Roper Technologies, Inc. (ROP) Q4 2012 Earnings Report, Transcript and Summary

The Roper Industries Fourth Quarter 2012 Financial Results conference call will now begin. I will now turn the call over to John Humphrey, Chief Financial Officer.

Thank you, and thank you all for joining us this morning as we discuss the results of our fourth quarter and full year. Joining me this morning is Brian Jellison, Chairman, President and Chief Executive Officer; Paul Soni, Vice President and Controller, and Jason Conley, Head of Planning and Investor Relations for us. Earlier this morning, we issued a press release announcing our financial results. The press release also includes replay information for today’s call. In addition, we’ve prepared slides to accompany today’s call which are available through the webcast and also on our website at www.roperind.com. If you’ll turn to Slide 2, we begin with our Safe Harbor statement. During the course of today’s call, we will be making forward-looking statements which are subject to risks and uncertainties as described on this page and as detailed further in our SEC filings. You should listen to today’s call in the context of that information. Now if you’ll turn to Slide 3, today we’ll be discussing our income statement results for the quarter primarily on a non-GAAP basis. A full reconciliation between GAAP and non-GAAP measures is in our press release and also included as a part of this presentation on our website. To detail that, for the fourth quarter the difference between GAAP and non-GAAP is a fair value adjustment to acquired deferred revenue at Sunquest. For the quarter, this impact was $6 million to revenue and operating profit. This adjustment, to remind everyone, represents revenue that absent our acquisition Sunquest would have recognized. We believe showing our results on this basis provides additional insight into the ongoing and recurring results of the business. For the full year, the difference between GAAP and non-GAAP is comprised of three discrete items: one, the fair value adjustment to acquired deferred revenue; second, acquisition-related costs specific to Sunquest and the debt extinguishment charge we recorded in the third quarter. We believe discussing our results excluding these items provides investors with additional insight and improves understanding of the trends of our business. And now if you’ll please turn to Slide 4, I will turn the call over to Brian Jellison, Chairman, President and Chief Executive Officer. After his prepared remarks, we’ll take questions from our telephone participants. Brian?

Thank you, John. Good morning everyone. So as we look at the Q4 enterprise financial results, it turned out to be the best quarter in our history on virtually every measurement category. Orders were at the highest level, revenue the highest, net earnings highest, EBITDA, and both operating and free cash flow were all-time records for us. Revenue was up 10% in the quarter. Organic growth was 3%, and all four segments really participated in our record fourth quarter. We ended the year with $953 million in backlog, which is 15% higher than it was this time last year, and our gross margin was really spectacular. It came in at a remarkable 57.9% for the quarter, which really speaks to the quality of our businesses and their ability to execute. So gross margin up 300 basis points, above levels that most people never even see. Our operating margin expanded 300 basis points to 28.3% because operating leverage in the quarter came in at about 57% on new revenue. Our operating leverage throughout the year has been above 50%, and we’ll talk more about that throughout the discussion this morning. Remember that we have a lot of non-cash amortization charges in our operating margins. If you look at them on an EBITDA basis, it would be substantially higher – another 4 points. Our EBITDA in the quarter was 275 million. You might remember at the end of the third quarter we’d said we hoped to hit a run rate in the fourth quarter of a billion dollars or more, and we certainly achieved that. Our EBITDA margins were up 370 basis points, even higher expansion than our gross margin, and reached 33.7% in the quarter. Our GAAP operating cash flow was 212 million in the quarter, which represented 26% of revenue,…

Thank you. We will now go to our question and answer portion of the call. [Operator instructions] We’ll take our first question from Dean Dray with Citi Research. Dean Dray – Citi Research: Thank you. Good morning everyone. On the medical side, you were flat on organic revenue growth. Did you see any pull-in from some of the year-end business getting pulled in, maybe related to the pending tax increase or any budget flush?

No, we really didn’t see that at all, and most of our stuff is kind of going direct so it’s not a like a distributor pull-in with standard products that some other people might have. Dean Dray – Citi Research: And then Brian, when you talk about the acquisition capacity approaching 2.5 billion, for the medical side are you more apt to pursue adjacencies, new products, new platforms in SAS like you’ve done in Sunquest, or would you be looking more in the device side like Verathon, Northern Digital, where you can drop a product line into your sales force?

Well, we would and are doing both. You just never know what you’re able to negotiate in terms of what’s the best use of funds. So we’re always really looking at the asset velocity of things, so the software businesses have an easier hurdle because they always have less assets. If their product businesses are such that we think they’re well positioned and have great defense mechanisms, we’re not opposed to adding to that. As a general rule, there certainly are some product transactions we’re looking at now, but most of the things we’re looking at are related to software and service opportunities. Dean Dray – Citi Research: Great, that’s helpful. Just one last one if I could – on the Neptune customer loss, give us some perspective, was this on pricing? Is it a market share shift? You said that there would be some impact in the next couple quarters.

Yeah, it’s a very large customer who has decided that they want to go to take the risk associated with the composite meters. We don’t think it says anything other than they’re going to try something else. We had a long-term contract with them that—and they had a change in management, and we’ll see how it works out. It will have an effect on the first half of this year from a revenue viewpoint. I don’t think it’s indicative of anything; in fact, we were up nearly 20% in (inaudible) sales in the fourth quarter, so you can’t see it. We wound up being flat because you got one large customer that’s down. John, I don’t know if you want to add anything to Dean’s question around the customer situation? I think it’s a one-off thing that—

Yeah, I’d agree with that.

It sort of supply chain people making the decision instead of operating people. I know the operating people aren’t happy about it.

And it’s one of those things that—I mean, it’s important in terms of Neptune, but once it gets to the Roper level, it really gets not as material, for sure. It will be an impact for the first quarter and the first half. Dean Dray – Citi Research Dean Dray – Citi Research: Great, thank you.

We’ll take our next question from Matt Summerville with Keybanc. Matt Summerville – Keybanc: Morning. Just a couple questions. Brian, can you talk a little bit about later in the fourth quarter and into the first quarter, the kind of order dynamics you’re seeing in your shorter cycle businesses like Dynisco, and you mentioned Struer equipment sales down. Has that trend changed?

Well, what’s important about the fourth quarter – it’s a great question, Matt – is we have three businesses: Dynisco, which is always supplying things which frequently have to do with capacity utilization; Struer, which is somewhat similar to that in terms of their consumables; and then our core AMOT business. Those three were leading indicators for us in Q4 of 2008 when you went into the ’09 downturn, so we’re looking at those things weekly. In the fourth quarter, they did better than the concern level you would have had, so we haven’t really seen anything in those businesses yet that would indicate that there’s any forward indicator; and in fact, December shipments were stronger for the businesses than October and November, which resulted in us having a little bit more receivables at the end of the year than we would have liked to have had, but you know, it’s the year-end stuff that happens frequently. So I don’t think there’s anything that makes us nervous, and in the case of the equipment it wasn’t core equipment that we provide out of Struers for cutting technology. We have a line of hardness testers that we sell, and they were off in the fourth quarter. Fortunately they’re lower margin products, so it wasn’t overly material, but it’s something we’re keeping our eye on. Matt Summerville – Keybanc: And then just one follow-up – can you just talk about what you’re seeing out of Sunquest in terms of pro forma organic revenue growth versus your expectation going into the deal?

Sure. I mean, they continue to do extremely well. We’re seeing high single digit organic growth out of that business, and we would expect to see that continue into 2013 also. Matt Summerville – Keybanc: Thanks Brian. Thanks John.

We’ll take our next question from Mark Douglass with Longbow Research. Mark Douglass – Longbow Research: Good morning gentlemen. Looking at your expectations of expanded EBITDA margins in 2013, can you help break down a little bit how much you expect in gross margin improvement versus operating expense growth? It seems like a lot of—I think certainly some of it is going to come from Sunquest, but if you can break that down, it’d be helpful.

You know, I’m going to need to follow up with you on that. We do expect to see gross margin expansion along with operating margin expansion, both because our faster growing businesses are also our higher margin businesses on the software side as well as on medical and the impact from Sunquest. So probably not quite as much on gross margin as we’re expecting on EBITDA margin, but both of them we expect to be up in ’13. Mark Douglass – Longbow Research: Okay. And then on Neptune again, Brian, it’s still been a pretty strong couple of years. Is there any ramp-down in sales and projects outside of the one that you lost, and what are expectations for the industry, and then with Neptune relative to the industry in 2013? And do you expect more people to go—maybe even shift to the composite?

Well, I think as far as the situation is, you’re going to get—we would get a disproportionate amount of new meters associated with housing starts, so as housing starts are picking up, so are our sales through distribution in the U.S. water market. So we expect pretty decent growth there, certainly high single digits, maybe more; and so other people who have lower shares than we do are likely to get some corresponding benefit in their business. I think it’s a generally favorable or more favorable market than it has been for replacement water meters and for just installs for (inaudible). When it comes to the rest of the world, that’s an entirely different story and our products really don’t play in anything other than the high pressure water market. Composite meters, nobody’s had great success with those over time. We don’t see any shifts to that at all except in people who come in who don’t know the industry, don’t know the products, and think everything is uniform because they’re SAP people. They can do things that will be proven to be a mistake later, and so we’re not really bothered by that. It’s not the first time we’ve lost a customer only to get them back a little bit later when they realize that value is more important than price. Mark Douglass – Longbow Research: Okay, thank you.

We’ll take our next question from Christopher Glynn with Oppenheimer. Christopher Glynn – Oppenheimer: Thanks, good morning. Brian, just apparent liquidity notwithstanding, wondering how you’re looking at the short to long-term acquisition pipeline, how you’re thinking about the range of scale and breadth, and if you see any scenario where a modest share issuance would be appropriate or warranted.

Well, I think we’re pretty reluctant to want to issue any equity. I really just don’t see the need for that. The reason that we do acquisitions is because we have great free cash flow, and when you lever that at, say, three times debt to EBITDA the acquired company, you can really make a material difference in your growth rate and kind of in the perpetuity growth rate of the enterprise, and that’s what we do. We just think that’s the best way to create shareholder value. If we wanted to increase—I mean, I don’t know why we’d issue equity unless it was just the most incredible, spectacular thing of all time, and we did that in December of 2003 when we acquired Neptune and didn’t have really a high quality public company balance sheet. We did it again in December of 2004 when we acquired Neptune. Those acquisitions represented four times trailing EBITDA of the company, for heaven’s sakes, in terms of what we had to do. You know, with trailing EBITDA with a run rate well in excess of a billion, we’re not planning on a $4 billion deal tomorrow at noon. So I think we can be quite satisfied with 1.5 billion-plus a year in acquisition growth, so I don’t think we would issue equity. Christopher Glynn – Oppenheimer: Thanks. And then the other one would be let’s go a little bit more into the bridge from the current orders rates to the EPS target for next year – very strong, but had some backlog runoff in the second half. We’ve gotten some color, but if we could just dive into any more qualitative around that.

Sure. I think as we went through our—not only the planning activity that we always do but also the fourth quarter operating reviews that we go through with each of our businesses, we look not only at what they actually did in the fourth quarter but their projections for the first quarter and the rest of the year, and what’s in their backlog, what’s in their pipeline of opportunities. As we went through that, we saw a number of things, both on the new product introduction side but also on the projects that are currently being bid and currently in front of us, not yet in backlog, that give us confidence that the second half of the year we’ll see a higher organic growth rate than what we’re going to see in the first half of the year. But I think that that’s going to be weighted more toward—well, probably RF will be a little bit stronger than industrial for the full year basis, but overall we expect to see full-year organic growth in all four of our segments. Christopher Glynn – Oppenheimer: Great. Thanks a lot.

We’ll take our next question from Richard Eastman with Robert W. Baird. Richard Eastman – Robert W. Baird: Yes. Brian, just a couple questions. In the energy systems business, the book-to-bill in the fourth quarter was maybe a little bit softer than we typically see seasonally. Has anything, again, maybe slowed there or is that just a comparison issue? And then within that, the compressor controls, the acquisitions you made, the smaller ones, it sounds like they’re bringing software into compressor controls. Is that the right way to think about that? I mean, are these companies bringing customers or are they bringing code? What are these small acquisitions—how do they expand the business?

Well, I’ll take the latter and then we’ll shift back to the nature of the orders. Each one of them is a little different, but United Controls brought with it a very significant engine manufacturer that we were not doing business with, and so that gave us a customer benefit. It also gave us some application engineering capability with that business that supports what we do, so that was good. It also gave us some improved regional activity in some parts of the world. Trinity Software was an entirely different concept where it had some breakthrough code, to use your term. It really has breakthrough technology that’s in its infancy. It’s going to be in maybe high single digit millions, but it’s the kind of thing that can move up quite dramatically over the next three years, so we’re investing a lot of time in bringing our business processes to that group of people. Cambridge is not in compressor controls. It’s in petroleum analyzer, and we have some, if not the best equipment in the world in analyzing different things for refineries, but we don’t have a lot of online capability and Cambridge brings us an opportunity to have online capability in software. So that’s an important growth venue for us. Now on the order flow and seasonality of fourth quarter, John, why don’t you take that?

Yeah, sure. In terms of the fourth quarter orders for energy, they were actually in line with what we had expected. What we’re seeing, of course, is with many of the projects that compressor controls has already completed and now it’s moving into field service, it changes the timing of those orders. It’s more of a book-and-ship, or a book and then maybe ship two or three months later when you recognize the revenue associated with field service, as opposed to their larger projects which oftentimes would—distort is probably not the right word, but would affect the book-to-bill ratio in fourth quarters of prior years. The other areas that we normally look for and did see seasonal benefits, both on the instrument side for Alpha Technologies and also on our petroleum analyzer business – once again, providing software algorithms and testing solutions for refineries – we did see a seasonal uptick in the fourth quarter, but that was both on revenue and orders so that seasonal uptick really didn’t change the book-to-bill ratio very much. Richard Eastman – Robert W. Baird: Okay, I understand. And then just a last question – in the RF tech business, we talked about some pretty nice wins on the tolling and CBORD side. This RF tech is always a little difficult to model out given the timing and the size of these projects, but when you think about ’13 and project out ’13 in your forecast, can RF tech have a double-digit growth year for ’13?

It can. I don’t think that that’s embedded in our guidance, though. Richard Eastman – Robert W. Baird: Okay, can but we shouldn’t time this out to the point where we’ll get a—

Yeah, our expectation with respect to 3 to 5% organic growth for the year, like I said, it’s a little bit more heavily weighted. RF may be above that, but we’re not ready to say that’s going to be double-digit yet. Richard Eastman – Robert W. Baird: Okay, fair enough. Thank you.

Although for our internal people listening, we expect you to move along those lines! Richard Eastman – Robert W. Baird: With better margin, huh? Great, thank you.

We’ll take our next question from Alex Blanton with Clear Harbor Asset Management. Alex Blanton – Clear Harbor Asset Management: Good morning. I’d like to address the guidance that you announced as you set a 15.1% increase over last year, and if you adjust for the higher tax rate, it’s about 17.5% increase. But that’s less than the company’s long-term average growth, the 20%. I don’t want to seem ungrateful – 17.5% is still pretty good. It seems that some of that is in the first quarter because that guidance is only up 11% from last year. Are you being too conservative here on looking at a weak economy? Just exactly what are the assumptions behind the guidance, because it isn’t as strong as, for example, you did in 2012. Is it possible that you’re getting so big or your margins are getting so high that you can’t get the same percentage increase in margins relative to the increase in sales that you’ve gotten in the past? Could you address all that?

Alex, I think one of the factors when you’re looking at our previous years’ growth rates, of course those always include not only what we do on an organic basis but also the effect of acquisitions; and our guidance for 2013, as it always does, excludes any acquisitions that we have not yet completed. So I think that is probably going to be one of the differences you see between our guidance and the actuals as they roll in, Sunquest being an example of that – of course, that added both accretive earnings but more importantly accretive cash flow to us for 2012. We would expect future acquisitions, although they’re never in our guidance, to be accretive from a cash basis also. Whether they are accretive on an earnings basis is always going to be dependent upon the accounting ramifications of amortization and other things. Alex Blanton – Clear Harbor Asset Management: Right. Well yes, and when they come in the year.

That’s also true. Alex Blanton – Clear Harbor Asset Management: It’s possible you could have accretive acquisitions that really wouldn’t add to 2013 if they came late in the year.

That is true. Alex Blanton – Clear Harbor Asset Management: But could you address your economic assumptions and why the first quarter is only up 11%? Because that would not include—I mean, that wouldn’t be because you haven’t added in acquisitions to the first quarter guidance, because you don’t have time to—

That is correct. That is correct, so kind of as we talked about a little bit earlier, we do expect the organic sales growth to be higher in the second half based upon what we’re seeing from a project pipeline and execution of our existing backlog relative to the first quarter. We also have in the first half a little bit of headwind associated with the Neptune customer that decided not to renew with us. So those are some of the things that we’re seeing – a little bit tougher comp against last year where we had 8% organic growth in the first quarter of last year. It’s a little bit of a tougher comp versus what we see for Q2, Q3 and Q4 as we go forward. Alex Blanton – Clear Harbor Asset Management: Okay. Then a follow-up – why is the tax rate up?

Well, Sunquest as a U.S.-based company generates most of their earnings in the United States, which is the highest tax rate in the world, and so those earnings come in at a marginal tax rate of probably 38 to 39%. And then just other normal tax planning activities, which is probably the—which is definitely the smaller portion of the increase that we expect for ’13. Alex Blanton – Clear Harbor Asset Management: Yeah, we definitely need corporate tax reform. Thanks.

I wouldn’t say protection; I’d just say a level playing field. Alex Blanton – Clear Harbor Asset Management: Thank you.

And that does conclude today’s question and answer session for this call. I will now turn the call back to John Humphrey for any closing remarks.

Okay. Thank you all for joining us and we look forward to talking to you as we finish our first quarter.

That concludes today’s conference. We appreciate your participation. You may now disconnect.