Sometimes the headline numbers don't tell you everything about a company's earnings, and that was definitely the case with diversified industrial Roper Technologies' (NYSE:ROP) first quarter. A revenue increase of just 4.4% accompanied by flat operating income isn't usually anything to write home about, but the figures mask a lot of moving parts under the surface, and the underlying picture is a bit brighter.
Let's take a closer look.
Roper Technologies' first quarter: The raw numbers
The key headline figures:
- Reported revenue increased 4.4% to $927 million, comprised of a 9.6% increase from acquisitions offset by negative organic growth of 3.2%.
- Operating income was flat at $249 million with margins declining 130 basis points (where 100 basis points = 1%).
- Diluted EPS of $1.50 compared to previous guidance for $1.42 to $1.47, representing a 3.2% decline from the same period last year.
Even though EPS came in ahead of expectations, it was superficially a poor performance from Roper, but as discussed above, headline numbers aren't everything.
In fact, management felt suitably satisfied with the first quarter to maintain its full-year guidance. As a reminder, the full-year guidance issued at the time of the fourth-quarter earnings presentation was as follows:
- Operating cash flow of around $1 billion.
- Full-year revenue growth of 8% to 10%, including 2% to 4% organic growth.
- Full-year diluted EPS of $6.85 to $7.15, implying growth of 2.5% to 7%.
Clearly, guidance for the full year implies a pickup in growth for the rest of the year, but what was it about the first quarter that gave management such confidence?
What happened in the quarter
A brief look at the key points:
- Orders grew 9%, creating an overall book-to-bill ratio of 1.02, implying an acceleration of growth to come.
- Excluding oil and gas, organic revenue increased 1%.
- Excluding headwinds from tough comparisons due to high-revenue-generating work in Puerto Rico and Toronto in last year's first quarter, organic revenue growth was 3.5%.
- Gross margin increased 210 basis points to 62.1%.
- Operating margin declined 130 basis points (see above) to 27.4%, but amortization (a non-cash item) accounted for 120 basis points of the decline.
- The earnings before interest and amortization margin of 32.9% was comparable to the 33% reported in the first quarter of 2015.
The order increase bodes well for future growth, and underlying margin performance is better than the headline numbers suggest. Moreover, regarding maintaining guidance for the full year, CEO Brian Jellison sounded an upbeat note on the earnings call:
We're really comfortable with the second half of the year. We're not really seeing any industrial contagion at all in those portions of either industrial or the energy businesses that are not oil and gas. And certainly, at the beginning of the year, that was something that many people were worried about.
He went on to claim that hitting the high end of guidance was dependent on issues such as project timing, software adoption rates, and seasonal activity -- all of which suggests confidence in underlying growth.
For those who don't know the company, Roper operates a highly acquisitive business model, involving purchasing asset-light businesses with high margins operating within niche markets. With such a model, it's a good idea to focus on cash flow generation -- a metric Roper's management prides itself on, especially as good cash flow is needed to fund future acquisitions.
The good news is, Roper continues to drive excellent cash flow conversion. Working capital as a percentage of sales declined to 4% in the first quarter, compared to 5% and 6.3% in the same quarter of the previous years. In other words, the company is tying up a lot less cash in order to generate revenue -- good for free cash flow generation. In fact, free cash flow as a percentage of revenue came in at a highly impressive 26% in the first quarter.
CFO John Humphrey expects second-quarter organic growth to be flat, leading into mid-single-digit growth in the second half of 2016. In other words, the underlying improvements in its business (orders, gross margin, and underlying organic growth) will start to shine through, leading to 2% to 4% organic revenue growth for the full year.
Risks still remain, not least from an uncertain economic environment as well as internal execution, but on the basis of the first quarter, Roper Technologies is on the right track. It's cash flow that really matters to the company, and management is doing a good job of generating it for investors.