Fortive Corp (FTV) — Q1 2023 Earnings Call Transcript

Thank you, Brent, 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 measures on today's call. Information required by Regulation G are available on the Investors section of our website 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, 2022. These forward-looking statements speak only as of the date 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.

Thanks, Elena. Hello, everyone, and thank you for joining us. I'll begin on Slide 3. We had a strong start to the year, delivering better-than-expected revenues, margins and earnings in the first quarter. At 9% core growth, we're demonstrating strong execution of our strategy, building leading positions across our customers' critical connected workflows. Our ability to deliver strong growth and continued margin expansion is directly tied to our culture of continuous improvement and dedication to the Fortive Business System. As a result, we expanded adjusted gross and operating margins by 80 and 100 basis points, respectively, taking margins to a first quarter record with expectations for further merger and expansion this year and into the future. Free cash flow in the quarter reflects our normal seasonality as well as the timing of China collections that pushed into April. Overall, our teams have done an excellent job managing working capital in a more challenging supply chain environment, as seen by our outstanding performance in 2022. By harnessing our unique competitive advantages and strong execution capabilities, we are confident in our outlook and are raising and narrowing our full-year 2023 guidance. Turning to Slide 4. I wanted to provide an update on what we're seeing and what we expect over the course of 2023. Starting on the left in the current environment, hardware product orders were better than expected, down mid-single digits and backlog was more resilient with a book-to-bill of 1.0 in the first quarter. Our software businesses continue to see good growth benefiting from strong customer value propositions, driving double-digit growth in our SaaS revenue streams. While industry challenges remained in our Healthcare segment due to China, consumables growth in March reaffirmed recovery is underway. We expect momentum to continue and accelerate growth and profitability throughout 2023. Moving to the right-hand side of the slide, we are seeing traction on our new product launches, favorably aligned to secular drivers including Fluke's latest family of solar tools and Tektronix' leading power and electronic test systems. Together with continued software strength and recovery in healthcare, we expect to sustain core growth in the second half. Combined with favorable pricing, cost savings and discrete productivity initiatives that span all segments, we expect over 75 basis points of margin expansion in the year. Lastly, we expect robust free cash flow growth again in 2023, which together with our very strong balance sheet, gives us confidence that our attractive M&A funnel will provide opportunities to enhance earnings and cash flow compounding in the future. Turning to Slide 5. We want to take a minute to remind you of all the work we've done to transform our portfolio and create focused segment strategies favorably aligned to a number of strong secular trends, has resulted in a more resilient Fortive with enduring growth and further margin expansion opportunities. As a result, today, we have a stronger collection of businesses with a more diversified end market mix and durable recurring revenue profile that includes leading healthcare and software franchises. Together with our enhanced innovation capabilities, we have focused our portfolio around multiyear megatrends, including automation, digitization, the electrification of everything, and improving healthcare trends to name a few, all to reduce the overall cyclicality of our businesses and provide more tailwinds for growth by expanding into new markets. As a result of these megatrends, we see continued growth across our portfolio, including the more durable software and services businesses as well as the nonrecurring portion, given the sizable amount of backlog some of our product businesses are working through, while continuing to see resilient demand. Finally, our portfolio quality is reinforced by the substantial improvements we've made in gross and operating profit, working capital and free cash flow as a percent of revenue, driven by the rigorous application of the Fortive Business System. Turning to Slide 6. FPS is a powerful mindset that makes continuous improvement a way of life at Fortive to drive deep engagement across our teams and hold them accountable for delivering on high expectations. With Kaizen activity accelerating, we saw significant results across the portfolio, including material improvement in delivery and past due backlog reduction in our hardware products businesses by improving planning and reducing part shortages with the Fortive material system. Board of software system deployment in our SaaS companies, including service channel, a current information is accelerating delivery of software features to customers, driving customer value and resulting in higher renewal rates and pricing gains. Our record gross margins in the first quarter were driven by a significant expansion of Kaizen events in the quarter, approximately double the number of the prior year, setting us up for improved performance throughout the year. Turning to Slide 7. Fortive made sustainability a priority since its founding. It is inextricably linked to our company's shared purpose, values, and business strategy, which you'll read more about in our upcoming 2023 sustainability report to be published in May. This year's report will further highlight how our commitment to sustainability is grounded in our culture of Kaizen, leveraging the power of FBS to innovate products and services that enable more sustainable outcomes. We'll also hear how our team has strengthened our responsible sourcing initiatives, ensuring robust review of the labor and given rights practices across our supply chain and how our strong and inclusive culture is creating a community where everyone belongs, which is positively reflected in our latest employee engagement and inclusion, diversity, and equity performance. In summary, we are accelerating progress towards a more sustainable future for Fortive and our customers as well as the environment and the communities in which we operate. We invite you to review our report next month. I'll now provide more details on each of our 3 segments, beginning with Intelligent Operating Solutions on Slide 8. IOS grew core revenue by 10% as our connected workflow strategy drove better-than-expected performance in the quarter. The segment saw good growth in all regions with mid-single-digit growth in North America and Western Europe, and mid-40% growth in China, lapping prior year shutdowns. Solid core growth in each workflow and strong FPS driven execution resulted in 300 basis points of operating margin expansion, taking operating margins consistently above 30%. Looking at our performance drivers by workflow. In Connected Reliability, Fluke core revenues grew by low double digits with mid-single-digit orders growth in the quarter and point of sale remained positive in all regions. Fluke is benefiting from lean portfolio management, driving record revenue attainment and Fluke's new product launches, including the SMFT 1000 solar tester, which are benefiting from strong demand in the energy, renewables, and electric vehicle markets. Elsewhere at Fluke, eMaint achieved another record quarter with strong double-digit growth. We are observing increased customer adoption of the X5 CMMS system, which also led to the largest deal ever with a key enterprise customer. EHS revenues rose by mid-single digits, thanks to solid contributions from both Industrial Scientific and Intellect. Industrial Scientific experienced growth across all product lines, including iNET, and order growth outpaced sales due to new product launches and cross-selling efforts. Intelex continued to show strong SaaS growth with low double-digit ARR growth. In the area of facilities and asset life cycle, we saw high single-digit growth in the first quarter, driven by high single-digit SaaS revenue growth. Customers are increasingly shifting larger projects to Gordian's job order contracting platform, while the wind down of endo-light programs is taking place. Although the shift in the business model and service channel reduced core growth, revenues surpassed expectations as customers look for more productive and digitized solutions to enhance their facilities management. A large worldwide retailer is migrating several manual processes to the real estate management platform at Acron, and a significant enterprise customer is utilizing service channels automation services to save substantial amounts on mismatched invoices. Moving on to Slide 9, Precision Technologies achieved another quarter of strong double-digit core revenue growth, with revenues rising by 14%. This increase was fueled by high single-digit growth in North America, low double-digit growth in Western Europe, and high 30% growth in China. PT also experienced a 190 basis points expansion in adjusted operating margins, as higher volume and effective pricing strategies more than compensated for ongoing inflation and foreign exchange challenges. Notable highlights from the quarter included over 20% core revenue growth at Tektronix. Orders exceeded expectations, driven by an increase in bookings and electric vehicle testing programs. This, along with strong sales across all major regions, led to double-digit growth across its product lines in the first quarter, which continued to experience good demand for the recently launched entry-level and mainstream offerings. Sensing Technologies reported low single-digit growth as expected, driven by another quarter of strong price realization across all businesses and continued broad strength of Ultra. Pacific Scientific EMC reported a second consecutive quarter of greater than 20% growth as the business continued to deploy FBS to improve operational performance. Moving now to Slide 10, in Advanced Healthcare Solutions. Core revenues are flat as the improvement in electric procedure volumes outside of China was offset by some supply chain challenges at Fluke Health Solutions and the expected headwinds in China elected procedures and the wind down in Russia. By major region, North America was up slightly, and Western Europe grew mid-single digits, offsetting a high single-digit decline in China. China elected procedures were covered in March, exiting the month at approximately 90% of normalized levels. Our outlook continues to assume that China electric procedures return to normalized levels in the second half of 2023. In the first quarter, AHS adjusted operating margins declined 260 basis points due to foreign exchange headwinds, supply chain issues at Fluke Health, decreased contribution margins, and higher-than-expected inflation. Some highlights from the quarter include stronger average selling price growth in consumables as we exited March, indicating a recovery after COVID with sales exceeding market performance in most regions. Census experienced double-digit growth, fueled by a strong demand for its products. Censis is also witnessing heightened demand for its AIT productivity platform and is enhancing productivity through the use of FBS tools, which have expedited the process from bookings to revenue. Fluke Health Solutions observed solid demand for equipment orders and dosimetry services, despite ongoing supply chain constraints that delayed equipment shipments. Finally, Provation continued to excel, reporting another quarter of double-digit growth, largely attributed to its Apex SaaS offering. Apex has received strong customer interest, resulting in substantial orders for Q1 and over three times the average revenue uplift from license migrations. Following a strong start to the year, we continue to expect the probations growth will accelerate through 2023 supported by customers looking to further standardize our formation across their health systems. In addition to our remarks on the first quarter performance, we thought it would be helpful to provide more detail on our expectations for the AHS segment for the remainder of this year. The headline is that we expect sequential improvement in both revenue and adjusted operating profit margin as we move through the year. Specifically on revenue, we expect favorable price in addition to the recovery of electric procedures in China, resolution of supply chain challenges at Fluke Health Solutions, and normal healthcare seasonality to drive higher volumes over the course of the year. As a result, we expect core growth will go from low single digits in Q2 to mid-single digits in the second half of the year. On margins, in addition to the uplift from higher volumes and favorable price, we see compounding tailwinds from the benefits of the productivity initiatives taking second half margins to approximately 25%. Go-to-market changes in ASP consumables in North America will improve performance and enable a closer connection to our customers to better serve their needs, transitioning from a primarily distribution model to direct to the customer. All these actions will have carryover benefits in the years to come, positioning us for accelerated growth and profitability as the general healthcare environment continues to improve. With that, I'll pass it over to Chuck, who will provide more color on our first-quarter financials and our 2023 outlook.

Thanks, Jim, and hello, everyone. I will begin on Slide 11 with a quick recap of our first-quarter revenue performance for Fortive. We generated year-over-year core revenue growth of 9%. FX was a 230 basis point headwind to growth. Turning to the geographies. We saw another quarter of strong revenue growth in each of our major regions. North America revenue was up mid-single digits, with growth in all 3 segments. Western Europe revenue grew high single digits with mid-single-digit growth at IOS and AHS and double-digit growth at PT. Asia revenue increased in the 20% range with low 30% growth in China driven by strength in both IOS and PT as we lapped easier prior year comps. Growth in China was partially offset by a high single-digit decline in AHS related to lower electric procedures due to COVID as we expected. Lastly, our high-growth markets together posted strong core growth of almost 20%. Turning to Slide 12. We show operating performance highlights for the first quarter. Adjusted gross margins increased 80 basis points to 58.4%. As Jim mentioned, FBS driven productivity and price realization more than offset inflation, leading to record gross margins in the first quarter, which was complemented by higher volumes. Adjusted operating margins expanded to 100 basis points to 24%, while adjusted earnings per share increased 7% to $0.75, reflecting strong volume conversion, partially offset by higher interest and tax expense. Free cash flow was $150 million. While the first quarter is typically our largest free cash flow quarter, receivables were negatively impacted by slower China collections in the quarter, which has since recovered in AHS. Turning now to the guide on Slide 13. We are raising and narrowing our previous 2023 guidance to reflect outperformance in the first quarter. For the second quarter, we anticipate core revenue growth of 2.5% to 4.5% with an FX headwind of approximately 0.5%. Adjusted operating profit margin is expected to increase 3% to 7% with margins in the range of 24.5% to 25%. Adjusted diluted net earnings per share guidance of $0.78 to $0.82, flat, up 5%, includes higher year-over-year interest and tax expense and free cash flow of approximately $285 million reflects approximately 100% of cash conversion in the quarter. For the full year, we now expect core revenue in the range of 4% to 5.5%, which continues to reflect year-over-year foreign exchange headwind of just under 1 point of revenue. Adjusted operating profit is expected to increase 6% to 10% with margins in the range of 25% to 25.5%. We are increasing our adjusted diluted net EPS guidance to $3.29, $3.40, which represents an increase of 4% to 8% and includes higher year-over-year interest and tax expense, as previously expected. Free cash flow is expected to be approximately $1.25 billion, representing conversion in the range of 100% to 105% of adjusted net income and 21% free cash flow margin. Turning to Slide 14. We've consistently said that Fortive today is delivering a higher and more profitable growth. There is nowhere that this shows up more than in our free cash flow. Between 2019 and today, we have more than doubled our annual free cash flow, and we expect to continue to further enhance our compounding model with over $5 billion of capacity for M&A, enabling us to continue to invest appropriately in our businesses to further position Fortive for long-term value creation. With that, I'll pass it back to Jim to review our upcoming Investor Day and provide some closing comments.

Thanks, Chuck. I'll now start to wrap up on Slide 15. Our team is thrilled to be back in New York for our first in-person Investor Day since 2019 to be held on May 25. We are looking forward to highlighting our progress, executing our strategy and the results that have yielded over the last 7 years, building on our strong foundation and enduring principles that underpin our execution capabilities. We will showcase how our businesses have leveraged FBS tools to innovate, take advantage of the secular tailwinds, and accelerate progress across our 5 critical customer workflows. This has translated into relevant product innovations helping to solve our customers' toughest safety, quality, and productivity challenges and contributing to sustained strong growth for Fortive. In the spirit of setting high expectations, we will set long-term targets. Looking out 3 and 5 years, culminating with the evolution of our strong free cash flow, supporting us ample opportunities to further accelerate our strategy. Wrapping up on Slide 16. The combination of portfolio work we have done and the productivity initiatives we are implementing in the first half of 2023 prepare us for the continuing evolving macro environment and set us up for differentiated performance again in 2024. As you saw in today's press release, we're also continuing to build on our exceptional leadership culture for the Fortive of the future by expanding Tammy Newcombe's responsibilities to include the Advanced Healthcare Solutions segment in addition to our current role as segment leader of Precision Technologies succeeding Pat Murphy, who will retire at the end of the year. As you heard today, FBS is more robust than ever with powerful new capabilities to bring breakthrough innovations to market for our customers faster and drive enhanced business results. The evidence of this is reflected in our strong financial performance, including our free cash flow, the currency we use to measure our success. These factors culminate in the powerful formula for value creation, enabling Fortive to make a real difference in the world and deliver exceptional value to shareholders. With that, I'll turn it back to Elena.

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

Maybe the first one, and sorry to be boring and predictable. But the AHS, you gave us some very good detail on that sequential improvement through the year. I guess a couple of things I just wanted to clarify on it. One was maybe the scale of the productivity savings in the second half? Is it sort of $15 million, $20 million, something like that, that you're getting in the AHS EBIT in the back half? And then just trying to make sure we understand the scale of the importance of China for AHS. Is it about sort of 10% of the business.

So Julian, I'll address the first part. We expect productivity to reach about $10 million in the first half, which typically has a 6-month payback period. Therefore, we can anticipate a similar amount in the second half, and when annualized, it will be somewhat larger.

Yes. And on the China aspect, yes, it's about 8% to 10% of the business overall. And as we said in the prepared remarks, maybe a little bit more color there is that we obviously started pretty low in electives in the first part of the quarter in January has got better through the quarter. We exited in around 90. So we'll see a little bit of continued improvement. I think at this point, it's fair to say we sort of see electives as kind of being back to normal going into the second quarter.

That's helpful. And then just switching back to the overall product hardware orders. You said those were down about mid-single digits in the first quarter. Is there any sort of interesting movement as you go sort of month to month? And any clues on how you're thinking about the second quarter? And if we look at the Precision Tech business specifically, and I suppose, Tektronix in it. You've had cautious comments perhaps from some companies who might be peers in recent weeks, have you seen anything shift in the market outlook for Tektronix or product hardware within PT?

Yes. To begin with, the orders for our product businesses this quarter were better than we anticipated. The book-to-bill ratio exceeded our expectations as well. Throughout the quarter, performance remained consistent. Comparatively, the year-on-year figures appear to improve, largely due to the impact China had on these businesses last year. Examining point of sale, it performed well globally during the quarter at both Fluke and tech. We are encouraged by this strength. Additionally, a significant highlight is that Fluke experienced mid-single-digit growth in orders, which we mentioned in our prepared remarks. This is certainly noteworthy. There was a slight carryover from the second quarter, which has effectively mitigated risks for us. Overall, we are monitoring the situation closely and are optimistic about our order trajectory at present. Furthermore, the two-year growth trends remain very strong, which requires some caution in our outlook. Importantly, the approximately $350 million of excess backlog we discussed at the beginning of the year is still intact. We aimed to emphasize this in our presentation regarding backlog protection. At Fluke Industrial, often seen as a leading indicator, conditions still appear positive, and we continue to uphold the backlog protection that we established at the start of the year.

Just back on AHS. I'd just like to deconstruct a little bit more kind of what happened in the quarter. Obviously, it was a very large margin miss. And then just you address it a little bit to Julian's question, but if you think about the climb out into the back half, how much of that is really in your control? You mentioned favorable price. I assume that's kind of in hand the supply chain questions. I just wonder if you could give us a little comfort or confidence that, that, in fact, is resolved and anything else to just give us some visibility on how we get to those numbers in the back half.

Jeff, I'll take the first part of that. There are 3 main things that happened in health in Q1. You mentioned about Fluke health supply chain, that was a hit. FX strengthening dollar shows up more here in one of our more global businesses. So that was a part of it. And then also just thinking about the mix effect of lower consumables from China as we had COVID really hit maybe a little harder than we thought there in the first part of Q1. Those 3 things are the main reasons we came in short versus our guide for in the health sake.

As we progress through the year, I want to highlight three key factors that we can control. First, productivity is well-managed, as Chuck addressed earlier. Second, we have seen three consecutive quarters of improved pricing, and the positive trend in pricing remains strong. We're committed to leveraging this success, especially in our average selling price. Lastly, we're seeing improved growth, with elective procedures normalizing, and we expect this trend to continue. We are implementing a direct go-to-market strategy at ASP in North America, which will enhance our customer engagement and ensure our sterilizers are actively utilized. I'm confident in our team's efforts, and I foresee improved results in the second quarter and beyond. Additionally, it's important to note the quality of our AHS quarter regarding Census and probation, both of which are high-margin businesses. When combined with the supply chain improvements we've made at Fluke Health, our top-margin segment, these factors will contribute positively. Overall, these elements position us well for continuous improvement throughout the year.

And then totally shifting gears, just PT strategically, right? If I don't know if you're going to end up commenting specifically on NATI, right? But it looks like you were there at or near the alter. You haven't deployed capital there really actually since Danaher bought Tektronix, really, right? And maybe you're on the verge of doing your biggest deal ever by an order of magnitude. So I just wonder if you could frame that up for us what your thinking is or was, and maybe the strategic direction of that particular segment in business over time.

Yes. We have made a few small acquisitions in both sensing and technology over the years, which have contributed significantly to our success. The Keathley acquisition is probably the largest investment we made some time ago, and it has proven to be a major success for us in technology. Since then, we have had a couple of small acquisitions in sensing, but not much else. Regarding the NATI process, we won't provide any comments on that. However, the interest shown by others certainly highlights the narrative we have been sharing at Tektronix. This is evident in the quarterly results and the quality of our backlog. Our innovation capabilities are well-aligned with key trends in automotive, particularly electric vehicles, as well as in power. This alignment supports our organic growth strategy and the investments we've made, especially in technology. Looking ahead, I want to remind everyone that we have transitioned technology from a low single-digit growth rate to a mid-single-digit growth rate, and we feel confident about this shift. We will continue to seek opportunities to enhance our capabilities throughout the company.

Can you discuss the decision behind the management changes? There seems to be a lot of visibility for Tammy, and since there are two quite different businesses involved, is this a permanent solution, or should we anticipate further changes in the future?

Well, I think it's certainly the solution that we feel really good about. I mean I think our talent development process. And if you go back a lot of years, you'd see us ebb and flow a little bit relative to those jobs as well as the jobs below that and Group President and operating company presidents. Our talent development is in, I think, really a good place. Every one of our group presidents was internally promoted. 80% of our current operating company presidents were internally promoted. So I think when we really feel good about the structure, it's not just what we have at the segment level, but it's within those group presidents and operating company presidents, and we've, quite frankly, never been stronger in that regard.

In terms of the portfolio, you have made many changes over the years. Is there a specific area you have been reducing in the portfolio? Are you still considering potential divestitures or spins? I'm particularly thinking about Tektronix, especially in light of the recent developments with Emerson and Nate.

I think we understood what you were saying despite some interruptions. When we assess the three segments we currently have and consider the quality of our businesses and our execution, we feel optimistic. The conclusion of the Nate process with Emerson does not alter the market structure. We are confident in our technology efforts and will continue to pursue strategies we believe are effective. A significant part of our current success stems from the strong execution we have demonstrated at Tektronix over the past few years.

I understand that there's a lot to discuss regarding NATI, but as Greg mentioned, it seems to be quite significant in comparison to your past. Is there a key takeaway regarding your willingness to take on larger risks? Is this a one-time instance? I realize the gross margin structure was appealing. Historically, it seems that you've focused on assets emerging from private equity or divisions of larger firms, rather than pursuing other public companies as a major part of your M&A strategy. Has that perspective shifted at all, Jim and Chuck, or would it be unwise to read too much into this?

I believe we will have a great opportunity to discuss this further at the investor conference in May. Currently, we have about $40 billion in our served market, and when we evaluate potential mergers and acquisitions, we've always emphasized the importance of breadth and depth. Breadth refers to our engagement across all three segments and our capacity to accelerate our strategy, while depth pertains to the various sizes of the deals we consider. We have tended to focus on mid-sized deals, along with some smaller bolt-ons, if you visualize our strategy as a triangle with larger deals at the top, which are fewer in number. I won’t specifically address any particular company or process, but we will consistently be scanning for opportunities to advance our strategy. We will remain disciplined in our approach, seeking high-quality financial opportunities to enhance our portfolio. Our performance in 2022 and our first-quarter results highlight the quality of our strategy. When we refer to breadth and depth, it indicates the wide array of opportunities available. However, many opportunities typically fall within the bolt-on and mid-tier categories due to their higher prevalence. We aim to accelerate our strategy across a few different businesses where these opportunities exist.

Fair enough, Jim. And just to clear something up. What was the Fluke Health supply chain issue? I don't recall hearing an explanation on that.

We believe we have effectively addressed our supply chain challenges. Currently, we are mostly dealing with isolated issues across our portfolio. The increase of 50% in organic revenue this quarter demonstrates the strength of our teamwork at Fortive in managing these issues successfully. We did face a problem with our quality assurance equipment business at Fluke Biomet, where we were short on one component, but we plan to resolve that in the second quarter. Overall, we are pleased with our progress. The supply chain difficulties have mostly been reduced to specific minor issues. Additionally, our overall performance is strong, as evidenced by the 80 basis points of gross margin expansion, which I believe will hold up favorably compared to our peers.

Just a question as I'm sort of looking at the sequential guidance for IOS and PT growth and looking at the comps. Just trying to figure out, it seems there is a step change down. And I apologize if I missed it, but I was just wondering, you also commented that the order book looks good, March looks good. So why this step down? And I was wondering specifically if there was some sort of clearing out of things in the backlog was sort of the golden screw becoming available or is there something else happening? Because you guys certainly don't sound particularly more pessimistic about the macro into the second quarter.

Andrew, I'll take that. The main thing to consider is what happened last year. The comparison is important because Shanghai was shut down at the end of Q1, and much of that revenue came in during Q2. So, if you adjust for that, Q1 and Q2 actually look quite similar compared to our performance this year. When you look at the two-year comparisons, you start to see some acceleration even in the second half. Yes, you're right. We believe we performed better than expected in Q1, and we are optimistic about the future.

Okay. Got you. But you're sort of saying take a look at a 2-year stack as opposed to 1-year stack.

I'm also saying look at the first half this year versus the first half last year, there was a lot of revenue missing in Q1 that showed up in Q2. So it's really a tough comp. But if you look at that, you really see that shutdown that happened in the last week of Q1 of last year is really what explains most of what you're talking about.

Okay. I'll take it offline. But can I just have a question on probation. Did we hear that right that the SaaS version is 3x revenue uplift and how fast is the SaaS conversion going? And what's the SaaS versus license mix?

Yes. You did hear it right, we're at about 3x right now. We would expect the early migrations to be maybe slightly a little bit higher than maybe what the downstream ones. But we're actually ahead of the game on new bookings relative to the SaaS. So that's good. So we're all up, just probation, things are better. We thought '22 was better than expected and we started the year off well. So we are seeing a little bit of extended discussions with customers, I would say. And maybe more broadly, there are certainly in the software world. There's a little bit more funnel activity, things sitting in the funnel a little bit longer just given maybe how typical start of the year, but we still have good confidence in the projections we have for what we have in software. We had a very good ARR quarter, and we feel good more broadly about software in general.

Just going to dig in a little bit on implied second half for PT, especially with the backlog holding up really well here in the first quarter. It looks like volumes would be kind of flat, maybe even down. Now I know the comp gets a little longer there, but just trying to triangulate the book-to-bill still being good with the basically kind of no growth second half.

Yes, it's really about the two-year comparisons. We saw significant growth in PT during the second half of last year. As mentioned, the book-to-bill ratio for the quarter has improved, which may indicate less risk for the second half. We expect to see more growth in PT in absolute terms during the second half, but it's really about the comparisons. We anticipate continued strong performance relative to the market as we move from the first half to the second half.

Got it. That's helpful. And then just on the order intake. Again, I know you're surprised that the book-to-bill was won in the quarter. But any sort of rightsizing of the order book as lead times start to improve a little bit, customers basically just saying, look, I still want everything, but now that it's not as urgent, was there any kind of air pocket pushout that you see as a function of that?

No, I think we've observed that point of sales remain strong. Some of this, particularly at Tektronix, may be due to the backlog decreasing, but we still have an excess backlog which truly reflects customer demand; it's not inventory that's still in high demand from customers. In particular, at tech, we have minimal distributor or channel inventory. Therefore, we feel confident that the demand is genuine and the backlog reflects actual demand. So far, we haven’t seen any significant slowdowns. We continue to monitor the situation closely due to macroeconomic factors, but to date, the demand is solid, and point of sales remain robust on a global scale.

I would like to revisit the idea presented on Page 5 regarding backlog protection, which Julian also mentioned in his question. It seems to me that some of this backlog growth, particularly in areas like Fluke with a short cycle, typically wouldn't show much backlog, but currently, it does. I believe this situation is more temporary, a result of supply chain issues that will likely resolve. How much of the backlog protection do you think is inherently temporary? Or do you believe there's a consistent portion that continues through each year based on how the business operates over a few quarters?

Yes, that's a great question. First, regarding the industrial business and specifically Fluke, we don't have a significant amount of excess backlog. The point-of-sale remains strong, and we're seeing continued effective execution from the Fluke team. The backlog mentioned is primarily related to Tek and sensing. In Tek, we don't expect that excess backlog to reduce this year. Therefore, we may run with excess backlog for an extended period. This situation really reflects the ongoing drivers we've focused the business on. For instance, we're seeing improved performance in Western Europe, largely due to sustainability initiatives, electric vehicles, and grid upgrades. These investments are actively occurring in Europe, and we're capitalizing on those opportunities. We appreciate the durability of the backlog. While some of it is classified as excess, there's also a degree of uncertainty regarding its long-term nature. However, our regular review of the backlog reassures us about its durability and resilience, largely thanks to the ongoing market drivers we highlighted. We believe we are in a stronger position for the year due to the strategic decisions we've made over the past few years in alignment with these market trends.

Great. That was really helpful. And then just as a follow-up, and I might have missed this. Did you comment on carryover pricing benefits and whether you plan any further pricing actions over the near term?

Yes, Deane, this is Chuck. We had about 4.5% price in Q1. Much of that is carryover. But we continue to be active at we still got inflation coming out. So maybe it won't be as high, I would expect that inflation is going to moderate from the rate set increases from last year, but there's still inflation coming out. And so we'll still be deploying price as we go through the year.

We continue to see opportunities with the FBS tools related to pricing. Even with the current price points in the market, we believe there are chances to achieve a higher realization. We'll maintain the strategies Chuck outlined earlier. Health will keep improving pricing, which is encouraging. It's about realization, and historically, we have achieved solid realization. Our aim to apply FBS to enhance this will persist throughout the year, even in scenarios where we might not introduce as much product into the market; we will focus on improving price realization.

So I want to go back to Tammy taken leadership at AHS. Jim, are you looking for a change in the way that HS is management? I have no idea what that means, it's bono question, but if you think about accelerating growth or improving the consistency of the margin performance, supply chain, et cetera, are there things that Tammy can bring to bear from the time running Tektronix that can actually improve AHS.

Yes. I think any time we get a new leadership into a role like that, Nigel, we see a new set of eyes and that always is a good thing. When we hired Olumide a few years ago, I think we got a new set of eyes on IOS, and you're seeing that quality of performance play out in IOS right now. He's brought some new skill sets to the role has done some things over the last year that you've had health that are definitely sticking and Tammy will bring the same thing. That's the expectation. And I think we benefit from sometimes those new perspectives.

Going back to the Nate situation, if you consider what benefits could have come from acquiring that business, are there organic ways to achieve similar results over the long term? You've successfully expanded into various vertical markets, but are there additional strategies you can implement to enhance validation and potentially enter the production phases for your customers? Are there other acquisitions you could pursue?

I would say our strategic thinking around technology has been very focused on the long-term trends. We have shifted our vertical focus, and that has been effective. Some of that has involved innovation efforts, and we would definitely consider adding more if opportunities arise. We remain open to possibilities, but that doesn't alter the factors affecting the external environment. That's why we develop strategic plans each year and adjust our emphasis accordingly. We feel confident about our technology strategy, and we're always looking for bolt-on opportunities in both technology and our other businesses to enhance our market strategies. For instance, we would like to expand in the power sector and would explore any relevant M&A opportunity if it comes up. A previous example is what we did a few years ago, which has greatly enhanced our capabilities in power, and we are now reaping the benefits of that initiative.

Jim, can you elaborate on the regional trends you're observing? You mentioned that you anticipate a slight slowdown in China, but it has remained strong for Fortive. Last quarter, you indicated that Western Europe might experience slower growth, yet you recently referred to some persistent trends in Europe. Are these trends turning out to be more robust than you initially expected? Additionally, do you foresee a prolonged CapEx cycle in the U.S. driven by trends like electrification and onshoring?

Yes. I definitely think China will experience a slowdown. We've had many strong years there, and we recently posted a 30% quarter. That performance will likely hold up well. I believe we will need to absorb some of that growth throughout the year, but I do expect China to slow down a bit in the second half, especially due to the challenging comparisons we discussed regarding the segments. Western Europe appears to be stable for the reasons previously mentioned, while broader Europe has seen a slight slowdown. In light of everything we have in our guidance, I expect Central and Eastern Europe to be a bit slower, partly due to the war and our exit from Russia, but also due to a general slowing trend. However, investment in certain Western European countries has remained robust. I still anticipate that North America will be a strong region for us, largely because our software and many of our resilient products are located there. It might still be too early to make definitive statements, but I expect that by the end of the year, North America will likely be the most resilient of all the regions.

Thank you, Jim. I'd like to ask a question about AHS in a slightly different way. You mentioned that China letter procedures reached 90% in March, showing a faster improvement from the beginning of the quarter, and you also pointed out that consumables improved overall in March. I understand that Invetech remains somewhat weak, which makes for challenging comparisons to the pandemic period. Do you believe that by the second half of 2023 we could see a return to normalcy post-pandemic, whether it's through increased staffing at your customer locations, better consumables for your operations, or changes in the surrounding market?

Yes, we do. We even noticed some positive signs in March, particularly in U.S. consumables, which experienced good growth. We believe that as we enter the second half of the year, things will start to get a bit unusual when comparing to 2019. Our expectation is that conditions will normalize. Labor shortages will still be a challenge. At the beginning of the year, we indicated that we anticipated 2023 would be an improvement over 2022, and 2024 would be better than 2023. This trend seems to be continuing through the year, and our self-help initiatives are also improving, as mentioned earlier. Therefore, I am confident that as the marketplace improves and we start to see the positive effects of our self-help efforts, we will see those benefits materializing in the second quarter and continuing into the latter half of the year.

So on the pie chart that you have for revenue where you have like the backlog protected that Deane was referencing earlier. Just curious like the biggest piece of that is recurring ex software. Just like if we go into a more of a real recession, how recurring is that business in a good time versus how recurring is it in a bad time? Is there slippage as customers get tighter with their wallet?

I believe it stands strong. Firstly, there are a couple of significant components at play. Consumables at ASP is substantial, and we have our EMC businesses involved, which are grounded in long-term contracts. Additionally, broadly defined services should also perform well. We are confident in this, especially considering how well it fared in the first quarter with impressive growth. When you factor in software and even healthcare hardware, we have a considerable portion of our portfolio that we consider highly resilient. Furthermore, about 25% of our nonrecurring hardware is protected by backlog, which gives us more confidence. The ongoing trends across the product segment also serve as a solid safety net. We are following the strategic approach we've discussed numerous times and are prepared for various scenarios. Earlier in the year, we made some restructuring and productivity adjustments, which we've since enhanced. We feel that we are formulating plans based on potential future developments. While predicting the future is challenging, our portfolio has been developed over the years to navigate many of these obstacles, and we believe we are well-equipped to handle them.

Fair enough. And then just to follow up on the discussion about the cyclical businesses. And so like IOS and PT, both came in quarter ahead pretty solidly ahead of what you suggested in your guidance for 1Q and the full year guidance on the growth side are pretty much the same, a little bit bump in one, but pretty much the same. Now how should we think about that? Is it kind of lower view of the second half? Or like you mentioned the backlog is totally high. So just curious how we should interpret that.

Yes. I think the first half doesn't change all that much. Chuck kind of talked about that a little bit. But I think you think about derisking the second half. It's a little bit of derisking. And if things continue to play out as positive as they have, there might be some opportunity. But I think right now, let's see how things play out. But as we said on a 2-year stack, the hardware business, the product businesses do get a little bit better given the tougher comps in the second half. But where we stand today, I think most people would be envious of the start that we had for the year, and we feel good about that.

Thank you, Brent, and thank you all for joining us today. We understand everyone has a busy schedule, and we appreciate your questions and interest. I hope you found our remarks, along with Chuck's and the presentation, informative. We're off to a strong start and feel optimistic. While there are some uncertainties, we believe we are well-prepared to navigate them. We're eager to address any follow-up questions and provide more insights where we can be helpful. We're also looking forward to sharing our long-term story at our upcoming investor conference, which we see as a chance to showcase not only our financial strength but also the effectiveness of our strategy. We had a successful 2022, and we are confident it will help us achieve a strong 2023. We look forward to seeing you soon. Thank you, and take care.