance here overall held up 125 basis points in margin expansion mid-single-digit growth. We think that's a great launch point. It certainly certifies a lot of the things we've been saying about the direct North American strategy and certainly more broadly around the strategy at ASP and how health will just be a real durable grower for Fortive in '24.

I just wanted to check on the sort of margins in the first quarter. So I realize it's not a big sequential decline in sales, but you've got a very heavy sort of sequential step down in margins there in Q1, 100% or so kind of drop-through. So is that reflecting maybe something on mix in any of the businesses in the first quarter versus the fourth? I'm just trying to understand maybe on Precision, in particular, how their margins are starting out the year in Q1?

Nigel, the biggest thing is there's just a seasonal step down in revenue dollars from Q4 to Q1, and that's what gives you a normally seasonal step-down in the margins, pointing out that our Q1 guide is up 75 basis points. So that's a pretty good expansion there. I think we're seeing pretty good performance across the segments in margin expansion, too.

Yes. And I would just say that guide represents record operating margins in the first quarter for Fortive. So I think when you just look at, we do have some expenses that start back up at the beginning of the year, obviously, salaries and some of those things. There's a little bit of that. But at the end of the day, if you just step back, record – that will be a record first quarter in the history of Fortive.

My follow-up question pertains to the guidance you've provided for year one, and now there are inquiries regarding year two. When I review Slide 14, it appears that you have projected approximately $450 million, or maybe around $430 million, excluding the capital deployment figure for 2025. A year from now, this will be a formal forecast rather than just a medium-term aspiration. Considering that this is only 11 months away, how should investors perceive the $450 million target? Achieving this will likely necessitate significant M&A activity this year. What are your thoughts on the current M&A market? One of your competing companies has indicated that conditions might be improving.

Yes, a couple of points. When you examine our history of double-digit EPS growth and consistent free cash flow, reaching that $450 million target doesn't seem overly challenging. That's why we provided those figures last year and have reaffirmed them in our guidance and presentations. We're confident, although a lot can change. Regarding the M&A market, we recently completed a quarter where we executed five deals, including one at the beginning of January. This spans every segment and includes various sources like private equity and founder-led companies, reflecting a healthy diversity in our workflows. We feel positive about the M&A landscape and have made solid advancements in that area. The EA acquisition is off to a strong start and we believe it will be beneficial for this year, shortly after closing. We've observed promising developments there. Overall, we're proud of our efforts, which have positioned us well. As for your point about 2025, the EA deal and others will undoubtedly support our goals for that year. In fact, considering our current environment, it appears to be somewhat improved.

Just a couple for me. Just back on ASP and the Consumables growth, 7% sounds pretty healthy. Is there some kind of I don't know, kind of channel fill in the direct model that had to happen, as you looked from distribution to direct? Is there something abnormal about that number? What are you expecting for consumables growth in the U.S. for 2024?

We'll be in the mid-single-digit range. There's probably a hint of catch-up from Q3 there but not a lot of inventory build; we would expect it to be mid-single-digit for them across the board. Obviously, I wouldn't want to be a predictor of 7% every quarter. But as we said, we validated the strategy, I think, in Q4 with what we want to do. As I mentioned, with the team last week, they're incredibly optimistic about where they stand today and where they stand for the year and in the future years as well. So, I think we're in a good place. We, first of all, we closed the first week of January; we're off to a good start. A 100-day plan is scheduled. We've got our integration meeting set up. Our teams are really excited about the work we can do together. As you remember, Jeff, when we announced the deal, we said we'd have the opportunity to take our big Tektronix sales force and sell those solutions. We started our annual sales kick-off over the last couple of weeks. A lot of excitement about that. Relative to specifically to your question, December was a record order month for the business. So they ended the year strong, and there's a tremendous amount of growth opportunities there in front of us. They've got a good backlog situation. So we feel good. We feel good about the revenue base for the year and what that can grow. Obviously, it won't be in our core until '25, but we feel good about the growth. Relative to that, we now think this is probably a mid-single-digit ROIC in '24, which is up from the original thesis around the deal. So we're already ahead of the game. Growth should be good. We think the business is probably in the $190 million to $195 million range; that's probably where it will be for the year. So we're in a really good place with the business. It's a good team. As I mentioned before, and it's going to – that's why I think when you step back and look at the deals we did, the previous question, we feel good about the year. 6% to 8% overall growth for the year stands up, obviously, EA being one of the big parts of that, but the other acquisitions are adding some as well.

And just I'm sorry, a little quick housekeeping one, too. Just the design piece of Invetech, is that a divestible business? Or are you just winding it down? And how big is that piece?

It's in the $20 million range of revenue breakeven. So, we'll look at a number of options. I think we've got, there are buyers out there for sure. The team is working on some different things. So the other part of that business is called motion. So as you can imagine, it really was originally in our Sensing and Automation businesses. It really helps Life Science and customers, but it's more industrial from an OEM perspective. That business has done pretty well over the last few years. So we'll anticipate keeping that as part of the portfolio, but we're going to look for options on the other time.

The word destocking didn't prop up in any of your prepared remarks, which is a relief. Any color there in terms of inventory in the channel, Fluke, sell-in, sell-through, any issues there?

Yes. I think to the second part of your question, mid-single-digit POS growth at Fluke around the world in the fourth quarter. So, good solid growth. Down from the double digits we've seen for a while. But still, I think that would be, that we take that number pretty solidly. A little bit of destocking at Tek in the U.S., single-digit millions, but a little bit in some in China, maybe more broadly. I would say that that's, we now think China is likely to probably not grow in the year; that's embedded in our guidance.

So just to clarify on China, that's flat for the year, is the expectation?

Probably down low single for the year. So that would be our anticipation at this point. A couple of things there. Just starting what we've seen thus far is customers are a little bit more conservative, as I mentioned. As you know, Deane, we've talked about this over the years. You really don't know China until you see March, you get out, you get to after the Chinese New Year, and see how channel partners and customers are going to unfold for the year. We've seen more conservativeness up to this point in the year. So our anticipation is that the year sort of progresses. We had a really tough comp in the first quarter in China. We had great growth in China last year in the first quarter, but we would anticipate for the full year that China would probably be down about low single digits.

So Dean, a couple of things to unpack there. When we got EA, they just came with a 40% incremental margin. I think the 100 basis points is about core growth that it adds to Tek, is what we called out. We would expect the volume growth that goes from 40% to 41%. Yes, that wouldn't be super surprising for them. But I think that was more about the impact on core growth for everyone for Tek. And then on the sales force, I think Jim can give a...

Yes. I mean, if they came with about a sales force of roughly 40 folks. We 10x that with Tektronix. We have the ability to sell that solution across the board. The teams are working through their cross-selling strategies. One of the things we said when we announced the deal was that we thought a real opportunity primarily outside of Europe to really accelerate the business through the addition of the Tektronix sales force. So yes, so as Chuck mentioned, already a very profitable company. They had great growth too; they're a good growth company, a great growth company. Even with their size, they had growth at Tektronix and PT. So we're excited about that opportunity. Obviously, that's not the core until the year; it'll be in '25. So far, we really, we're really excited about the business joining Fortive.

Good afternoon, everyone. Chuck, maybe just a little more color on the expected AHS improvement in '24. Could you talk about Fluke Health, they were discontinuing product lines in '23, as you know, causing you some noise; are they over the hump here in '24? And when you look at ASP, I know you're still building out your overall international infrastructure and supply chain. Are you over the hump there in terms of progress, and how much restructuring is helping your margin in '24?

Fluke Health will probably be in the mid-single-digit range for the year, so pretty close to the segment growth, maybe a little bit less in the first quarter and a little bit better in the second half. But they are through some of the things that you described as well.

With regards to the margin expansion, probably the bigger driver behind the margin expansion at Health is the growth at ASP, getting through that distribution and having consumables in North America show up like they did in Q4. I think that's probably 80% of what's driving the margins there. Well, I think there's a couple of things. In terms of the inflation we're seeing, we're seeing that come down, and that's why you're seeing the price we're putting into the market come down. But we will expect to stay ahead as we always do on the price-cost. To supply chains continue to get incrementally better every quarter, but that doesn't mean they're back to what we would call normal, and problems can crop up from time to time. But we think that incrementally better is what we see there. Remember, we're not open to big commodity exposures that can cause maybe some of our peers or other companies problems. We have pretty good line of sight, and every month, Jim and I are meeting with the OPCO teams hearing what we're seeing on inflation, but it's trending the right way, meaning the rate of inflation is coming down.

Yes. And I would just add the proof points. Our gross margin expansion over the last several years has been very consistent. I think that speaks to our ability to manage the situation, not just on the price side but also on the cost side, and our working capital continues to get better, as we noted, as a percent of sales. So we're doing that while not having to have significant increases in working capital. In fact, our working capital is getting better. So I think what we'll see this year Andy, just to add on to that is that our teams have done a really nice job. We were just with all of our teams a couple of weeks ago, and they're doing a really nice job on design savings as well. So not only on the negotiated savings but also looking at design, what we call our value engineering effort.

I'm not very skilled at the Star 1 thing. It's a talent, I suppose. Anyway, many questions have been addressed, but I'm curious about ServiceChannel and proVation. If we consider those deals together, they are quite significant for our long-term growth narrative, but they are also expected to be dilutive in the first year. Where do you anticipate being in 2024 concerning the deal model and those combinations? Will we see positive results from those? I would think the compound growth should be substantial; with high margins, the returns on capital should eventually improve significantly. Are we on track to achieve that by 2024?

Scott, a number of things. First of all, from a top line standpoint and really the bottom line, we think we're on track to running ahead. But I think when you're talking about dilutive as the ROICs come from low single digits, they're in mid-single-digit territory and accelerate going forward. So we think those two are right on. But accretive now to the top-line growth, so let me stop there and see if I understood that part of the question.

To give you some context, we initially anticipated $0.10 of accretion in the first year, but we achieved $0.12. We're pleased with these businesses, and if you examine their growth rates, they're quite impressive. proVation has always been a high-margin segment for Fortive. ServiceChannel was initially breakeven, which raised some concerns about reaching the strong accretive margin rates typical in Fortive and IOS. However, we're successfully achieving that on the Fortive side, and they're nearing the IOS benchmark. We're also emphasizing how FBS has made a significant impact. The net dollar retention and ARR growth reflect this. FBS teams have quickly adopted growth and innovation strategies, resulting in great retention numbers and a solid position for future success. Moreover, they won't stop at 10% margins; they plan to continue growing. With net dollar retention margins reaching between 110% and 112%, and given the current growth rates, we foresee margins exceeding 10% in the coming years.

Yes, that makes a lot of sense. Just real quick, guys. Does Invetech get worse before it gets better? Just partially just given Sprague's question on kind of the wind down or the sale of the design business but put these things you're selling into some pretty tough markets. But does that end up getting a little bit worse before it gets better in '24? Are we already there?

I think we're going to run into some easier comparisons in the second half, and so it will stop being a tough compare for us. I think that we need some of the dynamics of those markets to recover. Keep in mind, this is a business that's less than $100 million in total. And so it's not quite as impactful as bringing some of these other movers like EA and ASP right now.

I would say, Scott, embedded in the PT core growth outlook for Q1, there's about a 1% headwind to core growth in PT due to Invetech.

I may have missed this, Jim. But how do you think about your overall software growth in '24 relative to the 2% to 4% core growth? How does that roll up?

Yes. We feel really good about it, Rob. I think when you look at not only maybe starting with '23, we had really good growth in '23. We'll have high single-digit software growth in '24. So when we look at the ARR numbers, they're good. Obviously, we're just talking about ServiceChannel and proVation in the previous question. But I think across the board, we expect to see high single-digit growth. So we feel good about where it's at. I think it's a testament to the strength of how FBS is really adding value, and it's a testament to those businesses, and the work they're doing. We didn't talk a lot about AI, but we'll start to see as we get into late '24 and '25 some of our Data Analytics and AI solutions are also going to help the growth rates there. So we're in a very good place. I think the strategy is playing out the way we anticipated, which is those businesses would have more durable, higher growth rates, and ultimately that would benefit Fortive not only on the growth side but on the margin front. We certainly saw that in '23; you absolutely see that with our double-digit EPS kind of numbers that we'll show in '24. Yes. Well, in Sensing, we're about 6 quarters of negative order rates. So we don't anticipate to see the overall order rate start to change in the book-to-bill there probably in and around 1 in the second half, for sure, probably starting in sometime in the second quarter. So we start to see things move. We didn't talk about it but number, maybe more broadly, about Sensing. One of the things we saw in the fourth quarter was rather than get 12-month blanket orders, which we would typically get with OEMs, we got 3-month orders. So we will see that those orders pick up probably in the second half. So that's the state of the world. Relative to the semi-index and where it's at, we're starting to see the green shoots of customers that are starting to talk about orders, and our businesses that are maybe in the earlier stages there, a little bit of Setra, a little bit in our KEITHLEY business at Tektronix. They're starting to see customers talking about the second half of this year. So, I would think that just overall we'll start to see some things. We're not anticipating a big step up there. We'll let the order patterns determine that. But we do anticipate at least seeing some of that turn in the second half of the year.

Yes. Just maybe, and I don't know if when you were talking before Sensing, you were specifically referring to Sensing or Tek. But maybe just to confirm what's happening with Tek book-to-bill? And what kind of exit rate are we at a Tek right? Just sort of if you look at the peer orders, Keysight, NATI, you still have orders down, let's call it, mid-teens. So to understand correctly, we're thinking that based on the feedback we're getting on the comps, revenues will be up low to mid-single digits next year, right? Is that the right framework?

For Tektronix, we think business will be about low single digits for the year. So just from a revenue perspective, we've had 5 quarters of negative orders there. We'd probably see that in the first quarter. We'll start to see things turn. The book-to-bill starts to turn in and around the second quarter there; so just to kind of give you a sense. And that's we’ve had aerospace and defense; it's been good, and it continues to be good; but it's mostly broadly around electronics and things like that. So some semiconductor customers as well. So the comments I made around Sensing, semi, I also made a comment about KEITHLEY, which is the most of the exposure we have in Tektronix relative to the semiconductor. So we think the business is a good place. Obviously, low single digits in the fourth quarter against a 20% comp from a year prior. So still in a good place, record year for Tektronix from a revenue perspective. But probably a quarter or two here of absorbing, continuing to absorb some of the market dynamics we described, but the business is in good shape and exit rate into '25 probably is in a good place.

And where are we on book-to-bill, sorry?

Well, I think in the fourth quarter, probably 0.85; probably, but we're always below 1 in the fourth quarter.

Got you. And just a broader question because it's certainly been a weird '23, and it seems like '24 is going to be strange as well. But I think at your Analyst Day, and it's just sort of going back to Julian's question, you did outline the '25 target, but you also outlined longer-term targets, right? If you look at '25 target with sort of a CAGR of 12.5% and longer-term targets, 13.5%, right? We printed 9% EPS growth last year. This year target is 9% to 12%. I told to get there; there's cushion here, right? Invetech is out of the way. We're probably going to do some M&A. But from your perspective, what needs to sort of go back to normal change from a macro standpoint? What's the biggest lever that needs to change, right, to sort of get back to normal where you guys can sort of accelerate EPS growth from what we've seen last year and what we're sort of guiding to this year? Or is that all just M&A? Sorry for an extensive question, but yes.

Well, I think when you look at our track record over 4 years and what we try to do is not take any one particular year because when you average them out, when we're talking about the out years here, we're talking about the average, right? And when you look at the average, they're not too different from future versus prior history. So I think what passes a bit pull-off here. If you look at the success we've had over the last 4 years relative to EPS growth, and you sort of fast forward, we continue to use our free cash flow. Obviously, we had interest expense a little higher last year than we anticipated, which is why that number would be single digit; it will delever through the year, as you know. So that has some improvements as well. But I think at the end of the day, we're in a very good place relative to those targets, and I think this reflects it. So, there's obviously the macro is always a geopolitical situation; it's probably always one of those things you think about, but that's why we said in the prepared remarks that we've got some scenarios to continue to be agile and dynamic based on what the economic situation looks like. So Software and Healthcare are going to continue to compound at higher rates of growth and higher rates of margin expansion, and that's going to continue to mix up the portfolio, particularly if you take a longer period of time like in 2018. So I would say those are the dynamics. You've got to see those businesses continue to get better, like they will this year, like they've been doing, and continue to do the things that we've been doing relative to productivity and innovation to help us work through the various markets, secular drivers that we've attached ourselves to broaden the workflow. The last thing I'd say is the five deals that we did over the last 30 or 3 months or so, they all have an opportunity to continue to accelerate our compounding. They're all attached to good growth drivers. They're additive growth year from a margin perspective. From a bolt-on standpoint, they're all making their associated businesses better over time. And when you take a few years, they're going to become a bigger part of that. Some of them are small. But if you take a 2- or 3-year outlook, you'll see they'll be additive as well. So, as I said, the M&A environment looks like it continues to get better here, and we're excited about that.

Well, in terms of the dividends, what we've tried to signal is that as our free cash flow and earnings per share increase, you'll see our dividends increase on the same trajectory. With share buybacks, what we did is we restock to where we had over the last 2 years; we’ve been opportunistic on buying some shares back. And we just went back to the level we had 2 years ago. M&A is still the priority.

Just a couple on the M&A side and capital deployment kind of piggybacking on what Scott was talking about. So, I mean, you highlighted proVation, and you highlighted ServiceChannel. I think it's pretty clear as to how companies like that can lever up growth and they can accrete to EPS and what they can do to margins. I'm just curious on like the ROIC of these things. Because I think like on proVation, the math was something like it needed to grow 15% a year and have margins expand to like almost to mid-50s from the mid-30s or something like that to hit like a 7.5% return in year 5. It looks like at least that slide suggests it's under those targets. How do you evaluate where you are in ROIC on deals like that?

First of all, we look at our ROICs and go back to looking at where the revenue needs to be. Margins start to upgrade on proVation as talked about, and we're running ahead of where we thought we'd be on the top line. So maybe talk offline exactly what the original assumptions were. But that's where we know we're at for both of those deals. So we're on track or ahead of where we thought we'd be a couple of years in. I think the, so I think that's as simple as I can put it.

Joe, I would just add on the reason why we highlighted these two companies two years out is because when we bought the companies, there were some skeptics; quite frankly, people didn't think we could get ServiceChannel margins into the 20s as quickly as we did. People didn't think that proVation would grow during COVID the way it did. Yes, I wouldn't necessarily say these were slam dunks because there were some doubters out there. We tried to do in with two years in it suggests or to demonstrate that, hey, we're exactly where we thought we were in case we're ahead of the game, we were ahead of the game first year out, as I mentioned in the previous call relative to EPS. These businesses are in good shape. As we highlighted back in May, this is consistent with a number of the other deals, and that's really what you see in '24 is the portfolio durability based on the success of those deals.

And just to clarify, this came up earlier, but the combined ROIC, certainly for proVation is already in the mid-single digits for the '24 range.

Well, I would say, certainly, hardware deals are something we've been doing for 20 years, and there's, to use your muscle framework, there's a lot of muscle around that. You saw that in even with some of the COVID challenges in ASP, our continued ability to do things like really improve the free cash returns on the business because of working capital. Certainly, those are things that we've done for a long time. But I think, and this is really one of the reasons we put it on the slide, we've really built tremendous capability around software, FBS for Software. We didn't talk about it, but we've now got an FBS suite of AI tools that are really helping drive innovation, drive commercial activities for the software broadly but also for the software businesses. We’ve really, I'm really proud. I said it in the prepared remarks around how the FBS in and of itself is getting better. That really means more broadly. It's really, I think what we're really proud of is the fact that if you look at Fortive's portfolio today, FBS needs as much to a software business or a healthcare business or a traditional industrial business. FBS may mean different tools. It may mean different applications, but the rigor and discipline is exactly the same.

First question just related to the price-volume composition of organic and implying volumes kind of flat to up 1% for the year. And I'm trying to understand where kind of the upside risk might sit on the volume side and whether the embedded assumptions are more sort of moving sideways and there can be some upside risk on maybe easier short-cycle comps in the back half of the year? Or just how you've thought about that volume piece of the equation and if there's anything embedded within that as things getting better over the course of '24.

I think when you look at, and I'll take the hardware business here. When you look at the hardware businesses, there's not a big inflection point as we go through the year. So probably I would say we don't see a big volume; we don't need a big volume inflection as we go through the year simply because of that. I would say, secondly, we're not really expecting a lot of restocking here. So I would say there's probably some volume upside to restocking if we were to see that, but I would say we're certainly not counting on that, and if it was probably more a second half dynamic.

Yes. I think that normally we would expect 40% incremental margins. For the year, we're going to end up at 45%. There are some puts and takes earlier in the year that we've seen, but we're seeing probably if you think about probably $0.07 or $0.08 of productivity coming into from those actions that are selling into 2024. Just the benefits are coming in, not that we're taking any more. Sorry about that.

Thanks, Kristina, and thanks, everyone, for taking the time today. I know it's a busy day for all of you. Hopefully, what you heard today was really the benefits of the work we've been doing for several years, both in '23 and how we anticipate '24 to play out. So we feel very, very comfortable with where we stand today. There's lots going on in the world, as many of you know, but I think how we've built and constructed the portfolio over the last several years, post-Vontier, is we feel and expect to have a good setup for this year. We're certainly around for any questions. We want to thank everyone for your support for '23. We know we'll probably see a lot of you out on the road here over the next few weeks. We look forward to that, and obviously, our team is available for questions and follow-up over the next several days. So, thanks. Have a great day. Have a great earnings season and we'll see you on the road.