Earnings Call Transcript - ROP Q1 2023

Zack Moxcey, Vice President, Investor Relations

Good morning and thank you all for joining us as we discuss the first quarter financial results for Roper Technologies. Joining me on the call this morning are Neil Hunn, President and Chief Executive Officer; 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 used 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. Today, we will discuss our results primarily on an adjusted non-GAAP and continuing operations basis. For the first 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 4, I'll hand the call over to Neil. After our prepared remarks, we will take questions from our telephone participants. Neil?

Neil Hunn, CEO

Thanks, Zach and we hope everyone is doing well this morning. We're looking forward to sharing our Q1 results with you, which were quite good. As we turn to Page 4, let's look at today's agenda. We'll start with our enterprise highlights and financial results, then turn to our segment-specific discussion and wrap up discussing our raised 2023 enterprise guidance. So with that, let's go ahead and get started. Next slide, please. As we turn to Page 5, the three main takeaways for today's call are, first, the year is off to a strong operational and financial start as our higher-quality, enhanced portfolio is obviously performing really well; second, we're increasing our full-year guidance both in terms of organic revenue growth and adjusted DEPS; and third, we continue to be very well positioned for disciplined capital deployment. As it relates to our first takeaway, a strong start to the year, we saw total revenue grow by 15% and organic revenue grow by 8%. Consistent with our long-standing strategy, we continue to not only scale our enterprise but also simultaneously improve its underlying quality and recurring revenue base. Importantly, we had very strong cash flow performance with free cash flow margins in excess of 30%. Our results this quarter are another proof point that our higher-quality, less cyclical portfolio was purpose-built to consistently perform at a very high level. Finally and also during the quarter, we held our first-ever Roper Leadership Summit, where we had our 27 business unit presidents together and shared best practices and learnings across a variety of topics, including strategy development, strategy enablement, and team and talent. While honoring our high trust autonomous model, the operating and corporate teams left feeling a true sense of community. It was a terrific week. Given the strong start to the year, we're increasing our full-year organic growth outlook by 100 basis points from 5% to 7%, to 6% to 7%, and increasing our full-year DEPS guidance to be $16.10 to $16.30 or $15.10 at the midpoint. Our previous diluted EPS guide was $15.90 to $16.20. And finally, we continue to be well-positioned relative to capital deployment. We remain quite active in the market as we evaluate and diligently review many high-quality opportunities. Jason, I'll turn the call over to you so you can walk through our first quarter results and our strong financial position. Jason?

Jason Conley, CFO

Thanks, Neil and thanks, everyone, for joining us this morning. Turning to Slide 6. We're very pleased with how Q1 shaped up. Revenue came in at $1.47 billion, which is a 15% increase over the prior year. This was achieved through a combination of strong organic growth of 8% and an 8% contribution from acquisitions, led by Frontline, and this was slightly offset by a 1% FX headwind. Growth was broad-based across the segments and a little better than expected. Broadly speaking, customer demand was favorable in the quarter, and order pipelines remain strong. EBITDA was $582 million or 15% of our prior year with margins roughly flat and in line with expectations. DEPS of $3.90 was up 19% over the prior year and $0.06 above the high end of our guidance range of $3.80 to $3.84. Free cash flow of $445 million was 4% higher than the prior year. In our Q4 earnings call, we highlighted a $45 million settlement of a patent dispute for certain Verathon sales dating back to 2004. We paid that this quarter, so adjusted for the settlement, free cash flow would be 33% of revenue and up 14% over the prior year. We saw very good cash performance, especially in our software businesses. Our Q1 renewals and related collections came in strong as expected. As I mentioned last quarter, Frontline will collect most of the renewals in the third quarter, so that’s a bit of a drag on conversion in the first half. Overall, it was just a really great start to 2023. Now turning to Slide 7, let's review our balance sheet. Coming off solid Q1 cash flow performance, our balance sheet continues to strengthen. Gross debt was around $6.7 billion and our cash balance has grown to just under $1.2 billion, which yields net debt just shy of $5.5 billion. This puts our net debt-to-EBITDA ratio at 2.4, which was down from 2.7 at year-end. This, coupled with our undrawn revolver of $3.5 billion, gives us the capacity to deploy $4 billion or more in the near term. To that end, we've been quite active in 2023, evaluating a number of platform and bolt-on opportunities. As always, we will remain disciplined and patient in our capital deployment process. With that, I'll turn it back over to Neil to talk about our segment performance and outlook. Neil?

Neil Hunn, CEO

Thanks, Jason. Let's turn to Page 9 and walk through our Q1 highlights for the Application Software segment. Revenues here were $761 million, up 6% on an organic basis and EBITDA margins were 43.2%. Performance in this segment was strong across the board. To highlight a few of our business performances, we'll start with Deltek. Deltek was solid. As we mentioned last quarter, Deltek did see some slower customer decision-making, but that was largely rectified this quarter. Deltek had double-digit bookings in the quarter with strength across both enterprise class and SMB-sized customers, as well as government contracting and private sector solutions. As usual, both gross and net retention at Deltek remained strong and consistent with recent history. Aderant, our software business focused on the needs of law firms, continues to compete and win and take share from our competitors. In the quarter, Aderant experienced record bookings and continued success in the adoption of their SaaS solutions. Great job by Chris, Rafi, and the entire Aderant team. Vertafore, our software business at tech-enabled property and casualty insurance agencies, posted another solid quarter and continues to perform quite well for us. Of particular note, Vertafore's recent acquisition of MGA Systems, a software solution targeted to manage general agents, or MGAs, is proving to be highly strategic and bookings activity is tracking ahead of plan. Frontline continues to perform quite well for us in the first couple of quarters of ownership. Frontline's mission is to empower the front line of education. As many of you know, hiring of teachers and administrative staff is particularly challenging and Frontline software solutions better equip K-12 school districts to navigate these challenges. Because of this, Frontline solutions are mission-critical and of high importance to their school district customers. For the segment, EBITDA margins were down 90 basis points year-over-year, in line with our expectations. Our Acute Care software businesses, especially CliniSys, Data Innovations, and Strata are ramping up their implementation capacity based on recent bookings momentum. We expect to see similar margins in Q2. Looking to the balance of the year, we expect to see organic growth in the mid-single-digit area for this segment based on our leading market positions and growth in recurring revenue. Turning to Page 10, revenues in the quarter for the Network Software segment were $355 million, up 6% on an organic basis and EBITDA margins were strong at 53.1%. As with our Application Software segment, growth and performance were broad-based across this segment. Relative to business-specific comments, we'll start with our U.S. and Canadian freight matching businesses, DAT and Loadlink, which both grew nicely in the quarter. While freight market conditions are softer than this time last year, our businesses in this space are critical to the operation and execution of the spot freight market. In addition, and importantly, 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 and Loadlink continue to innovate and launch new products and offerings to help drive enhanced customer value and share of wallet with the current product strategy focused on tech enabling the connectivity between brokers and carriers. iPipeline, our network software business that tech enables the distribution channel for life insurance and annuities, is coming off a terrific 2022 and continued its high level of execution this quarter with very strong bookings, retention, and customer expansions. Foundry continued its string of strong performance in the quarter and had terrific seat growth for their flagship product Newk, which enabled continued double-digit recurring revenue growth. As we mentioned last quarter, Foundry commenced their subscription pricing transition for Newk and in Q1 had over 50% of the new seats sold under their new model ahead of their plan. Finally, our alternate site health care businesses, MHA, SoftWriters, and SHP were strong in the quarter. Execution was solid and the business has benefited from an improving census in skilled nursing, assisted living facilities, and home health, reaching the highest occupancy levels in patient volumes since the onset of the pandemic. Turning to the balance of the year, we expect to see mid-single-digit organic growth for this segment based on broad and sustained growth across this group. As we turn to Page 11, revenues in the quarter for our Tech-enabled Products segment were $354 million, up 14% on an organic basis. EBITDA margins for the segment were 34.7% in the quarter. Across the segment, business performance and execution was solid. Importantly, the broad-based supply chain issues continue to wane. Though we're not entirely out of the woods, we can now see a path to a more normalized supply chain environment. Neptune, our water meter and technology product business, continues to perform excellently. In the quarter, they had record revenue performance and set records for backlog levels. Importantly, Neptune continues to see increasing demand and momentum for their residential and commercial ultrasonic static meters. We remain bullish on Neptune and the market in which they compete as this market tends to be quite steady, as Neptune's customers' budgets are typically fixed year-to-year and not tied to broader macroeconomic trends or cycles. Great job at Neptune and congratulations. Verathon was strong in the quarter as well with double-digit order growth. Specifically, Verathon saw strength across the recurring single-use products, both bronchoscope and video innovation as well as bladder scan capital purchases. Importantly, Verathon has four product launches scheduled for the next few months which will help continue their market share gains and momentum. Northern Digital, or NDI, was also strong in the quarter and continued to see terrific demand for their optical and EM solutions. NDI's enabling measurement technology is used by scores of medical product OEMs and solutions such as robotic-assisted surgery and across multiple cardiac-specific modalities. NDI's high level of market focus and operational discipline will enable them to continue to be the market share leader for these measurement technologies long into the future. Our outlook for the balance of the year for this segment has improved to be in the low double-digit area and is based on continued strong orders and improving manufacturing productivity at Neptune as well as an improved growth outlook across our medical product businesses. Now please turn to Page 13 and let's review our increased 2023 guidance. For 2023, we expect total revenue growth to be north of 12%. In addition, we're updating our organic revenue growth outlook to be in the 6% to 7% range, an increase from our original guidance of 5% to 6%. As a result, we're increasing our DEPS guidance to be in the range of $16.10 to $16.30, up from our guidance of $15.90 to $16.20, assuming that this guidance contemplates a tax rate in the 21% to 22% area. Specific to the second quarter, we're establishing our DEPS guidance to be in the $3.96 to $4 range. Now please turn with us to Page 14 and then Jason and I will look forward to answering your questions. As we turn to Page 14, we want to leave you with the same three points with which we started. First, 2023 is off to a great start. We saw revenues increase 15% to $1.47 billion in the quarter. This growth was underpinned by 8% organic revenue growth and 8% recurring revenue growth. In addition, margins were quite strong. This quarter's financial and operational performance is yet another proof point of our capabilities and frankly, the expectations of our improved higher-quality portfolio of businesses. Most importantly, our revenue growth translated to impressive cash flow growth with our underlying free cash flow growing 14%. As you know, we view cash flow growth as the best measure of performance. Second, based on the strong start to the year, the higher recurring nature of our revenue stream, and the importance of our solutions to our customers, we are increasing our full-year organic revenue growth outlook to be between 6% and 7% and increasing our full-year DEPS to be between $16.10 and $16.30. Finally, we continue to be active with our capital deployment activities as we have north of $4 billion of available M&A firepower. As we discussed during our Investor Day last month, we have a very large universe and pipeline of opportunities; though, as always, we remain patient and highly disciplined to ensure optimal deployment of our available capital. Now as we turn to your questions and if you could flip to the final slide, our strategic flywheel, we want to thank those of you who joined us in New York or online last month for our first-ever Investor Day. During that long-form overview of Roper, we were excited to share with you our long-term strategy, the high-quality nature of our portfolio of businesses, our operating ability to improve our businesses, our process-driven capital deployment approach, and our compelling long-term business model that compounds cash flow in the mid-teens area. So, thank you for your continued interest in Roper. And with that, let's open it up to your questions.

Operator, Operator

The first question comes from Deane Dray with RBC Capital Markets.

Deane Dray, Analyst

It was great to see everyone in New York last month. Just maybe we can start off and it's a bit of a follow-up from last quarter with Deltek on some of the slowing in decision-making. This is kind of what everyone is watching, might there be any kind of fallout from bank turmoil or read-through in the construction markets and so forth. But the idea of slower customer decision-making, maybe just give us an update on how that played out, time to sign contracts, any new logos. Just any color there would be helpful.

Neil Hunn, CEO

Yes. Sure, Deane. Happy to talk about it. It's something we spent a tremendous amount of time talking to our leadership teams and our group executives about, trying to understand the signal. To set the obvious context, we spent the last several years trying to really work out the cyclicality of the portfolio and we're also in these very small niche markets where the customers tend to be not that cyclical. So the signal for us is faint. It's not nonexistent but it's faint. Last quarter, we certainly talked about Deltek and them having some slower customer demand, as we said in the prepared comments, that largely, it's not fully rectified itself this most recent quarter. Two or three quarters ago, we talked about the same thing going on at PowerPlan, that rectified itself the subsequent quarter as well. Some of the other macro things that we listen to, the amount of property casualty insurance written as a sign of sort of business formation or business growth, continued to grow; life insurance applications have remained steady. DAT, the number of carriers we expected and certainly have seen for a couple of quarters, carrier declines touched. But that meaningfully moderated in Q1. So we continue to listen for it, but we certainly have planned for the second half of the year with a concerned outlook relative to a slowdown. But the signal's faint at the moment. Jason, anything you want to add to that?

Jason Conley, CFO

Yes, I would just say our software bookings were up high single digits year-over-year in the quarter. So that just put some math behind what he was saying.

Deane Dray, Analyst

Great. That's really helpful and appreciate kind of that walkthrough of the portfolio there on sensitivity. And then just second question, it was nice to see the boost in organic revenue guide for the back of the year in tech-enabled products up low double digits. And just with the expectation, look, Neptune continues to do really well and we see that in the industry. That tends to be a bit steady. So how is it that you're seeing this acceleration? It must be also on the medical side too.

Neil Hunn, CEO

Yes. There are three key areas in this segment: Neptune, medical products, and a couple of smaller RF product businesses. All three have experienced growth, and we at corporate have raised our outlook for the remainder of the year. Neptune has shown remarkable order growth and strong factory performance, which boosts our confidence that they can reduce some of the backlog more than we initially anticipated at the beginning of the year. In the medical product sector, as we know, last year saw a decline of 7% to 8% in medical procedure volumes. We expected this trend to continue this year, but it has actually improved slightly, positively impacting Verathon, CIVCO, and indirectly NDI. Additionally, the RF product businesses, including Inovonics and RF Ideas, faced significant supply chain challenges at the start of the year. While we expected these issues to persist, they have improved considerably in Q1. This overall uplift gives us the confidence to increase our guidance for that segment.

Operator, Operator

The next question is from the line of Scott Davis with Melius Research.

Scott Davis, Analyst

I understand there isn't any specific business that stands out this quarter. However, when considering freight matching, it's clear that truckers have faced challenges recently. Some of the forecasts appear somewhat cautious due to difficult comparisons. How closely is your freight matching business tied to the miles driven and the B2C truck market? Is there a direct correlation? I would expect there is, yet it seems like you didn't experience significant issues in DAT this quarter.

Neil Hunn, CEO

Yes, DAT experienced growth in the quarter, showing both year-over-year and sequential growth. However, the relationship is indirect since our payment structure does not depend on miles driven or utilization metrics. Instead, we operate on a fixed subscription basis for both brokers and carriers. DAT tends to be less cyclical than the overall market for a couple of reasons. Firstly, there's a tension between cyclical patterns and long-term growth, as the spot market is gaining a larger share of total freight volumes. Over time, more freight is entering the spot market because it is becoming more liquid and easier to transact, something DAT actively supports. Secondly, it's important to understand how the spot market functions in both booming and declining market conditions, particularly regarding the pricing dynamics between contract and spot pricing. Spot prices fluctuate daily, while contract prices adjust on a yearly basis. In a strong market, demand for carriers increases, leading to higher spot market rates, which encourages more capacity. This has been a significant factor in DAT's growth over the past few years as more carriers enter the market. Conversely, when the freight market slows down, spot prices tend to fall below contract prices, prompting some contract freight to shift to the spot market for cost savings, which establishes a baseline demand for carriers. Historically, DAT has shown strong growth in up markets and slower growth in down markets due to these factors.

Scott Davis, Analyst

That's interesting. I hate to interrupt here, but I'm just going to do it anyway. How does this business evolve over time? Does AI become a significant enabler and predictor to help drive the liquidity you mentioned, Neil? How does technology, I suppose, change the game and assist you in gaining market share over time?

Neil Hunn, CEO

Yes. There are many technological developments and challenges in this field. Currently, I believe that on average, there are about 8 to 10 phone calls exchanged between a broker and a carrier to facilitate a load. Our goal is to reduce that to zero. A key element of DAT's product strategy is to incorporate technology to streamline this process. There is AI involved in matching freight, optimizing routes, and managing future truck logistics, such as determining timely pickup and drop-off schedules. Much AI can be integrated into these operations. However, the fundamental breakthrough for the industry lies in enhancing match efficiency, which is where a significant portion of technology investment is currently focused.

Operator, Operator

The next question comes from the line of Terry Tillman with Truist.

Terry Tillman, Analyst

Congrats on the quarter. So the first question, I guess, is on Frontline because that was the last major platform acquisition. I think you all talked about $370 million of revenue, expected contribution and $170 million EBITDA. And I think also you said it was a stub period; it was in the 80s and 4Q. What I'm curious about is how is it tracking to those targets? And I did notice they just announced a new HCM suite, there's a new CRO there. So it seems like there are some dynamic things going on. Just maybe double-clicking on Frontline and then I had a follow-up for Jason.

Neil Hunn, CEO

You take the first one.

Jason Conley, CFO

Yes. So they're tracking on their forecast. As you know, they are a business that has large renewals in the third and fourth quarter. So we'll expect the business to pick up sequentially in the second half, but they are definitely on track for their revenue and EBITDA numbers of $370 million and $175 million.

Neil Hunn, CEO

Yes. And as it relates to the new products and a couple of new leaders, we're certainly excited to have Bill, our new CFO, Scott, our new COO; and Curtis, the new Chief Client Operations Officer join. It's often the case that there are a few leadership changes that happen in the first year or so of ownership. And so that was expected; we're excited to have this team. It's an incredible group that has joined us. The thing that I'm particularly excited about and proud of in the first couple of quarters of ownership of Frontline is the strategic choice they've made. As a pattern we see from a lot of companies that come out of private equity is very limited choice is made, so they try to do too many things and not do them well. And so very quickly, Frontline doubled down on client experience and R&D productivity and actually made a choice to take a little bit of resource out of go-to-market which makes complete sense when you have 85% or 90% coverage of the customers. The entire strategy or the principal here strategy is to focus on cross-selling, up-selling. You need to deliver a tremendous experience, hence, the focus on client experience and you need to be able to innovate and sell them more products, hence the deployment for R&D. So we love the choice that's been made there and are excited for what that will yield in the future.

Terry Tillman, Analyst

That's great color. I guess just a follow-up for Jason is you were able to call out the adjustment from the settlement. So it was up 14% in terms of the free cash flow at low 30s on a free cash flow margin. Should we think about that for the remainder of the year in terms of kind of that mid-teens growth and maintaining a low 30s free cash flow margin?

Jason Conley, CFO

Yes, that's right. We're on track to deliver north of 30% free cash flow. As I mentioned, the second half is going to be better than the first half with the renewals at Frontline. But yes, we're still on track there.

Operator, Operator

The next question comes from the line of Steve Tusa with JPMorgan.

Steve Tusa, Analyst

A couple of the businesses that you guys didn't mention but I think to Deane's question around what's going on out there. ConstructConnect, what are you seeing there? And then perhaps CliniSys, another one of your kind of big ones.

Neil Hunn, CEO

ConstructConnect tends to perform countercyclically. For those who may not know, ConstructConnect has an excellent database of every commercial construction project in the planning stage. General contractors, trade contractors, and building product manufacturers find it valuable for planning and bidding purposes to understand the development stage of these projects. When the construction market is strong, contractors have more work, so there's less value in paying for information on future projects. Conversely, when work slows down, the utility of this information increases. Historical analysis shows a clear countercyclical demand pattern for ConstructConnect. Though it has modestly underperformed our expectations and has experienced low single-digit growth, we anticipate it should reach mid-single-digit growth. We are confident that with our current strategy and under the leadership of Matt Straza, who joined us from Deltek, we will achieve this growth. Matt has brought operational discipline and an exceptional strategy to the business. CliniSys has been performing excellently. Simpson has successfully integrated the U.S. Sunquest business with the European operations with minimal issues. The combined business saw growth this quarter, a significant improvement from the past due to challenges faced by the U.S. segment. We remain very strong in the U.K., where we are one of a few key IT vendors to the NHS, managing a vast majority of the laboratory network. Our pan-European capabilities are solid, exemplified by our management of the largest health system in France. In the U.S., we have expanded our product offerings to laboratories beyond healthcare, including environmental and toxicology labs, which is showing early promise. We extend our congratulations to Simpson and Andy, the CFO, and look forward to what lies ahead for CliniSys.

Steve Tusa, Analyst

Great. And then just one last one on free cash flow. It's a very pretty strong quarter, an upside surprise, at least versus what we were expecting. A little bit bigger of a drag from deferred but maybe a bit lower cash taxes or something. Just talk about the moving parts there and how you expect that to trend sequentially over the next couple of quarters on free cash.

Jason Conley, CFO

Sure, I can address that, Steve. The deferred revenue has decreased, which is linked to the cash consumption in the first quarter due to Frontline. We anticipate a increase in the third quarter when the renewals occur. Overall, the deferred revenue, excluding that factor, met our expectations and remained relatively flat compared to the fourth quarter. Regarding taxes, we usually make two federal tax payments: one in the second quarter and then one each in the third and fourth quarters. Therefore, we expect Q2 to be lower sequentially but higher compared to the previous year. For the entire year, as I mentioned earlier, we are on track with a free cash flow margin just above 30%.

Operator, Operator

The next question comes from the line of Julian Mitchell with Barclays.

Julian Mitchell, Analyst

I have a question regarding tech-enabled products. We're noticing that many hardware manufacturers in our sector are experiencing a significant surge in revenue as component shortages ease. However, there's less clarity on the future outlook once this revenue transition occurs. I wanted to address the very strong revenue performance in Q1 and your confidence in the outlook for the next three quarters. Could you provide more detail on orders and backlog trends, and clarify whether the strength we're seeing now is likely to be sustainable through year-end rather than just a temporary spike as the supply chain improves?

Neil Hunn, CEO

Yes. We have been closely examining two key aspects: the current status of our backlog and whether there has been any decline in orders. Fortunately, we have not experienced any significant order fallout from our backlog; orders remain robust, with a book-to-bill ratio exceeding 1 in the quarter. This suggests that our backlog is not merely inflated. However, as we look at the remainder of the year, we anticipate a period where order durations may extend. Customers are seeking to secure their supply, which has led to longer wait times. Eventually, we expect to return to a more standard order duration, although the timing of this shift is uncertain. We remain prepared for this eventuality and will not be overly concerned, as it is a natural response to the current situation. This observation applies broadly to our segment. In contrast, for our medical products, we do not operate with a substantial backlog, so the issue you raised does not apply there. Additionally, we have successfully addressed the supply chain challenges affecting our RF product lines, which were specific to those businesses. We will begin to alleviate some backlog, but this will primarily occur in the second half of the year rather than in the recent quarter.

Julian Mitchell, Analyst

That's very helpful. I want to revisit one of the more cyclical aspects of software, which has been mentioned a couple of times already. Specifically, I'm interested in the DAT and Loadlink businesses within Network Software. Given the mid-single-digit growth outlook for the segment for the remainder of the year, what are your expectations for DAT or Loadlink? You don't need to provide the exact percentage, but I'm curious how they compare to the segment growth of mid-single digits, for instance.

Neil Hunn, CEO

Yes. I'll provide some context. While I won't go into specifics at the company level, there is a difference of opinion between the DAT leadership and Sarasota regarding the outlook for the business this year. DAT is more optimistic about the remainder of the year compared to our perspective here in Sarasota. We maintain a conservative stance, especially concerning the carrier count for the rest of the year. Although we saw evidence in Q1 that the decline in carriers began to flatten, we do not expect that trend to continue or improve. Instead, we anticipate that the situation may worsen slightly.

Operator, Operator

The next question comes from the line of Joe Giordano with Cowen.

Joe Giordano, Analyst

I wanted to bring up something regarding the medical product side. Another company mentioned having unexpectedly high inventory levels of component parts in medical products. Their customers seem to have more products than they expected. I realize this might not directly relate to your situation, but I thought it was worth asking about.

Neil Hunn, CEO

It's not particularly relevant. There is one business, Northern Digital, which primarily sells through medical product OEMs. These OEMs are critical and necessary for many medical products, and they cannot ship their products without ours. We were concerned that there might have been a significant amount of inventory as a buffer in the channel. However, the Northern Digital team believes that most, if not all, of that inventory has cleared out. It's difficult to know for certain, but that's really the only area where it occurs. Otherwise, we sell directly to customers, including consumer customers.

Joe Giordano, Analyst

Yes, that's what I thought. I have a question about the M&A landscape. I'm curious about your competitors in the private equity space. With the current fluctuations in interest rates, do you think the volatility and uncertainty about rate direction is causing them problems? Is the ability or desire to secure debt at fixed rates affecting the market in any way?

Neil Hunn, CEO

Yes, it's been slow. The number of deals in the past couple of quarters has been very low due to the bid-ask spread between buyers and sellers that continues to exist, along with uncertainty regarding future exit values. When conducting an IRR analysis, the exit value and exit multiple are the most sensitive variables. Overall, this uncertainty has resulted in few deals or recaps. In private equity, there have been a small number of strategic deals. However, based on our historical pattern recognition, times of volatility tend to create opportunities. We experienced this after COVID when we capitalized on an opportunity in August 2020 with Vertafore. We are committed to maintaining investment-grade debt, enabling us to be nimble, flexible, and opportunistic because moments like this present opportunities for various reasons. Therefore, we are cautiously optimistic that such opportunities will arise over the course of this year.

Operator, Operator

The next question comes from the line of Allison Poliniak with Wells Fargo.

Allison Poliniak, Analyst

Just along the lines of that M&A, I know you mentioned you certainly have a pipeline platform versus bolt-ons. I guess just even what you're seeing today and sort of the comments that you just made, is there any confidence that you’d probably lean towards more bolt-ons in the next few months? Or are there some opportunities that you’re seeing on the platform side that could execute?

Neil Hunn, CEO

Yes. We see that the current level of activity in the M&A pipeline is leaning more towards add-on or bolt-on acquisitions compared to historical trends. I wouldn't read too much into it; it sometimes just happens that way. We are evaluating several platforms currently, which is typical for us, as we often have a few in advanced stages of consideration. Overall, there is a tendency towards bolt-on opportunities. These deals are usually our best because they complement one of our existing companies and often bring synergies. As we mentioned during the Investor Day, we would prefer to allocate more capital to the bolt-on strategy. However, we are not going to force it, but it would be beneficial to see more of it happen.

Allison Poliniak, Analyst

Got it. That's helpful. And then Application Software, the capacity ramp in acute care. I know you mentioned, obviously, it's impacting Q2. How should we think about that, the balance of the year? When does that slowly get running, that ramp?

Jason Conley, CFO

Yes, that's right. I mean, we thought EBITDA margins were in line with expectations in the first quarter and we did have those implementations. Also, CBORD had some large integrated security pull-ins; they finally got some parts for some of those projects. But for the second quarter, we're expecting it to be about the same and then it will pick back up in the second half. So you can expect EBITDA margins to be about flat year-over-year.

Operator, Operator

The next question comes from the line of Joe Vruwink with Baird.

Joe Vruwink, Analyst

Hope you're well. One observation I just kind of what we're hearing in the broader environment. It does seem like the system of record companies for the industries you serve, they're holding up pretty well. And then I think there's some particular industry examples like K-12 education would be one where the spend is actually consolidating a bit around these companies, so share of wallet is going up right now. Do you think you're generally seeing this so far? And any examples that come to mind where you kind of look at your growth relative to underlying IT spend and this wallet share dynamic is maybe playing out?

Neil Hunn, CEO

Yes, I would say we can discuss this in detail for each company if that would be helpful. At a high level, we agree. We have stated in our Investor Day and all of our communications that we are essential software systems. On the application side, companies like Deltek, Vertafore, Frontline, and Aderant illustrate our growth. Aderant, for instance, has moved from the second position to the top, doubling our company's size during this ownership period. Our net retention has increased from around 102-103 to the low 110s, indicating that these software companies invest significant time in building a customer base for cross-selling. Most of our companies derive 50% to over 75% of their new bookings from cross-selling and upselling. Frontline is a prime example of this, where over 80% of their growth comes from expanding their share of wallet. They've successfully captured customers over time, and now the focus is on increasing the value they get from each one. Particularly in Frontline's case, the market is more fragmented due to varying regulations and competition on a state-by-state basis. Currently, 50% of K-12 education systems prefer to purchase from a consolidated vendor, up from 25% or 30% five years ago. This trend shows that the education market is shifting towards companies like Frontline.

Joe Vruwink, Analyst

Okay, that's great. And then, I guess, a quick one on Frontline. In terms of the sequencing of free cash flow, so a 50% cash flow margin business, do they typically kind of burn cash in Q1, Q2, 3Q, and then 4Q? And so 3Q, we can think of more than 50% of that business's full year generation is probably hitting in that timeframe.

Jason Conley, CFO

Yes, I think that's the right way to think about it, Joe. A little bit more of a burn in Q1, a little less in Q2, and then a big cash inflow in Q3 and a little bit of cash in Q4.

Operator, Operator

The next question comes from the line of Alex Blanton with Clear Harbor Asset Management.

Alex Blanton, Analyst

Most of my questions on your operations have been answered but I wanted to ask about how you benefit from the sale of compressor controls. Like Clayton Doble and Rice, they sold it to Honeywell, they just announced this week for $670 million. Are they selling your piece? And do you get any cash from that?

Neil Hunn, CEO

I appreciate the chance to discuss this. We are definitely involved, owning 49% of Indicor and holding quarterly Board meetings. From our initial discussions about the value creation plan for Indicor, part of the strategy was to adjust the portfolio, making Indicor less focused on oil and more on industrial aspects. This asset was highly strategic for multiple industry players. The selling process was very competitive, and we are pleased to sell the business for 19 times this year's EBITDA. We believe Honeywell is an excellent fit for this business, which was important to us. The advantage for us as a 49% owner is that we can now use this capital to invest in industrial and industrial technology businesses. Our goal is to create a strong M&A cycle and hopefully develop the next major industrial company that could go public in three to five years, at which point we will realize the benefits of the entire value creation plan.

Jason Conley, CFO

The only cash we get, Alex, is we'll have a distribution to us for the tax liability of the sale. But most of the cash is going to stay in the business. So we'll get that cash whenever it closes, sometime in the second half.

Operator, Operator

This concludes our question-and-answer session. We will now return to Zack Moxcey for any closing remarks.

Zack Moxcey, Vice President, Investor Relations

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

Operator, Operator

That conference has now concluded. Thank you for attending today's presentation. You may now disconnect.