Fortive Corp (FTV) 2022 Q1 法說會逐字稿

Hello. My name is Emma, and I will be your conference facilitator this afternoon. At this time, I would like to welcome everyone to the Fortive Corporation's First Quarter 2022 Earnings Results Conference Call. (Operator Instructions) I would now like to turn the call over to Ms. Elena Rosman, Vice President of Investor Relations. Ms. Rosman, you may begin your conference.

Thank you, Emma, and thank you, everyone, for joining us on today's call. With us today are Jim Lico, our President and Chief Executive Officer; and Chuck McLaughlin, our Senior Vice President and Chief Financial Officer. We present certain non-GAAP financial measures on today's call. Information required by Regulation G 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, 2021. These forward-looking statements speak only as of the date that they are made, and we do not assume any obligation to update any forward-looking statements. With that, I'd like to turn the call over to Jim.

Thanks, Elena. Hello, everyone, and thank you for joining us. I'll begin on Slide 3. I'm extremely proud of how our teams have come together to navigate the continued challenging environment and deliver an outstanding quarter with better-than-expected revenues, earnings and cash flow. Our strong purpose-driven culture supported our relentless focus on executing for customers, shareholders and each other while facing unpredictable obstacles.

Despite these challenges, we saw record orders growth across several of our businesses, reflecting continued demand for our leading connected workflow solutions. Hardware orders grew 14%, adding approximately $130 million to backlog, and our software-enabled businesses grew mid-teens with double-digit growth in both our SaaS and license revenue streams. Through the rigorous application of the Fortive Business System, we continued to deliver improvement across our businesses, driving greater visibility in insurance of supply in the quarter.

Our teams also worked hard to overcome higher inflation, which resulted in 60 and 30 basis points of growth in operating margin expansion, respectively, 11% EPS growth and 36% free cash flow growth in the quarter. Overall, the momentum across all 3 of our segments in the first quarter sets a strong foundation for the year ahead and reinforces our confidence in our full year 2022 outlook.

Turning to Slide 4, I want to provide an update on what we're seeing and what we expect over the remainder of 2022. Starting on the left, in the current environment, strong orders growth was driven by accelerated innovation, continued share gains and leverage to favorable secular drivers spanning all geographies and end markets, yielding an 18% increase in hardware backlog in the quarter. Our continuity of supply is improving, driven by daily management and conversion abeyance, allowing us to ship more product in Q1 than initially planned.

Our China teams did a great job mitigating the intermittent government-mandated COVID lockdowns across the region, starting in Tianjin in January. The Shanghai lockdown at the end of March impacted shipments by approximately $20 million in the quarter, primarily at Tektronix. With operations restarting, we expect to face some bottlenecks in supply chain. However, our teams will be relentless and work to reramp quickly.

Moving to the right-hand side of the slide, we expect sustained core growth driven by normal seasonality, continued strong customer demand and record backlog, which gives us a tailwind for growth again in 2023. Combined with pricing and operational performance, we expect strong margin expansion and another year of double-digit earnings and cash flow growth. As Chuck will cover in more detail shortly, we are updating our outlook to reflect the strong start to the year, raising the low end of our guidance for the year.

Lastly, our ability to convert more earnings to cash underpins our investment thesis and allows us to reinvest in our businesses, accelerate our strategy and enhance our returns to shareholders. In the first quarter, we took the opportunity to buy back approximately 1 million shares totaling $64 million. The M&A pipeline remains full with hardware and software opportunities across each of our segments, and we estimate M&A capacity of approximately $5 billion over the next 3 years.

Moving to Slide 5. Our leading connected workflow solutions facilitate transformation across high-impact fields like workplace safety, facilities management, product development and health care. Our strategies across these segments is incredibly powerful. We serve customers ranging from technicians and facilities managers to engineers, product developers and health care professionals who all work in challenging environments where Fortive technologies provide higher-quality instrumentation, better sensors, superior software and real-time data analytics to empower them to do their jobs more safely and more efficiently.

As you can see, each segment is well positioned to benefit from favorable secular tailwinds and durable business models that underpin our strategy and vision to build a stronger collection of businesses with industry-leading profitability and free cash flow margins.

I'll now provide some details on each of the 3 segments, beginning with Intelligent Operating Solutions on Slide 6. IOS had a terrific start to the year as customer demand for maintenance, uptime assurance, environmental health and safety and facility planning solutions all contributed to double-digit orders growth and strong revenue growth in the quarter. Total revenue was up 15% with core growth of 8.7%. This included approximately mid-teens core growth in North America and high single-digit growth in Western Europe, more than offsetting a low 20% decline in China.

Our FBS countermeasures to improve assurance of supply are making progress, mitigating the effects of the COVID lockdowns and driving better core growth in the quarter. We continue to see solid price realization, which we expect to further benefit performance in the second quarter and the remainder of the year. And while our countermeasures enabled us to ship more product, we also incurred additional costs from elevated freight and logistics expenses. As a result, core operating margins were flat year-over-year despite price/cost being positive on a dollar basis.

IOS adjusted operating margins were 27.2%, down 145 basis points due to the dilutive impact of the ServiceChannel acquisition. As a reminder, ServiceChannel's margins are ramping nicely in line with expectations, and IOS core margins are up over 200 basis points on a 2-year stack basis.

Some other highlights in the quarter include: record revenue and bookings at Fluke supported by strong point of sale, particularly in the U.S., where point of sales grew mid-teens. Industrial Scientific continues to make progress diversifying its business with 9 out of the 10 largest Q1 deals booked with new customers outside of oil and gas. Intelex has also seen strong demand for its SaaS solutions, continuing to grow at a healthy double-digit pace. And likewise, we saw record core growth in facilities and asset life cycle management in the quarter, where Accruent had a solid start with mid-single-digit growth and is on track for sales acceleration in the second half.

Gordian generated strong double-digit growth and secured a large data win with the U.S. Army Corps of Engineers. Further, ServiceChannel had a strong double-digit revenue growth and record bookings in the quarter as customers continued to outsource their facilities maintenance work.

Turning now to Slide 7 in Precision Technologies. We saw record customer demand driving double-digit order growth across major geographies and a broad set of end markets, including HVAC, aerospace and defense, automotive and electric vehicles and semiconductors. PT revenues grew 3.4% with core revenue growth of 4.6%. High single-digit growth in North America and Western Europe was partially offset by a low double-digit decline in China, driven by COVID-related lockdowns in Shanghai at the end of the quarter.

As a reminder, Tektronix operates a major manufacturing facility in Shanghai, which shut down the last week of March. The impact was approximately $15 million of PT revenues or 350 basis points of growth, which also impacted their margin performance in the quarter. That said, PT operating margins expanded 30 basis points, reflecting over 50 basis points of gross margin expansion, partially offset by continued investments in new product development.

Some highlights in the quarter include: successful new product launches driving incredibly strong order growth at Tektronix, including the refresh of the 5 Series in the first quarter, which is tracking solidly above plan; Sensing also saw low double-digit top line growth, reflecting solid share gains across its key markets and had over 100 basis points of operating margin expansion in the quarter, staying well ahead of inflation.

Moving now to Slide 8 in Advanced Healthcare Solutions. AHS continues to accelerate innovation and digitization in hospitals and ASCs. With custom and clinically superior workflow solutions, AHS is well positioned for a multiyear recovery in health care. Revenue increased 8.5% in the first quarter with core revenue growth of 0.6%. Mid-single-digit growth in North America was largely offset by a low single-digit decline in China due to the impact of COVID restrictions on ASP and a high single-digit decline in Western Europe as expected. AHS operating profit margins benefited from FBS-enabled productivity initiatives, driving core margin expansion at ASP as well as the accretive benefit of the Provation acquisition, partially offset by lower volumes at Invetech.

Some highlights for the quarter include: elective procedures in North America were roughly in line with expectations in the first quarter. As a reminder, we expect electives to continue to improve and average 88% of pre-COVID levels for the year. We saw approximately 20% growth in the CensiTrac SaaS offering at Censis, an approximate doubling of subscription orders in the quarter; and Provation secured several significant orders in the first quarter, including 4 competitive GI wins and a large 20 hospital network win for its eye procedures anesthesia solution.

Execution in an otherwise challenging and uncertain environment is 1 example of how FBS continues to be an important differentiator for Fortive. As shown on Slide 9, FBS enabled our businesses to enhance supply chain resilience, drive innovation and profitable growth across the portfolio and build skills and capabilities in our leaders to effectively deliver on our commitments in the quarter. Examples include: an improvement in unit output and reduction in supply chain risk at Fluke through the use of daily digital management, allowing them to outperform in the quarter; the execution of lean portfolio management at Tektronix, driving several new customer-driven product launches in the coming quarters; value pricing and price leakage tools driving strong price realization at CensiTrac; substantial margin expansion at ASP from broad cost reduction and spend, more than offsetting lower consumable volumes in the quarter.

Daily management and problem solving drove an improvement in working capital turns at port of China. And several examples of our progress in our software businesses, including incremental growth realization at Accruent from improved uplift on renewals, a 20% improvement in time to first revenue for procurement customers at Gordian and an acceleration of growth opportunities at Provation. As you heard me say before, I'm incredibly proud of the work we've done continuing our progress towards building a more sustainable future, as you can see on Slide 10. Fortive's commitment to sustainability started on day 1 when we developed aspirational and actionable targets and subsequently invest significant time, energy and talent to establish a performance-driven program. This time line reflects the evolution of our program and commitments we have made since 2016.

In early June, we will publish our fifth Sustainability Report, reflecting consistency and progressing levels of transparency, including adherence to the GRI Reporting Framework and completing our first CDP Climate Change Disclosure in 2020, adding the FASB reporting standard to enhance our climate-related disclosure to investors in 2021 and new in 2022, we will provide our first UN Global Compact Statement of Progress to define our status and plans for TCFD-aligned disclosure and offer initial Scope 3 emissions data and Scope 2 market-based emissions in our CDP Climate Change Disclosure.

It is our shared purpose that also pushes us to create innovative and sustainable products and services for our customers, trying to solve some of the world's biggest sustainability challenges. For example, Intelex's leading software solutions for EHS and sustainability managers, serves leading Fortune 500 companies across multiple industries. In fact, our EHS and sustainability teams use the Intelex application to manage and drive continuous improvement of our greenhouse gas emissions accounting in accordance with the GHG protocol. And Fluke's diverse range of products provide solutions in advanced workplace health and safety as well as optimization of renewable energy installations for our customers.

Consistent with our culture, we are driving incremental improvements in sustainability, and we look forward to continued progress in the years to come. With that, I'll pass it over to Chuck, who will provide more color on our first quarter financials and our second quarter and full year 2022 outlook.

Thanks, Jim, and hello, everyone. I will begin on Slide 11 with a quick recap of our first quarter performance. We generated year-over-year total revenue growth of 9.3%, core growth of 5.3%. Acquisitions, net of FX, were as expected, contributing 4 points to total growth. Turning to the right side of the slide. Jim covered the segment highlights earlier and I wanted to provide some additional color on the regions. North America revenue was up high single digits, including low teens growth in software and related services, partially offset by lower consumable volumes at ASP. Western Europe revenues grew mid-single digits, more than offsetting year-over-year declines in Advanced Healthcare Solutions, driven by a difficult COVID-related compare at Invetech. That said, we had good growth at ASP despite capital installed delays in the region.

We had low double-digit growth in Asia outside of China, while China revenues declined low teens, driven by the impact of the COVID-related lockdowns. Note that we continued to build backlog in China with high teens order growth in the first quarter, thus reinforcing our outlook for double-digit revenue growth for the remainder of the year.

On Slide 12, we show operating performance highlights for the first quarter. Adjusted gross margins were 57.6%, increasing by 60 basis points year-over-year, while adjusted operating margins increased to 23%, in line with our guidance. We realized over 300 basis points of price in the quarter, more than offsetting inflation, yielding 30 basis points of core operating margin expansion and 250 basis points on a 2-year stack. Adjusted earnings per share increased 11% to $0.70, while free cash flow generation of $196 million represented a stronger-than-normal conversion of adjusted net income in the first quarter. The strong free cash flow performance included an improvement in the timing of receivables collections, representing a normalization of the trends we saw in the fourth quarter.

Turning now to the guide on Slide 13 and starting with the second quarter. We expect low to mid-single-digit core revenue growth, which includes a headwind of approximately $40 million from the COVID-related government shutdowns in Shanghai, which we expect to subside in mid-May. Adjusted operating profit margins are expected to be up at least 80 basis points year-over-year. Adjusted earnings per share of $0.70 to $0.73 assumes a 15% tax rate in the quarter, and free cash flow conversion of adjusted net income is expected to increase to approximately 100%.

For the full year 2022, we are raising the low end of our revenue guidance by $40 million to reflect the strong start to our year. We continue to expect adjusted operating profit margins for the full year to be up over 100 basis points. Adjusted EPS is now in the range of $3.04 to $3.13, up 11% to 14% and free cash flow conversion of approximately 105% for the full year.

Moving to Slide 14. We are expecting a 48-52 split of revenue first half to second half, which represents a step-up of approximately $255 million of revenue and includes favorable price and FX first half to second half, in addition to higher volumes, supported by a robust backlog position and the work we've done to mitigate supply chain constraints across our portfolio. We also expect to recover lost China volumes as a result of the government-mandated lockdowns in the first half, shifting more revenue to the second half. Incremental margins on sequential volume are expected to flow through at attractive levels, contributing to strong margin performance in the second half.

In summary, our portfolio continues to show the benefits of the actions we have taken to build a more durable growth company with high recurring revenue profile, mitigating the risk of slowing demand in the second half. With that, I'll pass it back to Jim for some closing remarks.

Thanks, Chuck. I'll now start to wrap up on Slide 15. Over the last 6 years, we have articulated a portfolio strategy to build a more resilient, less cyclical business, capable of outperforming in even the most difficult of times. The Fortive portfolio today is a reflection of how well we've executed that playbook. Our acquisitions have added approximately $2.3 billion of revenue to Fortive as of 2022, which is expected to grow low double digits this year. And in doing so, we've doubled the through-cycle core growth of the company versus the time of the spin-off from Danaher in 2016.

We have also more than doubled recurring revenue as a percentage of our total revenue to approximately 40% and built a portfolio of software-enabled workflow solutions, which is approaching $1 billion of revenue and continues to enhance our long-term competitive advantage. In addition, the businesses we have added to Fortive have been an important contributor to the more than 1,000 basis points of gross margin expansion that we have driven since 2016. In short, the Fortive of today is delivering higher and more profitable growth, and there's nowhere that this shows up more than in our free cash flow.

Lastly, on Slide 16, that strong free cash flow, which has nearly doubled since 2019, continues to be a hallmark of our investment thesis, compounding faster than revenue and earnings and allowing us to accelerate growth and compound returns through disciplined capital deployment. 2022 is off to a great start as the outperformance in Q1 reinforces our focus on sustained growth and execution. Leveraging the power of FBS, which will always be a part of who we are and how we do what we do, we expect another year of double-digit earnings and free cash flow growth, on track to deliver on the multiyear targets set last year with differentiated growth and profitability amongst our industry peers.

As a result, we're confident the work we do to create long-term sustainable competitive advantages for our operating companies and strategic segments will yield best-in-class returns for Fortive for a long time to come. With that, I'll turn it back to Elena.

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

(Operator Instructions)

Your first question today comes from the line of Steve Tusa with JPMorgan.

So within kind of the businesses that are most exposed to China, what are you seeing there in kind of the -- just the ground-level economy, not necessarily like the shutdown dynamic, but what are you seeing outside of the shutdowns? And what does your kind of order pace and backlog look like over there?

Yes, Steve, it's Jim. First of all, I think commercially, we think the business was -- had a very good quarter. Orders were up double digit in the quarter. And despite the shutdowns that started in various cities at the beginning of the quarter, we really didn't see a lot of impact relative to our commercial activity. Point-of-sale is still good throughout the quarter.

So from a commercial perspective, we pivoted, like as an example, when we had to have folks work from home, we did that in 2020 so that was an easy process. So the real impact was really just to the manufacturing facility in Shanghai that we described in the prepared remarks and was really not really a commercial issue relative to commercial activity, really just a function of the fact that our factory -- the Tek factory and as well as our Industrial Scientific factory were shut down and our logistics providers were shut down as well.

Right. And I guess if -- can you maybe talk about, have you guys done any analysis around what -- if we went into kind of a mild global recession, what would be kind of the algorithm for you guys? What you think your core would do, how you would defend earnings? I mean, I think there's obviously a lot of concern around recession out there. You guys get bucketed in this kind of short-cycle industrial camp for some reason. Maybe talk about what you would kind of -- any leverage you could pull to mitigate the cyclicality that's inherent in the business.

Yes. Well, I think number one, in the short run, given our backlog position, we would be in very good shape. As an example, if we saw the sort of slowdown that some businesses saw in '19, we would weather that storm with the backlog without an issue. We would just dip into the backlog more than we anticipate in this guide. So in that sense, we've got much more of an insurance policy going into the second half.

More broadly, as you remember, I think, even when we see something more dramatic, like we did in Q2 of 2020, our -- we had outstanding free cash flow then. We had obviously protected our gross margins extremely well. And with a high gross margin number, we can flex expenses pretty well in the medium term, which we demonstrated in '20. So I think those are some of the levers.

And then the last thing would just be, we'd lean on the 40% of recurring revenue in the health care side of the business, which we're going to be in a health care resurgence here, I think, because of COVID. And it's really not going to be economically impacted. It's really going to be all the things we've described and I'm sure we'll talk a little bit more about. So I think we certainly don't want the recession in any way, shape or form, but I think we've built the portfolio for the last 5 or 6 years, with anticipation that inevitably something like that might happen. And we'd be far more resilient relative to our business model in which we'd be able to handle a situation like that.

Your next question comes from the line of Julian Mitchell with Barclays.

Maybe just a first question, trying to drill into the adjusted operating margins. So I guess looking sequentially, revenues were flattish in Q1. You had a big margin dip sequentially. You're assuming a pickup sequentially in Q2, even with the China headwind getting worse. Or looking at it year-on-year, you're looking for a bigger acceleration year-on-year in Q2 than Q1, again, even with that China headwind. So maybe help me understand the sort of the confidence on margins, particularly as I think you only came in, in line with the initial guide for Q1.

Yes. So Julian, a couple of things. First is, while revenues were flat from Q4 to Q1, but really there was -- we've brought on ServiceChannel that didn't have the same -- I'm sorry, Provation, I mean, into that mix. But when you look at Q1 to Q2, I think that there's merits and things that come in but Q2's margins are up 80 basis points over the prior year and really showing those 40% incrementals in Q2.

And then as we move through the year, we see more revenue coming through, not even having it come through, probably around 50% incremental margins on the step-up in volume, plus things like ServiceChannel and margins will increase as we go through the year and also probably get a little bit more consumables. We expect to have more consumables in the second half. All these things build towards that margin expansion. Having said that, a tough environment, 23% in line operating profit margins for Q1. It's up 30 basis points, and given everything that went on, we feel very good about where -- the start to the year.

And then just wanted to discuss sort of how you're thinking about your orders in the current quarter. I think you called out, Jim, hardware orders overall at Fortive are up 14% in Q1, even including strength in China there. So wonder how you're thinking about the resilience of that order intake in the current quarter and whether you've seen anything change, for example, in terms of European demand yet.

What's interesting, Julian, is European orders were good. We -- I would say -- so I think as we look around the world, and I'll stick to the order question, obviously, continued improvement in orders. I like the fact that when we look at things like U.S. POS for Fluke and Tek as an example, that those numbers were in line with POS, so our order growth was pretty close to our sales out. So I think we feel very good about the durability of the order pattern at this point.

The numbers are slow on a real basis simply in the second half simply because of the 2-year stack and things like that. But I think if you look at the progression of strength, it remains there. We saw a little bit of advanced buying at Fluke for some -- ahead of a price increase. So there's a little bit of that but that's all inherent in our guide. And I think we built, as we said, $130 million in backlog. So I think what you're really looking at is the durability is good. Some of the order strength in Sensing was advanced ordering for the second half. We saw some large customers who put in their orders for the second half.

So I think we have a good sense of what's advanced ordering and what's really real-time demand and we base that against a number of the things that we're looking at. Channel inventories are in pretty good shape, a little bit of elevation but not anything that we would be alarmed, certainly within the band of what they'd typically be at. So I think on balance, when we look at the hardware businesses, we're certainly looking for signs of things that might suggest a slowdown or anything like that. I think thus far, we've yet to see that, and feel good about the backlog situation that we're in and our ability to sort of deliver on that.

So if the order rate were to go down as an example, like I said on Steve's question, if the order rate were to go down in the second half, then we would just dip into the backlog, which in the current guidance, we're not planning to do much of.

Your next question comes from the line of Andrew Obin with Bank of America.

Just looking at the Slide 14, you seem to be embedding high throughput in volumes, just shipping more hardware. And looking at the progress from Q4 to Q1, can you just talk about some tangible steps that enables you to achieve this, that you could share on this? Is it just more supply chain clearing or the countermeasures that you are taking, but just maybe dig in a little bit more as to what is allowing you to sort of actually finally get the volume out of the system?

Yes. So thanks, Andrew. I think number 1 is what we saw in the quarter were some nice examples of getting after a number of the things relative to some of the supply chain constraints that we've described, obviously, for a few quarters here. And to be just consistent with what I've said pretty much for the last 9 months, we really never anticipated the supply chain issues would go away in 2022. What we anticipated and I think what we saw in the quarter, and we'll continue to see is the impact of our countermeasures.

And so you saw that at Fluke with their growth rate as one example. Certainly, Sensing, Tek's performance in the quarter, which was outstanding, both on the top line and bottom line is another good example of that. And quite frankly, we would have seen more of that at Tektronix if it hadn't been for the shutdown in Shanghai in the last week. So a number of examples of progress in the quarter relative to those challenges. So not from a lack of challenges but just the power of FBS to countermeasure those challenges. We'll continue to see that as the year progresses.

As you mentioned, the -- what -- some of the things that will provide that volume in the second half, some of that is just kind of normal seasonality. We just tend to see things go out a little bit more in the second half. Some of that is U.S. government buying in the third quarter. Some of it is year-end stuff. So some of it is inherent in that. We're going to see consumables get better as elective procedures get better. We'll see ACV growth continue to sequentially improve in our software businesses. And then as I described, we'll see some continued improvement at Fluke, Tek and at Sensing Tech, which I think we demonstrated in the first quarter, and we'll continue to demonstrate through the remaining part of the year and into '23.

And then just a follow-up question and perhaps it's a conjecture on our part, but we would have thought that Tek has the most advanced chips and, once again, a conjecture, but probably the tougher supply chain situation. So what gives you the confidence you'll be able to catch up on the $60 million of volume that was shifted out of the first half into the second half?

Yes, sure. I think number 1 is, if we look at Tek's performance in the quarter, you never like to say if China hadn't happened. But the reality is we had an unanticipated shutdown of a manufacturing facility in the last week of the quarter. If we ship some of that volume, roughly $15 million, you're into a good growth rate for Tek. And I think that just represents the progress we're making.

But you're right, a sophisticated supply chain, for sure. We've got good partnerships with a number of large-scale semiconductor manufacturers who supply us a number of key components. We're redesigning some things that are going to occur in the second and third quarters. So I think we look at the tangible actions that are in place, the progress that we've made thus far and the confidence in that progress going forward. So those are really -- and this is not in a theoretical level. This is really -- we talked about the conversion abeyance and some of the daily digital management as part of FBS. This is literally walking into those abeyance and having a sense for the actions, pressure testing them like we would under any kind of operating review that we do every month.

And really what comes out of that is a higher degree of confidence as we progress through the year. Chuck and I were with the Tek team down at Beaverton a few weeks ago. I guess it was more than that now and literally walking through the factory and seeing the actions and what the team is doing and that's where that confidence comes from.

Your next question comes from the line of Nigel Coe with Wolfe Research.

By the way, I love the new format of the slides. It's so much easier to read, much more informative. So just thinking about the Accruent and Gordian performance. Double digits, I think, maybe mid-teens in 1Q. And I want to make sure I heard this right. Accruent grew mid-single digits, which I think is the first quarter of growth in some time. And so number one, just maybe talk about that transition back to growth at Accruent. And then looking into 2Q, you guided to mid-single-digit growth from Accruent and Gordian. That's a decel from 1Q. Just wondering what you're seeing there.

Yes. I think we have a -- first of all, we had good quarters in both businesses. I think we're -- we mentioned in the fourth quarter call about we were starting to see traction with some of the countermeasures and actions that were happening in the current -- I think we've just seen -- we continue to see those things. It's a consistent message from what we said in our last call. Olumide is doing a really great job with him and the team, I think, in making progress. And so that's, I'd say that's a multi-quarter continued improvement, but we're starting to see the green shoots of their efforts. And obviously, you see that in the quarter.

Gordian had a fabulous quarter across many, many ways. Their solution was up over 20%, I think. So just a very good quarter and really across their product line. That's just, I think, just a continued strength of that business that we've seen for some time. And the combination of those 2 businesses is really performing well right now. As you know, we've moved some product lines between businesses. So it will slow a little bit in the second quarter because of a comp that we had at Gordian last year, where they had some finishing of contracts that -- in their job order contracting that was some upside in the second quarter last year. But in the base business and kind of on a 2-year stack, we're seeing good performance Q1 to Q2 sequentially with a comment in those businesses, for sure.

Great. And then just on price. I think you -- the Q called out 3.2% price in the quarter. Can you just remind us what your expectations are for the full year, and how that shakes out between first half versus second half?

Well, I think we had about -- I think we have roughly about 300 basis points of price, if I remember, in the quarter, I think if I remember that number right. And I think it was -- we had good price across the board. We'll probably see a part of -- you obviously saw it in the bridge, there's, I think, $20 million more in price in the bridge first half to second half. So you're going to see a little bit more price in the bridge.

So I think on balance, we're continuing to see good traction with price and a good balance between price and volume as well. So I think we're certainly getting price and price/cost. I think the idea that we grew gross margins by 60 basis points in the quarter, I don't know a lot of companies that grew gross margins in this environment. And for us to grow gross margins in the quarter, I think, is just a real testament to the high-quality work we mentioned on the slide, the price realization work and the price Kaizen that we do, really continuing to demonstrate our ability to get price, but also quite frankly, our ability to still maintain and deliver value to customers.

And Nigel, I didn't answer your second question. So the second part of that question, which is that will improve, as I said, $20 million in the second half. We would believe that there's -- and that just demonstrates, I think, the continued success that we would have relative to those Kaizens. So we're going to continue to do a lot of those events through the remaining part of the year, not assuming that inflation does anything but either stay the same or maybe even get worse. We want to be ahead of the game and proactive on the price game.

Your next question comes from the line of Deane Dray with RBC.

First question, just to clarify the expectation or how you land on that $40 million impact from China. Is that a bottom-up analysis of the front log, customer discussions and so forth? Or is it kind of a top-down swag on a percent of the business that you'd be expecting?

So Deane, it's really not a customer issue at all. As we mentioned, we've got a really strong backlog. It's just about the rolling lockdowns in Shanghai, particularly in having the factory open and being able to produce that. We've done a great job of getting material in and available and improving supply chains. But we need those lockdowns to end and it's a function of how many days of lockdown. That's how we're calculating the impact.

And customer-specific orders, to your question around details, Deane, this is not -- this is really looking at orders that are on hand on the books. In some cases, products that are already sitting in the factory and just need to go out.

Understood. Is there -- if you think about potential sales that could not be realized in the second quarter, you've quantified China. Are there any other, either areas, regions or product lines that -- of sales that will be either past due, you just can't ship, component shortages or is it all China?

Well, I think the story of -- certainly, the story we talked about is the China story. Certainly, inherent in the way we've talked about our backlog is that we continue to have a very robust backlog. But of course, that means the customers aren't always getting the product in the time frame that they necessarily want them. In some cases where it's distribution, that might be going into the distributor inventory. I think the stat we look at in that case is we look at the amount of time to fill, meaning what is our -- if we're missing an order from an on-time perspective, how much time does it take for us to fill it on to the time that the customer requested?

And those numbers are getting better. So I think first thing we look at is that time to fill. After that, then we look at the on-time deliveries. So with those numbers starting to get better. We're in customer conversations all the time in situations. So throughout those conversations around backlog, we're having conversations with customers about are we -- how do we help them be more successful? And I think what's been good about that is I think we continue to see share gain opportunities and have seen share gains across the portfolio in a number of those cases. So I think that suggests that we're doing a nice job of managing those challenges.

That's helpful. And then just as a follow-up on the commentary about M&A and the capacity. You said you've got both hardware, software candidates there. Do you have a bias between the 2? Is there a bias on deal size? And then lastly, what inning do you think Fortive is in, in terms of the portfolio pivot that has started a couple of years ago? Because if you go back 2016, you had a set of businesses and it's been dramatically changed in terms of higher gross margin, higher recurring revenues, more software.

If we think of that as a journey, at what point -- what inning do you think you're in today? And when would you see that there'd be a stabilization or maybe a landing point? I know there'll be continuous tweaking from there but just some context would be helpful.

Yes. Great question. I think number one, we don't -- I think what -- our bias is a balance, and I think we're going to be deal dependent in the sense of what comes available. It's hard to say with -- relative to the funnel, hardware, software balancing act versus what becomes available, what we've been working towards and that kind of thing. So I would say at any point in time, it's going to look like we have a bias. But I think over a longer period of time, you see that balance coming out. So I'll stay away from committing to that balance because some of it is very much asset-dependent.

I think probably a bias more towards bolt-on kinds of deals right now, I would say. I think given where -- we just did 2 great deals in Provation and ServiceChannel. If we missed that in the prepared remarks, they're out of the gate and out doing really well. And we certainly see an opportunity to do a number of kinds of deals, the breadth and depth of the funnel. But if you have to sort of think about, there's probably a slight bias for a bolt-on or 2 here in the near term at least.

Relative to the transformation, I think it's interesting, and Chuck and I have talked a lot about this with -- if you look at the segment structure today, we're only 12 months into that segment structure. And I think when you look at it and you look at the power of what the segments have delivered this quarter, I think you could only look at that and say, we must be in the final innings of a transformation because the performance is so strong across the board, and the opportunity is so great with $40 billion worth of served market.

So you never say never. That's why we do strategic plans every year. That's why we sit down with the Board on a regular basis to talk about performance. But I think where we stand right now, we feel very good about where we're at. And it's spring so we're always optimistic as baseball fans. But I think at the end of the day, we feel really good about the portfolio right now. And I think if you look at the guide for the remaining part of the year and you start to see how the full year stacks up segment to segment, strong growth, strong margin expansion with great free cash flow performance. I mean, all 3 segments are going to be strong contributors to Fortive.

Your next question comes from the line of Scott Davis with Melius Research.

I was interested in just getting an update on Provation. I mean, where are you versus kind of the deal model? I mean, it's pretty big growth rates but you're expecting good growth rates. Are we ahead of the deal model or in line, behind? An update there would be helpful.

Yes. We did a 100-day plan with the team actually last week and could not have been more excited about the work that they did, the quality of the business and the degree of growth opportunities. They're certainly out of the gate, well ahead. We'll see where they end up in the year. It's still early but we feel really good about where the business is at. We mentioned in the prepared remarks about the number of GI wins and as well as their extension, one of the largest orders in the history of the company with -- in anesthesia solutions.

So we're seeing those additional strategies. We're seeing the strength of the clinical superiority. We feel really good about the business and the ability for that business to grow, I think in the short run, like we thought. In the long run, I'm starting to think maybe even better, just given the number -- the strength of the strategic plan, but strategies are just PowerPoint slides. You've got to go out and execute and I like our chances with the team we have.

Okay. And then on Slide 4, there's a little quote there that just says M&A returns nearly double the next 5 years. What's the context on that? You mean deals done in the last year double in the next 5 years, done in the last 5? Is there a little color you can put on that? And what does that mean, double from 5 to 10 or 4 to 8 or 3 to 6?

So Scott, we're talking about the ROIC returns. And I think that for -- it would be doubling -- say, 4 to 8 is probably a good way to think about that. That doesn't mean -- we think most of our deals are getting to the 10% ROIC in 5 years and we're very pleased with the progress. But coming out with the last couple of years, we feel like we're inflecting here and we're going to start seeing more from these deals and that's what we're trying to talking about.

I think what we saw in the quarter and what you'll see, maybe just to add on to Chuck's spot on here, I think the legacy deals, the ones we did earlier, we made in ISC and Landauer are doing outstanding, some of that medium-term. You're starting to see Gordian's trajectory just take off here. Intelex had a strong quarter. Accruent, as I mentioned in the question around -- continuing to improve. And ASP with really strong margins and ready for consumables to come back as health care changes and certainly, the last 2 deals we've done as I described.

So I think we're in a great place relative to returns. And this inflection is obviously we're excited about. I think we put a lot of hard work into it. I think we're in a really good place relative to -- it doesn't mean we won't have an issue or 2. But I think what we've seen certainly in the last several quarters as well as these inflections have started to happen in the business.

Your next question comes from the line of Jeff Sprague with Vertical Research.

Two from me. Just first on -- back on price/cost. Jim, you noted IOS was price/cost on a positive on a dollar basis. Was that true for the other segments? And also if you could maybe put it in the context of margins, as you noted, gross margins did improve nicely. Would that -- was that in spite of negative friction on price/cost, right? You can be positive on dollars and still negative on margins, kind of the essence of the question.

Jeff, this is Chuck. For Q1, our core operating margin expansion is up 30 basis points. So as a percentage basis, we talked about the dollars being up, but certainly, we saw real margin expansion. We continue to see that accelerate as we go through the year. And so that -- it was true for everyone. It's true in PT but we were down a little bit in AHS, down, I think, about 40 basis points, that's on the slide deck, noncore.

Okay. And then on AHS, I think you gave us the 88% recovery on procedures for the year. What was it actually in Q1? And what's the magnitude of improvement you're expecting in Q2?

So 85% was Q2 -- or Q1, excuse me. And obviously, that got progressively better through the quarter. So I think we're probably in a couple of basis points better in the second quarter and then, obviously, probably starts to approach 90% as we get through the second half of the year. So still early. Omicron was an influence in January and February, particularly in the U.S. But we expect now to really to see gradual improvement.

And we're seeing some green shoots. We're starting to see some hospitals that are now over 100% from their 2019 level. So it's a combination of sort of confidence gets built on the overall number but also kind of looking through the detail to understand what hospital networks and where they're at. And we're starting to see some of those numbers where hospitals are getting in much better shape as they progress through the quarter.

Your next question comes from the line of Andy Kaplowitz with Citigroup.

Jim, you mentioned the new 5 Series in Tektronix, and you've been talking about a significant product refresh, I think, in Tek and Fluke for some time now. So maybe you can give us a little more perspective on how much new product growth should help you in '22. How might this new product cycle compared to previous cycles you've had? And then I think you said last quarter that you expect minimal backlog reduction in Fluke and Tek for the year. Is that still the case?

Yes. So let's break them up. I think Tek certainly has a refresh coming in a couple of product lines. We mentioned the 5 Series. I don't want to ruin their announcements here, but we'll start to see in the second and third quarter some announcements around things that they're coming out with. So we'll -- inherent in that sort of step up in -- from the first half to the second half probably is some new product introductions at Tektronix. It's hard to sort of say what the backlog reduction, what's new product demand set, to sort of put those.

But we will see good product refresh. Some of that refreshing, quite frankly, comes with some changes in chips as we were doing some things relative to component changes and so decided to make some improvements in the product as well. So I think at Tek, we're going to see nice -- we don't anticipate much by way of backlog reduction in Tek in the year consistent with what we've been saying before. But I think the business is going to be in very good shape.

We said as we said, the China situation is very much an independent situation relative to just Shanghai. Overall growth in the rest of the world was very -- was good and should continue to improve through the year. Relative to Fluke, Fluke's kind of always a little bit of a -- has a pretty broad product line. So there's really no 1 product that necessarily moves the needle, but they will -- they do have some things that are going on in terms of new clamps and some acoustic imaging and things like that, that are coming through that will probably be more back half.

But online Tek where 1 product category can make a difference, typically, at Fluke, it takes us -- that is -- they just have a broader product line, it's the nature of the business. But we do -- we will get a little bit of backlog reduction at Fluke this year, I suspect, but again, they'll end the year as well in a good position for '23. So both businesses showed -- demonstrated success against their countermeasures relative to challenges in the quarter and inherent in what we think about the year, will be the continued -- those continued countermeasures will continue to have impact for the business.

And then, Jim, maybe just talking a little bit more about the M&A market, you obviously have a ton of capacity. You mentioned the big pipeline of opportunities. Have summers past come down yet a bit, given lower market valuations? Or do you think it might take some time to get buyers and sellers on the same page here, given the volatility in the markets?

Well, every deal has its story, but I would say typically, it takes longer. Our conversations here recently in a couple of situations probably would suggest that -- and some transactions that we've watched occur, would suggest that things are still -- I would say things haven't changed much. So I would anticipate that's more of a second half or early '23 real impact. Some deals will have different situations and be -- certainly be situational dependent. But I think at the end of the day, just more broadly about how we think about things, I would say it's -- we're probably still waiting a little bit more until some of the -- maybe some of the uncertainties that we've seen recently sort of find their way to kind of knowing the natural direction of what that might be, interest rates being 1 of them, the macro, some of those things.

Your next question comes from Josh Pokrzywinski with Morgan Stanley.

Just a quick question on the backlog. Jim, you mentioned it several times on this call. And I think for across kind of the shorter cycle industrial world, this has been a bit of a talking point, like what does backlog really mean in this environment? Any historical context for what happens to backlog if incoming orders soften? Like do you see cancellations? Is there any kind of context for something like a double ordering or channel dynamic? Like doesn't sound like anything's happening. Just trying to get my arms around like what does backlog look like if the environment will change?

Yes. I think it's something we spend a lot of time on, Josh. Obviously, when you build another $130 million in backlog like we did in the first quarter, obviously, a topic of conversation every month with our operating reviews with the president and CFOs. And I would say I'd break it into a few places within Fortive. In our Sensing Tech businesses, we have a real sense of what it looks like. And what we're seeing is we are seeing some orders being placed for like November shipments and things like that. That's not double ordering. That's just somebody wanting to say, "Hey, I want to get in the queue for deliveries for that kind of thing." And so in the case of Sensing Tech, I think we have a good sense of the backlog. We don't see double ordering, a little bit of people trying to get around some pricing. But at the end of the day, that backlog will flow and it will flow out, we're confident with that.

On the Tek side, 50% of the business is direct and we can very much see those customers and their use cases and their needs, and we've tested that pretty profusely. I feel very good about that. The channel inventory then, and that's about a little bit less than half of Tektronix revenue and close to 75% or 80% of Fluke's revenue, that's where we get into looking at point-of-sale data, where are those trends going? What do inventory positions look like? What do they have on order? And we have a sort of methodology and calculation that we use from an analytical perspective to test that.

And what we see today is in those, we don't see anything getting out of range. And so point of sale remains good. Inventories remain in a good place. And there's no natural increases that if you sort of play around with the analytics where things would go haywire quickly. And that's what we watch and we watch it consistently. We get a little bit better more refined data in the U.S. and Europe and some of those things that we do in the rest of the world. But that's how we touch the portfolio.

And I think when you step back and say, what does it all tell you, we'd say the natural demand patterns are good. Inventory levels are not substantive relative to natural numbers. And one-time order doesn't significantly increase their inventory at any time soon. So that's what makes us feel pretty good about the near term. And I would say that informs our guide. It gives us the confidence we'll start the second half with good backlog. And so if we saw some changes in some of those demand patterns, you might see a little cancellation, although -- and I would say, historically, we haven't seen a lot of that.

Got it. That's helpful. And then I guess, just on some of the more facilities-facing platforms on the software side, return to work and maybe even more of a hybrid model than remote than folks would have expected 6 months ago, it seems like it's well in order. Anything that's kind of permeated through that organization or customer behavior that tracks alongside some of those changes, good or bad?

Well, I think it's great to be in facilities in asset life cycle management from a software perspective because it's really -- the combination of what we're doing at ServiceChannel and Accruent and to some extent, Gordian, they support hybrid work and supports the kind of changes that are going to occur in facilities over time to support collaboration and the kind of things that people want to do as people come back into the offices, not full-time but from time to time. So I think that trend and that secular driver is going to be out there for years. It's well documented that we're very in the early innings of those transformations.

And so I think on balance, we're back. Our customers are, in many cases, back in hospitals we're -- there's times on our service revenue, trying to get customers on-site to get things serviced can take a little bit longer. But as we mentioned in a couple of places, we're starting to see the opportunity to compress those time lines from when we come on site to help start up a customer, as an example, whether it be in a hardware or software business, and the time to value. So we're starting to see those come down as people come back to work and back into the office, back into the facilities. So I think on balance, inherent in sort of our natural trajectory of the business is some of these things happening and being helpful to how we conduct business.

Your final question today comes from the line of John Walsh with Credit Suisse.

Kind of following along those lines, I was just curious if you could talk to, for the software businesses, kind of what you're seeing in terms of maybe a net add as it relates to subscribers or if you have more granularity around churn and absolute adds. And then just as -- I'll do my follow-on right now, the pricing, are you seeing anything different between the ability to get the price on the software side versus the hardware side?

Yes. Great questions. I think on basis, we announced -- a lot of the prepared remarks, we tried to highlight a number of places where new logos are occurring. And I think quite frankly, we had -- I think we had our largest -- I think we have one of our largest iNet deals in the history of the company at ISC. We have one of our largest -- I think we have the largest anesthesia procedures eye procedures order and probation. So a number of places where new logos. We're in a good place relative to new logo growth in the quarter.

And I think when you look at where our software growth was, I think our low double-digit teens, low double-digit growth in SaaS and our teens growth in software, that's going to stand up, I think, against a lot of software players. Looked at a few folks that reported today even and feel really good about where that double-digit number is going to stand up relative to others. That's also helpful because our net dollar retention continues to improve on the backs of churn reduction. And so I think we're in a really good place to continue to improve net dollar retention.

Our FBS efforts are making a difference there. And I think that some of that is also getting a little bit more price. So we're still getting more price in the hardware businesses to the second part of your question, John. We think we're in a good place relative to that. And I think the balance -- we didn't talk about this, but in our hardware businesses, that good balance of probably about 50% price, 50% volume in our growth, I think it's an outstanding balance. It really demonstrates the strength of our brand, the strength of our value propositions. So we think that's going to play out this year. And obviously, we're getting the price that's inherent in some of the inflationary challenges that we've documented, but we're also driving tremendous value with customers that ultimately is driving our volumes.

So anyway, I think I'll end it there. Thanks, everybody, for a great call today. I think we're incredibly proud of the quarter we had. We're incredibly excited about 2022. We've said this was a show-me year and I think we just did that. So we look forward to your follow-up questions. We'll talk to you soon, and we'll see you on the road. Thanks.

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