Fortive Corporation (NYSE:FTV) Q3 2022 Results Conference Call October 26, 2022 12:00 PM ET
Company Participants
Elena Rosman – Vice President of Investor Relations
Jim Lico – President and Chief Executive Officer
Chuck McLaughlin – Senior Vice President and Chief Financial Officer
Conference Call Participants
Deane Dray – RBC Capital Markets
Josh Pokrzywinski – Morgan Stanley
Steve Tusa – JPMorgan
Julian Mitchell – Barclays
Scott Davis – Melius Research
Jeff Sprague – Vertical Research Partners
Andrew Obin – Bank of America
Nigel Coe – Wolfe Research
Andy Kaplowitz – Citigroup
Joe Giordano – Cowen
Operator
Good day. My name is Dennis, and I will be your conference facilitator today. At this time, I’d like to welcome everyone to the Fortive Corporation’s Third Quarter 2022 Earnings Results Conference Call [Operator Instructions].
I would now like to turn the call over to Ms. Elena Rosman, Vice President of Investor Relations. Ms. Rosman, you may begin your conference.
Elena Rosman
Thank you, Dennis. And thank you, everyone, for joining us on today’s call. With us today are Jim Lico, our President and Chief Executive Officer; and Chuck McLaughlin, our Senior Vice President and Chief Financial Officer. We present certain non-GAAP financial measures on today’s call. Information required by Regulation G is available on the Investors section of our Web site at www.fortive.com. Our statements on period-to-period increases or decreases refer to year-over-year comparisons on a continuing operations basis. During the call, we will make forward-looking statements, including statements regarding events or developments that we expect or anticipate will or may occur in the future. These forward-looking statements are subject to a number of risks, and actual results might differ materially from any forward-looking statements that we make today. Information regarding these risk factors is available in our SEC filings, including our annual report on Form 10-K for the year ended December 31, 2021. These forward-looking statements speak only as of the date that they are made and we do not assume any obligation to update any forward-looking statements.
With that, I’d like to turn the call over to Jim Lico.
Jim Lico
Thanks, Elena. I’ll begin on Slide 3. We had another quarter of outperformance with 12% core revenue growth; 80 and 160 basis points adjusted gross and operating margin expansion, respectively; 20% adjusted earnings per share growth and 22% free cash flow growth, all above the guidance we set coming into the quarter. Our ability to outperform reflects the quality of our portfolio, our team’s rigorous execution and the power of the Fortive business system, delivering higher and more profitable growth and free cash flow generation. Third quarter also demonstrated continued success launching a number of new products and solutions that solve our customers’ toughest safety, quality and productivity challenges. We have strong conviction in the secular drivers favoring enduring growth in these markets. As a result, we are confident the work we do to create long term sustainable competitive advantages for our operating companies and strategic segments will yield best-in-class returns for Fortive for a long time to come.
Turning to Slide 4. We are delivering 2022 at the high end of our initial outlook we set back in February, reflecting continued strong momentum as we’ve moved through the year. Short cycle demand has held up well with hardware product backlog more than double what it was at the beginning of 2021, while our software businesses have continued their double digit pace of growth. This speaks to the strength of our portfolio and our ability to countermeasure challenges. Our supply chain measures across the portfolio continue to gain traction, especially at Fluke and Tektronix, although, we expect some component constraints to persist into 2023. Our latest outlook now reflects a year-over-year foreign exchange headwind of approximately $175 million on revenue and $0.11 on EPS for the year. Despite these headwinds, we are driving higher growth and operating margins by leveraging FBS tools to accelerate profitable growth and position the company for continued outperformance in 2023. Moving to the right hand side of the slide, we are preparing scenarios for a range of potential macroeconomic outcomes in 2023, including moderating hardware product orders growth. Lastly, our strong balance sheet, supported by robust free cash flow growth, presents several levers for earnings growth and continued value creation compounding.
Turning to Slide 5. We just finished our annual strategic plans for each of our operating companies, and I’m even more excited about the depth of our strategy to take advantage of the secular tailwinds accelerating progress across our five critical customer workflows. Our solutions for managing facilities and assets, environmental health and safety and measurement and connected reliability keep much of the world running safely, productively and sustainably. We are enabling product realization with precision measurement and sensing solutions underpinning many of the most exciting product innovations in the world from your phone and car to the electric grid and to safer food and pharmaceutical production. Our health care solutions for the perioperative loop keep clinicians and patients safe, serving over 5,000 customers, including all the top US hospitals, as well as hospitals around the world. Each workflow is well positioned to benefit from durable business models that underpin our vision and strategy to build a stronger collection of businesses with industry leading profitability and free cash flow margins. They’re also aligned to our sustainability mission by helping our customers accelerate safety, good health and well being, advanced industry and customer productivity, utilizing new and more efficient clean energy resources and drive reductions of our customers’ greenhouse gas emissions. Today, over 60% of Fortive’s products and services enable more sustainable outcomes that are aligned to the United Nations’ sustainable development goals. As we continue to accelerate innovation for our customers at scale, demand is proving more resilient even in the face of slowing economic growth, given the recognition of how our workflow solutions drive productivity benefits for our customers.
I will now provide more details on each of our three segments, beginning with Intelligent Operating Solutions. IOS continued its strong momentum with revenues up 14% as unfavorable FX was offset by the ServiceChannel acquisition, which became core in mid-August. Our region growth was broad based with low double digit growth in North America, mid teens growth in Western Europe and low 20s growth in China. Double digit core growth in every workflow drove 345 basis points of core operating margin expansion, more than offsetting inflation and incremental FX headwinds. Some other highlights in the quarter include: At Fluke, demand remains solid with double digit point of sale growth in each major region. Using FBS Voice of the Customer and product development tools, Fluke launched a breakthrough platform serving the renewables market that reduces the time to test solar installations by as much as half. This kit combines multiple Fluke hardware tools with a software platform and has been awarded industry recognition for its safety and time saving features. EHS had low double digit revenue growth as we continue to see the benefits of share gains and efforts to diversify its customer base. Industrial Scientific saw a greater than 20% increase in bookings with strong iNet quotes and instrument bookings in both Europe and the Middle East. And Intelex had another quarter of mid teens SaaS revenue growth.
Moving to facilities and asset life cycle. Gordian revenues were up double digits once again with the business continuing to drive accelerated penetration of projects flowing through Gordian’s job order contracting platform with an expanded set of customers. Accruent saw strong software demand with its SaaS offerings growing low double digit. Accruent also continued to utilize FBS tools to improve its annual recurring revenue profile, with the recent Kaizens focused on driving price and improved customer retention. Finally, ServiceChannel had another exceptional quarter with strong double digit revenue growth and high teens growth in SaaS. As some customers face mounting cost pressures, they are increasingly turning to ServiceChannel to help them outsource their facility maintenance work, reducing their third party contractor costs. As a result, we are reinvesting a portion of their upside into transitioning customers to our more profitable SaaS managed service offering to continue to drive profitable growth.
Turning now to Slide 7 and Precision Technologies, which delivered core growth ahead of expectations in every business. Core revenues were up 19% with double digit growth in all our major regions driven by continued investment in the industrial, power and energy, semiconductor and medical end markets. PT also saw 280 basis points of adjusted operating margin expansion with higher shipments and strong price realization more than offsetting inflation and FX headwinds. Some highlights in the quarter include, seven consecutive quarters of double digit orders growth in Tektronix, fueled by a number of new entry and mainstream scope product launches. As a result, trailing 12 month orders are now greater than $1 billion. Our teams are diligently applying FBS to countermeasure supply chain constraints to deliver on this record level of demand. Sensing Tech benefited from another quarter of volume growth and strong price realization. While supply chain constraints continue to limit output, Sensing book-to-bill was greater than 1, with strong demand in Qualitrol’s utility and power business. Similarly, Pacific Scientific EMC saw improved material availability and capacity expansion across key production lines, driving double digit revenue growth in the quarter.
Moving now to Slide 8 and Advanced Healthcare Solutions. Total revenue increased 3% in the third quarter with a core revenue decline of 1%, as continued supply chain constraints limited growth at ASP and Fluke solutions, resulting in lower than expected core growth in the quarter. Mid single digit growth in Western Europe was more than offset by low single digit decline in North America and a mid single digit decline in China. We saw a sequential improvement in core growth at ASP as their supply chain shortages constrained capital equipment growth started to ease in late September. Electric procedures improved to the low 90% range, excluding China, while rolling lockdowns kept electric procedure rates around 70% of pre-COVID levels there. AHS core segment margins were down almost 400 basis points stemming from lower volumes and FX headwinds in the quarter, as well as the recognition of a bad debt reserve in Invetech. As you can see, the team is diligently deploying pricing and cost controls to offset these headwinds, which we expect will deliver margin recovery in the fourth quarter. Some other highlights for the quarter include: an acceleration in new hospital bookings at Censis and double digit growth in their CensiTrac SaaS subscription revenues. Provation SaaS offering is also seeing good demand from customers looking to further standardize on Provation across their health systems. Lastly, we completed the sale of Fluke Health therapy physics product line, which will be adjusted from core growth going forward with annual sales just under $20 million.
Turning to Slide 9. Fortive Business System continues to be a differentiator for us, enabling our business to drive innovation and profitable growth. I’m excited to share that we just completed our annual CEO Kaizen event, accelerating our culture of performance. We brought together our most senior Fortive leaders, including our segment leaders and many of our operating company presidents with a total of 28 teams and over 400 team members, driving significant improvements in growth, margin, free cash flow and breakthrough innovations. In Fortive, how we do Kaizen is what sets us apart. It’s the deep engagement of our leadership and teams as well as the achievement of our high expectations. Some highlights include the teams of Fluke identified gross margin opportunities, resulting in margin expansion through freight cost reductions and value engineering opportunities. At ISC, lean conversion Kaizen realized a 20% to 40% improvement in productivity across four product lines, and they improved the lead time for iNet quotes by 80% and time to market for newly developed software by 75%. Our teams reduced the average test time by more than 25% on a highly constrained production process in Tektronix. And Censis implementing Kaizens yielding a 2 times improvement in productivity and reduced time to onboard new software customers. These results are a continued example of how FBS is driving results at Fortive.
With that, I’ll pass it over to Chuck, who will provide more color on our third quarter financials and our updated 2022 outlook.
Chuck McLaughlin
Thanks, Jim. And hello, everyone. I’ll begin on Slide 10 with a quick recap of our third quarter performance. We generated year-over-year core revenue growth of 12%. Acquisition benefits were as expected, contributing approximately 4 points of growth, offset by higher than expected FX headwinds in the quarter. As a reminder, the ServiceChannel acquisition became part of our core growth in mid-August. Turning to the right side of the slide. We saw double digit core revenue growth in each of the major regions. North America revenue was up low double digits with mid-teens growth in software. Western Europe revenue grew mid-teens with favorable contributions from each segment. Asia revenue increased in the low 20% range with mid 20% growth in China, driven by robust growth in Precision Technologies, partially offset by a decline in health care. Lastly, we saw high teens revenue growth across our high growth markets. On Slide 11, we show operating performance highlights in the third quarter. Adjusted gross margins increased 80 basis points to 58.1% as volume and strong price realization continued to demonstrate the value proposition of our products and solutions. Adjusted operating margins expanded 160 basis points to 24.4%, up 440 basis points on a two year stack basis. Adjusted earnings per share increased 20% to $0.79, reflecting strong fall through on higher volumes, partially offset by higher interest expense. Free cash flow was another standout at $307 million, reflecting approximately 108% of adjusted free cash flow conversion.
Turning now to the guide on Slide 12 and the outlook for the remainder of the year. For the fourth quarter, core revenue growth is expected to be approximately 11% at the midpoint and adjusted operating profit margins are still anticipated to be up at least 100 basis points year-over-year. Adjusted earnings per share are expected to be in the range of $0.82 to $0.85 in Q4, representing year-over-year growth of 4% to 7% or 10% to 13% normalized for a low tax rate in Q4 of last year. This reflects an incremental $0.03 headwind from currency movements not contemplated in our prior outlook. For the full year 2022, we are narrowing and raising our adjusted earnings per share outlook to $3.10 to $3.13 to better reflect operational performance in the third quarter, partially offset by FX headwinds. The tax rate is expected to be approximately 14.5% for the year. Lastly, we anticipate that free cash flow will be seasonally strong in the fourth quarter and we continue to expect full year free cash flow of $1.17 billion and conversion to be approximately 105%.
Turning to Slide 13. I wanted to update you on our strong credit and liquidity positions. Early in the fourth quarter, we amended our $2 billion revolving credit facility, extending the maturity out to 2027. The amended credit facility utilizes a sustainability feature whereby pricing varies depending on our achievement of our recently published commitment to reducing our absolute Scope 1 and 2 greenhouse gas emissions by 50%. We also added a new $1 billion delayed draw term loan, giving us the financial flexibility to refinance the $1 billion term loan coming due in December, with a prepayable loan where we can delever with available free cash flow without penalty. We are now levered at roughly 2 times on a net debt to EBITDA basis with an average debt maturity of five years and a 3.2% weighted average interest rate. The proactive moves we made to strengthen our balance sheet, combined with our robust free cash flow generation, also give us ample capacity to invest for growth and compound returns through disciplined and accretive capital deployment.
With that, I’ll pass it back to Jim for some preliminary color on 2023 and closing remarks.
Jim Lico
Thanks, Chuck. Turning to Slide 14. We wanted to share some initial thoughts on 2023. Starting with the hardware products business, which includes Fluke, Tektronix and Sensing Technologies. Backlog across these businesses are roughly double pre-pandemic levels and the secular trends I mentioned earlier are driving market expansion and development of new innovations where we have a strong right to play. As a result, that gives us increased confidence in our ability to grow through a potential decline in new customer orders in 2023. Our software services and other recurring revenue businesses, including facilities and asset life cycle, environmental health and safety, Provation and others, are expected to benefit from enhanced market positions driving double-digit growth in our SaaS and license revenue streams. At the same time, our healthcare businesses, excluding software, are 70% recurring with consumables and services. On the capital side, we expect supply chain to normalize, while the overall pace of recovery in hospitals will continue to be slow given the labor and productivity challenges likely to continue into 2023. While we haven’t completed our planning process for next year, we are confident the work we have done to build a more resilient revenue and earnings profile will enable us to outperform the evolving macro environment.
Lastly, on Slide 15, we are demonstrating the results of our successful portfolio transformation, yielding higher cash compounding power having nearly doubled free cash flow over the last three years. Our sustainable competitive advantages are evidenced in our ability to outgrow the attractive markets we serve and deliver workflow innovations that solve our customers’ most critical safety, quality and productivity challenges. The third quarter demonstrated our team’s continued success launching a number of new products and solutions, generating compelling investment returns and adding to our ability to continue to compound results. Lastly, our ability to raise our earnings outlook for the year once again in the face of continued headwinds speaks to the power of the Fortive Business System and our culture of Kaizen, which is all about finding a better way. We have a strong culture of setting high expectations. And through the rigor, discipline and the unrelenting efforts of our teams, we are delivering strong results. When taken together, this creates a powerful formula for value creation with a high quality portfolio of desirable brands favorably leveraged to sustainable secular trends, industry leading margins and free cash flow generation and best-in-class execution, enabling Fortive to outperform in almost any environment.
With that, I’ll turn it back to Elena.
Elena Rosman
Thanks, Jim. That concludes our formal comments. Dennis, we are now ready to take questions.
Question-and-Answer Session
Operator
[Operator Instructions] And your first question is from the line of Deane Dray with RBC Capital Markets.
Deane Dray
Can we start with the comment on ’23 regarding the positioning on the hardware backlog of 2 times historical? Can you parse out how much of that is reflecting incremental demand versus supply chain inefficiencies? And when you talk to a few quarters back, you don’t typically see a big backlog in Fluke. But are lead times normalizing? And so I just want to get a perspective on how that hardware backlog looks heading into ’23.
Jim Lico
Dean, I think as we said, we continue to — we’ll take backlog down a little bit in the fourth quarter, which I think is the first quarter we’ve done that in quite a while. Order demand remains very robust. So if I were to look at that backlog, I would say a good chunk of it will be at Tektronix, which we think is mostly demand in a number of places, and lead times are out. So we feel very good about the backlog. Fluke is lowering backlog from where they were. They are — and their lead times have come down a little bit. So if I were to think about it, most of the Sensing backlog, I think, is really advanced orders for ’23. So if you were to think about it, probably parses out to protection of — longer lead times on protection kind of getting in line, if you will, which makes it, I think, pretty certain, probably half of that is — at least half of that is that number and the other half is good demand throughout — mostly at tech but in other places as well. So I mean that’s why I think our confidence in the backlog is much higher than maybe what others might think just because I think we’ve really examined it pretty deeply and feel good about the opportunity to deliver that in ’23.
Deane Dray
And a follow-up for Chuck. Can you break out the year-over-year margin decline in Advanced Healthcare Solutions? Just kind of how much is supply chain price cost, or is that bad debt included? If you could size that.
Chuck McLaughlin
You’re talking about the third quarter specifically?
Deane Dray
Yes.
Chuck McLaughlin
So when you look at year-over-year, the biggest — the first thing is the bad debt at Invetech, is pushing, I think $5 million reserve. We still hope to — we haven’t given up on collecting that and getting some back to that, but that’s an accounting reserve. It’s just good management there. I think that there’s — year-over-year, there’s — we’ve got FX and inflation, that’s probably 100 basis points that’s causing a problem. And then really just lack of the growth as the supply chain, the rest of it is supply chain and Fluke Health and a little bit in our biological indicators at ASP.
Deane Dray
What was that last one?
Chuck McLaughlin
Biological indicators that ASP…
Jim Lico
It’s literally a plastic vial. It’s when you think about the BIs go through the sterilization process to calibrate the effectiveness of the sterilization cycle.
Operator
Your next question is from the line of Josh Pokrzywinski with Morgan Stanley.
Josh Pokrzywinski
Jim, maybe just to kind of close out something that Dean was asking about in terms of the backlog. I mean we’re hearing supply chain getting better pretty quickly here across a whole different host of verticals and product lines. It doesn’t really look like 4Q guidance in IOS has a significant amount of backlog reduction, or is there some assumption about seasonality orders or something else going in there. But of that extra backlog, I mean is that something that you should be able to work down over the next couple of months? And would you prefer to keep more backlog in this business versus just kind of get it all out the door in a quarter or two for that excess?
Jim Lico
Well, I think, first, it starts with customers. And obviously, we’re doing everything to take care of customers. Fluke specifically and more broadly, but Fluke specifically, point of sale is very strong. As we said in the prepared remarks, it’s double digit across all regions. So point of sale is good right now. So we obviously want to take take advantage of those opportunities. I would say, Josh, so I would characterize the supply chain as broadly getting better. But at the end of the day, it’s down to a few hundred components around Fortive that still have very, very long lead times, like in the 50, 60 week kind of time frame. So while broadly that number of components has gone down dramatically, there’s still a number of components that are keeping our lead times out there. Now we’re more used to it. It’s more in our cycle. But that’s why we suggested in the prepared remarks that supply chain constraints probably continue into ’23 and I think that’s pretty well documented around the electronics supply chain world. So we’ll take down a little bit of backlog here, but we’ll — I think the robustness of what we do relative to FBS has those continued improvements helping us, and that’s why you see strong growth in IOS in the fourth quarter. But obviously, as we said in Dean’s question, we’ll still go into the year with what I would call a nice sized backlog in which to mitigate any potential short cycle challenges that might be out there potentially.
Josh Pokrzywinski
So there won’t be a quarter where you like blow out $100 million all at once because supply chain gets better…
Jim Lico
No, we won’t be. I think we feel it’s just that — the supply chain situation is just not that robust in that sense.
Josh Pokrzywinski
And then just following up on tech. I mean performance in the quarter was pretty exceptional. I know you guys have talked about kind of the virtuous product redesign cycle that everyone’s going through based on new chip availability. And I’m kind of wondering, how much is that determining kind of the go forward visibility intact versus maybe some residual backlog that could be electronics facing and more susceptible as the economy slows?
Jim Lico
I think one thing we’ve said from — since the inception of Fortive is that we were going to work diligently to improve the growth rate of Tektronix and to reduce its cyclicality. And so they’ve had exposure to cycles in the past, and I think we’re pretty well — we’ve talked a lot with you and others about the fact that we’ve made good progress in that regard. What we’re really seeing and we said in the prepared remarks around the seven consecutive quarters of growth is really the secular drivers playing out. The innovation cycle that has been such a great success in Tektronix really hits the market at the right time relative to the kinds of things whether it’s the power challenges in the EV market or in IoT, everything becoming digital, requiring a hardware backbone and infrastructure. All of those dynamics are secular in nature and are going to continue to be part of the investment cycle, I think, over the next several years. Now part of the business will still be exposed to some of the macro potentially, but I think the backlog and the work we’ve done around innovation match to these secular drivers is ultimately going to make it growthier and more durable for sure.
Operator
Your next question is from the line of Steve Tusa with JPMorgan.
Steve Tusa
Just on the — I guess, to follow up to Deane’s question on the fourth quarter at AHS. I mean, it looks like you’re still growing core but margins are down. Maybe that’s 4x or something like that. Can we get a bridge kind of to the fourth quarter there for AHS margins?
Chuck McLaughlin
So Steve, when you look at — the biggest thing is a little bit of FX, but I’d say a little more in AHS in fourth quarter around inflation there. We don’t — it takes longer to get pricing in the health segment, and so I think inflation is a little bit ahead of us there, unlike maybe the rest of our portfolio where we’ve been able to be ahead and we’re ahead of the total on that. So that’s probably the biggest thing, the reason we’re down in the fourth quarter.
Steve Tusa
I guess why wouldn’t that have been hitting you already over the — I don’t know, over the last like 18 months of inflationary pressures? Why is that hitting you now in the fourth quarter?
Chuck McLaughlin
Well, I think it has been hitting us, but FX has also accelerated and is hitting us a little bit more as well.
Jim Lico
Steve, I think the other part of that is the volumes that we ship in healthcare, because the predominance of the revenue being in consumables and service, we were able to mitigate some of those supply chain and expenses for a longer period of time than we were in some of the other businesses. So as Chuck said, we’re seeing a little bit more inflation. Most of this all predicted, most of the — many of these things. And ultimately, we’re continuing to improve margins here at health. So we feel like with mid single digit growth in the fourth quarter and into next year, we’re going to — we’ll start to see some of these improvements playing out.
Steve Tusa
What’s the carryover level of price you guys have in the next year, if you just snap the line today, for total company…
Chuck McLaughlin
We didn’t do anything different. While the first half has looked probably a lot like the second half of this year, so probably plus 4% to 5%, we might lap a few things there. But we would expect to continue to deploy price to offset inflation throughout the year. So it might be a little less than this year, but that’s just the theory. We have to wait and see what inflation is. We’re committed to being ahead on our price cost there.
Steve Tusa
And one last one. Any loosening up of the acquisition environment, Jim, and anything looking a bit more attractive here?
Jim Lico
I think for sure. I think the — I think we’ve been patient in a number of situations here over the last several months. But you’re starting to see, I think, probably more on the — maybe not as much on the private equity side but certainly elsewhere on the other parts of the private market, certainly some public things that we’re starting to see. So yes, I think we feel — we obviously are going to be disciplined. It’s a noisy environment as we all know and will probably continue to be, and that should continue to [Technical Difficulty] but given the fact that we do work on these things throughout the cycles, we feel confident we can — we’ll be able to deploy some things that can certainly accelerate what we’re trying to do in 2023.
Operator
Your next question is from the line of Julian Mitchell with Barclays.
Julian Mitchell
Maybe just a first question around the hardware business. Just trying to understand exactly what’s going on in orders. So I think orders in hardware are up 9% in Q2 year-on-year. It sounds like they’re up maybe low mid single digit Q3. And then is the point that they’re down in Q4 and that’s helping to explain the backlog reduction that’s taking place? And if there’s any difference to call out between hardware orders trends at IOS versus PT at the moment?
Chuck McLaughlin
I think you’ve got the bookings right in Q2 and Q3. And in Q4, the rate slows but it doesn’t go negative. But in a normal Q4 what happens is we would normally expect sales to exceed bookings and then take backlog down. And I think that’s what we’ve got modeled in there, but that doesn’t mean our orders are actually negative in Q4.
Jim Lico
I think the other thing, Julian, is as we started the year, we had always said really consistently that the second half orders would be slower than the first. We saw orders much better in the first half. So some of that, as we talked about, was a little bit of things that we saw were coming in a little earlier because of lead times and things like that. So parsing quarter-by-quarter is a little bit dangerous just because of the strong demand we had — stronger demand in the first half, and I think that really speaks to the strength that what Chuck just described of how we really, obviously, saw very strong third and we’re going to continue to see a strong fourth. So I think it just speaks to — orders have played out almost better than we thought for the full year, for sure. And I think it puts us in — as we talked about, puts us in a great position for ’23.
Julian Mitchell
And then my follow-up just on the Healthcare segment. You talk on Slide 14 about a modest pace of recovery there on the ex software piece in 2023. Just when we’re trying to think about the overall healthcare business from here, I think this year, you’re guiding for just under 2% core growth for the year with a very big — or a decent step-up again in Q4. When you’re thinking about next year, what’s the sort of framework for healthcare growth? I think it’s tended to come in a bit below what people had hoped for various reasons in the last two or three years. Are we thinking core growth is similar to this year’s just under 2% next year, or is there a chance to do better than that?
Jim Lico
I think first of all, what we’re trying to sort of frame for ’23 is we think the hospital market is going to be better in ’23 and ’22. I think it’s pretty well documented. If you look at some of the public hospitals as an example, in the US, certainly, there have been challenges, obviously, with COVID in the first part of the year and some of the labor challenges that they’ve had. We think that — we’ve studied it pretty deeply. We certainly think that the market will be good next year. And we think mid single digit is possible. We’re going to see that in the fourth, and we think that’s possible leading end of the year. So yes, it won’t be back to what I’ll call normal. I think we’re still determining what the new normal is. But I think as we look from Q3 to Q4, it gets better, it gets better at probably Q4 to Q1. So I think we’re pretty — I don’t want to be bullish necessarily in the overall situation, in total, pollyannaish, if you will. But I think for sure the market is going to be better in ’23 than it was in ’22. And as we look out, we just finished our strategic plan with all of our health care businesses, 24 looks better than 23%. So think, obviously, COVID wasn’t that far away when we really think about it. It feels that way a little bit but it was only four or five months ago. So as I think we continue to see step through some things. And as we said, really, what we saw in the quarter from a revenue perspective, what it played out, as we said, if it hadn’t been for a couple of supply — very specific supply chain challenges. So I think in general we have some confidence in the outlook here.
Operator
Your next question is from the line of Scott Davis with Melius Research.
Scott Davis
I wanted to ask about Provation just since we’re talking about healthcare. Do you think that business would be kind of ripping on labor shortages? But at the same time, you think it’s maybe hard to do installs when you have labor shortages, too. So how does that — what drives that business, how does that kind of ebb and flow with the issues that are going on today?
Jim Lico
Well, you’re spot on around productivity. I think the productivity and value proposition that comes in the GI suite is very positive, and we talked about the SaaS numbers in the prepared remarks being very strong. We’ve seen a little bit of delay on the sales funnel, Scott, from the standpoint of just taking a little longer to implement. So some of our services revenue is a little slower than it had been, but we’re probably — we’re very bullish on the business. The value proposition is very specific and very much in right in the sweet spot of what challenges hospitals and ASPs are seeing. So we secured a very large order with a large government entity, that’s going to take a little while to implement. But I do think it just speaks to the breadth and strength of the recognition of the value proposition. So yes, we think that business is going to continue to accelerate. Got a few challenges that we’ve got to work through because some of those labor challenges in hospitals aren’t just kind of the folks in sterilization labs or whatever, they’re also in some of the IT organizations. But I think when you start to look over the next six, 12, 18 months, we feel really strongly about the business. And it’s obviously still on track from a profitability and returns perspective. So we feel really good about it right now.
Scott Davis
And then follow-up, earlier question on M&A. You had an interesting response, which perhaps was different than what you’ve said in the past where you mentioned publics. Now just to be clear, are you talking about pieces of public companies you could potentially take, or are you talking about potential public to private — or public to public, opportunities, which is not necessarily something you guys have done a lot of in the past?
Jim Lico
I would say, first of all, when you look across I think just public valuations being more in the zone of — in certain places, so I think it really is more a general comment relative to that. But we’re certainly eyes wide open in whatever opportunities are available. And we’ve got, obviously, a really — a very specific set of places where we think there’s great investment opportunities, but we’re also patient relative to those situations. So I never want to — as you know well, I never want to predict what we do for lots of reasons, but we feel good about where the environment is going to be going here over the next several months.
Operator
Your next question is from the line of Jeff Sprague with Vertical Research Partners.
Jeff Sprague
Just a little kind of geographic walk here, if we could. First on China, do you think the strength here is kind of reflective of just the lockdown balance, or I don’t think you’re expecting 20% organic growth to continue necessarily, but it does seem extraordinarily strong. So just what’s driving that, and what are you expecting here in the next quarter or two?
Jim Lico
Well, we’ve had so much strength in China over the last three or four years. I mean I think it really does speak to the — how we built the businesses over there. Pretty independent China manufacturing and design for the market, there’s a little bit of a bounce there. So I think that’s definitely true. But our outlook is still pretty good. And I think, obviously, healthcare, as we said in the prepared remarks, both IOS and PT were good. IOS obviously a little — healthcare a little slower just because of the COVID lockdown. So I think as we look out, we still continue to see a good growth opportunity there. We’ll see that in the fourth quarter. We should see it next year. Some of that backlog, obviously, that we described in the previous conversations includes China as well. So we think this can be a good market here certainly for the next several quarters as we look out.
Jeff Sprague
And how about Western Europe, any signs of cracking there?
Jim Lico
For obvious reasons, we’re continuing to put a real microscope on everything we do over there. Point of sale remains pretty good. So I think when we look across some of the things that would typically tell us, we had good healthcare, I think it was our best region for healthcare. So I think at the end of the day, we continue to think Western Europe probably has hit some [stars] here. But if you look at the signs that we would typically look at, still holding up there pretty well. But I would anticipate it’s hard to believe that just given some of the challenges they’ve got that there isn’t some issues certainly in ’23, and it’s part of our scenario analysis.
Jeff Sprague
And maybe just the last one sort of on that on kind of thinking about scenarios. Obviously, there’s a lot of mix even within the segments. But at a high level, how would you have us think about decremental margins if we were to get into kind of, call it, a moderate recession environment where you’re putting up negative maybe mid single digit type organic growth?
Chuck McLaughlin
Well, I think if we got to negative — actual negative growth, you could probably expect what we did during 2020 with the — our up and down. We try to manage it to the same level. But keep in mind that we’ve got a really strong elevated backlog position. And while we expect slowing, we also — that might not be our base case. But we’ve always said we manage to the up and down decrementals.
Jim Lico
I think it’s part of our — as we look at our playbook, too, Jeff, to Scott’s question around how we should think about all this, I really think that when we look at broadly our solutions, and Scott got to the Provation question. But if you look broadly across the portfolio, everything we do pretty much today is around productivity improvements. And whether it’s Provation example we were talking about or what we do at ServiceChannel like we talked about in the prepared remarks, how we’re bringing innovation and design cycle times down with our Tektronix solutions, what we talked about in the prepared remarks around solar with Fluke, we’re really focused on saving money for customers with our solutions because of our workflow strategy. And so I think to Chuck’s point, we certainly have scenarios across the board of what could happen relative to the macro. But I’d be remiss if I didn’t sort of think about what we’ve really built in these workflow strategies is really to be, to be there for customers at their toughest — with their toughest challenges. And I think we’re certainly seeing that in a number of places where our orders are very, very strong. Because the reality is, is that customers are going to need to save money in the future, I think. It’s going to be more important, and our solutions really play well to those challenges.
Operator
Next question your next question is from the line of Andrew Obin with Bank of America.
Andrew Obin
So when you guys talked about ’23 outlook, and I appreciate it. It’s very, very initial. How should we be thinking about the pricing as we frame ’23, right? I think price was 6 points in the third quarter. So how much momentum do you have going to next year?
Jim Lico
Well, from a momentum perspective, obviously, we’ll have more price in the second half than we did in the first half of this year. So I think that’s a starting point from a momentum perspective. As Chuck said before, we don’t take some of that lightly. We’re continuing to look at where situation is where we would continue to get more price. So I think we think the pricing envelope for next year, certainly in the first — it’s hard to have a 12 month outlook by every quarter. I think the price rate itself will not be as high as it’s been this year. But our ability to retain price while at the same time getting additional price, I think, still is there. So I’ll probably stay away from a specific number until we kind of get closer to the guide and how we see the fourth quarter play out. But I think we still — as we’ve talked about, we think we can get more price in the software businesses. We think there’s still some more price to get in the health care businesses. So there’s still opportunity within the portfolio to accelerate some things while at the same time continuing to do the things that we’ve done so well over the last several quarters.
Andrew Obin
And just a slightly different question. There were all these restrictions imposed by the Biden administration in China semiconductor production. I think there was a headline today that SK Hynix is like thinking to pull out of China. How do you — how should we think about businesses like Tech Keithley in China? And I know even business like Fluke will have exposure to just sort of regular day-to-day CapEx in China. Have you guys been able to quantify or do any sort of initial assessment of the potential impact of the restrictions?
Jim Lico
So first of all, as you know, semiconductor exposure broadly through Fortive is still pretty small. But I think we’re certainly aware of what’s going on there. Given the current regulations, we feel comfortable that, that’s not a huge impact relative to customers. We typically don’t sell into production fabs. We tend to be more in the innovation cycle. Some of that work that maybe gets shut down or moved out of China gets moved to other places. We should benefit from that, whether it’d be the US, whether it’d be back into Korea or other parts of the world. So I think we benefit from some of those changes over time as we see those play out. We need to continue to evaluate what we see and what happens in China from those regulations, which are still pretty new.
I think what you know to be true is that we’ve continued to countermeasure challenges in China and still be successful over the last three years. We’ve had good growth over there despite export control. It started several years ago and some of the other things we’ve lost close to 28 customers at tech over the last few years because of export control. So we’ve weathered a number of these things as they’ve been applied, and I think we’ll continue to do that as we see fit. And depending on reactions that come back from China, we’ll react to those as well. So I think we understand what’s going on there today. It’s obviously a very fluid environment. We’ll continue to watch it. But I think one thing that’s been true over the last several years is our ability to be successful despite — being able to play within the rules and do the things necessary to continue to build business more broadly around the world.
Operator
Your next question is from the line of Nigel Coe with Wolfe Research.
Nigel Coe
So obviously, lots of impressive growth rates across the portfolio. What stood out to me was Gordion, Accruent up high teens and IOS. So it seems like that’s really clicking now. But we don’t really expect these businesses to grow high teens, maybe a bit slower and steadier. So just wondering to provide a bit more breakdown on what’s driving that growth. You mentioned pricing in software, but just wondering what’s driving the strong growth rate there. So maybe talk about net retention there as well.
Jim Lico
One, we really — as we’ve said, with the addition of service channel and the combination of service channel, Gordian and accruing into the one business that we really call facility and asset life cycle, really a very strong quarter. We had always said that we were going to have some self help happening to Accruent over time, and we saw good steps forward in that regard. So I think that business is very good. ServiceChannel is really a great value proposition for facilities managers. We’re transitioning that business as well, as we mentioned in the prepared remarks where we’re trying to take some of the pass-through revenue and turn it into longer term SaaS revenue. So really, we’ve executed well. Net dollar retention, as you pointed out, is improving. So that is inevitably probably now our fourth biggest business, and we’ll pretty quickly be probably moving up to scale in that regard just because of its impressive growth rates.
So I think it’s been a great addition to the portfolio. We still have great profitability opportunity in the business. Gordian is certainly firing on all cylinders. So I think we feel like — we feel very good about it, lots of work to still do, but I think we really feel good about what’s that and you heard that in the prepared remarks. I think longer term, we certainly see those opportunities to still be there, consistent with some of the comments I made about value propositions and productivity, really our solutions really give customers a better view of their facilities, better view of their assets, how they can reduce costs, how they can reduce investment. And obviously, pretty much everybody in the world is thinking that way these days. So that value proposition is going to continue to resonate well into ’23 for sure.
Nigel Coe
So it sounds like you’re starting to see the revenue synergies from put together three businesses. Okay. And then going back to Tektronix, I understand the chip and everything secular themes, but you’ve had store the amount of product vitality this year. I think you launched the 2 Series midyear, and there’s been other launches this year. So I’m wondering, have those new product families, has that had a disproportionate impact on growth rates this year?
Jim Lico
I would say they’ve been incredibly successful, but 2 Series just launched in — really launched in the third quarter for around the world, and it’s exceptional. And I think it really — that is a product along with the new [V] version of our 6 Series — 2 big launches, the 6 Series just won our innovation award at Fortive last week. So I think we’re still seeing early days of those innovations, to be honest with you. So our capability there is just only increasing with the value proposition of those products. And most of our success in the quarter really was more broad based than that. So we still think we’re in the early days of some of those successes. And really more broadly, the innovations that we’ve really been doing over the last 12 to 18 months are still continuing to help from a success perspective.
Operator
Your next question is from the line of Andy Kaplowitz with Citigroup.
Andy Kaplowitz
Jim, you said you examined demand break deeply at some of your shorter cycle businesses, and you mentioned point of sale is still very good at Fluke. Obviously, we’ve begun to see some destocking, more consumer facing businesses than other companies, but it seems like you’re suggesting that your short cycle industrial channel inventory is in reasonably good shape. But maybe you could just elaborate on that.
Jim Lico
Point of sale of both Fluke and Tech has been good. As I was mentioning before, Tektronix inventories have been at all-time lows for the better part of the year now. So we don’t feel like there’s destocking risk there just given lead times, while orders have been strong, as you well know, our revenue has been accelerating. So we feel — we look at the combination of backlog and inventory in order to make sure that things are not out of whack there, and we feel good about that. A little bit elevated inventory at Fluke from a few years ago, but not anything recent. The point of sale really and our lead times sort of would — just the math there would suggest that that’s nothing more than a little bit of elevated lead times. We’re going to watch POS more than anything there, and that continues to be strong. So certainly, we’re keeping a watchful eye on it. But as we sort of snap the eye right now of what we’re seeing, so far, things look — still look pretty good. We’re not in any way, shape or form, thinking that what’s happening around the macro more broadly and certainly into next year wouldn’t influence that, and that’s why I think we’re keeping a close watch on that pretty much every day and every week.
Andy Kaplowitz
And then Chuck, you’ve continued to generate basically spot-on cash flow versus your own expectations, good conversion when most — a lot of your peers have faltered to an extent. We know much of the good performance is likely coming from FBS? But why haven’t you incurred either a bigger inventory build or receivables build as your core growth has been higher, and do you see conversion continuing at this rate in ’23?
Chuck McLaughlin
Well, first, I’ll take the easiest one. We think 105% for the year is the right conversion rate for this business. I think there’s two things that are really helping us here, most obvious one is FBS and in a really tough supply chain environment that’s not only helping us get products out the door, but mitigating the impact that inventory is having on this. We do have elevated inventories from where we would normally be, but I think that’s certainly — we’ve done very well maybe versus some of our peers, I would theorize, because of FBS. The other piece is the addition of these software businesses that while taken in whole have negative working capital. And so the free cash flow generation from the software business is incredibly stable. And I think that’s an element that we’re very — that’s playing out as we expected but very happy with.
Andy Kaplowitz
And then, Chuck, just real briefly, just given the changes on your balance sheet, should we — knowing that there is some floating rate debt. Should we think about higher interest expense in ’23? How do we think about that?
Chuck McLaughlin
I think because we’re delevering, we’ll give absolute guidance going out, but I don’t think it’s a huge headwind at this point from — even though rates are going up, but our debt is coming down. Overall, our debt level is really very low. We would expect to be — well, we’re at 2.0 net leverage now and going down between now and the end of the year.
Operator
Today’s final question will come from the line of Joe Giordano with Cowen.
Joe Giordano
Two quick ones from me. When we think about the elective volumes, and let’s just focus on North America for this. We haven’t really had like COVID lockdowns or anything for a long time now. Is there some risk that like maybe the bar to go in for an elective surgery has just changed, and like we’re trying to get back to a level that like isn’t the level anymore. Is that a possibility?
Jim Lico
No. I mean I think at the end of the day, when you look at where we’ve been on a lot this year lately, we’ve been pretty close to the close to the pin here. So China is obviously its own story. But when you look at the US we’ve been pretty much spot on in what we thought. So I think at some point in time, we’re going to get out of the conversation what electives are doing and just talk about the growth rate year-on-year. And I think we think electives will continue to improve. I think that’s where we see it today. It is a — COVID wasn’t that long ago and labor productivity, labor challenges do restrict. We have a number of customers that are not running all of their ORs right now but would like to. So I think you’re going to continue to see that as an improvement over time. And fundamentally, that’s going to be, as I mentioned a few questions before about how do we see the ’23 hospital market, we think it improves off of this year. ’22 is probably the low point from a combination of all kinds of challenges, the financial challenges that occurred that have sort of cropped up in ’21 and ’22, the labor challenges and COVID. So 22% is probably the low point in that regard and we continue to see things pull up here over the next — into ’23.
Josh Pokrzywinski
And just to be clear, I wasn’t talking about your ability to forecast for electives. What I just meant like as a country, what do electives actually…
Jim Lico
I think they’re just going to continue to improve a little bit, but not — they’re not going to go from 90% to 105% or 110% right away. But they’re going to progressively move up through, I suspect, over the next several quarters.
Josh Pokrzywinski
And then just last, like we’ve been hearing from some companies that while the order environment is still pretty good, but like behaviorally, maybe customers are being a little bit more measured about saying yes to things. So are you seeing like any sort of like incremental behavioral shifts or like the bar to accept projects or anything like that is moving somewhat higher or taking longer to get to the end of the line?
Jim Lico
I think we talked a little bit about this. We are seeing it in a few places where sales funnels are extending a little bit. where we might have closed business. I’m just going to pick a number, 60 days, maybe that’s moved to 70 days or 75 days. So we are seeing sales funnels to close business move out a little bit, that’s in software and hardware a little bit. So yes, we are seeing a little bit of that, but we’re not losing business. I think in a number of places where we saw things extend that was caught on eye, in no situation have we lost any business. So it’s really just — it comes down to maybe customers stretching their dollar a little bit. And that’s why the point I made around our value proposition is so important, because I think we’re going to stay at the top of the list of things to do with our customer base simply because of the value proposition and our ability to save money and the return profile that you get from an investment in the workflow solutions that we’ve sort of developed over the last five or six years. So it doesn’t mean it’s going to happen exactly like we think it is from a time frame perspective, but we’re not seeing things fall out yet, which I think is good news for the — into ’23 for sure.
Operator
This concludes the Q&A portion of today’s call. I would now like to hand the call back to Jim Lico for any closing remarks.
Jim Lico
Well, thanks, Dennis. And thanks, everyone, for taking the time today. We know you have a busy schedule today and this week. Hopefully, you heard from Chuck in our remarks on the Q&A as well as our prepared remarks. We’re really proud of the quarter we just had. I think it demonstrates the power and the resiliency of the portfolio. I think the gross margin and operating margin expansion and free cash flow on the accelerated organic revenue is just demonstrative of the power of what we’re building here, and we’re really excited about what’s going on. Obviously, a lot of noise out there, both from a macro perspective and geopolitical. We understand that. We’re not oblivious to that in any way, shape or form. We’re preparing scenarios for that. We’ll continue to see how things play out here in the fourth quarter, and we’ll look forward to talking to you through the quarter and obviously into ’23 as we get ready for a guide in the new year. So thanks, everyone, for the time. Good luck this week, and we look forward to talking to you all soon. Thank you.
Operator
This concludes Fortive Corporation’s Third Quarter 2022 Earnings Results Conference Call. Thank you for joining. You may now disconnect.
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