Roper Technologies, Inc. (NYSE:ROP) Q4 2022 Earnings Call Transcript

Page 1 of 9

Roper Technologies, Inc. (NYSE:ROP) Q4 2022 Earnings Call Transcript January 27, 2023

Operator: Good morning. The Roper Technologies Conference Call will now begin. Today’s call is being recorded. . I would now like to turn the call over to Zack Moxcey, Vice President, Investor Relations. Please go ahead.

Zack Moxcey: Good morning, and thank you all for joining us as we discuss the fourth quarter and full year financial results for Roper Technologies. Joining me on the call this morning are Neil Hunn, President and Chief Executive Officer; Jason Conley, Incoming Executive Vice President and Chief Financial Officer; Rob Crisci, Executive Vice President and Chief Financial Officer; Brandon Cross, Incoming Vice President and Principal Accounting Officer; 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 please turn to Page 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, in our press release and in our SEC filings. You should listen to today’s call in the context of that information. And now please turn to Page 3. Unless otherwise noted, we will discuss our results and guidance on an adjusted non-GAAP and continuing operations basis. For the fourth quarter, the difference between our GAAP results and adjusted results consists of the following items: amortization of acquisition-related intangible assets; purchase accounting adjustments to commission expense; a legal charge related to the settlement of the Boral versus Verathon patent litigation matter.

The case related to the sale of certain Verathon products from 2004 through 2016, there are no future financial obligations for Verathon related to this matter. Next, transaction-related expenses for completed acquisitions, and lastly, we have adjusted our cash flow statement to exclude the cash taxes paid related to our divestiture activity. GAAP requires these payments to be classified as operating cash flow items even though they are related to divestitures. Reconciliations can be found in our press release and in the appendix of this presentation on our website. And now if you please turn to Page 4, I’ll hand the call over to Neil. After our prepared remarks, we will take questions from our telephone participants. Neil?

Neil Hunn: Thanks, Zack, and good morning, everyone. As we turn to Page 4, we’ll walk through our usual year-end agenda, highlights for the most recent quarter and full year, followed by color commentary for each of our segments and then the initiation of our 2023 guidance. Let’s go and get started. Next slide, please. As we heard on Page 5, the main takeaways for today’s call are First, we delivered another great year of strategic, operational and financial progress. To this end, we concluded our multiyear divestiture program, which was centered on improving the quality of remaining portfolio, namely emphasizing less cyclical, more asset-light and higher-growth businesses. In addition, we successfully deployed $4.3 billion towards market-leading and application-specific software businesses.

More on this later, but we also continue to have substantial M&A firepower well north of $4 billion. Organically, we grew just shy of 10% for the year while simultaneously improving the underlying quality of the enterprise. During the course of the year, our businesses did a terrific job of innovating and capturing share, which leads us to our second main takeaway for today’s call that we’re well positioned for another solid year of performance in 2023. Our higher quality, less cyclical and more highly recurring nature of our portfolio will serve us well during 2023. Now as I hand the call over to our Incoming CFO, Jason Conley, let me take a moment and thank Rob Crisci for all he’s done for Roper and for me. Rob has been a significant contributor to our success and an important member of our executive team with meaningful insights and contributions across a variety of topics, including our most recent portfolio repositioning.

We’re excited to welcome Jason to his new role. Many of you know, Jason, for those of you who do not, Jason has been with Roper for 16 years. He started in corporate IR and FP&A, then the operating CFO at MHA or one of our businesses and most recently serving as Roper’s Chief Accounting Officer. Since he has returned to corporate, he has been a member of our capital allocation team and has attended every Board meeting. The team and I are excited to partner with Jason for the next leg of our evolution. So, with that, looking forward to the partnership, Jason, and thank you, Rob, for all of you done to make Roper better than when you joined. Jason, let me turn the call over to you, can walk through the fourth quarter and the full year financial summary.

Jason?

Jason Conley: Thanks, Neil. I am very excited and incredibly grateful for the opportunity to work with you and the team in this new role. And of course, thanks, Rob, for your awesome partnership and mentorship over the years. It’s been just a great experience working together. So first, I’d like to introduce Brandon Cross as our new Principal Accounting Officer. Brandon joined Roper about five years ago, progressing to our Assistant Controller and more recently, has led and transformed our audit services function. He has significant M&A and integration experience. So this is a natural and well-earned promotion for him. Brandon, I look forward to working together in your new role.

Brandon Cross: Thanks, Jason.

Jason Conley: If you indulge me, I’ll rip on Roper for a few seconds. I’ve been blessed to help guide and execute our evolution from Roper Industries to Roper Technologies, which has been underpinned by our North Star belief that cash is the best measure of performance. And as we enter 2023, our best years are ahead of us. We have a family of market-leading businesses with durable growth drivers and terrific free cash flow margins. Further, the leadership teams and talent processes at our businesses are the best in the company’s history. And finally, we have significant capacity to execute our proven and disciplined M&A strategy that I’ve been a part of for many years. I anticipate being quite active on the road this year. So for those on the call, I look forward to either meeting you or reconnecting in the coming months.

All right. Let’s get into the financials. Turning to Slide 6. We’ll do a quick review of our Q4 performance. We capped off a solid year of growth with revenue of over $1.4 billion, which was 14% higher over prior year. Organic growth was 7% with strength across the portfolio, which was enhanced by 10% software recurring revenue growth. Acquisitions added eight points of growth, led by our Frontline business that closed in early October, and currency was a two-point headwind. EBITDA of $592 million, was up 17% over the prior year. We experienced strong operating leverage across the enterprise and improving gross margins in our TEP segment to finish out the year. DEPS came in at $3.92, which was 17% against prior year and $0.18 above the midpoint of our guidance range.

Next, we’ll look at free cash flow. free cash flow. Free cash flow of $457 million was down 8% over the prior year. Excluding the Section 174 impact, we were down 3%. And factoring out a $30 million Vertafore tax benefit in 2021 that doesn’t repeat, we’re up about 3% to 4% in the quarter. Taking a broader view, you can see we compounded cash 11% over a four-year period, despite the Section 174 headwind, and we’re well positioned for double-digit cash flow compounding going forward. Turning to Slide 7. We’ll now do a quick overview of our Q4 segment results, as Neil will unpack more detail on the full year a bit later. We had a nice finish to a great year across the three segments. For Application Software, revenue was up 22% to $740 million, with organic growth of 7%.

EBITDA margin increased to 45.6% in the quarter. We had strong SaaS bookings growth and overall solid net retention throughout the year, which is just naturally rolling through recurring revenue in the quarter. Growth was broad-based across the segment, aside from some delayed decision-making in the large government contract in space within Deltek. On margin, we had lower incentive-based SG&A and employee medical costs, so some favorability in the quarter. If you look at the full year margin of 44%, that’s about where we would expect to be over a longer horizon. Our Network Software segment grew nicely in the quarter, with revenue up 9% to $350 million and EBITDA also up 9% to $189 million or 54% of revenue. Growth was led by our freight matching businesses, which continued driving higher ARPU from premium offerings to offset moderating carry activity as we expected.

Tech-enabled products revenue was $340 million and grew 5% organically in the quarter. Demand remained strong, and we had some orders that didn’t get delivered toward the end of the quarter, which will benefit Q1. EBITDA grew 7% to $119 million, resulting in EBITDA margin of 34.9% or 100 basis points over prior year, with strong operating leverage as the price cost dynamic was neutralized in the quarter. Turning to the full year 2022 performance on Slide 8. Revenue was 11% higher than prior year to $5.4 billion, with 9% organic growth. EBITDA was 12% better to nearly $2.2 billion, with EBITDA margin coming in at 40.4%. The of $14.28, was 15% over prior year and reflected strong P&L leverage against the 11% revenue growth. Notably, compared to our 2018 pre-divestiture financial profile, our revenue is about $175 million higher, while EBITDA is nearly $365 million higher.

MacBook Pro, Tehnology

Photo by Tianyi Ma on Unsplash

So, through a combination of organic growth and capital deployment, we’ve grown despite divesting about 40% of our 2018 revenue. And most importantly, the composition of our portfolio today positions us for higher and more durable growth going forward. Free cash flow came in at about $1.5 billion, so down 7% versus prior year. It’s a bit of the same situation as our fourth quarter with both the 2022 headwinds of Section 174 of nearly $100 million and the nonrepeating of the 2021 Vertafore tax benefit of $117 million. If we normalize for those items, free cash flow grew about 8%. We’ve had a bit of an inventory build within our tech segment as supply has become more available. This is not a new normal, and we certainly expect that to improve in 2023.

If we kind of take this up to a multiyear view, you can see we’ve compounded cash at 15% over a four-year period. And as we look forward, the impact from Section 174 will be fairly neutral, and we expect to convert plus or minus 80% of flow. So, we’re clearly well positioned for double-digit growth. Turning to Slide 9. Let’s take a look at our financial position. We certainly had a lot going on in Q4. On November 22, we completed the majority sale of our industrial businesses, which are now operating under the name Indicor and received $2.6 billion in upfront proceeds. Also, in the quarter, we paid $270 million, representing all taxes due related to the majority sale. So, this yielded us net proceeds of over $2.3 billion, a very good outcome here indeed.

Related to our stake in Indicor, this is now appearing as an equity investment on our balance sheet. We will be updating the fair value of the equity investment each quarter going forward. To provide a clearer picture of our continuing operations, we will provide a non-GAAP adjustment for this fair value accounting and any tax expense related to this investment. So just looking at our balance sheet, even after our $3.7 billion Frontline acquisition, which was completed in October, our net debt-to-EBITDA ratio stands at 2.7 times. So, our solid leverage profile, coupled with strong free cash flow generation and an undrawn revolver of $3.5 billion, gives us $4 billion plus of M&A capacity. Clearly, we are very well positioned for disciplined capital deployment in 2023.

And with that, I will turn the call back over to Neil to go through our segment details. Neil?

Neil Hunn: Thanks, Jason, and well done. Let’s turn to Page 11 and walk through our 2022 highlights for our Application Software segment. Revenues here were $2.64 billion, up 7% on an organic basis, and EBITDA margins were 44.1%. Performance across this segment was just solid in 2022. Vertafore, our software business that tech enables property and casualty insurance agencies accelerated their growth, led by continued strength in their enterprise class segment. In addition, the two Vertafore bolt-on acquisitions are strategically on point, integrated and performing well. As we’ve been discussing, SaaS migrations have been a key theme for us over the past few years, and 2022 was no different. Both Aderant and Deltek continued their SaaS migration momentum and both grew nicely based on solid customer adds and strong retention.

Deltek was particularly strong in their private sector end markets. But as Jason mentioned, Deltek did see some slower decision-making specific to new bookings in the enterprise segment for their GovCon solutions. At our upcoming March 21 Investor Day, you’ll get an opportunity to hear directly from the leaders at Vertafore, Deltek and Aderant about how they’re competing and consistently winning in the market. As it relates to Power Plant, we liked what we saw last year. PowerPlan was strong given their refocused and narrowed strategy combined with a highly aligned team. As a result, PowerPlan crossed a meaningful milestone, launching a SaaS solution for their flagship product, tax fixed assets. Congrats to the team for a great 2022 and looking forward to more great things in 2023.

2022 is a very good year for application health care IT businesses as well. Strata’s combination with EPSI has just been great. The integration is complete and the number of EPSI, the Strata has conversions and upsell, cross-sell are both meaningfully ahead of our deal expectations. Clinisys and Data Innovations continue to win in the marketplace. The internal combination of Clinisys and Sunquest has rejuvenated and energized their high-performance culture, which is enabling the business to more effectively compete and win in the marketplace. Data Innovations continues to gain share and evolve to become the de facto standard as it relates to Lab Middleware. Finally, Frontline, our cornerstone 2022 acquisition is off to a solid start. We look forward to sharing the strategic and financial success of this business in the quarters and years to come.

I’d like to reiterate with what we started with. Performance here strategically, operationally and financially was just great in 2022. Very proud of the team and the performance. Congrats and thanks. Looking to the outlook for 2023, we expect to see organic growth in the mid-single-digit area based on our market positions and growth in recurring revenues. Turning to Page 12. Revenues in 2022 for our Network Software segment were $1.38 billion, up 13% on an organic basis, and EBITDA margins were strong at 53.3%. As we dig into business-specific performance, our U.S. and Canadian freight matching businesses were great in 2022. Their exceptional growth is based on many factors, certainly favorable market conditions, but also continued product and network innovations as well as terrific product and package designs that drove increased value for the network participants.

iPipeline and iTrade network were stellar performers throughout 2022 and benefited from having strong renewal and expansion activity. iPipeline like that a PowerPlan is benefiting from having a narrowed and more focused strategy, namely tech-enabling the life insurance and annuity distribution network. Moving to Foundry, which had another great year as part of Roper. Foundry continues to be the market-leading software in postproduction media entertainment. During 2022, Foundry’s product innovations were impressive with several new features focused on ML-based automation. Starting in 2023, Foundry’s flagship product Nuke will begin its subscription transition, so looking forward for solid progress on that front. Growth in our businesses that focus on alternate site health care was led by SHP and SoftWriters and importantly, retention rates across SHP, SoftWriters and MHA remained extremely high.

Broadly, the performance across this segment was great. Congrats to the teams for this terrific year of financial performance. Turning to the outlook for 2023. We expect to see mid-single-digit organic growth for this segment based on broad and sustained growth across the group and a normalization of market conditions for freight and logistics applications. As we turn to Page 13, revenues in 2022 for our Tech-enabled Products segment were $1.35 billion, up 10% on an organic basis. EBITDA margins for this segment were 35.4% for the year. As expected, EBITDA margins expanded in the second half of the year as pricing and supply chain improvements flow through. Let’s start with Neptune, our water meter and technology product business. This past year was just terrific with very strong growth based on strong margin conditions, strong share gains and strong adoption of their static ultrasonic meter technology.

In addition, Neptune launched their cellular connectivity solution and did a fantastic job migrating a large chunk of their customer base to their newest data management solution. Spectacular job Neptune, congrats you and your team. Northern Digital, which is our precision measurement tech company, continued to see terrific demand for their optical and EM solutions. NDI benefits from having a strategy that is laser-focused on health care applications and an R&D capability that is unmatched in the industry. NDI’s core tech is using countless life-saving procedures on a daily basis across the globe. Verathon turned in another solid year performance in 2022 as well. The growth is based on momentum across their video innovation and single-use bronchoscope product lines.

As you saw in the press release, we did take the opportunity to clean up a legacy patent dispute. Make no mistake, the innovation capability at Verathon is nothing short of exceptional, and we cannot be more confident about their most recent product launches and the new concepts in the development pipeline. As it relates to the single-use rock space, we hope to see Verathon capture the number one market position in North America in 2023. Our outlook for the year in this segment is in the high single-digit area and is based on continued strength in backlog at Neptune as well as continued growth across our medical product businesses. Specific to the first quarter, we do have easier comps versus a year ago. Now please turn to Page 15, and let’s review our 2023 and Q1 guidance.

For 2023, we’re initiating our DEPS guidance to be in the range of $15.90 and $16.20. Underpinning this guidance is expected organic growth of 5% to 6% and a tax rate in the 21% to 22% area. Specific to the first quarter, we’re establishing our DEPS guidance to be in the $3.80 to $3.84 range. Now please turn with us to our final page, Page 16. As we turn to this page, we want to leave you with the same key points with which we started. First, 2022 was a year of great accomplishment for our teams and our enterprise. We grew revenue 11%, 9% on an organic basis. And we did this while continuing to increase the underlying quality of our revenue base. In fact, we delivered double-digit increases in our Software organic recurring revenue during 2022.

EBITDA grew 12%. Our EBITDA margins expanded 20 basis points to 40.4%. Also, we successfully concluded our multiyear divestiture program and deployed $4.3 billion against our long-standing capital deployment strategy, headlined by Frontline Education. The second key takeaway is that we’re well positioned for double-digit cash flow compounding in 2023 based on our organic revenue growth outlook, contributions from our 2022 acquisition cohort and having well north of $4 billion of M&A capacity. To this end, we continue to be very active in the M&A markets. But as you saw during 2022 and as always, we will remain super patient and highly disciplined to ensure optimal deployment of our available capital. Finally, and perhaps the most important, the new higher quality Roper portfolio is becoming increasingly more evident, and we’ve never been more excited about the future of enterprise.

As we open up to your questions, we’d like to take this opportunity to remind everyone that we’re hosting an Investor Day on Tuesday, March 21, in New York. We look forward to seeing many of you there. So with that, let’s open it up to your questions.

See also 12 Best S&P 500 Dividend Stocks To Buy and 12 Cheap Biotech Stocks To Buy.

Q&A Session

Follow Roper Technologies Inc (NYSE:ROP)

Operator: Today’s first question comes from Deane Dray at RBC Capital Markets. Please go ahead.

Deane Dray: Thank you. Good morning, everyone. Just start with the best wishes to Rob. I remember when he was a starting as a rookie Investor Relations professional and just wish him all the best. Thank you.

Robert Crisci: Thank you, Deane, I appreciate it. It’s been a great decade.

Deane Dray: It’s fabulous. And then, Jason, I think you’ve been on every one of our callbacks for the 16 years. So you’re absolutely — we know exactly who you are and your experience. And so congrats on the new role.

Jason Conley: Thanks, Deane. Appreciated.

Deane Dray: All right. So for a question, maybe we can start with a bit of a macroeconomic sensitivity because you typically, you don’t see much of this within Roper, but just called out the Deltek delayed decision-making, Neil, is there any change in the pace of like new customer adds or the migration, new logos? Anything that you would point to that perhaps there is some economic sensitivity reading through in that kind of the pace of business?

Neil Hunn: Yes. I think the — if I take it at the highest level, we’ve been 8% to 10% organic. The last couple of years, obviously, are guiding a little bit below that for 2023. So I think you see it in our guidance model reading through as a general matter. If you take the Software businesses, our retention rates will stay very high. We expect that as to the intimacy and the criticality of our applications. So retention rates to be very high. But as our customers, I mean, across all these end markets, I mean, if there’s macroeconomic sort of headwinds or slowdown, then they’re going to be affected to some degree, so we expect customer expansion activity maybe a little bit of net new to be slowed a little bit. The Software businesses will be great.

They’ll grow for sure, but a little bit slower. From an end market perspective, we’re in a number of end markets that are generally macro insensitive. There’s a little bit, obviously, in our transportation business is that we called out on the call. That will be a little bit slower. But there’s some hedges inside the portfolio. ConstructConnect should be good in the slower economic environment and also our medical product businesses as staffing levels and hospitals gets a little bit easier. Patient volume should come back and that should help those businesses. And then from a product, Neptune has got a gigantic amount of backlog, which will carry them through much of this year. So we feel pretty well set up. It doesn’t mean that we’re completely insensitive to macro, but relatively insensitive.

Deane Dray: That’s real helpful. And then let’s just switch over to free cash flow and maybe I’ll be accused of quibbling. The $161 million free cash flow conversion is still elite, but it did lag your five-year average. And I know there’s some dynamics here, and you touched on them in the remarks, the Section 174 and the comparison from the tax benefit last year. Anything that on the working capital side or maybe the Frontline contribution because they’re on a different school year, so maybe more of a third quarter collection. But is there any change in the seasonal tilt on free cash flow conversion?

Robert Crisci: Yes, Deane, good question. I think you’re spot on. So we typically convert on — from an EBITDA to free cash flow will be in the 90s typically and Section 174. If we adjust for that, we are in the 80s. And so you’re right. Frontline has a very seasonal sort of cash collection cadence. So the third quarters when all the renewals and upsells happen, so most of their cash comes in the third quarter. So in the fourth, you won’t see that converting to cash from EBITDA. So that’s exactly what you saw. So we’re looking forward to next year and especially in the third quarter will be a little bit more weighted than normal.

Page 1 of 9