Multi-industry industrial company Roper Technologies, Inc (ROP -0.39%) on Monday reported strong third-quarter earnings that helped illustrate the benefits of its asset-light business model and ongoing transition toward more software-based revenue streams. While the quarter wasn't without blemishes, the results reveal a company making strong progress following a difficult 2016.
Roper Technologies is a prodigious generator of cash. Image source: Getty Images.
Roper Technologies third-quarter earnings: The raw numbers
Starting with the headline numbers:
- Total adjusted revenue of $1.17 billion increased 24%, and 5% on an organic basis.
- Adjusted diluted EPS of $2.36 increased 20% and came in ahead of guidance of $2.24-$2.30.
- Gross margin expanded to 63% from 61.3% in the same quarter last year.
- Earnings before interest, tax, depreciation and amortization (EBITDA) margin increased to 34.8% from 34.6% in last year's third quarter.
- Year-to-date operating cash flow of $866 million increased 18.5% from last year and represents 25% of year-to-date revenue.
In a nutshell, Roper managed to increase margin -- something other industrial companies have struggled to do in this reporting season -- while generating good organic growth of 5%. Acquisitions helped grow revenue by 19%, but Roper has long been a highly acquisitive company. Essentially, Roper's business model involves buying asset-light and high-margin companies operating within industry niches. As you can see above, this lends itself to a high amount of cash conversion.
Guidance and a blemish
The strength of the results was behind management's decision to hike full-year guidance:
- Third adjusted diluted EPS forecast in the range of $2.56-$2.62.
- Full-year adjusted diluted EPS expected in the range of $9.27-$9.33, compared to previous guidance of $9.12-$9.30.
That said, the quarter wasn't without issue. A look at segment performance reveals the laggard in the quarter was the medical and scientific imagery segment.
|
Segment |
Revenue |
Revenue Growth |
Organic Growth |
Operating Profit |
Operating Profit Growth |
|---|---|---|---|---|---|
|
RF technology and software |
$492 |
61% |
4% |
$144 |
49% |
|
Medical and scientific imaging |
$344 |
2% |
1% |
$116 |
(3%) |
|
Industrial technology |
$200 |
12% |
12% |
$62 |
18% |
|
Energy systems and controls |
$135 |
8% |
6% |
$36 |
14% |
Data source: Roper Technologies presentations.
On the earnings call, CEO Brian Jellison outlined that he'd expected 4%-5% organic revenue growth out of the medical segment, and that many of the businesses within the segment achieved "mid-single digits and above." However, poor sales at Verathon (video laryngoscopy and bladder volume measurement devices) reduced organic growth in the quarter to just 1%.
When quizzed on the earnings call about the matter, Executive VP Laurence Neil Hunn put it down to "a combination of channel execution challenges that are being corrected as we speak, and then a little bit of timing between product cycles, new products we're developing and the timing of those releases." He then said it might take "a couple" of quarters to correct, and Jellison later outlined how Roper was adding sales resources at Verathon in expectation of "much stronger demand, particularly in the second half of 2018."
Clearly, the Verathon situation is worth following closely in the coming quarters.
Cash flow, deferred revenue, and working capital
It's worth noting a few things about how Roper's business transformation is affecting its metrics. When a company grows its software revenue and its subscription-based revenue, it's likely that its cash-flow generation will increase, alongside its deferred revenue (subscription revenue that hasn't been recognized yet).
The difference can be seen in the numbers. For example, Roper's annualized working capital requirements changed from 2.7% in last year's third quarter to a contribution of 2.5%, helped by an 84% increase in deferred revenue to $535 million.
Moreover, with capital expenditures totaling just 1% of revenue year to date, the operating cash flow of $866 million dropped into $822 million of free cash flow generation -- around 24% of revenue on a year-to-date basis.
All told, the improvements in Roper can also be seen in its headline numbers (profit and loss) and underlying improvements in cash flow generation.
Looking ahead
Investors will want to see improvements in the medical segment in the fourth quarter and a continuation of the company's transformation to more software-based revenue. Roper has had a good year in 2017, and management's confidence in 2018 will hopefully play out as expected.
