Roper Technologies Inc (ROP) — Q3 2019 Earnings Call Transcript

Thanks, Zack, and good morning, everyone. As usual, we'll start with our third quarter highlights. I'll then turn the call over to Rob to discuss our financial results. Then I'll walk us through the segment details and outlook, followed by our Q4 and remaining 2019 guidance. I'll then wrap up our prepared comments with a summary of our third quarter activities and share some of our early thoughts for 2020, then we'll open it up for Q&A. Next slide please. We had another really strong quarter here at Roper. Revenue grew to $1.36 billion, margin execution was tremendous, really fantastic, and free cash flow came in at $387 million or 29% of revenue in the quarter. Gross margins expanded 80 basis points in the quarter broadly across the enterprise. And we always like to see the leverage down the P&L with organic revenue plus 2%, EBITDA up 5% and DEPS growing 6%. We saw broad-based growth across our software businesses in both our Application and Network segments. Our medical product franchises remains very strong as well as RF product businesses. Neptune had a nice quarter coming off strong double-digit comp from a year ago. But we did experience some short-term supply chain capacity constraints, which we will delve into later in this call. Our Process Technologies segment continues to do a really impressive job of executing through the expected decline in oil and gas markets with tremendous margin improvements in the quarter. Also, we announced and closed two acquisitions, iPipeline and ComputerEase for a total of approximately $1.8 billion. Our capital deployment capability continues to operate at a high level. We'll talk much more about these acquisitions later in the call. Further, we successfully executed a $1.2 billion very attractive bond offering in the quarter and we also agreed to divest Gatan to AMETEK for $925 million, which is a great outcome for Roper and our shareholders. Finally, as we look towards 2020 we are encouraged by many factors, not the least of which is TransCore's recent contract award to deploy and maintain New York City's congestion pricing tolling initiative. At the end of the call we will further unpack some of our views for 2020. With that, I'll now turn the call over to our CFO to walk you through our consolidated quarterly results. Rob?

Thanks Neil, good morning everyone. Moving on to the Q3 income statement metrics, I will outline some key figures from the quarter. Revenue reached $1.358 billion, marking a 3% increase compared to last year, with organic growth at 2%. The organic growth was driven primarily by our two software segments: the Application Software segment grew 5% organically, while the Network Software & Systems segment saw 4% organic growth. As Neil highlighted, margins were impressive, thanks to the outstanding execution by our business leadership teams throughout the enterprise. Gross margin increased by 80 basis points to 64.6%, while EBITDA margin rose 90 basis points to 36.7%, with an EBITDA of $498 million for the quarter, reflecting a 5% growth. We saw a slight benefit in the DEPS line due to the favorable timing of perpetual license wins, where we recognized a few cents of earnings in Q3 that were initially expected in Q4, primarily from Aderant and Deltek. This resulted in a DEPS of $3.29, significantly exceeding our guidance range of $3.16 to $3.20. Next slide. Now, discussing our asset-light business model, which is a favorite topic for us. As many of you know, a significant aspect of the Roper governance model involves our focus on balance sheet efficiency. Over the next couple of months, we will meet with every business as part of our annual review process, particularly focusing on long-term growth opportunities and strategic deployment for all businesses. Additionally, we will assess if we have the right business model, including our effectiveness in collecting receivables and managing working capital, to ensure we continue to grow our cash flow. Looking at the numbers on the slide, we see strong performance, with negative working capital at minus 3.1% for the enterprise, inventory down to 4.4% compared to over six years ago, and improved receivables. Additionally, we've experienced a significant increase in deferred revenue as we transition towards a high recurring revenue model, now at 13.5%, which we expect to rise further. Next slide. Regarding cash flow, the company demonstrated consistent strong cash flow conversion, with operating cash flow at $404 million in the quarter, representing 30% of revenue, and free cash flow at $387 million, which is 29% of revenue, with a conversion rate of 78% from free cash flow to EBITDA. Our trailing twelve months free cash flow showed a commendable 12% growth compared to the previous year, and we achieved a 15% CAGR on TTM free cash flow over the past few years. We anticipate this trend of consistent cash flow compounding to continue. Next slide. On our robust financial position, following our successful iPipeline process in August and considering the prevailing rate environment, we adhere to our principle of being opportunistic in locking in favorable long-term rates. Consequently, we accessed the bond market in August just before the summer slowdown, supported by an excellent effort from the full Roper team and our advisors, resulting in a successful $1.2 billion bond offering, consisting of $500 million in five-year notes at a 2.35% interest rate and $700 million in 10-year notes at 2.95%. At that time, I believe this represented the lowest coupon year-to-date for any company at our rating level, exemplifying great execution by the broader team. Additionally, regarding the Gatan divestiture, we expect to finalize this later this month, further enhancing our capital deployment capabilities. At the end of Q3, our gross debt to EBITDA ratio was about 3.0 times, and with the anticipated proceeds of approximately $700 million from Gatan, we will be well below 3 times. As you know, every month we generate a substantial amount of cash, which primarily goes towards reducing our revolver balance when there is one. This provides us ample capacity for capital deployment, and we concluded the quarter in a strong position to pursue capital deployment opportunities and capitalize on our impressive pipeline of acquisition prospects. I will now hand it back to Neil.

Thanks Rob. Let's turn to our Application Software segment. Revenue came in at $405 million, which represented an increase of 5% on an organic basis. EBITDA was $168 million, an increase of 7% versus prior year and EBITDA margins were 41.4%. At Deltek we saw the continuation of a few trends that we discussed over the past several quarters. Specifically Deltek grew high single-digits in the quarter following the difficult 2Q comp. In addition, we continue to see a good balance of perpetual software transactions and a continued acceleration in recurring revenues as a result of an increased mix of business towards Deltek SaaS offerings. Also the business continued to see a nice bounce of activity across their two macro end markets, professional services and government contracting. Deltek’s team continues to execute exceptionally well. Also in the quarter, we acquired ComputerEase for $185 million. ComputerEase is a leading enterprise software solution provider for construction firms with particular emphasis on the smaller end of the market. They have over 6,000 customers in North America and deliver the software on either on-premise basis or in the cloud. This solution is very specific to the needs of building contractors including job costing, construction accounting, project management, asset management as well as payroll. This business fits nicely with Deltek's leadership position in the architecture and engineering vertical. This is a great addition to Deltek's AEC platform. Aderant experienced yet again double-digit growth as a result of continued share gains within the large law vertical and the adoption of their newer SaaS solutions targeting smaller law firms and cross-selling new products to the larger firms. As you may know, we have highlighted Aderant’s competitive strength for several past quarters and are proud of the long-term market share gains by the Aderant team. Strata logged another great quarter based on very strong new logo ads, continued strong renewal activity and the adoption of their new bolt-on products for their cost accounting and decision support SaaS products targeted to the hospital market. Data Innovations and CliniSys performed quite well in the quarter, each up high single-digits. Data Innovations, our global clinical laboratory middleware or connectivity software business continued nice share gains for their core connectivity products. And CliniSys, our European hospital laboratory ERP business continues to benefit from market consolidation in most of the Western European markets. In particular, CliniSys products are essentially the only hospital laboratory ERP products proven to scale to meet the needs of the larger consolidated customers. We're quite bullish that this trend will continue for many years to come. And before we turn to the outlook, CBORD did very well in the quarter on increases in their recurring subscription revenues. Of importance, we announced a partnership with Apple whereby students’ and faculty’s security and payments credentials can be onboarded into the Apple Wallet. Six universities, Clemson, University of San Francisco, University of Tennessee Knoxville, University of Vermont, MIT, and University of Kentucky have or are adopting this technology for this full year. For CBORD, this opens up a new recurring revenue stream as each credential is activated. Though very early, this could prove to be a nice long-term growth driver for CBORD. And finally, and we have to highlight the tremendous, just excellent cash performance in the quarter from CBORD. Great job and congrats to Jim, Rob and the entire team there. As we turn to the outlook, we want to highlight that Deltek and Aderant were benefited by the acceleration of a few high margin perpetual transactions. These transactions were in the sales funnel at the end of last quarter but the timing of which is always difficult to pinpoint. So we assumed they were closed in Q4. But they were executed in Q3. Notwithstanding, we continue to expect mid-single-digit organic increases for this segment in Q4. Next slide, please. Turning to our Network segment, revenue in our Network Software & Systems segment for the quarter was $394 million, an increase of 4% on an organic basis. EBITDA was $176 million increasing 15% versus the prior year, and EBITDA margins were 44.7%. During the quarter, we acquired iPipeline for $1.625 billion. iPipeline, we'll report it in this segment, and we'll discuss iPipeline in detail on the following slide. The quarter was highlighted by continued growth in our DAT or North American freight match business. In particular, we saw strength in demand for a rate data offering which helped drive increased ARPU in the quarter. Foundry also started strong with double-digit revenue growth in their first full quarter as part of Roper. In particular, there was nice growth across both their media and entertainment core vertical, and their emerging digital design business. Also in the quarter, Jody and the team delivered major releases to both their Nuke and Katana product offerings. iTrade grew double-digits in the quarter based on strong renewal activity and new customer adds. MHA’s performance in the quarter was highlighted by several strong trends. To remind everyone, MHA is the largest group purchasing network for the non-hospital market with leadership positions in long-term care pharmacies, long-term care facilities, and home infusion marketplaces. The team continues to win the market share gain relative to on-boarding new and startup pharmacies. Importantly, in the quarter, MHA continued to see the benefits of increased customer purchasing volumes due to several new pharmaceutical products being on contract. Also, it's worth reminding everyone about the favorable end market conditions, essentially the aging of America and the increasing demands this aging demographic puts on the healthcare system. This trend benefits MHA. Finally, the President of MHA, Mike Sicilian announced his intention to retire from the business. Mike has been the MHA President since our acquisition in 2013 and has done a terrific job growing MHA and providing leadership to both SoftWriters and SHP. Congrats to Mike for a wonderful career with MHA and Roper. And Mike, thank you. His successor, Diane Koontz has been MHA's COO for the GPO business for several years. As a result, MHA's leadership succession plan has been seamless, which is a testament to Mike and Diane working together in pursuit of this transition for several quarters. Turning to RF IDeas, we continue to see strength in this business. In fact, another record quarter for RF IDeas. The strength was based on continued adoption of RF Ideas’ core reader technology in secure print and secure sign-on applications. This is another very good example of a leadership niche business in this case Roper style products business. Great job by the team. And finally, in the quarter TransCore was down low single-digits based on project timing. Importantly, TransCore was recently awarded with the design, implementation and maintenance contract for New York City’s Central Business District Tolling Program. The total contract value was approximately $507 million and we expect to recognize approximately $200 million of revenue associated with this contract next year. The recurring revenue operations and maintenance portion of the contract will commence in early 2021 and run for a minimum of six years. Thank you to the MTA for trusting TransCore to deliver on this very important and highly visible contract. And also congratulations to Tracy and the entire TransCore team for building the products and technologies needed to implement this project as well as the many years of experience integrating similar solutions. As we return to the outlook, we continue to expect mid-single-digit organic growth for this segment in the final quarter of the year. Next slide please. iPipeline is a wonderful addition to our growing stable of software businesses. iPipeline is a leader in cloud-based software solutions for the life insurance industry. Specifically, iPipeline provides the necessary workflow automation solutions needed to quote, apply, underwrite and manage life insurance products. The software solutions enable a very broad network of carriers, distributors, and agents in the sales and delivery of life insurance products. The purchase price was $1.625 billion and is immediately cash accretive. We expect the business to grow in the high single-digit range and this is based on the company's long history of revenue, EBITDA, and cash flow growth. For 2020, we expect iPipeline to deliver approximately $200 million in revenue at roughly 40% EBITDA margins and generate approximately $70 million of after-tax unlevered free cash flow. Importantly, iPipeline is a Roper-style software business. They have very strong cash flow characteristics and are very asset light, in fact negative net working capital. The management teams led by Larry Berran exemplify what we look for in our leaders. Long-term commitment to solving customer problems with solutions that have recurring revenue streams, teams that love to build great businesses. They are the clear leader in this niche vertical and as a result have very deep domain knowledge. And given this, they have very high levels of recurring revenue and their customer intimacy provides clear opportunities to continually enhance the products and solutions to continue to grow over the long-term. We've been tracking this business for several years and are excited to welcome the team to Roper. Next slide please. Revenue in the quarter in our Measurement & Analytic Solutions segment were $389 million, a decrease of 2% on an organic basis. EBITDA was $137 million, a decrease of 6% versus the prior year and EBITDA margins were 34.4%. Verathon had a strong quarter whose growth was led by increases in their GlideScope consumables recurring revenue. In addition, the Verathon team has done a nice job launching their new single-use bronchoscope product line, on path to becoming a meaningful product for Verathon within the first year of launch. NDI had another great quarter. This quarter’s strength was rooted in NDI’s electromagnetic and optical measurement systems used by several OEMs in surgical applications. Great job again by the NDI team. Our CIVCO MMI business in Iowa City had a very nice quarter that was highlighted by strong execution in their ultrasound guidance market. Neptune did well in the quarter especially coming off a strong double-digit comp from a year ago, but the quarter's growth was hampered by supply chain constraints specific to their newer ultrasonic residential meter offering. Of note, over the past couple of years Neptune has invested to develop a static meter based on ultrasound technology for both the residential and larger commercial and industrial meter markets. In the quarter, Neptune saw bookings for ultrasonic meters outstrip their current production capacity, which we view as generally a good thing as this newer product appears to be striking a positive chord with several new customers. The Neptune operating and supply chain teams are working aggressively to boost production, which we expect to see the benefit of as we head into 2020. All-in-all, a good quarter for Neptune. As we expected our short cycle industrial businesses declined high single-digits. This performance was consistent with the last part of last quarter and consistent with our expectations heading into Q3. The business has started taking cost actions in Q3 and will continue into Q4 to best position these businesses for 2020. Importantly, this group did a tremendous job managing margins in the quarter. As we have discussed, we reached an agreement to sell Gatan to AMETEK for $925 million. We expect the sale to close at the end of this month. Given the backdrop of a two-year sales process and a very intensive divestiture workload over the last three to four months, the Gatan business had a challenging third quarter down high single-digits as volume shifted out of Q3 and into Q4. We expect most of these delayed shipments to occur after the closing of the divestiture. As we turn to our guidance, we see organic revenues flat for the fourth quarter. We see our medical product business is growing mid-single-digit plus for the final quarter of the year. We expect Neptune to grow low single-digits as they are working to expand their static meter supply chain capacity and we expect our short cycle industrial businesses to be down high single-digits. Finally, as we mentioned before, we expect the divestiture of Gatan to close later in this month. Of note, Gatan's annual EBITDA has historically been extremely back-end weighted through the last two months of the year, a period we do not expect to own in 2019. Next slide please. And finally revenue for our Process Technologies segment for the quarter was $160 million, a decrease of 5% on an organic basis. EBITDA was $58 million, a decrease of 3% versus prior year and EBITDA margins were 36.6%, an increase of 100 basis points. We saw very strong, actually outstanding margin performance for this group of businesses in the quarter. This was driven by our business unit leadership teams executing to remove cost from the businesses on a rapid basis. To this end, it’s always worth reminding everyone the vast majority of our businesses’ cost structure are variable. For this reason, when times are good we tend to only have modest incrementally positive leverage, but this meaningfully benefits us when times get more challenging. We are able to quickly take cost out of the system and position the businesses in the most optimal manner. The teams did a great job of this in the quarter. Relative to CCC, we continue to see strength in their LNG project pipeline and we are the contracted vendor in essentially all new projects coming online over the next several years. Finally, prior to turning to our guidance, we are excited to announce new presidents at both our PAC and CCC businesses. Both businesses have and continue to perform well, but the addition of Ed and Pete to our team should greatly enhance these two businesses’ ability to develop and deploy strategy, drive targeted operational improvements, and simplify the operational complexity of each of these businesses. Welcome to both Ed and Pete to the Roper family. Turning to our outlook, we do see and expect a weakened outlook for upstream oil and gas businesses as we head into Q4. Given this we are guiding to mid-single-digit organic revenue declines in this segment for Q4. Next slide please. Core guidance, we are tightening our DEPS guidance to a range of $12.98 to $13.02 compared to our prior guidance of $12.94 to $13.06. Also for establishing Q4 adjusted DEPS guidance to be in the range of $3.32 to $3.36. Please note that Q4 and the full year guidance includes an $0.08 headwind based on the net impact of our Q3 acquisitions and the Q4 divestiture of Gatan. Finally we expect our tax rate to be approximately 22% in the quarter. Next slide please. As we turn to our final slide before Q&A. We continue to see strength in our niche market strategy and governance model that promotes nimble local execution. This led to strong performance in the quarter across the enterprise. EBITDA margins were up 90 basis points to 36.7%. DEPS grew 6% to $3.29 and TTM free cash flow increased by 12%. Also and importantly, we successfully deployed $1.8 billion for two terrific Roper-like software businesses in the quarter, ComputerEase and iPipeline. Finally in the quarter we were able to reach an agreement with AMETEK to divest Gatan for $925 million and complete a $1.2 billion bond offering at a very attractive long-term rate. Great execution across the entire enterprise in the quarter. As we look towards 2020, we see several encouraging trends. First, our enterprise continues to be less and less exposed to macro cyclical impacts as our expanding software portfolio increases our recurring revenue mix. This is a longer-term trend that we feel great about. Next, our balance sheet remains very strong and will only be strengthened by the Gatan divestiture proceeds. Further, our acquisition pipeline remains very strong with several high-quality opportunities across various stages of deal maturity. We continue to see a very large number of very high quality assets. And finally, TransCore's New York City congestion pricing infrastructure project will drive meaningful revenue, approximately $200 million for the enterprise, beginning in 2020. Now as we turn to questions, we want to remind everyone that what we do is very simple. We compound cash flow by running a portfolio of operating businesses that have market-leading positions in niche industries. We provide the business leaders with Socratic coaching about what great looks like relative to strategy, operations, innovation, and talent development. We incent our management teams based on growth. We have a culture of mutual trust and transparency. And finally, we take our excess free cash flow and deploy it to buy businesses that have better cash returns than our existing company. These simple ideas deliver powerful results. Now, let's turn the call over to your questions.

Hey maybe you can just start with some clarification on the perpetual license revenues that came in for Deltek and Aderant. Just give us some context here. Is this the customer deciding when these will be executed and are they one-time? And I think Rob said that it pulled maybe $0.02 out of what would have been in the fourth quarter and the third quarter, is that right?

Yes, it was probably closer to $0.03, maybe $0.04. It's just timing those things come in at really 100% margin. And so what, go ahead, you can talk about the customers.

Yes, the situation for both Aderant and Deltek involved larger transactions. They were quite late in the pipeline as we were preparing our guidance for the upcoming quarter, but the timing of these larger deals can be unpredictable. Therefore, we tend to adopt a more cautious approach regarding timing, and these deals just arrived a bit earlier than we anticipated.

Good morning, everyone, and congratulations on a great quarter. A lot of really good things to talk about. But I think rather than talk about the good things I'll be more of the fox and hedgehog. The Gatan divestiture, I think you guys were in print about a year ago when you announced the sale to Thermo about $150 million in sales. And then I think the most recent press release suggested $180 million, but now I think you cited for the full year expectation of some disappointment there. So, what is the updated expectation for 2019 revenues for Gatan in the context of what you've already disclosed?

Right. So, yes, the full year numbers are the numbers that were disclosed I think when the announcement was made. So, I mean, there is no update at all to that.

Yes. So, our experience within this water industry — I don't think — there's no sea change. It's sort of tectonically changing. It's slow and paced and conservative. That said, for many years, at least three or four that I can think going through the Neptune strategic plans, they have focused a number of resources on what they call network-as-a-service and then also the data that comes out of the water meter to be able to do more leak detection and more reporting to the customers on sort of their utilization patterns etc. So, it is certainly attractive. Neptune opened an R&D center and a software development center in the Atlanta market, the sort of how some of these resources. That said, it is a small part of Neptune today. I mean Neptune is the leader and will continue to be the leader both on the mechanical meters and emerging on the sort of static ultrasonic meters. And as you know, the technology that we place on top of the meter has been a long-term differentiated advantage for us as you don't have to touch the meter as the reading technology changes from sort of mobile to fixed. So, that's our views on there and happy to spend more time on that, if you like.

I'm curious about your perspective on the overall market for strategic buyers of manufacturing assets, especially in light of the efficient reprocessing of the Gatan transaction and how you view the dynamics surrounding your portfolio mix.

I don't know if that's a trick question, but we — the businesses that we have that are on the product side are great businesses. They've been in the portfolio for a long-time. They're amazing cash producers that enable our — meaningfully enable our capital deployment strategy. We talked in this quarter how the cost structures are positioned to be on a variable basis to best sort of let us sort of ride up and down as the macro market rides them. And so they are in the portfolio. We like them in the portfolio and expect them to stay in the portfolio.

This is Joe for Julian. I have a broader question regarding your SaaS businesses. As they become a larger part of your portfolio, how are you approaching the medium to long-term trends regarding your average revenue per user? You mentioned that Aderant saw benefits this quarter from cross-selling. Do you believe this will also be applicable to other SaaS businesses? Additionally, are you providing any incentives for customers to transition to the SaaS products, particularly at Deltek? Does this suggest that there could be a tailwind when those incentives are removed further down the line?

Alright. Hey, there's a lot in there. So, I'll try to sort of take it one by one. So, it's hard for us to make out a comprehensive or broad-based sort of statement across the many SaaS businesses that we have or businesses that are selling their products on a subscription basis around the cross-selling up-selling, but it is — that said for each one, it is a very meaningful part of their strategy, right, where just take the most recent one iPipeline. They've got gross retention in the high 90s and net retention like 110. So, a big part of their strategy is cross-selling and up-selling additional products to the existing customer base.

So, you guys didn't give a total company organic revenue update for the year for guidance. I think it was 4% the last quarter. What's that going to be now?

Yes. So, we gave each of the segments. I think if you add up all the segments for the fourth quarter, it's going to be pretty close to the Q3 organic, so in the 2% range. So, I think if you add that up for the full year, we're somewhere just north of 3%.

Just another one without giving any names, are there any businesses within your portfolio that you're looking at or that makes sense to divest in the next year or so?

Certainly, if there were, we couldn't talk about it. So, we can't talk about it.