Roper Technologies Inc (ROP) — Q1 2018 Earnings Call Transcript

Thank you, Abby, and thank you all for joining us this morning as we discuss the first quarter financial results for Roper Technologies. Joining me on the call this morning are Brian Jellison, Chairman, President and Chief Executive Officer; Rob Crisci, Vice President and Chief Financial Officer; Neil Hunn, Executive Vice President and Chief Operating Officer; Jason Conley, Vice President and Controller; and Shannon O'Callaghan, Vice President of Finance. Earlier this morning, we issued a press release announcing our financial results. The press release also includes replay information for today's call. We have prepared slides to accompany today's call, which are available through the webcast and are also available on our website. Now if you'll please turn to Slide 2. We begin with our safe harbor statement. During the course of today's call, we will make forward-looking statements which are subject to risks and uncertainties as described on this page and are further detailed in our SEC filings. You should listen to today's call in the context of that information. And now please turn to Slide 3. Today, we will discuss our results for the quarter primarily on an adjusted non-GAAP basis. A full reconciliation between GAAP and adjusted measures is in our press release and also included as a part of this presentation on our website. For the first quarter, the difference between our GAAP results and adjusted results consists of the following items on a pretax basis: a $74 million adjustment for amortization of acquisition-related intangible assets and a $2 million purchase accounting adjustment to acquire deferred revenue relating to software acquisition. This represents revenue that those companies would have recognized if not for our acquisition. And now if you'll please turn to Slide 4, I'll hand the call over to Brian. After his prepared remarks, we will take questions from our telephone participants. Brian?

Thanks, Zack. Good morning, everybody. We'll go through the first quarter, look at the segment detail, talk about the rest of the year, and then take your questions. So next slide. We had a record quarter across virtually every kind of metric you can think of. Revenue was up 9% to $1.2 billion and organic growth was up 6%. It was broad-based across all the segments; they all grew mid-single digits or greater. Gross margin was up, again, 30 basis points to 62.5%. We'll talk a little bit about that later because in an environment where people are starting to worry about cost-push, inflation or price-cost issues, it's sometimes forgotten that the 62.5% means something really important; our cost of goods sold is only 37.5%. In an environment where people worry about material, if you only got a cost of goods sold ratio of 37%, it looks a lot better than those guys that have gross margins of 38%, meaning cost of goods sold of 62%. Earnings before taxes were up 10% to $332 million. We put that in as a distinct reference so you can see what was unrelated to the Tax Act versus what's related to the Tax Act. So the 10% uptick is earnings before tax. The DEPS earnings, which includes the trifecta around the Tax Act for us, were up 24% to $2.61. The operating cash flow was $282 million, which is 23% of revenue. We'll discuss that number. It's terrific at 23% of revenue, a little lower than last year for a specific reason. We reduced debt by $535 million in the quarter, and since the end of 2016, we've taken $1.6 billion off of our gross debt number. So it was really a great quarter, and throughout the enterprise, we had very good execution. Next slide. Looking at the income statement, you'll see revenue went up from $1.1 billion to $1.205 billion. Gross margins from 62.2% to 62.5%. The tax rate down at the bottom, you can see was 28.2% last year, this year, it was 18.1%. I think we guided people sort of high teens. For the remainder of the year, we think it will be about 23%. Q1 is a little lower because of some unique benefits that happened in the first quarter on a tax perspective. The adjusted DEPS number was up $0.50 from $2.11 to $2.61. Next slide. We look, again, at the progress we continue to make on deferred revenue, and our asset-light business model. If we just look at the last two years, two years ago at the end of the first quarter, we had 4.8% net working capital to revenue. This quarter, we closed out at a negative number of 2.7%. You can start to see a trend now because on this slide, if you look at the column on 3/31/17, that was a negative 2.9%. That was the first time that we had gone to negative working capital. Now this time at 2.7% is the fifth consecutive quarter where we've been at negative working capital. This has run from a negative 2.9% to 2.4% to negative 2.5% and negative 3.3% and now, negative 2.7%. So starting to see a real-world, new normal for Roper. Looking back five years ago, when you look at the same data, inventory this quarter was at 4.5% of revenue, and five years ago, it was 6.8%. Receivables are at 16.4%; five years ago, they were 19.3%. Payables and accruals were exactly the same, 11.5% this year and 11.5% five years ago. But deferred revenue close to doubled from five years ago; it was 6.5%, five years ago of revenue, now, it's 12.1%. When you total it up from five years ago, we were at 8.2% net working capital to revenue, and now, we're at negative 2.7%. So when you basically make an 11% swathe on sales of approaching $5 billion, it's a big change. Deferred revenue, you can see, totaled $585 million at the end of the first quarter, which is more than double what it was just two years ago. So as we continue to grow, we find that the working capital becomes a source of funds for us. Next slide. We continue to compound cash flow and are in a particularly good place to achieve another all-time record in 2018 for cash flow performance. In the first quarter, we had two unusual things to consider. There was the timing of a tax payment in 2018 that totaled about $43 million, and then we had, in the first quarter of last year, a big MTA payment for that project. It was around $34 million and another one in the Middle East for about $16 million. So there was $93 million of an unusual variance between the first quarter of this year and last year, and that will smooth out as the year goes on, and we'll still deliver a very high operating cash flow to revenue and free cash flow as well. You can see the conversion number here with the GAAP to net earnings conversion at 141%. Next slide. As for the financial position, you can see the debt structure here. Cash is at $366 million. We were able to repatriate about $300 million of non-U.S. cash in the first quarter, with still a couple of hundred million left that we think we'll be able to repatriate during the course of the year. Our undrawn revolver has $2.5 billion, and there's nearly $1.8 billion in that revolver that remains undrawn. So our capacity for investing and capital deployment is very high. Our gross debt has dropped down $1.2 billion just in the last year, and the net debt number also down substantially. If you look at our trailing EBITDA for that period, we're up $261 million. So you're up on EBITDA, down on debt, and that gives you the net debt-to-EBITDA number here of 2.6x versus 3.7x a year ago. And you're picking up more than 20 basis points on that number every time. It takes no time at all for us to be below 2x net debt-to-EBITDA. But we're likely to find ways to deploy capital here in 2018 that could happen sooner than later. We're in a number of transactions now, all of which are attractive, but you never know if you're going to get any of them done. Next slide. Here we look at the segment detail, and all of these things are exceptional businesses. If we turn to the next slide, here to Slide 11, you'll see our trailing 12-month margins, the gross margins on the top and the EBITDA margins on the blue line at the bottom are really spectacular for all of our segments. Looking at energy at a 57% gross margin and 31% EBITDA margin, part of what I want to point out is that the enterprise in total is running about a 62.5% gross margin, very much like the RF & Software line. If you've got 37% cost of goods sold, which would be the reciprocal of that gross margin, and half of your cost of goods sold is material, a 10% increase in material prices means you can raise your prices by 1.9% to avoid any cost risk at all. If the material is only a third, which is more like what it is for us, and prices go up on material by 10%, you wipe that out with a 1.5% price increase. So we are not seeing, nor do we expect to see, this cost push and price pressure that others are complaining about. That’s largely because our cost of goods sold is quite modest compared to the other multi-industry players. Our businesses operate in outstanding niches, are nimbly led, and I can assure you that we are on top of any of these issues related to tariffs, material prices, or anything else. Next slide. In our biggest segment, the RF Technology & Software group, we reached nearly $0.5 billion in revenue for the quarter. Revenue was up 7%, operating profit was up 13%, and the operating profit margin was up 130 basis points, which was particularly satisfying due to a lot of the amortization that contributes to that operating profit margin. Organic growth for the segment was up 4% with FX having a favorable impact of just 1% here. There was low single-digit growth in toll and traffic, which we weren't necessarily expecting but we found good execution; hence, we are achieving good margins without negative variances. Much of our work is out for quotation, but we find the feedback on timing is just unclear. Our Deltek Software business continues to thrive in both GovCon and professional service markets; the bolt-ons we did for them are performing as expected and we are realizing the synergies that Deltek anticipated. Regarding ConstructConnect, I will ask Neil to share a little bit about the two acquisitions we made to expand our preconstruction takeoff and estimation software. These strengthen our network, one called QuoteSoft and the other called PlanSwift. In total, we invested about $39 million. So, Neil, could you explain how those improve the ConstructConnect network?

Both QuoteSoft and PlanSwift are in the preconstruction planning space focusing on automating the takeoffs and estimation activities of contractors. Both enhance the ConstructConnect network and product platform, making it more comprehensive in ConstructConnect's quest to be embedded in the daily workflows of contractors regarding their preconstruction activities. QuoteSoft focuses on the HVAC and plumbing trades, while PlanSwift focuses on other trades such as flooring, drywall, windows, etc. Thank you, Brian.

Aderant also had a spectacular quarter; they were up double digits with significant gains from large law firms. So we continue to feel optimistic about Aderant, and they are certainly outperforming this year. Our Freight Matching business growth has been driven by a combination of solid markets and substantial improvement in retention and net subscriber additions here. We just launched another app to enhance the ability to track loads, which we think will drive additional growth in the second half of the year. Lastly, our RF IDeas unit in Chicago is performing exceptionally well amidst privacy concerns, as their technology allows for the identification of individuals across a variety of access areas related to access control and storerooms. Overall, we expect mid-single-digit growth in the software businesses for the rest of the year, with their outsized margins and cash performance. The toll and traffic sector is harder to predict; we anticipate modest growth there, but it could potentially be outsized as well. In summary, we project the segment will grow around 4% to 5% and maintain the outstanding margins that we currently witness. Next slide. In Medical & Scientific Imaging, revenue reached $366 million, increasing by 5%. Revenue outperformed expectations thanks to some particularly strong breakthrough moments. We've experienced an accelerating adoption rate for Strata's financial decision support cloud software. Notably, Kaiser Permanente, one of the largest entities in the country, adopted our national cost accounting program technology that is backed by Strata. To understand the magnitude, Kaiser has 12 million members, 22,000 doctors, and 39 hospitals. This serves as an excellent validation of our technological leadership compared to the competition, and we expect adoption rates to continue to increase, allowing us to gain market share from those with older systems. The second aspect I want to highlight is the 4% organic growth despite a decline in revenue in the high margin U.S. lab business; thankfully, this was offset by revenue growth in our data innovations diagnostic connectivity business and CliniSys, our international lab business. This is encouraging news, although it cannot compensate for the operating margin decline of 150 basis points to 32.9% due to pressures within the U.S. lab business. We're seeing high single-digit growth in the software solutions for long-term care and home health thanks to acquisitions from a few years back called SoftWriters and SHP. The medical product segment overall is achieving mid-single-digit growth, and we foresee this trend continuing throughout the year. Gatan is also building its backlog as new products launched last year are expected to drive growth over the coming years. We've started shipping the next generation of cryo-EM products right at the end of the quarter. For the remainder of the year, from Q2 through Q4, we anticipate broad-based growth across all medical businesses and an improvement in scientific imaging compared to the previous year; we expect mid-single-digit organic growth for the segment in total, while potentially experiencing about 100 basis points margin decline due to the U.S. lab business’s higher margins diminishing as part of the segment mix. Next slide. In Industrial Technology and Energy, we recorded pretty impressive double-digit growth for both segments, at 18% and 11%, respectively. In Industrial, organic growth was up 15%. We witnessed double-digit growth at Neptune, and they achieved all-time record orders due to a strong customer-centric innovation approach. Over the past 1.5 years, the software experience we gained from our other businesses has significantly augmented Neptune's capabilities and guided their product development, leading to exciting new technologies building in Atlanta focused on their strengths. At Neptune, we are backward-compatible in nearly everything we do. As a technology company, Neptune is evolving to behave more like an emerging tech firm, instead of just a traditional manufacturer. The Cornell Pump division reached records, gaining share at the expense of competing pump companies at an extraordinary pace, suggesting a record year ahead. The first quarter's performance was just phenomenal, and we would like to extend our gratitude to Robert and the entire team for their outstanding work. Our Roper Pump business performed well, with strong market execution and technology products aiding their resurgence. The DuraTorque technology offers enhanced solutions for rubber and bearing wear, allowing us to drill faster and deeper than many competitors. While they haven't returned to the all-time high levels enjoyed a few years back, they have seen substantial improvement. For the remainder of the year, we are expecting high single-digit organic growth with strong leverage. In the Energy segment, we witnessed 5% organic growth, with strength mainly in upstream applications, similar to Roper Pump. Our AMOT businesses made significant contributions. Importantly, our compressor control business exceeded our expectations, remaining stable compared to previous years. We are starting to see positive indicators for compressor controls projects for 2019, a timeframe we hadn't anticipated seeing these early signs. This is a positive development for the long-term sustainability of that business. Across the industrial companies in the Energy segment, we saw a reasonable level of overall performance. As we look to the rest of the year, we anticipate around 5% to 7% organic growth with solid leverage throughout. With that, I think we can move to our guidance update. Next slide, Slide 16, showcases that we are raising our full-year guidance from $11.08 on the low end to $11.08, and from $11.20 increasing to $11.32 on the high end. Organic growth projections have been adjusted up by a point, now ranging from 4% to 6%, up from the previous 4% to 5%. The end market data we observe continues to support this outlook. Our tax rate is expected to stabilize around 23% for the second quarter, as well as for the third and fourth quarters, following the first quarter's lower tax rate of 18%. For Q2, we anticipate earnings guidance to be between $2.65 on the low end and $2.71 on the high end. All of these figures indicate that operating cash flow should remain record-setting in 2018. If we summarize Q1, the two main themes are our asset-light, niche market strategy continues to deliver outstanding results, driven primarily by agile execution. We had broad-based revenue growth, as mentioned, with organic growth at 6%. The end-market data we’re seeing is encouraging. We likely haven’t encountered more optimism as a group than during our Q1 reports. There’s a mature level of confidence without euphoria. Everyone feels positive about being insulated from geopolitical, tariff, and cost-push inflation issues on materials due to the low material cost structure in our cost of goods sold. Our gross margins increased, further demonstrating our ability to manage the price-cost dynamics effectively. Earnings before taxes rose by 10%, while the trifecta of tax reform allowed us to repatriate cash, giving greater value to the cash retained because of the lower tax rate. Consequently, we experienced a 24% increase. On the capital deployment front, our balance sheet has recovered significantly. We have reduced our debt by $1.6 billion since the end of 2016; the projected pace is around $7 billion in acquisitions over the next four years, including the current one. We are encountering more appealing opportunities in our pipeline already and are engaged in several attractive transactions at this moment. All in all, it was a fantastic first quarter, and we are positive about our outlook for 2018, which is why we have decided to raise our guidance. Now, let’s open the floor to questions.

Just a couple of things, Brian. The core growth outlook for '18 kind of bumped up by a point. When I sift through the commentary on the platforms, is it safe to assume that the industrial tech platform has more momentum than planned earlier in the year? Is that primarily where the core growth outlook has improved?

I wouldn't say that. It was a little stronger in the first quarter than we expected because some industrial businesses, certainly Neptune were spectacular, deviating from everything others say about these spaces. We felt better about that. There's nothing that’s soft, so we are discussing high single digits for the rest of the year, not at 15%. But yes, that is good news. Actually, I’m encouraged by the medical sector in some respects because two good occurrences happened. The reduction in the U.S. lab business was as we expected; it wasn’t any higher, and it was manageable. Meanwhile, we compensated by growth in other segments of our lab business. So that was a reassuring factor. Overall, everyone demonstrated an organized understanding of their forecasts, reinforcing our confidence in the revised organic growth projection.

Yes, it really was, Rick. It was broad-based. The first quarter saw all four segments outperform our internal models. That confidence persists throughout the year as we conduct our review process and discuss results with all our leaders.

Sure. Okay. As a follow-up, when you analyze the M&A pipeline, Brian, you indicated it’s practically full and overflows with decent opportunities. Is it primarily populated with application software targets, which would align with RF? Or are there any in medical software? I presume most of it is software-driven, but could you provide further insight into the pipeline?

I think most of the opportunities we’re looking at are application software and network-related, hence, less likely to be medical for the moment. We are beginning to look at one medical opportunity which is smaller. However, there are multiple application software ventures, and we are exploring ideas with some past clients who took our advice to enhance their companies. We may reconsider those options in light of new analyses.

Okay, we will proceed to our next question from Deane Dray with RBC Capital Markets.

This is Jeff on behalf of Deane. My first question pertains to your toll and traffic business. Could you possibly describe the bid pipeline that you are observing and the overall adoption of cashless tolling?

I believe the bid pipeline is exceptionally full. Many look to see if any infrastructure program funding might emerge from the government to finance projects that would otherwise require their own capital. We've consistently driven cashless tolling since we possess advanced technology for reading various specifics. We have a family of multi-protocol readers capable of interpreting a wide variety of systems, fostering accelerated adoption. Additionally, we have a strong execution capacity for remote access to those systems, aiding management. Lastly, our technology is also complemented by substantial administrative back-office capabilities, which greatly enhance our bid competency in light of outdated administrative systems still in place.

Okay, great. As a follow-up, do you have any updates pertaining to the timing surrounding the resegmentation of your portfolio and the measures to streamline the internal P&L?

The situation surrounding that largely depends on our planned acquisitions for this year and if we anticipate divesting anything. Neil has already dedicated considerable time this quarter to that improve those processes, and he’s continuing to spend significant time in Q2 traveling and engaging with key stakeholders. I suspect the process will continue to make progress throughout the year.

This is Lee Sanquist on behalf of Julian. In the medical segment, you mentioned headwinds in U.S. labs, but what about the startup costs for the Queensland project? Can you provide an update on the expense ramp-up?

Yes, it's Neil. The project has indeed started and is on track. However, the revenue timing relative to expenses will exhibit some imbalance this year, which should rectify over the remaining nine years of the contract. Overall, adjustments are occurring per our expectations, and we expect the project to advance accordingly.

Understood. Regarding the balance sheet, your deleveraging efforts have been very impressive. Could you provide an updated perspective on capital deployment priorities if, by chance, M&A does not materialize?

There’s no chance that M&A will not materialize. Just to provide context, even in a slow year, we see around $10 billion of opportunities to pursue for offers. It’s inevitable that we maintain excellent M&A transaction capabilities.

I’d like to ask about Aderant's growth, specifically regarding how early or late we are in the customer base cycle regarding their decision-making. Could you provide insight into this?

Yes. I would describe this segment as being in the middle of the curve. Competitors will face a forced migration in approximately 3.5 to 4 years, prompting customer decision-making ahead of that. Importantly, Aderant is not simply waiting for that change; they are proactively launching new products and other initiatives aimed at offsetting that future growth dynamic.

Great. Regarding the portfolio, you mentioned that most opportunities lie within application software, particularly network-related. Are there noticeable themes emerging, or should we expect more fill-in acquisitions of existing platforms?

There are certainly existing themes guiding our targets, highlighting the priority for companies featuring deferred revenue, high margins, and solid growth potential. These businesses must serve critical customer needs. We focus on software that necessitates implementation services, avoiding prolonged service engagements subsequently. The markets we look to acquire should facilitate our clients' success, ensuring their willingness to invest in our offerings. Without disclosing specifics, we target firms that wield considerable leverage over large sums of revenue, even if they are smaller companies in their own right.

Are there any application-based opportunities connected to Neptune? I’ve noticed substantial technological progress among metering channels there. Is that all organic growth for Neptune, or might there be analytical software additions to that business?

We have made other investments and activities that support Neptune's innovations. However, Neptune stands out in how it creates compatibility with the older systems, allowing for seamless upgrades without forcing client changes. Many customers are resistant to dramatic change, and we emphasize this backward compatibility which proves invaluable.

Yes, exactly. We have consistently invested in software organically within Neptune, which remains our focus moving forward. As Brian mentioned, we are doing this in Atlanta. There's a great customer base, and our solutions significantly enhance the clients' ability to collect revenue. We are confident these investments will yield future returns.

I would like to ask about your comments related to compressor controls. Did you mention that orders were coming in better than expected for 2019 projects?

No, I wouldn’t phrase it as orders; rather, we're observing heightened activity. Looking back, while larger LNG projects were anticipated to commence later, we're now witnessing smaller projects popping up ranging from $1 million to $2 million that companies consider for 2019. However, we would not see actual orders for these until 2019 or the following year.

What do you attribute this improved activity to? Is there something driving that?

Various factors contribute to this, such as export dynamics and the recognition of profitable opportunities that may not have seemed feasible before. Pricing mechanisms also play a role, but each customer has unique views regarding their engagements with us. The key point is they are engaging, which is a refreshing change compared to 12 to 15 months ago when such interactions were absent.

Is this in part linked to gas pricing dynamics, would you suggest?

We prefer not to draw conclusions on that. Each customer's perspective is different. These are large players, and their outlooks are shaped by macroeconomic factors, whether it is oil pricing or opportunities related to product exports or delayed investment need.

Regarding the first-quarter tax rate, did you clarify why it was only 18% compared to the anticipated 23% for the remainder of the year?

Yes, it was just related to the timing of deductions associated with stock-based compensation.

I lack a clear understanding of the energy segment's performance relative to the past peak. A couple of years ago, this business saw a substantial downturn. How does it now compare to the past peak?

It’s likely still off by around 40% from peak levels. One particular business, Cornell Pump, stands out; it has surpassed its peak due to its focus, largely outside of energy. Businesses like Roper Pump and others serving upstream markets saw gains of about 35% but were previously down 60%.

What will it take to reach those peak levels again, and when do you think that might occur?

It's all about balance. The midstream and downstream sectors have not bounced back like upstream has. The optimism we see for compressor controls is still speculative since it’s quite late in this cycle. As you know, this segment constitutes a tiny slice of Roper now, making long-term predictions regarding recovery toward previous peaks challenging.

That’s true, but it's still a rather minor fraction of our overall portfolio. In fact, these segments will continue to dominate as single-digit contributors to Roper.

Thank you, everyone, for joining us today, and we look forward to speaking with you during our next earnings call.