My name is Alexander, and I will be your conference facilitator this afternoon. At this time, I would like to welcome everyone to the Fortive Corporation's Third Quarter 2021 Earnings Results Conference Call. [Operator Instructions]. I would now like to turn the call over to Mr. Griffin Whitney, Vice President of Investor Relations. Mr. Whitney, you may begin your conference.

Thank you, Alexander. Good afternoon, everyone, and thank you for joining us on the 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 SEC Regulation G relating to these non-GAAP financial measures are available on the Investors section of our website, www.fortive.com, under the heading Investors Quarterly Results. We completed the separation of our prior Industrial Technologies segment through the spin-off of Vontier Corporation on October 9, 2020, and have accordingly included the results of the Industrial Technologies segment as discontinued operations. The results presented on this call are based on continuing operations. During the presentation, we will describe certain of the more significant factors that impacted year-over-year performance. All references to period-to-period increases or decreases and financial metrics are year-over-year on a continuing operations basis. During the call, we will make forward-looking statements within the meaning of the federal securities laws 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 uncertainties and actual results might differ materially from any forward-looking statements that we make today. Information regarding these factors that may cause actual results to differ materially from these forward-looking statements is available in our SEC filings, including our annual report on Form 10-K for the year ended December 31, 2020. These forward-looking statements speak only as of the date that they are made, and we do not assume any obligation to update any forward-looking statements. With that, I'd like to turn the call over to Jim.

Thanks, Griffin, and good afternoon, everyone. Early in the third quarter, Fortive celebrated its fifth anniversary as an independent public company. This quarter, we continue to demonstrate the success of the strategy we outlined in 2016 to enhance growth and margins across our businesses through the successful execution of the Fortive Business System, the acceleration of innovation and the impact of disciplined capital allocation. Our third quarter results were highlighted by 32% growth in adjusted earnings per share. We continue to generate significant revenue momentum throughout the quarter, realizing 9.1% core revenue growth, an order growth of just over 20% against the backdrop of strong broad-based demand. Strong execution and application of FBS helped to generate 325 basis points of core operating margin expansion, along with very strong free cash flow despite widespread supply chain disruption. In the third quarter, our software businesses grew by low double digits, supported by strong demand and improving net dollar retention. In total, we now have almost $750 million of annualized software revenue across the portfolio with double-digit organic growth profile as well as a high share of recurring revenue and high operating margins. In August, we closed the acquisition of ServiceChannel, adding another differentiated high-growth software asset to our Intelligent Operating Solutions segment. The ServiceChannel acquisition significantly enhances our strategic position in the facility and asset life cycle market, extending our leading suite of offerings for facility owners and operators and providing a variety of potential avenues to deliver unique value-added solutions in combination with Gordian and Accruent. As you can see on Slide 4, across Fortive, we continue to invest in product development to drive organic growth and enhance our competitive position. Many of our investments in organic innovation are focused on enabling digital transformation across our customer base. This includes vertically…

Thanks, Jim, and good afternoon, everyone. We delivered another quarter of strong margin performance in Q3, using FBS tools to deliver strong pricing and successful value engineering to implement component substitutions across a variety of hardware businesses. This FBS execution and the continued strength of our software businesses helped deliver adjusted gross margins of 57.3% in Q3. This reflects 90 basis points of expansion on a year-over-year basis as we accelerated to 220 basis points of total price realization. Q3 adjusted operating profit was 22.8%, reflecting solid execution across the portfolio, including counter measures enacted in the face of ongoing supply chain challenges. We had strong margin performance across all of our segments, resulting in 325 basis points of core operating margin expansion. On Slide 9, you can see that in the third quarter, we generated $252 million of free cash flow, representing a 105% conversion of adjusted net income. Free cash flow over the trailing 12 months increased 22% to $991 million. Our current net leverage is approximately 1.6x and we expect net leverage to be around 1.3x at year-end, excluding any additional M&A. Turning now to the guide on Slide 10. We are raising the low end of our full year 2021 adjusted diluted net EPS guidance to $2.70, resulting in a range of $2.70 to $2.75 for the year. This represents a year-over-year growth of 29% to 32% on a continuing operation basis. This assumes that total revenue growth of 14% to 14.5%, adjusted operating profit margins of 23% to 23.5% and an effective tax rate of approximately 14%. We continue to expect free cash flow conversion to be approximately 105% of adjusted net income for the full year. We are also initiating fourth quarter adjusted diluted net earnings per share guidance of $0.74 to $0.79 representing year-over-year growth of 6% to 13%. This assumes total revenue growth of 6.5% to 8.5%, adjusted operating profit margin of 23.5% to 24.5% and an effective tax rate of approximately 15%. The adjusted diluted net earnings per share guidance also excludes approximately $12 million of anticipated investments in strategic productivity initiatives that we expect to execute before the end of the year. For the fourth quarter, we expect free cash flow conversion to be approximately 125% of adjusted net income. With that, I'll pass it back to Jim for some closing.

Thanks, Chuck. We're very pleased with our performance in Q3. We worked diligently to countermeasure supply chain challenges that persisted throughout the quarter and which we expect to continue into 2022. Our teams are doing an excellent job deploying FBS to navigate those headwinds while also delivering strong margin performance and free cash flow generation. Looking across our end markets, the demand backdrop we're seeing is very strong with significant momentum in our order flow, driving continued growth in our backlog and double-digit growth across our software businesses. While continuing our focus on execution, we're investing in innovation, expanding our base of leadership talent and pursuing additional capital deployment opportunities as we look to enhance our competitive advantage and pave the way for consistent double-digit earnings and free cash flow growth in the years to come. With that, I'll turn it back to Griffin.

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

[Operator Instructions]. We have your first question from Scott Davis with Melius Research.

It's a pretty good quarter overall. I'm just trying to nitpick a little bit. If price up 220 basis points is - did that fully offset your cost, Jim? And is price still going up as you go into Q4 here to offset kind of the deltas as costs continue to rise?

Yes, Scott, thanks. I think number one is we've been ahead - as you know, we've been in a really good position all year relative to price cost. And hence, our gross margin's going up 90 basis points in the quarter. So yes, we're ahead. I think one of the things about price is when you think about it, we really think about it in the big hardware businesses as Fluke, tech and Sensing. And in that - those businesses, we were over 300 basis points. So yes and we'll see improvement from there in the fourth quarter. So yes, so we're in good shape. You'll see the price in the software businesses in the net dollar retention. And so net dollar retention at 102 or so with some of our businesses even higher means we're also - we're getting that price in a number of the software businesses. It just doesn't show up in the metric the way you'd like it. But we're, I think, in a very good shape relative to price cost in the hardware businesses relative to any inflationary pressure we might have.

Okay, good. And then ServiceChannel, you made some positive comments. And what is it more specifically that you like more perhaps today than when you closed the deal?

Well, I think number one, the team, I think, we didn't have full access to the entire organization when we were in the deal. So I mean, I think with the work we've done, we've been in person with the team, and I think we're excited about the quality of the organization. That's number one. We always said the product was great. So I don't think there's any surprise there other than the product is great and the solution is good. And as we articulated in the prepared remarks, the breadth of opportunity is really positive. I would say the other thing is we're really starting to see how we can continue to expand the business and some of the levers that are out there. So we'll do - as you know, we'll do our 100-day plan here in about a month, and we'll certainly codify for the remaining rest of the year, but more importantly for next year, relative to our plans. And right now, we're, I think, in a very good place relative to how we see the business.

We have your next question from Deane Dray with RBC Capital Markets.

Just maybe start with Fluke. And in most circumstances, something has not gone right if you're building backlog in Fluke. My guess is that was a factor with the supply chain issues. Maybe some color there would be helpful.

Yes. Sure. I think we had a very, very strong quarter at Fluke. As we mentioned, we did build backlog. As you know, any product that has a range of electronic components here is going to be a little bit of a challenge. So orders were in the high teens. So we're really good shape on the order side. We built backlog as you mentioned. I've been with the team a couple of times on the shop floor, and they're doing some really good work to get on with many of the component challenges they've had. But we're in a very good place with backlog and with the position of the business. I like where we're at, as we mentioned, from an innovation perspective in the prepared remarks, a number of examples of where I think we're really handling things well, and we're taking market share. And of course, all of that's also really driving strong margins there as well.

Okay. And then as a follow-up, I guess you should not be surprised. This is really a page from your playbook to jump on the opportunity to do some discretionary restructuring in the fourth quarter to get a jump start on the coming year. So this $12 million, just to be clear, that was not in your prior guidance. Is that correct?

That's correct, Deane. We've got some things going on with the ASP Day 2 countries that we plan to get after, but hadn't been put into our guide. And then we've also got some things around facilities reductions that we're looking at reducing our footprint.

Got it. And which segments would benefit from those - from that spending?

Yes, about half of - half of it's in IOS and the other half and the other 2, almost split evenly between PT and health.

We have your next question from Jeff Sprague with Vertical Research.

Interesting answer to the prior question, absorbing that. Also, is there some dilution from ServiceChannel in Q4 as you bed that down? And any change of view of kind of that year 1 accretion, I think, in the $0.04 to $0.05 range?

So Jeff, this is Chuck. No change to the year 1 accretion around that $0.04 range. And actually, it's coming in just as we expected. But in the fourth quarter, we're going to get revenue with, really, not a lot of operating profit as it moves into profitability, really, in next year. So that's not different. And so inherently, there is a little bit of dilution there in Q4.

Great. Margins look good in spite of that. And then just on this Walgreens deal, was that something in the pipeline already? Or is there some synergy that's already occurring with the Gordian or Accruent or some other part of Fortive?

Jeff, I'd love to take credit for it, but it was in their funnel and the team did a great job executing on it. So I won't - we'll take credit for when the synergies happen, maybe next year. But right now, the team is - we - obviously, we saw it in the funnel when we did our due diligence. So we knew, and I think their say-do ratio of things they said they were going to do during due diligence versus what they've completed during our short time period with them has been really high. That happens to be one of the things that they've executed on extremely well.

And is the answer to the tech backlog, the same as the answer to the Fluke backlog, essentially just some supply backing up a little bit?

Yes. I mean it's - we're not the first company to talk about it, what I understand. So I think at the end of the day, electronic components. What we said at the beginning of the quarter was it would be more an availability issue than an inflationary issue. We've seen some inflation for sure, but a lot of that's temporary because we're just - given the demand has continued to accelerate, it's a good news story here. This isn't just a supply constraint issue. It's really a demand acceleration standpoint. And with demand - the combination of demand accelerating really has our teams working diligently on these things. But it just puts us in a really good position at the end of the year, I think, to start 2022 off well in addition to, I think, just having a good backlog in the fourth quarter.

We have your next question from Andrew Obin with Bank of America.

Just a question on pricing. Just going back to the tariffs. I just remember that putting in pricing, price cost was an issue, and we have a lot more cost and all of a sudden price is not an issue. What has changed inside Fortive to enable this kind of pricing power? Because I just recall, like, 3 years ago, it was a lot more of a drag.

Well, I think a couple of things. One, we've been working at pricing all year long. And I think what you're remembering is we offset the tariffs, but on a one-for-one basis, and so that created an operating margin drag because equal amounts of price and cost will do that. In this case, what we've been doing is staying ahead of that and getting, as Jim mentioned, in our hardware business, it's up to 300 basis points of price, and we still are getting PPV and taking it out of the business. But we are seeing that getting chipped away at, but we've been able to stay ahead, and that's why we're delivering margin expansion.

And just a follow-up question. Looking back, you turned out to be prudently conservative on your view on elective procedures relative to everybody else and frankly, us. But where do you see elective procedures sort of going over the next 3 to 6 months? What's the pace of improvement as you see it globally?

Yes. Thanks, Andrew. What we saw, I think we ended Q3 at about 88%. Obviously, the Delta variant had impact in the quarter as the quarter progressed. We - we're assuming for the fourth quarter about the same, no real uptick. I suspect when we get a number - the federal vaccine mandate in the United States continue to get, hopefully, we start to get kids vaccinated here. Hopefully, we'll start to see in the first quarter, start to see some of those procedures coming back. And we'll get to the first quarter once we finish the fourth. But specifically for the fourth quarter, our assumption is things stay about the same as they are today. So we're in a good - we're in a really good place at ASP. As we mentioned, we had not - just a follow on to your question, a very good quarter at ASP. Equipment came in better than we anticipated to offset some of the headwinds from what we had on consumables. We had very good margin expansion at ASP in the quarter. So we like where that business is at. And if electives come back on the continuous basis in 2022, we'll be in a really good position to take advantage of that.

We have your next question from Julian Mitchell with Barclays.

Maybe just the first question around the core growth guidance for Q4. So I think it's sort of plus 5% at the midpoint. You've probably got around 3 points of price in there. So sort of 2 points of volume growth . Is that reflecting just a big slowdown in the sort of short-cycle hardware businesses as that recovery has matured? Maybe is there something going on in China? I saw there was a big slowdown. Is that maybe going negative in Q4? Maybe just any context around the sort of volume growth assumption for Q4, please?

Sure. There's a couple of things. I think the way you're looking at it, 200 basis points is the price increase. 300 is specific to the hardware businesses, but - so 200 overall, but you've got that about right. But when you look at it on a 2-year stack, we actually think we're still expanding, growing, increasing our growth rates in Q4 versus even Q3. So I think that's important. Also, I think as we noted, bookings are actually very strong here. So with the - what's implied in the growth, what we're able to get out the door right now isn't really reflective of the underlying demand of the businesses.

And Julian, I'd just say a couple of things. One, as Chuck said, the underlying demand on the orders for the second half is double digits, so very good order. From a demand perspective, we're seeing good demand. Relative to your China question, in the quarter, we had good growth at Fluke and ASP and as well as in Sensing. We'll see China get better in the fourth quarter, simply because while tech had a little bit lower growth in the quarter, they had over 20% order growth. And so we will see China get back to mid-single digit like growth in the fourth quarter. So we've seen good point of sale in China. So we're watching it carefully, certainly because of a lot of the headlines. But we had a good quarter. Chuck and I were on with the team last week doing an operating review. They're optimistic about what's happening on the ground there and the fourth quarter should improve sequentially from the third to the fourth.

That's very helpful. And then just a quick follow-up around operating margins. So you had very strong incrementals in Q3 year-on-year company-wide. It looks like for the fourth quarter, maybe you're assuming something in the third - maybe mid-30s operating leverage, so very good but a little bit lower. Is that just the sort of the run rate going forward for where we are with current sort of volume growth outlook and price cost and ServiceChannel coming in? Or is there anything sort of specific moving around in Q4?

Great. So our underlying assumption is 40% incrementals. And I think when we print Q4, I think that's what we're seeing. Maybe when we get to the follow-up call, we can talk about ServiceChannel and - if that's confusing your model. But we have the incrementals in Q4 around that 40% as well. So I'm not seeing any slowing there.

We have your next question from Nigel Coe with Wolfe Research.

So just going back to the restructuring, I think you said $12 million, Chuck, half of that in IOS, I think. The decision to do that, was that just because you've come in ahead of plan and you just decided that - a good idea to maybe do some investment here. And how should we think about this? Is this something that we can consider to be sort of a, "one-timer?" Or would the intention be to do quite a restructuring of this sort of magnitude in '22, '23 as well?

Well, first of all, I think we always had an intention knowing that we'd bring on these Day 2 countries, and we'll need to continue to make some adjustments as we go forward to them on the ASP realm. I'd also say that as we come out of COVID, we're going to continue to evaluate our footprints here and see what we need going forward, then that's probably going to be an evolving thing. So you could theorize that we could see that going forward, but it's not like we have a plan. We're going to do a certain amount each quarter. It's as we see what the situation is and we need to make a change, then you're going to - and then we'll tell you about it.

And Julian - sorry, Nigel. The other part of it is we did some in the third within the business in Sensing to do some factory relocation as well. So really, in the second half, these are early ideas around the second half. And quite frankly, I think puts us in a good position. As we come together with our return to work plans, it really says that in certain - some of the businesses we have, we can take our footprint down. And so we're obviously going to take advantage of those opportunities as they come at us.

Great. And then on Accruent, low single-digit growth versus mid-20s bookings. So obviously, a big disconnect there. Maybe just update us on how you see the revenue momentum at Accruent. I think there's a SaaS transition going on there. And maybe just touch on as well, the net retention of 102, that's the year-to-date metric. Is that changing at all through the quarters? And what's your target around net retention?

Yes. So relative to Accruent, you're right, we had a little bit slower revenue growth there, but we did have good bookings, really strong bookings in a couple of - several of what we'd call the growth businesses. We called those out in the prepared remarks but really strong bookings relative to the performance in those businesses. So I think we're set up well for mid-single digit in 2022. But you're right, we had a onetime hit on revenue that occurred in the quarter, a couple other things - a couple of little churn events or many churn events that we didn't anticipate. So certainly slowed it down a little bit in the quarter. But we think we're - because of the order strength, particularly around new logos, we are - we're in a good position for next year. Relative to the 102, we're always going to have some businesses up and down relative to where that number's at. ServiceChannel and eMaint would be our best performers on that metric as an example. Intelex would be pretty high. But we - I would suspect we'll get to sort of thinking about budgets as we go through the business. But I would suspect that you'd expect 100 basis points of improvement, 100 to 200 basis points of improvement somewhere in that range each year, at least for the next few years as we continue to - while these businesses are still new to Fortive.

We have your next question from Josh Pokrzywinski with Morgan Stanley.

So just a follow-up question, not to nitpick on some of the - like, the margin differences here with the restructuring and then ServiceChannel coming in. But I just want to make sure I'm understanding this right, in Intelligent Operating Solutions that if we sort of add back in the half of the slugger restructuring that goes there, it doesn't look like ex ServiceChannel, there's really much of a difference in margins in 4Q. Is there something seasonal there or supply chain that's sort of interrupting that? Or am I just sort of putting this under a microscope unnecessarily?

Well, I think their margins are very good, and they've got good margin expansion. So I think that there's just - we're talking about some - the highest - some of the highest margins we've got in the company. So happy to get through your planning sheet with you in detail and to help you understand that. But we're seeing, sequentially, margin expansion, I think, in all of our businesses.

Got it. And then just in terms of kind of your specific thwarted flavor of supply chain, maybe talk about like the 1 or 2 things that would be particularly helpful. I know some folks are really focused on chips, others have like freight and air freight or labor as issues. Like, what would sort of be kind of your top 1 or 2 things, Jim, that would be best to see.

Yes. Well, I can take you through a lot of detail because I think I've been more involved in these kinds of things over the last 60 days than I typically would, takes me back to some routes, I guess. Josh, I would say a couple of things. One, certainly in our businesses, think of it as the more electronic content, the more likely to have a challenge. So you can think about a circuit board at Tektronix, which is incredibly complicated, has multiple semiconductors on it, has multiple - all kinds of chip technology on a board like that. You're going to just have higher variability because of that. Fluke will be as true as well and then Sensing a little bit less. So from a - just how that goes, that's how it would be. We are seeing mostly electronic shortages. And as I said in the previous comment, mostly around availability. We're paying a little bit more to get things. So there's some premium freight involved in inflation, very - not a lot of labor. We have pretty low labor content in the company, simply because of our decades of productivity initiatives, so we're seeing some labor inflation, but at the end of the day, doesn't move the needle as much. It's really about the material availability first and foremost. And given our gross margins on those products, it makes sense to - even if we spend a few pennies more to get something in faster, given the high demand we have right now and just given the momentum in orders right now, it makes sense to sometimes pay those things, because ultimately, the margins. It just makes sense to do that. And obviously, our first and foremost, we're taking care of customers. So hopefully, that gives you a window. Every day, we're well set up to deal with this because we have daily management, what we call visual management. You've seen it in our factories during tours. Our businesses manage every cell and every factory by the hour. And so we're well set up to just sort of put that on steroids a little bit in order to amplify the challenges and just get after it. And so it doesn't mean we don't have issues. It's how well we countermeasure that really makes the difference here.

We have your next question from Markus Mittermaier with UBS.

I wonder how agile pricing is in your backlog. I mean 40% backlog increase year-over-year sounds great on the one hand, but it's a double-edged sword, obviously. So once things hit your backlog sort of how flexible are you to adjust price further if you have to?

Well, number one, I think what we do is in the big businesses where we sell into distribution or we certainly limit the amount of buying that can occur at pricing. So if we have a price increase stated, we obviously have contractual terms, markets. And we will contractually make sure - we work with our channel partners as part of their contractual obligations to not necessarily buy, like, 6 months ahead or something like that. So that's a partnership and certainly part of how we work with channel partners. We've been able, in many OEM cases to reprice orders as well. So I think it really speaks to - I think others have talked about having problems in their backlog with pricing. We have really good granularity around what that looks like, and that's what gives us confidence to know that we'll continue to get the price here going forward and to know that our price cost will continue to improve.

That's good to hear. And then maybe one - the follow-up on ASP. You talked both a bit on elective procedures where that's trending. But in your opening remarks, you also commented on installed base growth. So if I look into 2022, what's potentially the bigger driver here? Because it seems like the equipment placing trends are actually quite positive as well. So if I get that and I get elective procedure recovery, sort of what sort of growth should we be dialing in here?

Say, Markus, I think that you're right. Our underlying business in placing units is starting to - is continuing to accelerate. We're very proud about that. I think elective surgery's coming back. This could be half - quite a bit of the growth if it all springs back in 1 year. But I think we need to get closer to next year to really see what they actually do and in what month. But I do think that it's a - just to answer your question, if it all came back at once, that would be the bigger driver of the year for ASP and be quite a tailwind coming forward. But we're not calling that all coming back at once in 2022. It will probably ramp. It's over some period of time.

And I think, man, Markus, one thing we know to be true over the last - certainly over the last 2 years, but certainly in the last 6 months, is that something has occurred every 3 months relative to electives that's caused it to go a little bit sideways. So I think it's premature to call next year, but it's safe to say that when we get to a more normalized sort of event in our hospitals, we'll be in - that business is certainly laying the groundwork, laying the foundation for good growth. I was with a major hospital network about a month ago in their facility. They're placing equipment, and they're looking forward to adding more elective procedures as they get forward. And maybe just one other comment on elect is, it's not only COVID, it's also - particularly in the United States, it is also the nursing shortage. So it's - it probably doesn't snap back, but it certainly comes back over time, which we really are looking forward to, obviously.

We have your next question from Andy Kaplowitz with Citi Group.

So obviously, Fortive continues to have a really strong balance sheet. I think you said 1.3x leverage at year-end. So could you talk about the M&A environment out there? We've obviously seen a flurry of software-focused acquisitions after your ServiceChannel acquisition. And I know valuations continue to be on the rich side. But do you see Fortive remaining active over the next few quarters on the acquisition front? And would you lean toward continued focus on recurring revenue and/or software-related assets such as ServiceChannel?

Well, Andy, our - as we said over the last few years, we've - as we've talked to you, we remain very busy. And I think the opportunities are certainly out there. I - we're working on some hardware things. We're working on some software things. It's really about accelerating strategy. It's about adding technology to advance our - what we do within workflows with customers. So I think we have a balanced approach to things. I think we see lots of opportunities to deploy capital in ways that really, not only accelerates our strategy, but gets us good returns, is additive from a growth perspective. We're certainly going to lean in on recurring revenue. We think that's a good way to - we really think that's a strategy towards building a more durable, resilient Fortive over time. And so I would say we're certainly leaning towards those kinds of opportunities. As we know, even our hardware deals, whether they were Industrial Scientific or Landauer or certainly ASP, we had a heavy amount of recurring revenue in those deals even when they were hardware. So we're going to continue to look for those opportunities, not exclusively, but probably the majority of the things we're doing is really going to have a passion for growth, but also with that idea that we can continue to build a more durable, resilient growth rate.

And then maybe if I could follow up with asking you about tech in sort of a different way. You've always had good momentum there, and you talked about new product introductions this quarter. I know you mentioned tech's continuing strategy of focusing on data centers, EVs. So is that where the momentum continues to come from? And is tech's growth just maybe on a higher plane versus past cycles, given the sort of change in focus?

Well, I think number one is it's more resilient because our - we had, I think, low-digit growth in our service business, but just a resilient durable base and foundation of revenue that we've built over time. So number one, I think we've got a more resilient durable growth rate just because of that service business that we've built into the revenue stream. We've got some software offerings there that we started with. We mentioned that in the prepared remarks. So we're building a more durable revenue stream. While at the same time, as you mentioned, we've taken advantage of a number of real opportunities relative to what I would call higher growth situations. And quite frankly, when we think about going forward, obviously, the semiconductor cycle is going to extend as people continue to invest in the kinds of things that we've talked about, but also these supply chain issues and constraints fundamentally require a lot of folks who have electronics in their products to redesign those products for different chips or different components. And quite frankly, one of the things they need to do that is in oscilloscope. So we think there's also, not only the sort of long-term secular trends that the business has been going after, but also some shorter-term opportunities is as people start to continue to have to deal with some of these supply chain challenges. And fundamentally, that can often end up in a redesign. And certainly, we have the products and solutions to help people do that. So we're very bullish on the business. Obviously, it still has a component of volatility to it. But we - I think the team has done a nice job of continuing to drive technology and innovation towards higher growth, more durable revenue streams.

We have your next question from John Walsh with Credit Suisse.

Maybe just a first question, going back to the gross profit margin improvement in the quarter. Obviously, very nice in the face of inflation. You called out the price cost benefits in kind of the hardware businesses. But wondering if you're also getting a lift from kind of this portfolio mix that you've been doing towards more software, more SaaS revenue? Or if that's not yet showing up? Just curious how you parse out that growth.

No, I think - that's a good question. Especially when you take a look at our software businesses, you heard Jim mention a little bit ago about the net retention. That's another - where we also see price and great margin expansion. And we've got those businesses with their great margins growing faster than fleet average. That's going to give you a lift as well. So it's certainly our software businesses, but also the - staying ahead on the price cost is very important and offsetting what's a challenging environment.

Great. And then you obviously highlighted both the internal and external promotions here. Was wondering if you could just give us a look kind of the next layer down and kind of your ability to keep the talent from the acquisitions that you've made? Any color there, please.

Yes, sure. Well, we're incredibly excited to have Olumide join us. We obviously announced that earlier in the quarter. and he's off and running IOS and, really, we're excited to have him join the team. He brings a real view on software. It's really - all his experience is in software. And he created an enormous digital data analytics capability at CoreLogic. So he really brings a data-centric approach to these businesses, which I think is a wonderful part of his leadership style. Obviously, Tami's promotion is a great view on our internal development capability in a window on how we develop internal talent. So we're in a very good place with her promotion. Relative to the next layer down, we announced 2 internal promotions, both of whom came with acquisitions. Justin and Bill both came to us with acquisitions, Justin with ISC, Bill with Gordian. And so the promotions that we announced in the prepared remarks is a good example of how we continue to retain folks from acquisitions and how they are additive to our leadership capabilities. So we have a very rigorous internal development process. We announced several internal President appointments here recently as well to backfill for people like Bill and Justin. And we're in a very good place relative to adding talent. On the health care side, we brought in some new real new talent from a health care standpoint at ASP to really give us - even be additive to our health care experience. So I think we've not only have we been able to retain people through a very rigorous development process, but we've become a destination for talent, and we've certainly been able to recruit some top-notch talent. We mentioned Read Simmons as our Head of Strategy in the second quarter. We've continued to take opportunities to bring in folks who bring new approaches, and we're - we've been very successful in being able to do that.

We have your next question from Joe Giordano with Cowen.

So one of your competitors was talking - one of your competitors to tech was talking about having success in integrating like protocol analyzer capability into their scopes for, like, connected devices, IT. Is that something that you're doing? Or is it something you think is worthwhile? Just curious if that's an offering yet.

Well, I think at the end of the day, we have some protocol capability, but I think it depends on the use of the scope and the range of the scope where that's appropriate. So I would say that our direction has been more rather than adding additional measurement capability to some of the scopes, we've been really adding more solutions focused to really different probes, different software around the application to really help folks. That's where we've been really successful in automotive and in data centers, really bringing forward, call it the post scope work that really helps the engineer in the application - specific application that they're moving forward with.

Okay. And then, Jim, going into - when you guys gave guidance last time, you knew electives - you were appropriately cautious on elective surgery. Supply chain was bad then. I'm just curious, like, what are the big - like, the 1 or 2 single biggest, like, top line variances that will end up being realized versus what you thought last time?

In the third quarter?

Yes, like versus when you gave...

Yes. I mean I think electives certainly were part of it. We thought electives were going to be - we were conservative on electives, but we were - they were lower than we anticipated. So you could probably think about maybe $10 million of revenue that was there - just there. And then certainly, on the - we could have easily hit the upper end of our guide relative to revenue, which is roughly 300 basis points if we hadn't had some of the supply chain constraints that ended up. We always said that September's a big month. And we had several things that hit us in September that we didn't anticipate. So we still manage, as we noted, to have tremendous margins and tremendous free cash flow despite those challenges. And I think that's really - that really speaks to the power of FBS in terms of facing challenges, being able to countermeasure through those things. And this isn't a story of the absence of challenges, but rather the ability to deal with them. And that's what we'll continue to do in the fourth quarter. And you didn't ask it, but I would anticipate that we'll be dealing with a number of the supply chain issues well into 2022.

Can I just clarify one thing? The stuff that you couldn't get out from supply chain. Is that - because you couldn't - I guess, can you break it down between stuff that you were able to manufacture and the customer wasn't worried to take delivery and it's now sitting in inventory? Or it's stuff that you just couldn't get the components on your side to kind of...

No, this is all - oh, it's not getting components. We have - demand picked up tremendously through the quarter. As we said, we had very strong orders and we'll have strong orders through the rest of the year. So our demand profile's very good. Customers are taking things as soon as we can get them to them in most cases. So this is not an inventory situation or anything like that. This is purely a component shortage challenge that we're dealing with as, I think, has been well documented by a lot of other companies.

We have your next question from Andrew Buscaglia with Berenberg.

I just wanted to ask on Advanced Healthcare as well. I mean - It doesn't seem like this will exactly be a snapback situation. You're facing some tough comps into the first half of the year. So I guess the question is where, I guess, FBS, but will we see some margin leverage? Like, I guess, what needs to happen to really see those margins pick up in kind of more muted first half maybe?

Well, I think first, in Q3, we saw some outstanding margin expansion in the 8 - Advanced Healthcare segment going from, I think, around 20% in Q2 to 23% of adjusted operating profit. So we're seeing good margin expansion. And that's not just at ASP. Censis had a really good quarter, so did Fluke Health. So we've got - and our hardware placements there. And so you're seeing that already. What we're saying is it could have been better with - if elective surgeries - and that's going to be a future advantage. But to be clear, we had a good step-up between Q2 and Q3 in Health. And from Q3 to Q4, there's - we expect to do another 100 to 200 basis even with elective surgeries to staying where they're at right now.

Okay. Fair enough. And Chuck, maybe you can comment, I know M&A is definitely on the top of your minds with - given where leverage is. But stocks is kind of getting cheaper here and kind of - I've done a whole lot the last year. What's your - where are your thoughts on a buyback or maybe choosing that as a different avenue for the cash?

We remain very optimistic about the opportunity to deploy capital. We've said that we laid out that we had probably $5 billion in the first 3 years post separation with Vontier. We've done $1.2 billion. It sounds like we're running way behind there. So we think we've got ample opportunity for that. And so we're not changing our priority being M&A.

We have your next question from Steve Tusa with JPMorgan.

Just a question on the AHS margins. I think if we kind of backed into a number last quarter. They were a little bit higher exiting 4Q. I don't know if you did a better job on margins this quarter. Is there anything going on there? Is there a - like, is that elective procedures? And can we think - can we still kind of think about a potentially kind of high 20s margin as we look out into kind of next year?

I think it's - first of all, I think that margins - we expect margins to expand for a number of years in health, as we discussed. Yes, they're lower in Q4, and it's all about elective procedures being around 90% rather than the high 90s. That's somewhere around $12 million to $14 million of 75% to 80% margin business. And so when you do that, that clipped off about 200 basis points of margin expansion, but we're still expanding margins from Q3 to Q4. And we know that soon - that electric procedures are going to come back. So today's headwind there is tomorrow's tailwind. So - but we don't - the destination are going into those high 20s. That's still what we think is very possible. Nothing's changed about that.

Got it. And then just heading into next year, you're exiting at kind of a mid- to - I guess, mid- to highs on organic. I mean, anything about the comps next year that would make that exit rate kind of unreasonable from an organic perspective? Should next year be more in line with your longer-term guidance on mid-singles? Or can you maybe do a little bit better than that given the headwinds you're kind of facing here in 3 and 4Q with the supply constraints?

Well, it's safe to say that we're going to end the year in a backlog position we never had before, Steve. That would certainly suggest some great opportunity for us next year. I'll hold my enthusiasm until we get to the full year guide. But things are setting up pretty well. Orders are very strong. They're going to continue to be good in the fourth. There's a lot of variables out there. Obviously, there's still to be considered, as we play out the rest of the quarter, to give consideration to. But as Chuck just said, relative to how AHS is setting up, we certainly talk about the software businesses, even where we had a little bit less growth at the current, we had good orders. So we think we can continue to build on our net retention. So I think we're certainly setting up for some good things, but let's get through this quarter. I'm pretty focused on the things we got to do right now to deliver October. So - but we'll get there pretty soon. And obviously, I think if it plays out the way we think, we'll certainly have - we'll be in our best backlog position that we've ever been in.

I'm showing no further questions at this time. I will turn the call back over to Mr. Whitney for any closing remarks.

Well, I think I'll take it from Griffin, but thank you, Alexander, and thanks, everyone, for your time tonight. We appreciate it, as always. We benefited from the hard work and determination of our 17,000 employees all around the world. We appreciate all your support, and we look forward to continuing to follow up with any questions you might have around the quarter as we get into the finish of the year. Thanks. Have a great day, and have a great earnings season. Bye-bye.

Ladies and gentlemen, this concludes today's conference call. Thank you for your participation. You may now disconnect.