Earnings Call Transcript
ROPER TECHNOLOGIES INC (ROP)
Earnings Call Transcript - ROP Q2 2023
Operator, Operator
Good morning. The Roper Technologies Conference Call will now begin. Today's call is being recorded and all participants will be in listen-only mode. I would like to turn the call over to Zack Moxcey, Vice President, Investor Relations. Please go ahead.
Zack Moxcey, Vice President, Investor Relations
Good morning and thank you all for joining us as we discuss the second quarter financial results for Roper Technologies. Joining me on the call this morning are Neil Hunn, President, and Chief Executive Officer; Jason Conley, Executive Vice President, and Chief Financial Officer; Brandon Cross, 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 two. 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 three. Today, we will discuss our results primarily on an adjusted non-GAAP and continuing operations basis. For the second quarter, the difference between our GAAP results and adjusted results consists of the following items: amortization of acquisition-related intangible assets and the financial impacts associated with our minority investment in Indicor. 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 four, I'll hand the call over to Neil. After our prepared remarks, we will take questions from our telephone participants. Neil?
Neil Hunn, President and CEO
Thank you for joining our call. We're excited to share our second quarter results with you this morning, which, similar to Q1, were quite strong. Let's look at today's agenda. I will begin with our second quarter enterprise highlights, then Jason will share our financial results. After that, we will move to our segment-specific discussion and conclude with our updated 2023 enterprise guidance. As we examine the four main takeaways for today: first, we continue to perform exceptionally well and had a very robust second quarter, showcasing the strength of our portfolio. Second, we are raising our full-year guidance for both total and organic revenue growth, as well as adjusted DEPS. Third, we are excited about the potential of Generative AI and will discuss the reasons why. Fourth, we are well positioned for disciplined capital deployment. Regarding our performance, we recorded a 17% growth in total revenue and a 9% increase in organic revenue. Consistent with our long-standing strategy, we are not only scaling our enterprise but also enhancing its quality and recurring revenue base. This quarter's results further affirm that our portfolio, designed to be higher quality and less cyclical, is capable of consistently high performance. With this strong second quarter, we are raising our full-year total revenue growth estimate to around 13%, our organic revenue growth estimate to approximately 7%, and our full-year DEPS guidance to a range of $16.36 to $16.50. In terms of Generative AI, we believe we have a structural advantage and are enthusiastic about this technology since our vertical and application-specific businesses can leverage our specialized market knowledge to deliver customer value and improve productivity. Lastly, we are actively exploring and assessing numerous high-quality opportunities for capital deployment. Jason, I'll now hand the call over to you to discuss our second quarter results and our strong financial position.
Jason Conley, CFO
Thanks, Neil, and I hope everyone is doing well this morning. Turning to slide six, the second quarter was another good quarter in 2023. Revenue came in at $1.53 billion, which was up 17% over the prior year. Organic growth was 9%, which was led by 8% software recurring revenue growth across the enterprise and outsized growth of 19% in our tech-enabled product segment. EBITDA increased 20% to $617 million with EBITDA operating leverage of 46%. Notably, margin expanded across all three segments in the quarter. DEPS of $4.12 was $0.12 above the high end of our guidance range and 20% above the prior year. DEPS growth was in line with EBITDA growth given the offsetting impact of a higher tax rate and lower net interest expense. Moving to free cash flow, as a reminder, the second quarter is always our lowest conversion quarter in the year as we make two federal tax payments. We delivered $295 million of free cash flow in the quarter, which was up 17% over the prior year. As I previously mentioned, Frontline’s cash flow is seasonally weighted to Q3 and Q4, especially in Q3, which is in line with our K-12 customers' annual renewals. So we expect a meaningful increase to cash flow in the second half. Taking a broader view of cash flow on this slide, recall that we acquired Vertafore in 2020 and had a one-time cash tax benefit of $120 million, of which about $60 million benefited the second quarter of 2021. We've therefore had very strong multi-year cash flow performance when normalizing for this 2021 tax item. For the year, we are confident that free cash flow will be greater than 30% of revenue. Turning to our balance sheet on slide seven. Our net leverage sits at 2.2 times at the end of the quarter with about $6.7 billion of debt and just under $1.5 billion of cash against our TTM EBITDA of $2.35 million. Also, our $3.5 billion revolver remains fully undrawn. To summarize, we have significant acquisition capacity and remain quite active in many bespoke processes. In Q3, we expect to close on Replicon, which is a bolt-on acquisition for our Deltek business with a purchase price of $450 million or about $370 million net of a long-term cash tax benefit. Neil will discuss the details around this exciting addition to the Deltek platform in the segment discussion. So with that, I'll turn it back over to Neil to talk about our segment performance and outlook.
Neil Hunn, President and CEO
Thanks, Jason. Let's turn to page nine and walk through our Q2 highlights for our Application Software segment. Revenues here were $770 million, up 6% on an organic basis, and EBITDA margins increased to 43.7% in the quarter. In this segment, we continue to see consistently strong performance across the entire group of companies. We'll start with Deltek. Deltek was once again solid across both our government contracting and private sector businesses. Importantly, Deltek continues to see momentum build with our SaaS offerings and retention rates remain at historically high levels. We announced the acquisition of Replicon for Deltek, Roper’s largest bolt-on to date. Replicon is a market-leading timekeeping and workforce management SaaS solution focused on professional services firms and it's highly complementary to Deltek strategy. We expect Replicon to contribute over $70 million of revenue and $24 million of EBITDA next year, and expect the deal to close during the third quarter. During the quarter, the Washington Post awarded Deltek as the number four top workplace in the D.C. Metro Area for large companies. We believe that talent and culture can create long-term competitive advantage, and this is certainly the case for Deltek. Under Roper's ownership, the company has increased its organic growth rate, retention levels, recurring revenue, and margin structure. A big contributor to that success is the structural talent advantage that Deltek continues to build. Congrats to Mike and to your entire team. Aderant, our software business focused on the needs of law firms continues to perform excellently. In the quarter, Aderant saw record bookings and continued success in the adoption and cross-sell of their SaaS solutions. During the quarter, Aderant launched their Generative AI enabler, MADDI. Today, MADDI is enabling two solutions: outside counsel guidelines management and time entry, with plans to extend this to accounts receivable cash receipt matching and docketing over the coming months. Over time, MADDI will be integrated widely across Aderant’s product platforms. Generative AI for the legal space has tremendous potential. One such example in the market today is Onyx, powered by MADDI, which solves a challenge that law firms face in navigating outside counsel guidelines or the billing requirements that clients impose. It's common for a large law firm to have to navigate hundreds of thousands of custom client billing requirements. Onyx uses Generative AI to extract contractual terms and convert them into business tools used in the time entry and billing processes—a true game changer. More broadly across Roper, we're excited about the potential of Generative AI and large language models. Given our deeply verticalized and application-specific business model, our businesses are structurally advantaged as all AI, computational, and generative technologies require context within dated workflows. Internally, we're working closely with our businesses on the productivity opportunities associated with Generative AI. Certainly, there is much more to come on this.
Jason Conley, CFO
Turning to page 10. Revenues in the quarter for our Network Software segment were $358 million, up 5% on an organic basis, and EBITDA margins were strong at 54.2%. As with our Application Software segment, growth and performance was solid across the segment. Our U.S. and Canadian freight matching businesses, DAT & Loadlink, both grew in the quarter despite continued challenges across the broader freight and logistics markets. Our businesses are critical to the operation and execution of the North American spot freight market. The spot market is a long-term secular beneficiary in terms of the volume of future freight shipments. Throughout and across the freight and economic cycle, DAT & Loadlink continue to innovate and launch products to drive enhanced customer value and share of wallet. DAT is launching a Generative AI enabled solution among other initiatives targeted to combat freight industry fraud. This is in addition to their existing computational AI and data science-driven solutions like DAT iQ, which they have deployed at scale over the last few years. Our network software business, which tech enables the distribution channel for life insurance and annuities, achieved nice ARR gains in the quarter driven by strong retention and customer expansion activity. Foundry continued its strong performance with terrific growth for their flagship product Nuke, which enabled continued double-digit recurring revenue growth. As we mentioned last quarter, Foundry commenced their subscription pricing transition for Nuke, and the first half of the year had over 60% of their new units sold under their new model ahead of their transition plan. Our alternate-site healthcare businesses led by SoftWriters and SHP performed strongly in the quarter, benefited by an improving census in skilled nursing, assisted living facilities, and home health reaching the highest occupancy levels since the pandemic. For the second half of the year, we expect to see mid-single-digit organic growth for this segment.
Neil Hunn, President and CEO
Turning to page 11. Revenues in the quarter for our tech-enabled product segment were $403 million, up 19% on an organic basis. EBITDA margins for this segment were strong at 36.4% for the quarter. Across this segment, business performance and execution were exceptional. Importantly, broad-based supply chain issues continued to ease. Neptune, our water meter and technology product business, continued to perform well, achieving record revenue performance. Neptune sees increasing demand and momentum for their residential and commercial ultrasonic or static meters. We remain bullish about Neptune and its market. Given this market tends to be quite steady, Neptune's customers’ budgets are typically fixed year-to-year and not tied to broader macroeconomic trends. Verathon also performed excellently in the quarter with double-digit order growth and strong operational execution. Specifically, Verathon saw strength across their recurring single-use products, like the Bronchoscope or B-Flex and video innovation or GlideScope. Northern Digital or NDI also performed well, setting revenue records for their business. A group of smaller businesses here, IPA, rf IDEAS, and Inovonics performed fantastically in the quarter as they worked through a series of challenging supply chain issues. For the second half of the year, we expect high-single-digit organic revenue growth. Recall, we have a tough Q3 revenue and margin comparison from the prior year. Now please turn to page 13, and let's review our increased 2023 guidance. Based on our strong second quarter performance, we're raising our full-year 2023 guidance for total revenue, organic revenue, and adjusted DEPS. We now expect total revenue growth to be around 13%, an increase from the previous guidance of 12% plus. Additionally, we're raising our full-year organic revenue outlook to be in the 7% range, an increase from the previous range of 6% to 7% and 5% to 6% in our original guide. As a result of our improved revenue outlook, we're increasing our DEPS guidance to be in the range of $16.36 and $16.50, up from our prior guidance of $16.10 to $16.30. This guidance assumes a tax rate trending towards the upper end of the 21% to 22% range. For the third quarter, we're establishing our DEPS guidance to be in the range of $4.16 and $4.20. Now please turn with us to page 14, and then we'll look forward to answering your questions. We want to leave you with the same four points with which we started. First, the year started strong, and we delivered solid second quarter results, with revenues increasing 17% to $1.53 billion. This growth was underpinned by 9% organic revenue and 8% organic software recurring revenue growth. Additionally, EBITDA margins were strong at 40.3%. Second, based on the strong second quarter performance, the recurring nature of our revenue stream, and the importance of our solutions to our customers, we're increasing our full-year total and organic revenue growth outlook and increasing our full-year DEPS outlook to be between $16.36 and $16.50. Third, we're excited about the potential of Generative AI, both for internal productivity and to provide context for new product development ideas. We look forward to sharing progress in the coming quarters. Lastly, we continue to be active with our capital deployment activities, with over $4 billion of available M&A firepower. We have a large pipeline of opportunities, but as always, we remain patient and highly disciplined to ensure the optimal deployment of our capital. Now let's open it up to your questions.
Operator, Operator
Yes, thank you. We will now move to the question-and-answer segment of the call. The first question comes from Julian Mitchell with Barclays.
Julian Mitchell, Analyst
Hi, good morning. Maybe just the first question around Network Software; you had very strong margin performance, up over 200 points with only mid-single-digit organic growth. I wondered if there was anything driving that, perhaps on mix or any one-time factors? And then also in that division, how are you thinking about second-half growth in DAT & Loadlink versus the first half?
Jason Conley, CFO
Hey, good morning, Julian. It's Jason. Yes, I mean, I think we had strong performance across a lot of the businesses. The standout is our ConstructConnect business. We acquired a bolt-on that we closed last year, and we're realizing the benefits from that deal. Beyond that, it's just solid performance across the segment.
Neil Hunn, President and CEO
Relative to your second question, for the second half for DAT & Loadlink, our freight matching businesses, we continue to be cautious and conservative. DAT performed well, growing high-single-digits, with strong retention rates in the broker and data analytics part of the business. However, as we all know, the carrier side of the market is experiencing changes, which could affect DAT. The wildcard is what happens with Yellow and other market factors. So we'll monitor those developments closely.
Julian Mitchell, Analyst
That's interesting. Thank you. As we look at the second half guidance, you called out the tough comp for Q3. One other thing I wanted to check on is that the guidance implies fourth quarter DEPS doesn't really go up much sequentially. Historically, you've often had a mid-single-digit type EPS increase in Q4. I wondered if that was just conservatism in the forecast this year or if there's anything specific going on?
Jason Conley, CFO
Nothing really specific sequentially. We’ve talked about some seasonal shutdown at Neptune historically, but I wouldn’t point to any conservatism per se. We expect to see networks still performing at mid-single-digits. So there’s nothing unusual there.
Julian Mitchell, Analyst
Great. Thank you.
Neil Hunn, President and CEO
Yes. Thanks.
Jason Conley, CFO
Thanks, Julian.
Operator, Operator
Thank you. The next question comes from Deane Dray with RBC Capital Markets.
Deane Dray, Analyst
Thank you. Good morning, everyone.
Neil Hunn, President and CEO
Good morning.
Jason Conley, CFO
Good morning.
Deane Dray, Analyst
Can we start with just the broad tone of business? There was a reference in the first quarter and at the Analyst Day about slower customer decision-making. The upside in organic side and the outlook this quarter seems to indicate that has improved. Would you measure that in new logos and SaaS conversions? Can you provide some context on that tone of business?
Neil Hunn, President and CEO
I would characterize our software businesses as performing as we expected, anticipating a slowdown. We are seeing delayed decision-making pushing out net new sales, which in turn affects gross retention. Expansion activities with our customers are a bit less as they are cautious looking forward. This situation is not acute in any one of our businesses; it's a trend observed across our portfolio. However, there was very strong demand in some areas like our medical businesses.
Deane Dray, Analyst
That's good to hear. Can we discuss the impact of AI in terms of evaluating M&A candidates? Is there an eye towards the deep domain expertise types of businesses where AI might be a threat? How do you evaluate candidates on this front?
Neil Hunn, President and CEO
It is definitely a consideration today, and computational AI has been on our radar for a few years. Generative AI is newer this year. Fortunately, our M&A strategy aligns well with the strengths of generative AI technologies—verticalized and application-specific targeting with deep customer intimacy. We always apply a conservative lens to our evaluations to ensure that we don’t pursue opportunities where we foresee significant risks. This assessment is not new for us, but it is becoming increasingly vital.
Jason Conley, CFO
I think that's right. We've always avoided content-oriented businesses, which makes our positioning logical given the advent of AI and Generative AI.
Deane Dray, Analyst
Thank you.
Operator, Operator
Thank you. The next question comes from Joe Vruwink, Robert W. Baird & Company.
Joe Vruwink, Analyst
Great. Hi, everyone.
Neil Hunn, President and CEO
Hey, good morning.
Joe Vruwink, Analyst
If I go back to last quarter, you referenced the Leadership Summit and the business unit presidents coming together. This quarter, there was an announcement about iPipeline and Vertafore partnering together on product. Can you connect these two things together? Can sharing best practices across operating divisions uncover incremental product opportunities that could broaden your suite in certain markets?
Neil Hunn, President and CEO
There are demonstrable benefits for bringing our leaders together, primarily to share best practices, leadership philosophies, and lessons from failures. However, many of our businesses operate in independent markets. If a collaboration makes sense, we’ll pursue it, but we won’t force it. The partnership between iPipeline and Vertafore occurred organically, evidencing its authenticity and value for our customers.
Joe Vruwink, Analyst
On the topic of generative AI, your businesses provide the context that the applications require, which can enhance retention while creating new growth avenues. Are these early products strengthening the core, or do you foresee separate monetization opportunities?
Neil Hunn, President and CEO
There are definitely separate monetization opportunities. While it is a long game focused on long-term customer relationships, substantial value can be derived from leveraging both computational and generative AI. Our historical relationships and trust can help capture value generated in the process.
Joe Vruwink, Analyst
Great. Thank you very much.
Neil Hunn, President and CEO
Thank you.
Jason Conley, CFO
Thanks, Joe.
Operator, Operator
Thank you. The next question comes from Allison Poliniak with Wells Fargo.
Allison Poliniak, Analyst
Hi, good morning. I saw the announcement with IntelliTrans stepping out and partnering with the product sensor business. Is this something unique to IntelliTrans, or are you leveraging your asset-light business more broadly? Any thoughts?
Neil Hunn, President and CEO
That initiative is specific to IntelliTrans. We don't have an enterprise-wide strategy in that regards; if it makes sense for certain circumstances, we will pursue it.
Allison Poliniak, Analyst
On tech-enabled products, that business continues to excel organically. You mentioned difficult comparisons in Q3. Can you provide more detail on the cadence between Q3 and Q4 to reach that target? What drove that exceptional performance this quarter?
Jason Conley, CFO
Yes. This is Jason. The outperformance in Q3 was broad-based. Neptune continues to execute well in their backlog, and their daily sales exceeded their targets. Healthcare also performed well in terms of procedures. Some of our other businesses also cleared backlogs, contributing to this strength. In the second half, growth should remain consistent, but we are facing tough year-over-year comparisons.
Allison Poliniak, Analyst
Great. Thank you.
Neil Hunn, President and CEO
Thank you.
Operator, Operator
Thank you. The next question comes from Terry Tillman with Truist.
Terry Tillman, Analyst
Good morning. Can you all hear me?
Neil Hunn, President and CEO
We can hear you perfectly.
Jason Conley, CFO
Yes, all good.
Terry Tillman, Analyst
Happy Friday, Neil, Jason, everyone. My first couple of questions are regarding Deltek, which is one of your biggest businesses in application software. How is the relative health and demand? Specifically, can you discuss government contracting versus the private sector? As for Replicon, which you mentioned could have good revenue synergy opportunities, how do you plan to integrate this product into the Deltek installed base?
Neil Hunn, President and CEO
Deltek's performance was solid across both government contracting and private sectors. We're encouraged by the pipeline build in government contracting as it normalizes following the debt ceiling issues. As for Replicon, while it's the largest bolt-on we've done so far, we haven't integrated projected revenue synergies into our forecasts yet. We believe there is a strong potential for Deltek to introduce this product to the government contracting market over time.
Terry Tillman, Analyst
Great. As for your M&A pipeline, can you give us a sense of whether you're seeing more actionable bolt-ons versus platform deals compared to 90 days ago?
Neil Hunn, President and CEO
Our pipeline is still leaning more toward bolt-on opportunities. Over the last 90 days, it's encouraging to see some sizable deals not happening due to buyer-seller valuation differences, which suggests valuations may normalize. However, there are still many bolt-on opportunities in the market.
Jason Conley, CFO
Yes, deal flow is down significantly year-over-year. There are many assets that need to be sold eventually, and we are optimistic that such opportunities will arise.
Terry Tillman, Analyst
Great. Thank you.
Operator, Operator
Thank you. The next question comes from Christopher Glynn with Oppenheimer.
Christopher Glynn, Analyst
Thanks. Good morning.
Neil Hunn, President and CEO
Good morning.
Christopher Glynn, Analyst
I want to discuss Foundry. Is there any risk due to labor strikes affecting your business? Additionally, can you revisit the comments about the transition plan?
Neil Hunn, President and CEO
The Foundry business is tied to the media and entertainment industry. Currently, production has ceased due to both a writers' and actors' strike, but there is still a robust pipeline in post-production. We expect these strikes to resolve this year, leading to a minimal impact on Foundry. Foundry's transition to a subscription pricing model for their premier product, Nuke, is progressing well, and ARR is growing double digits with expectations to transition entirely by next year.
Christopher Glynn, Analyst
Thanks for that.
Neil Hunn, President and CEO
You bet.
Operator, Operator
Thank you. The next question comes from Steve Tusa with JPMorgan.
Steve Tusa, Analyst
Hey, guys. Good morning.
Neil Hunn, President and CEO
Good morning.
Jason Conley, CFO
Good morning.
Steve Tusa, Analyst
Can you discuss what you expect for third-quarter free cash flow? Specifically, what is causing the deferred revenue drag you experienced in the first half? What are your organic bookings year-over-year for the software businesses in the second quarter?
Neil Hunn, President and CEO
For Q3, Frontline has all their renewals happening then, traditionally consuming cash in the first half. We usually have solid free cash flow seasonality in the second half, so we expect a strong second half. The first half cash consumption included incentive payouts and a legal settlement. For enterprise software bookings, we've seen a sequential increase year-over-year, though not as strong as Q1, showing low single-digit growth paralleling our anticipated downturn in new activity.
Steve Tusa, Analyst
Great. Thanks, guys. I appreciate it.
Neil Hunn, President and CEO
Yes.
Operator, Operator
Thank you. The next question comes from Brent Thill with Jefferies.
Unidentified Analyst, Analyst
Hey, good morning, everyone. This is Dave filling in for Brent. Thank you for taking my questions. Regarding the AI topic, are you developing an AI strategy for your portfolio of companies?
Neil Hunn, President and CEO
We don't have a playbook per se, but we are accelerating education across our businesses regarding what AI is, its possibilities and risks, IP ownership issues, and productivity enhancements in various functions. We are running several educational sessions that have attracted significant participation from our teams.
Unidentified Analyst, Analyst
Understood. As you think about the macro environment, have any companies surprised you with their performance relative to your expectations?
Neil Hunn, President and CEO
No major surprises in terms of macro resilience. As previously mentioned, DAT is growing exceptionally, but this year we are moderating. Neptune remains solid, and overall, I have not seen anything surprising in terms of cyclical performance.
Jason Conley, CFO
I don't think so.
Operator, Operator
Thank you. The next question comes from Joe Ritchie with Goldman Sachs.
Joe Ritchie, Analyst
Thanks. Good morning, guys.
Neil Hunn, President and CEO
Good morning.
Jason Conley, CFO
Good morning.
Joe Ritchie, Analyst
Regarding free cash flow margins going forward, should we anticipate a rate of around 20% in the second quarter due to deferred revenue considerations? How do we model that?
Neil Hunn, President and CEO
Free cash flow will remain lower in the second quarter due to federal tax payments. The historical seasonal shift means that margins can be below typical in the first half.
Joe Ritchie, Analyst
Understood. Regarding tech-enabled products, can you quantify the easing of supply chain impacts this quarter? Is that an ongoing consideration as we navigate the second half?
Neil Hunn, President and CEO
That may be challenging to specify. Mid-single-digit growth is standard for this segment. We need to analyze Verathon's strength and supply chain dynamics; however, there will likely be impacts going forward.
Joe Ritchie, Analyst
I'll follow up offline, thank you.
Neil Hunn, President and CEO
You bet.
Jason Conley, CFO
Thanks, Joe.
Operator, Operator
Thank you. This concludes our question-and-answer session. I will now turn it back to Zack Moxcey for any closing remarks.
Zack Moxcey, Vice President, Investor Relations
Thanks, everyone, for joining us today. We look forward to speaking with you during our next earnings call.
Operator, Operator
Thank you. The conference has now concluded. Thank you for attending today's presentation. You may now disconnect.