Roper Technologies, Inc.
Q1 2019 Earnings Call Transcript

Published: 25 Apr 2019

[Operator:]

Good day, and welcome to the Roper Technologies First Quarter 2019 Financial Results Conference Call. Today's call is being recorded. I will now turn the call over to Zack Moxcey.

[Zack Moxcey:]

Good morning, and thank you all for joining us as we discuss the first quarter financial results for Roper Technologies. Joining me on the call this morning are Neil Hunn, President and Chief Executive Officer; Rob Crisci, Executive Vice President and Chief Financial Officer; Jason Conley, Vice President and Controller; and Shannon O'Callaghan, Vice President of Finance.

[Neil Hunn:]

Thanks, Zack, and good morning, everyone. We'll start our call today with the enterprise highlights and financial results for the quarter. We'll then turn to our segment detail and outlook followed by an update to our 2019 guidance and the establishment of our second quarter guidance. And then turn it over to questions. Next page. We characterize the first quarter here as a strong start to the year with strong organic growth, operating leverage and cash flow as well as capital deployment. Revenue grew 7% to $1.29 billion with organic growth coming in at 6%. EBITDA improved 13% to $438 million, and margins expanded 170 basis points to 34%. Importantly, we saw margin expansion across all 4 segments, which indicates the breadth of the strength of the quarter. Free cash flow improved 15% to $312 million or 24% of revenue. It's always great to see the expansion down the P&L.

[Rob Crisci:]

Thanks, Neil, and good morning, everyone. Turning to the income statement metric page. Revenue grew 7%, 6% organically, as Neil mentioned, to $1.288 billion. We had our 3 largest segments, each grew organically between 6% and 9%. Our smallest segment, Process Technologies, grew 1%, which did exceed our expectations for the quarter. Gross margin expanded 50 basis points to 63% as we continue to benefit from our increased mix of high-margin software businesses. So we are very well positioned should any macro headwinds build around tariffs and material cost inflation or anything that's like that, really would have minimal impact for Roper as they have historically had very minimal impact. EBITDA grew 13% with EBITDA margin expanding to 34%. We really had very high leverage in the quarter aided by a couple of items

[Neil Hunn:]

Thanks, Rob. If we can turn now to Page 11 where we're summarizing our new segments. Earlier in the quarter, we did announce the new segments. To remind everyone, our resegmentation process was not a portfolio or a business review. Also, the resegmentation does not have anything to do with how we run or operate our governance model but rather how we summarize the activities of our 45 businesses in a manner that is more easily understood by investors and is more consistent with our strategy. So to this end, we chose to resegment based on a business model construct versus end market.

[Operator:]

We'll take our first question from Deane Dray with RBC Capital Markets.

[Deane Dray:]

I wanted, just to start off with a comment that we appreciate all the hard work that went into that the resegmentation. And as promised, this recasting just makes a lot of sense since it's easier to see and explain the portfolio, so thank you for all, getting that to the finish line. And on Foundry, just your comments this morning. Just to let you know, you had me at Game of Thrones, so that actually worked for us. So first question is on Deltek. And it was interesting that you recently had a big database software cloud provider actually call out Deltek as an opportunity for them. Our experience is has been with good businesses with attractive margins. It can attract new competitors, but what do you make of this? And maybe some comments about the moat that Deltek has? And how you expect this to play out?

[Neil Hunn:]

Yes. I appreciate the question. We read the same comments. There's a series of companies that were listed, so we'll talk specifically about Deltek. I can't comment at all about the other companies that were listed. And we certainly highlighted a number of those when we went through the, our SaaS strategy with Deltek. But I think, perhaps the most important thing to start with is that not just Deltek but all of our businesses are in niches and have very specific built-for-purpose software aimed at a specific user. And so if you think about Deltek, government contracting, right? it is a, we are the ax in that space from a software perspective. Virtually every large enterprise uses our software because of, it does what it does so well, you don't have to customize it or tweak it or tune it. It's both on-premise and in the cloud. And then you have a considerable amount of R&D resources that are just 100% focused on making that product better. Same thing can be said for the professional services end market. Deltek does not attack professional services broadly. They attack architects, they attack engineering firms, they attack marketing services firms, accounting firms, so very targeted. And the way those businesses run their business are not just generic to professional services. And so you buy our software out of the box, and a normal marketing services firm can actually deploy without any customizations at all in any way, shape or form where the larger places, you have to go through a SI layer and do sort of customizations, then you have to worry about upgradability of those and whatnot. So the core of what we do is preferred by our customers and that seen time and time again with win the rates is an excess of 50% when you go head to head for net new opportunities against the larger players. And then from a code-based, tech stack cloud strategy, I think we're as current as anybody can be in that business.

[Deane Dray:]

That's all really helpful. Appreciate it. And then just as a follow-up, can you clarify what the drivers are on the boost to the low end of organic revenue growth for the year.

[Rob Crisci:]

Yes. Sure. Good morning. This is Rob. I think overall, we certainly had some outperformance in the first quarter. And I think if we look at all of our segments, we see, sort of, at least as good as originally planned or a little bit better. I think specifically in the Process Technologies segment, which is the smallest segment, we upped our outlook there where we're not seeing sort of a downside as bad as we thought coming in. And so we're just up the bottom of the range a little bit. I'd say, overall, a little bit of outperformance everywhere and a little bit of a better outlook everywhere.

[Operator:]

And we'll take our next question from Christopher Glynn with Oppenheimer.

[Christopher Glynn:]

So some of the businesses you acquire are -- lots of them always interesting to think about the network effect. Clearly, Foundry seems prohibitive of competitive risk. I'm wondering particularly with the network segment if any of these stronger results are kind of kicking into a higher gear, potentially you're accelerating a network effect breakout. And I'll anchor the question around MHA, and iTrade maybe suggest that dynamic.

[Laurence Hunn:]

So I'll start broadly, and then try to get specific to iTrade and MHA. So I would not characterize that -- It's like this breakout of networks, right? I -- Yes, we've seen that consistently at DAT. It's truly a two-sided network where both sides incrementally gain more value as the size of network improves. ConstructConnect, iTrade, for example, is what we'll call one-sided networks where we need sort of the anchor tenants. In ConstructConnect, which is the general contractors, and then -- In iTrade, the retailers to be in the network. And then it drives supply chain efficiency through. So we've seen just good solid execution across those businesses. So it's not -- it has a network effect but it's not one where -- it's driven because of the execution of the software and the sales and the distribution capabilities of the business. On MHA, this is a group purchasing organization. They've continually done a great job of retaining their customers, adding customers, adding new products to the portfolio that our providers -- health care providers can buy. And then there's what we call compliance activities, both Rob and I called it out. This is where you're just constantly monitoring and make sure that both sides of the network pay what they need to pay the network. And there's a large amount of that activity in the quarter, so it's nice to see that.

[Operator:]

And with JPMorgan, we'll hear from Steve Tusa.

[Pat Baumann:]

Hi guys. Thanks for taking my question. This is actually Pat Baumann for Steve Tusa. Quick follow up to Deane's question on the bridge on your organic raise. Can you bridge us on the EPS raise for the year as well to $0.65 at the midpoint?

[Rob Crisci:]

Sure. So the $0.41 discrete tax item we mentioned, if you look at M&A, we've got around $0.07 or so net of incremental M&A. While we had the -- call it around $0.14 for Foundry, as Neil mentioned, we lost $0.02 or $0.03 from the Imaging transaction closing sooner than expected. That actually hit in the first quarter, and then there's around $0.05 for the Gatan shipments, so they're slipping to the period where we don't expect to own the business anymore. So if you net all of that together, you get $0.07. And then the remainder, $0.17 or so, that's your, sort of, just better operations, better operations, better margins and better organic growth throughout the portfolio.

[Pat Baumann:]

Got you. That's really helpful. And then maybe circling back to, a lot of, obviously, commentary on Deltek given the comments from that large company. You said it was up high single digit organically in the quarter. Just wanted to kind of step back. And if you could offer some perspective on how is that business grown organically since you bought it back in 2016? I think you were kind of alluding to a high single-digit type growth rate but just wanted to confirm that. And then on...

[Neil Hunn:]

No. That's right.

[Rob Crisci:]

Yes, it's been high single-digit organic since we bought it, which is better than we expected. We expected mid-single.

[Neil Hunn:]

Yes. And I, we highlighted that when we talked about, the Deltek SaaS migration has resulted in that high single digit growth since we've owned it.

[Pat Baumann:]

Yes. Yes. And then also just wondering have you guys done any deals there since acquiring it? Just curious what kind of deals you've done to try to bolster the business if at all.

[Neil Hunn:]

There's been a couple of bolt-ons. Now the high single digit we talked about is organic, right, so the growth there is not...

[Rob Crisci:]

It's quite a bit higher if you include the M&A that we've done.

[Neil Hunn:]

Exactly.

[Rob Crisci:]

We've done several acquisitions also that add to that business.

[Neil Hunn:]

Small tuck-ins generally characterized as products that can be sold to the existing customer base. We've talked about ConceptShare and Workbook in the past to name a couple.

[Pat Baumann:]

So what is the revenue base now if you don't mind sharing some color on that?

[Rob Crisci:]

We don't like to give exact revenue numbers on our businesses, but I think we said it would be $550 million. The first year we owned it, it's way over $100 million on top of that $550 million.

[Operator:]

Next is Julian Mitchell with Barclays.

[Lee Sandquist:]

This is Lee Sandquist on for Julian. You highlighted double digit SaaS growth in application software. How big is the SaaS business today? And secondly, could you just provide a little bit of color about the margin differential here versus other software models in your own portfolio?

[Neil Hunn:]

So I'll take the first part of this then let Rob follow-up. So we talked about the double-digit SaaS at Deltek. I just, I want to be clear in our commentary there, that's not a broad Roper statement. And I'll let Rob talk about the percentage of the total revenue of Roper that's software and SaaS.

[Rob Crisci:]

Yes. I mean where we sit today of the software revenue is pretty evenly split from a SaaS subscription model and a license on-prem model, and that's been moving more towards SaaS and we expect that to continue. But as we sit here today, the business models are roughly the same, about even. And then as we've talked about in the past, EBITDA, software EBITDA for Roper is an excess of 50% at this point in time.

[Lee Sandquist:]

Okay. And then compressor controls has put together several nice quarters in a row now. How far below peak are we? And then secondly, how large is the LNG exposure since you called it out in that business?

[Rob Crisci:]

Yes. So compressor controls is historically a late-cycle business, so it just bottomed out later than the rest of the oil and gas businesses, and it has begun growing since sometime late last year. And I think it's an opportunity there with a lot of, Neil mentioned there's a lot of LNG opportunities out there that we expect to get our fair share of. So this business is the size that is roughly 20% of our Process Technologies segment, so I think those upsides, sort of tailwind opportunities that are exciting. But again, it's a recently small part of the overall Roper portfolio and a small part of the segment.

[Neil Hunn:]

Yes. And I would add. It's obviously highly indexed LNG, it's what they do. But it's not just tied to new. I mean there's a lot of retrofit Brownfield activity as well that they consistently add channel capacity to identify and the capability to drive upgrades there.

[Operator:]

And we'll hear from Robert McCarthy with Stephens.

[Robert McCarthy:]

Hi. This is Robert McCarthy on for Robert McCarthy. How are you today?

[Rob Crisci:]

Thank you for joining us.

[Robert McCarthy:]

Well I think a lot of people were tapped in and across a lot of land lines right now, also bunch of different calls. So one thing I wanted to catch up on in all seriousness is -- and I apologize if I missed this in your prepared remarks. What is the update you can provide with respect to Gatan and the potential divestiture there?

[Laurence Hunn:]

So the update is, as we talked about, it's in our guidance through the end of the second quarter. We're in, along with Thermo, we've been working through the regulatory process with the U.K. CMA. And we're hopeful that concludes here at the end of the second quarter.

[Robert McCarthy:]

Okay. So you're still confident that this can be done?

[Laurence Hunn:]

Certainly. There's lots of resources working on clearing the CMA objections.

[Robert McCarthy:]

Okay. Thank you for that color. And then maybe you could talk about -- I think you mentioned -- Is it Harold Flynn?

[Laurence Hunn:]

Yes.

[Robert McCarthy:]

Yes. Maybe you could just amplify kind of what he's going to bring to the table and talk about his background, his experience and what you're really looking for? Two or three key things that you think that's really going to help you kind of use him to enhance the governance and kind of coaching across the platform.

[Laurence Hunn:]

Sure. So first, what is the role of the Group Executive here, right? The role is to help coach both the company's to become great and achieve greatness and help the leaders in the businesses become great leaders, right? And we think about that across many dimensions, but 3 principal ones are how do you develop strategy? We want that to be very much outside in and focus on answering 2 questions

[Robert McCarthy:]

If I can just sneak one more in since I showed up in person. Maybe you could just talk about level setting our expectations for more acquisitions in terms of firepower, opportunity set? And maybe if you could comment on the pricing of assets in the competitive environment.

[Laurence Hunn:]

Okay. So as Rob and I both mentioned, Foundry is just the beginning. We have a very strong balance sheet. We've worked hard to get the balance sheet to be offensively positioned, which it clearly is, and so we're, we feel great about that. The pipeline, we said it now for several quarters, it's very robust. The quality of the assets is quite high. As you know, we're always trying to buy things that are a little bit better than what we are. It's been the hallmark of our strategy for a long period of time. So relative to the pricing, with the assets we want, the things that have all the defensive characteristics and network characteristics, great management teams, the negative net working cash flow, mid- to high single-digit organic growers, low capital intensity, those assets are not inexpensive. But in our CRI orientation, there's always value to be gained by our shareholders by deploying capital against those type of assets. So we feel very good about it. We feel very confident about our future here for that type of plan.

[Rob Crisci:]

And on the balance sheet, I think we both mentioned in our comments earlier that the balance sheet is very well positioned, so in the low 2s from a net debt-to-EBITDA standpoint, we're obviously deeply committed to investment grade, but we also have TTM EBITDA approaching $2 billion. So we also have $700 million that would come in as the Gatan deal closes. So with or without that $700 million, we could easily deploy $1.5 billion or more on M&A whenever the opportunity arises.

[Neil Hunn:]

Yes. And from a competitive situation, I would say it's largely unchanged. If there is a super strategic that's going to bear a lot of synergies, we are not and have never been a viable competitor for that target. We're almost always the feedstock of candidate targets for us. It principally come out of private equity. And then at the finish line, we're normally competing against private equity. And so in the asset that we described where the management teams are builders and growers and are attracted to our model, we tend to compete and win at a very high clip when all the things line up.

[Robert McCarthy:]

Congrats on the quarter.

[Operator:]

And we'll hear from Joe Giordano with Cowen and Company.

[Joe Giordano:]

So I think when you announced Foundry, when you go through the financials of it, it clearly fits the profile, but I think there was at least some thought of, okay, now we're getting into Pixar and some things that we're not used to. Can you maybe just talk about how you guys conceptualize these things internally? As, there almost seems like there is no bridge that's too far when you're looking at it strictly from a financial standpoint, but how do you get comfortable with key man risk at those individual businesses and your ability to be able to run those businesses in that kind of framework, things like that.

[Neil Hunn:]

Sure. So I might have misunderstood a part of that question, but I'll just, I'll clarify so it's on the record. So it's not a bridge too far financially. So these are always...

[Joe Giordano:]

No. Definitely not. It's definitely not. It's not just financial.

[Neil Hunn:]

Okay. Now I understand. So we'll go through our process, right. So the processes is does it meet our CRI thresholds, yes or no? This one clearly does. Then it's about does the management team, are they going to really thrive in our environment? And an easy simple way to think about that is are they fundamentally about, intrinsically motivated about building their business? So when engaged with this team, which we are able to do a couple of times before the process started, it's very clear that this team is completely passionate about what they do. They've been doing it for a very long period of time. The technology officers in this business actually have personal awards for what they've done in this animation sort of compositing space. And so they are built-for-purpose for this business. Then we get into is it a business we like and that's, is it in a niche? Is it a leader, network effects, all the things we've been through many, many times. And so one of the things we did as a team think through is, hey, it's meeting all these criteria, but is it -- does it do something that's sort of sexy? And do we not like it because of that? And at the end of the day, because it meet -- met all their criteria so perfectly, we're like, "Hey it's a software business at the end of the day." And what they do is they do things that you can see on HBO and other places unlike things, the other things in Roper. But it's really, at the end of the day, a pretty boring software business.

[Joe Giordano:]

Is there maybe -- if I ask that a different way, without naming anything specific obviously, are there examples that you could tell us of companies that have met the financial criteria? But when you guys get in the room, you're like, Do we really even understand what's going on here at this business and maybe we're not the right owners?

[Laurence Hunn:]

All the time, right? And so we see scores of our amazing CRI businesses, and then when we start doing the work, I would say the number 1 reason we walk away if it meets our financial criteria is just the management team. For one reason or another, they're not just about builders, so there's not good chemistry or worry that they're going to leave in a short period of time. And then if you're still comfortable there, if there's a product that we're worried about, could there be -- if there's -- if we view there's any sort of 0 in the Monte Carlo analysis, then we generally are walking away, right? Being long-term owners, we don't want to onboard any of that risk. So we spend a lot of time around that.

[Rob Crisci:]

And if we don't yet know the industry well, we do a ton of work around the industry with outside consultants, and there's a lot, a lot of work that goes on. There's many readouts. And if anything scares us away, we just say no, and we walk away. And that happens all the time.

[Operator:]

And we'll next hear from Joshua Aguilar from Morningstar.

[Joshua Aguilar:]

Hey guys. Can you hear me?

[Laurence Hunn:]

Yes good morning.

[Joshua Aguilar:]

Hey. How are you doing? Hey. We were -- So I wanted to go back a little bit to the annual contract value because I think you recently said at a conference that you've been reporting 50% higher annual contract values in ConstructConnect in just the first year and 1.5 years of ownership alone. And so some of the internal debate we had was really around was this more to -- maybe perhaps they were underpricing their product at that time? Or were you looking to the cover of the cost of the purchase sooner? Or where would you push back on the -- somebody who would insert something like that?

[Laurence Hunn:]

Yes. So I appreciate the question on ConstructConnect. So I think we talked about a couple of times in the past, ConstructConnect, again to set the context is our network that connects general contractors and subcontractors to building product manufacturers in its large network. And the strategy since we've owned this business since the fourth quarter of '16 has been to basically drive habitualization of the core product to the contractor community. And to do that, we had to actually build, and we've work to do this, a number of software elements that go on top of and interlink with the contents that we have. And so the increase in revenue per user at ConstructConnect are early gains of our new product launches because we just have more value to sell is what it is. So it's not the construct, like you said, that try to cover our purchase price or anything like that. It's just the continuation of the strategy and the commitment we have to the long-term ownership of the assets.

[Joshua Aguilar:]

Great. Thanks for that. And then I guess a little bit on TransCore. You were talking about that being more of a nationally interoperable solution coming online this year. Is -- how's -- what's the progress there? And maybe you can give me a little bit of insight there if that's okay.

[Laurence Hunn:]

I think it's quite good. I think that's a -- that can reflect in the recent wins we've had and the tolling projects that are ongoing. It's been good execution by the team.

[Joshua Aguilar:]

And last one for me, sorry about that. In terms of just the organic growth guidance, is that just a function of the lower end of process solutions, sorry, Yes, process solutions just kind of moving up? Or is there something else there that I should be looking at in terms of the segments?

[Rob Crisci:]

Yes. I think it's a combination of that and the combination of the outperformance in the first quarter, building that into the full year numbers. Maybe a little bit net, more good guys than bad guys if you look everywhere else. But that's the majority of it.

[Operator:]

We'll next hear from Alex Blanton with Clear Harbor Asset Management.

[Alex Blanton:]

What was the dollar amount you paid for Foundry? You could give it in pounds, but I want to know what it was in dollars.

[Rob Crisci:]

Yes. If converted to $530 million or so in dollars. $535 million in dollars.

[Alex Blanton:]

$535 million. Okay. And on compressor controls, you mentioned that it's well below the peak. Is that right?

[Rob Crisci:]

Certainly, if you look at the performance of the business over the past several years, they're just sort of on the way back up given the fact there was no new construction for several quarters, and now the new construction business is starting to come back. As Neil mentioned, they've done well in retrofits and Brownfield activity and doing a great job of covering their install-base and doing a lot of great things for customers. But the new construction projects are just now starting to ramp up with LNG taking the lead.

[Alex Blanton:]

How much is that of the total? When that, When you acquired that business in 1992, most, almost all the business was retrofit because none of the OEMs were using software. People would buy the compressors using the OEM software, and then they would retrofit it with CCC. So, But it sounds to me like that has changed and that you're getting a lot of business now with the OEMs delivering your software with their compressors. Is that the case?

[Neil Hunn:]

Yes. So Alex, I would say that the team over many years has built, it's an incredible capability of getting into this feed and getting this getting prefeed and really speccing projects very, very, very early. It's, as you know, it's a multiple year process to get spec'd in these new projects. It's a true core capability of that business now.

[Alex Blanton:]

And what percentage is pipeline? You used to do a lot of business on gas pipelines. In fact…

[Rob Crisci:]

It's, Yes. It's a pretty small percentage. I don't have the exact number, but it's pretty small.

[Alex Blanton:]

Because when you acquired the business, the first huge contract you got was to equip Gazprom pipeline with your stuff. So that's pretty small now in relation to the total?

[Rob Crisci:]

Yes.

[Operator:]

And we'll end our question-and-answer session for this call. We now return back to Zack Moxcey for closing remarks.

[Zack Moxcey:]

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

[Operator:]

This concludes today's conference. Thank you for participation, you may now disconnect.