Earnings Call Transcript - ROP Q4 2022

Zack Moxcey, Vice President, Investor Relations

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 Hunn, President and CEO

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 the 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 to 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 you've 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 Conley, Incoming Executive Vice President and CFO

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. 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. 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 the 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 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 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 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 DEPS 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. 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 non-repeating 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 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 Hunn, President and CEO

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 Plan, 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 to 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 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 to 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 to 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 of 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 the 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.

Operator, Operator

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

Deane Dray, Analyst

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

Robert Crisci, Executive Vice President and CFO

Thank you, Deane. I appreciate it. It's been a great decade.

Deane Dray, Analyst

It's fantastic. Jason, you've participated in every one of our calls for the past 16 years, so we definitely recognize your experience. Congratulations on the new role.

Jason Conley, Incoming Executive Vice President and CFO

Thanks, Deane. Appreciate it.

Deane Dray, Analyst

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 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, President and CEO

Yes. At a high level, we've seen organic growth of 8% to 10%. However, we're guiding slightly below that for 2023. This is reflected in our guidance model. In our Software businesses, we anticipate retention rates to remain very high due to the importance and necessity of our applications. While we expect our software businesses to grow, customer expansion activities and new customer additions may slow down a bit due to macroeconomic pressures. Our end markets are generally less affected by economic fluctuations, although there may be some slowdowns in our transportation business. On the positive side, we believe ConstructConnect will perform well in a slower economic environment, and our medical product businesses should benefit as hospital staffing levels improve and patient volume increases. Additionally, Neptune has a large backlog that will support its operations throughout much of this year. We are reasonably well positioned, although we are not entirely immune to macroeconomic changes.

Deane Dray, Analyst

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, Executive Vice President and CFO

Yes, Deane, that's a great question. I believe you're absolutely correct. Typically, our conversion from EBITDA to free cash flow is usually in the 90s, but when we adjust for Section 174, it falls into the 80s. Frontline has a notably seasonal pattern in cash collection, with the bulk of their cash coming in during the third quarter when renewals and upsells occur. Therefore, you won't see that cash conversion from EBITDA in the fourth quarter, which explains what you observed. We are optimistic about next year, especially anticipating a stronger third quarter than usual.

Deane Dray, Analyst

That’s great. That’s exactly what we’re looking for. Thanks.

Operator, Operator

Our next question today comes from Scott Davis of Melius Research. Please go ahead.

Scott Davis, Analyst

Good morning, everyone. Congratulations, Rob, and good luck, Jason. I wish you all the best, Jason, as you have a few more years to work with Neil. Good luck.

Jason Conley, Incoming Executive Vice President and CFO

Fair enough.

Neil Hunn, President and CEO

Thank you.

Scott Davis, Analyst

I can say that I guess. But anyway, I don't want to delve into details here, though I know there's no single asset that significantly impacts the results. Can we revisit PowerPlan? I think you mentioned the narrower product focus, which I didn't completely understand. How relevant is the cloud rollout to the business? Maybe if we could go back, could you explain again what drives PowerPlan? I'll leave it at that.

Neil Hunn, President and CEO

I appreciate the chance to discuss our businesses, and it's been some time since we explored PowerPlan in detail. PowerPlan offers software and services that connect the financial system with the asset tracking system for large utilities, including both investor-owned and public utilities. The PowerPlan software provides a well-organized view of the assets within our customer base. This view is essential because the assets are continually updated and not static. This dual-system approach allows us to ensure optimal tax treatment, lease accounting, and other financial benefits. Upon acquiring the business, we found that while it was serving its core customers effectively, it was also attempting to grow in areas that weren't aligned with its strengths. Our strategic assessment conducted about a year to a year and a half ago revealed that significant opportunities existed within its core services to drive growth for many years. Hence, we focused on refining that core business, a strategy we are applying throughout Roper. As a result, PowerPlan has recently launched a fully SaaS solution for its primary product, fixed assets, in the fourth quarter. We are enthusiastic about this transition since moving our customers from on-premise to a cloud solution presents significant value capture potential and will foster growth for the business.

Scott Davis, Analyst

And can you get pricing in the process? Or is this just more about retention?

Neil Hunn, President and CEO

No, that's the value unlock, right? So we're doing more for our customers with the SaaS solution, right? So we're not just hosting it. There's more features. You're on the latest release, where certainly, we know how to operate our software ourselves better than third parties. And so it's the efficiency and the uptime is higher. And as a result of all that, you do get price. We'll see we talked about there's roughly $900 million in legacy on-premise maintenance in our revenue base. And as that is lifting and shifting to the cloud over a long arc of time, that should lift and shift north of 2 times, right? So there's $1 billion of growth that's latent inside the portfolio as we lift and shift that on-premise maintenance to the cloud.

Scott Davis, Analyst

Okay. I look forward to the Analyst Day. I'm going to pass it on. Thanks, guys. Congrats on another good year. See you on Analyst Day.

Operator, Operator

And our next question today comes from Julian Mitchell at Barclays.

Julian Mitchell, Analyst

Hi, good morning. Thank you, Rob. And I look forward to working with you, Jason. So maybe my first question, just to try and home in a little bit more on the sort of macro framework in the guide. Maybe specifically, I think about 25% of your Software revenue is recurring and non-recurring, so maybe more cyclical kind of talk. Maybe just remind us sort of what the organic growth of those two in aggregate was last year and what you're dialing in for 2023 or any flavor of that? And then within Network Software specifically, transport and freight, it's almost 1.25 of the revenue. And you mentioned you're dialing in, I think, normalization was your phrase. Maybe just any finer point on what that means exactly of growth this year versus last?

Neil Hunn, President and CEO

Yes. Let me address those points in order. First, I'll explain the difference between recurring and reoccurring revenue. Then, Jason will discuss the growth rates, and finally, we'll address your question about DAT freight. To clarify, recurring revenue refers to subscription-based or contractual income, while reoccurring revenue is mostly seen in our MHA business, where we receive a percentage of the drug and food expenses that go to the network. This is not strictly recurring but tends to happen frequently. It’s one of the most stable aspects of our portfolio, particularly in long-term care and healthcare settings where residents and facilities are consistently consuming food and pharmaceuticals. This revenue is quite secure and not as affected by broader economic conditions. I’ll now hand it over to Jason to discuss the growth rate.

Jason Conley, Incoming Executive Vice President and CFO

Yes, I'm happy to clarify. MHA, as Neil mentioned, primarily involves drug purchases from pharmacies, and customer retention in these businesses is very strong. We generally consider the business to be around the lower end of mid-single digits or possibly low singles. This aligns with our experience this year and our expectations for next year.

Neil Hunn, President and CEO

Great. Now let's discuss your freight and logistics concerning DAT specifically. There is a notable tension between the cyclical freight dynamics and a long-term benefit that DAT and its customers are experiencing as the spot market becomes a more efficient platform for placing freight. From a cyclical perspective, we anticipated and have observed a slight reduction on the carrier side of the network, and we expect this to continue shrinking somewhat over the year. DAT had growth during the freight recession of 2019 and has grown every year since 2010. Therefore, the conversation around DAT is more about the growth rate rather than whether it expands or contracts, as it tends to be quite stable. As an initial observation, January appears to be slightly better, with the number of carriers in the network remaining flat and not declining. Industry analysts who predict freight timing and potential recessions are observing a buildup for a significant spring shipping season, largely driven by produce, and we may be beginning to see some early signs of this, but we will have to wait and see how the next few quarters develop.

Julian Mitchell, Analyst

That's very helpful. Thank you for the color. And then just within TEP, I understand the recurring piece is minimal there in its 99% product-related. Any flavor you give us on the sort of what you're seeing in medical versus Neptune for 2023, any major difference in kind of visibility between the two or the growth rate expected?

Neil Hunn, President and CEO

Yes, we have greater visibility at Neptune than ever before. The order volume continues to come in, and the duration of those orders is increasing. We feel confident about how 2023 is shaping up for Neptune. In terms of medical products, as we mentioned a few quarters ago, the recurring elements from Verathon have become the largest revenue source. There is significant demand for consumables associated with the capital equipment. Northern Digital also has a substantial amount of consumables tied to that segment, which is driven by procedures and patient needs. As I mentioned earlier, we believe we are fairly well positioned, although it's not part of our base case. In 2022, we experienced declines of 6% to 8% in patient volumes in the areas we service, primarily due to hospital staffing issues. We are cautiously optimistic that as the labor market improves, hospitals will be able to staff adequately and return patient volumes to previous levels.

Julian Mitchell, Analyst

Great. Thank you.

Operator, Operator

Our next question today comes from Steve Tusa at JPMorgan. Please go ahead.

Steve Tusa, Analyst

Good morning. Congrats to all. Rob and Jason, I'm looking forward to working with you. Just on the free cash, you mentioned plus or minus 80% conversion to EBITDA. Obviously, the last couple of years have been a bit volatile around all these tax items. But in '21, I think you had a decent number of deferred revenue benefit on the cash flow statement. Maybe just give us a little bit of color looking into next year with concerns around the macro that can be a pretty big variable. I mean are you going to be around that 80% in '23? Or will you be kind of more in between what you did in '21 and '22, I think, adjusted around 70%? Maybe just a bit of color on the free cash, and then I have a follow-up on Frontline.

Jason Conley, Incoming Executive Vice President and CFO

Yes, I'm happy to share. We are feeling very positive about the 80%. Our deferred revenue and renewals were particularly strong this quarter, and we are pleased with the sequential growth and year-over-year increase. Based on feedback from our businesses, we are optimistic about the renewals. Additionally, we anticipate improvements in our inventory ratios next year. We did see some build at the end of this year, and Frontline will certainly contribute positively to our negative working capital profile, which is currently at negative 40%. Most of that impact will occur in the third quarter when all the renewals are finalized. If Section 174 is repealed, it would be a remarkable year for us, but we are not counting on that for the time being.

Steve Tusa, Analyst

So like something in the $1.8 billion range for free cash for next year?

Jason Conley, Incoming Executive Vice President and CFO

I'll let you come to your math on that.

Neil Hunn, President and CEO

Okay. We will.

Steve Tusa, Analyst

And then just Frontline, revenues roughly $95 million this quarter. Is that about right?

Jason Conley, Incoming Executive Vice President and CFO

No. They were somewhere in the '80s. We had a few days knocked off at the beginning of the quarter because we closed on the 4th.

Steve Tusa, Analyst

Okay. By the way, I really appreciate all the discussion on the businesses and looking forward to the Investor Day, learning more on this portfolio. So very helpful detail on the moving parts of all the different businesses.

Operator, Operator

And our next question today comes from Allison Poliniak with Wells Fargo. Please go ahead.

Allison Poliniak, Analyst

Good morning. Just want to circle back on DAT. I know you talked about it growing historically through cycles, but it's certainly been an unusual one. A lot of new entrants here. Is there any risk to the retention rate should that spot rate not hold in terms of stabilization in some of those new entrants, I guess, can't survive? And then I guess along with that, that premium offering, in this type of uncertainty, does that drive maybe more increase or interest in that premium offering versus just to gain some visibility here in an uncertain market? Just any thoughts there?

Neil Hunn, President and CEO

Yes. When talking about new entrants, I assume you mean the new carriers in the network rather than competitive entries, as there are no new competitive entrants. Regarding the carriers, the last couple of years have been remarkable, influenced by the fluidity and liquidity in the spot market, which is a long-term positive trend, combined with significant cyclical growth. Historically, the number of carriers tends to decrease by about 10% from peak to trough during a cycle. We anticipate a more substantial decline in our guidance due to the unprecedented buildup. We believe we have conservatively planned for this in our outlook, but the ramp-up has been extraordinary. We are somewhat encouraged by the carrier count in early January, as the fact that it's relatively stable instead of continuing to decline is a good sign, although we want to see more data points. Regarding the premium offering, DAT has done an excellent job developing products and package designs that offer greater value for all network participants. This has contributed to an increase in average revenue per user, as participants are receiving more value.

Jason Conley, Incoming Executive Vice President and CFO

So different packages, different features and functionality that they've upsold.

Neil Hunn, President and CEO

That's right.

Allison Poliniak, Analyst

Great, that's helpful. In terms of the M&A pipeline, is your primary source of opportunities still the new portfolio focused on private equity? Have you expanded this source? If so, are you considering any additional metrics beyond CRI, which is your foundation, to explore new opportunities? I'd appreciate your thoughts on this.

Neil Hunn, President and CEO

Yes, you're correct. Historically, we have sourced all our opportunities. However, during my tenure, we’ve made one significant acquisition from private equity and one from a small founder, which represent our main focus areas. Nevertheless, that isn't the only scope of our business development. We continue to explore public markets, though we haven't yet identified compelling value there. We may consider entering the cycle earlier, competing more closely with private equity at an earlier stage in a company's life. For instance, after completing the Vertafore and Frontline transactions, several of our investors questioned why we didn't acquire those companies earlier when they were still with private equity. This is something we might pursue in appropriate circumstances. However, we plan to maintain our dominant strategy, which has served us well for the last two decades—focusing on lower-risk, highly recurring application software businesses sourced from private equity.

Allison Poliniak, Analyst

Great. Thank you.

Operator, Operator

And our next question today comes from Brent Hewitt with Wolfe Research. Please go ahead.

Brent Hewitt, Analyst

Hi, thank you. And good morning. You noted that your adjusted EPS calculation will include the fair value accounting and tax impact of Indicor. But why would you not include the minority interest contribution as well? Just wondering what is the logical downside not including that, shouldn't it be a positive and growing contribution?

Jason Conley, Incoming Executive Vice President and CFO

Well, it's a calculation that's going to be based on many variables. It's mainly an accounting exercise. We don't think that it's going to be meaningful until we reach the exit, as we believe that will provide a better reflection of the expected economics. We feel really confident about what that will look like. We've partnered with CD&R on a strategy regarding this. They typically assess several multiples of return on investment, and that's our objective for the exit.

Brent Hewitt, Analyst

Okay. Great. That's helpful. And then in terms of price contribution in Q4, what did that look like? And then also how much pricing is embedded in your 2023 guidance?

Neil Hunn, President and CEO

So price for us, I mean, it's an important lever to our growth algorithm, not just for '22 and '23, but all prior years and all forward years. Teasing out specifically how much is price is a very, very difficult thing across our 27 companies and rolling it up to a number that is meaningful. And so we're not going to share a specific number in that regard. I'll tell you the pricing, the value capture that we have, given what we do, the criticality of what we do, we've always had pricing power and pricing value capture, and there's nothing different with that. Do you want to add anything to that, Jason? Perhaps, we go to the next question?

Operator, Operator

Our next question today comes from Brendan Luke with Bernstein. Please go ahead.

Brendan Luke, Analyst

Good morning. Just wanted to take a quick look at macro, question here. I was wondering if you could offer any color on your exposure to construction end markets? And how that's playing into your growth expectations for FY '23. And I guess, specifically, I'd be curious around Deltek, ConstructConnect, and Neptune as well.

Neil Hunn, President and CEO

I appreciate the opportunity to discuss this. Let’s break it down into three parts. ConstructConnect has an extensive database of all commercial construction projects in the planning phase across North America. This service experiences countercyclical demand. When there are many new projects, subcontractors and general contractors find it easy to identify their next tasks. However, during times with fewer projects, they rely on ConstructConnect's subscription service to discover upcoming projects they wish to bid on. ConstructConnect has performed moderately well over the years, and we anticipate a strong performance in 2023. For Deltek, it has been a strategic focus, with 60% of its business in government contracting and 40% in the private sector, of which construction is a smaller segment. Our prepared comments noted that the private sector was robust in Q4 for Deltek. However, we do expect some softness in construction for Deltek in 2023, and we have accounted for that in our guidance. Regarding Neptune, we believe it is not tied to the economic cycle. They sell water meters and related technology to municipalities, which typically have budgets for these meters. In times of significant new residential construction, a larger portion of the budget is allocated for new meter installations. When new projects decrease, the total budget remains constant, but municipalities may focus on retrofitting and replacing aging infrastructure instead. This demonstrates a resilient demand for Neptune’s offerings. Additionally, we are confident due to an unprecedented backlog for Neptune in 2023, and we expect it to perform well this year.

Brendan Luke, Analyst

Very useful. Thank you.

Operator, Operator

And our next question today comes from Rob Mason at Baird. Please go ahead.

Rob Mason, Analyst

Good morning, and congratulations to Jason and Rob. I want to focus on the technology-enabled products area. There was a mention that some products did not ship in the quarter and may have been delayed. Could you provide an update on your supply chain situation regarding product availability in your businesses? Additionally, I'm interested in understanding the impact that these deferred shipments might have had in the fourth quarter.

Neil Hunn, President and CEO

Let me set the stage, and then I'll pass it over to Jason. In the TEP segment, we discuss Neptune and the medical process, along with a small group of RF product businesses. The fourth quarter was particularly challenging in terms of supply chain for those RF product businesses. With that said, I'll hand it over to Jason to discuss anything he would like.

Jason Conley, Incoming Executive Vice President and CFO

Yes. It wasn't significant. It was probably in the $5 million to $10 million range, and it was across a number of businesses. So I think we expect the first quarter for TEP to be up a little bit more than the rest of the year because of that and because of some of the easier comps. So maybe low double digits in the first quarter, but that's sort of the range. So, yes, a lot of this is in the rearview. Of course, things do pop up here and there, but we're not hearing as much sort of meaningful impact in the quarters.

Neil Hunn, President and CEO

In general, we are not the only ones experiencing this. However, the supply chain is improving, as Jason mentioned, despite the ongoing chip shortage and related issues. This is a global situation, and we believe the supply chain challenges will ease throughout 2023.

Rob Mason, Analyst

Sure, Neil, you’ve mentioned Neptune several times during the call, along with the gains in market share and the strength of your backlog. Typically, that business doesn't experience significant shifts in share. Could you elaborate on what’s happening there? What actions you've taken, whether they relate to the adoption of ultrasonic technology or the introduction of cellular, or if it's part of a broader initiative at Neptune that’s contributing to this?

Neil Hunn, President and CEO

Neptune has consistently gained market share during my time here, which spans a decade. There are several reasons for this success, starting with their product orientation that ensures existing customers are not left behind with outdated technology. For example, with their proprietary protocols that connect mobile and fixed points, municipalities can use a single fixed point combined with roaming points and some manual reads. Their master data management software can integrate all this data without forcing customers to choose a specific technology. This flexibility is fundamental to their product development. Additionally, their products are designed with a long-term focus on customer needs. Take their large commercial ultrasonic meters, which accurately measure both high and low flow rates. This is crucial for applications, such as in hotels, where water flow can vary significantly at different times of the day. Their ultrasonic meter can handle both low and high flow equally well, while competitors often focus on just one of these for precision. Furthermore, when the battery in their ultrasonic technology needs replacement, it can be easily swapped out, unlike competitors’ products that often require complete meter replacement. These seemingly minor advantages contribute significantly to their long-term market share growth. In 2022, their consistent product availability throughout the year proved beneficial, particularly when some competitors faced lead times of over a year. Neptune's lead times were reduced to about 8 to 12 weeks, allowing them to serve accounts where they had previously lacked presence. This capability has enabled them to capture market share in the short term.

Rob Mason, Analyst

Great. That’s very helpful. Thank you.

Operator, Operator

And our next question today comes from Alex Blanton Clear Harbor Asset Management. Please go ahead.

Alex Blanton, Analyst

Thank you. Good morning. First, I just want to say that I think your format for the slide presentation this time is probably the best ever. And I think you should stick with it. It's really a great presentation.

Neil Hunn, President and CEO

Noted.

Alex Blanton, Analyst

Now most of my questions have been answered, but something came up from one of the other participants regarding the business that accumulates commercial construction plans. And Barry Sternick, who's the CEO of Starwood, was on CNBC yesterday, saying that in his business and across the board really in commercial construction, as interest rates have gone up, people will complete the projects they have, but hold off on starting new ones. And so that's why he's looking for a big drop in commercial construction in the second half of this year because new projects are sliding. Do you see that in your statistics?

Neil Hunn, President and CEO

It's interesting. I can provide information from ConstructConnect, which publishes a quarterly overview of the construction planning landscape. I have not personally reviewed the most recent report yet, so I won't comment on its content, but we can share that with you.

Alex Blanton, Analyst

Okay. Because it would seem that if new construction projects are not being put into implementation, it would show up in those numbers, wouldn't it?

Neil Hunn, President and CEO

So here's the countercyclical nature of that. And so if you have several hundred thousand construction workers, construction, small subcontracting firms, ConstructConnect has tens of thousands of customers. So as those hundreds of thousands are looking for work, it only takes a small percentage of that cohort to become a customer of ours to exhibit countercyclical growth behavior, which is what's happened in every prior slowdown in the history that we've been able to observe with ConstructConnect.

Operator, Operator

And ladies and gentlemen, this concludes our question-and-answer session. We will now return back to Zack Moxcey for any closing remarks.

Zack Moxcey, Vice President, Investor Relations

Thank you, everyone, for joining us today, and we hope to see you all at our Investor Day on March 21 in New York.

Operator, Operator

Thank you. The conference has now concluded. Thank you for attending today's presentation. You may now disconnect your lines, and have a wonderful day.