Roper Technologies Inc (ROP) 2014 Q2 法說會逐字稿

Roper Industries second-quarter 2014 financial results conference call will begin now.

I will turn the call over to Mr. John Humphrey, Chief Financial Officer.

Please go ahead.

Thank you, Tina.

And thank you all for joining us this morning as we discuss the results of our record second quarter.

Joining me this morning is Brian Jellison, Chairman, President, and Chief Executive Officer; Paul Soni, Vice President and Controller; and Rob Crisci, who heads up 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 have prepared slides to accompany today's call, which are available through the webcast and also on our website at www.roperind.com.

Next slide, 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 further detailed in our SEC filings.

You should listen to today's call in the context of that information.

If you please turn to slide 3, today we will be discussing our income statement results for the quarter on a GAAP basis.

Prior-period results are presented on an adjusted basis for comparison purposes.

A full reconciliation between GAAP and adjusted measures is in our press release this morning, and also included as a part of this presentation on our website.

Now, if you'll please turn the slide, I will turn the call over to Brian Jellison, Chairman, President and Chief Executive Officer.

After his prepared remarks we will take questions from our participants.

Brian?

Thanks, John.

Good morning, everyone.

If we look at enterprise financial results for the quarter they were, once again, truly outstanding.

We had all-time record orders.

Record backlog closing out the quarter, record revenue within the quarter, record net earnings in the quarter, and of course another record for EBITDA performance.

Our revenue was up 13% in the quarter on a GAAP basis, but 10% on an adjusted basis, which is the way we really look at the quarter.

Organic revenue was quite substantial at plus 8%.

For us it was very broad-based.

All four segments were up organically, which was nice to see.

But certainly medical and RF had a blowout performance on an organic basis.

Our gross margins just continue to go up.

It is a remarkable achievement, up 120 basis points to 59.1%, which is really why we call our Roper Technologies these days and not Roper Industries.

Operating profits up 18% to $247 million in the second quarter.

Our operating margin is up another 180 basis points, clearly above the gross margin improvement at 120 basis points.

And operating margin came in at 27.9%, which includes a lot of amortization, too, folks.

So, you add that on top of it and the number is even stronger.

Our DEPS in the quarter on an adjusted basis at $1.56 GAAP against last year's adjusted number were up 19% on a GAAP basis.

GAAP to GAAP were up 41%.

And operating cash flow in the quarter was an additional $141 million, which was 14% better than the prior year.

So, we are very well-positioned to assure a record year in 2014 for the Company, along with delivering just an outstanding second quarter.

Next slide.

If we look here at the income statement you can see that even though we had the very strong revenue quarter up 10%, with organic 8% our book-to-bill was virtually 1. A little bit of lumpiness in RF with TransCore that we will talk about, but that's not unusual.

If we look at the gross profit, as we said it went up from 57.9% in the second quarter of last year to 59.1% in this quarter.

And operating margin went up from 26.1% last year to 27.9% this year.

Interest expense was a tad less.

And our tax rate was just a little bit lower than it was a year ago, 70 bps.

Net earnings, we talked about, at $156 million versus $131 million.

We are really again broad-based on a segment-by-segment basis.

Next slide.

Here if we look at the EBITDA growth and the trend in the Company, we tend to show you a couple of years of trailing results at a time.

You would probably be well-served to remind people if you go back to 2003 our EBITDA was about $125 million, not the $1.153 billion that you see now on a trailing basis.

And our EBITDA margins were in the high teens, not the 33.5% you see today.

So, that's why the Company really has become much more of a technology company with higher margins, more sustained and continued performance.

And these very high margins, up 420 basis points on an EBITDA basis in the last two years alone, really allow us to reinvest internally for growth at a much faster pace than Roper would have been able to do 10 years ago, or even 5 years ago.

You look at the gross margin, which we probably don't talk enough about, you can see in 2012 trailing 12-months performance was 54.6% gross margins.

Back 10 years ago gross margins were always high at Roper, say 50% or so, but certainly didn't have the kind of reinvestment and growth strategy back then that we do today.

450 basis point improvement in gross margins is something we are very proud of over the last two years.

Next slide, if we look at the cash flow, cash flow in the quarter, $141 million of operating cash flow and $130 million of free cash flow, really resulted from the fact that we had very little cash tax due in the first quarter, about $25 million, and we had $132 million of cash tax here, as economic patriots that we are.

So, you wind up with quite a high amount of tax paid in the second quarter.

It is about $107 million more than it was in the first quarter.

Those things tend the level themselves out over the course of the year.

Our first half operating cash, you can see, represents 21% of revenue at $353 million.

And our free cash flow at $333 million is up 15% over last year.

We expect outstanding cash conversion throughout the remainder of the year.

And our total operating cash flow to revenue will be as it has been in years past, continuing to grow.

In the metric you see here, $845 million of operating cash flow in the last 12 months,.

And that's up from $620 million just two years ago.

So, a 36% improvement in operating cash flow during that two-year period.

Next slide, if we look at the asset light business, again, just astonishingly good numbers.

Two years ago we were below 10% and people were marveling about our ability to get there.

But we certainly haven't given up any of our internal strategies.

You can see we've reduced inventory from 7.2% of revenue two years ago to 6% now.

And our payables and accruals have expanded from what they were two years ago.

You can see that the net working capital, the way we define it, inventory plus receivables minus payables and accruals, has dropped from 9.5% to 6.2%.

So, that's a 35% improvement in just two years.

Next slide, if we look at the balance sheet, the strong financial performance always gets best seen when you compare your balance sheets.

The year ago, our cash was $375 million.

Today it is $565 million.

And our undrawn revolver is virtually just very little drawn against it.

So, it gives us a cash and undrawn revolver flexibility to invest $2 billion.

More importantly, you can see that gross debt has dropped by $513 million, even after doing the $1 billion MHA acquisition last year.

So, we continue to pay down debt pretty quickly.

The gross debt to EBITDA number is below 2, at 1.9.

Our willingness to have a higher debt level than that our debt tolerance, is certainly much higher than the kind of number you see here.

And that, coupled with the reality of having a couple of billion dollars to deploy, we would expect to have pretty rapid cash deployment aggressively over the next few quarters.

We think you'll see some things now and some things later in the year, and much larger things probably next year.

Next slide, here we look at the segment detail for each one of the business.

Next slide, looking at Energy Systems and Controls, you can see it was up organically 5%.

It had strong revenue out of our compressor controls business, driven by both midstream and downstream installations.

We had decent growth in our instruments and consumables business and service for refineries.

And then we had much better demand, certainly a resurgence in Canada with oil sand activity and various things that have to do with pressure sensors we have, and things that have to do with [beast] lines and shutoff valves, and what have you.

Our book to bill in the second quarter, even though organic was up 5%, was still at 1. You can see total revenue was up 7%; a little bit of contribution from a small acquisition we made last year.

Operating profit up 8% and OP margin improved a little bit to 27%.

Organic growth in the second half of the year for Energy we think will be pretty strong in the third quarter.

Probably a little less than that in the fourth quarter, but over the balance of year should be fine.

We do have this mid single-digit outlook for the segment for the entire year.

It probably would be better if we saw a return to large project activity.

That's pretty slow.

You can see that with everybody that's in the oil and gas side of activity, the geopolitical ambiguity that could get worse, could create project timing issues and slow decision-making.

Notwithstanding that, everything else is strong.

So, the aftermarket products doing very well.

Field service is also doing well.

We have an easy comp in the second half of this year because Zetec will be back to its normal type of activity which will be a substantial increase over last year's disappointing third quarter.

And the oil and gas end markets remain pretty favorable, particularly with the oil sands getting stronger and the prices associated with Canadian product going up.

Next slide, we look here at Industrial Technology, you will see we had continued great results out of Neptune.

They grew revenue and also had better margins in the quarter.

US was particularly strong for Neptune.

Neptune was awarded an Amazon web service award for what's called their City on the Cloud Innovation Challenge.

They have a program called N_SIGHT, which is a trademarked -- N_SIGHT IQ, which helps municipal water companies manage the flood of water data that they get, which they're ill-equipped to deal with.

And this allows us either to host or provide software that makes it easier for them to understand the data that they have and respond to questions about that from users.

I believe there's -- I think you could see a Youtube video about that, too.

Roper pump continues to have great business in the directional drilling applications that we've talked about in the past.

They continue to gain share from other people.

And our material analysis business, Struers in Denmark, had particularly strong equipment orders and sales of their hardness testers, which is good news on that handle, although they're lower-margin items.

And it did impact their margins some, as equipment grew much faster than the consumables and that's something we think will rectify itself in the second half.

I would point out Industrial Tech, which had operating margins of 29.5%, which are beyond world-class, and they were up 100 basis points sequentially from our first-quarter on operating margins.

In the second half of year we think we will have a little bit better organic growth in the fourth quarter than in the third quarter.

Some of those businesses tend to get year-end benefits.

We expect for the balance of the second half to have mid single-digit revenue growth in the segment, but with very strong margins and excellent cash contributions from the segment in the second half.

Two double-digit growth type things are our Cornell pump business is going to have very strong second half as the rental market continues to add capacity for pumping stations with fracking back alive and well.

And Roper pump strong demand at increased capacity means we will grow double digits there, and we will have better margins since they get leverage out of that growth, certainly stronger than it was in the second half of 2013.

Next slide, here, if we look at the RF Technology businesses, everything in here is quite spectacular, although we had a fairly soft booking book-to-bill period.

The segment came in at 0.96, which is certainly not unusual.

But everything else was really just amazing.

We had an absolute all-time record for TransCore in terms of revenue for their toll and traffic operations.

The projects that were underway in Florida, Texas and California, Virginia all performed very well.

Actually, Q2 enjoyed some pull in from project execution effectiveness that we would have not expected until end of the third quarter, so that benefited us in the second quarter.

We had some really important wins in the area.

We got the San Francisco Bay Area express lane conversions, which were extremely hard fought by everybody in the industry, and we were selected.

That will be over a $50 million project.

We got the Massachusetts Department of Transportation back-office extended.

That's a big contract over a decade, $250 million.

And then we got the Henry Hudson Bridge, which is a very strategic thing because New York, New Jersey in tolling is the largest agency in the country, and it is not an agency we've had much work with.

So, again, our technology being preeminent allows us to get our foot in the door there, which will be, we think, a forward predictor of how well we're going to do there over the next several years.

We had great tag shipments in the second quarter, which benefited the revenue, which you can see is up 10%, OP up 17% in the quarter.

We also had some strong sales out of our RF security products.

For all of us who go through airports and a look at the TSA agents, you probably don't know that now every one of them will have a little pendant, so people know a little bit more about what's going on there.

And we've received the award for those pendants which will start to ship here in the second half of the year.

Our SaaS business has continued to grow modestly in the quarter, but they are growing.

The college and university security projects, though, were a little lower than last year because we had finished Northeastern University, which was a very big install.

Profitability was actually better for CBORD because the installation business always carries very modest margins.

But the revenue was not up a lot in the quarter for that.

In the second half of the year we will expect low single-digit growth.

We've got a couple of headwinds that are probably going to pull down our overall organic growth, but we will grow organically in the half 2014.

Our toll and traffic projects are going to continue to remain at high levels.

But we started a lot of those last year so the comps will be a little bit more difficult even though the numbers will be high.

And iTrade was able to make an acquisition that closed on July 2 called FoodLink.

This is really a technology acquisition.

It reminds us of United Toll Services for TransCore.

What they do is they provide the traceability, a farm-to-fork basis, so from the grower, if you will, to the in-store purchaser of products which are fresh.

One wants to know where they came from and how long they've been in transit.

And all those traceability factors are things that iTrade could acquire from others but now will have its own technology to be able to do this.

Makes it much easier for the stores to deal with iTrade on a broader network basis.

So, we are encouraged by that.

Next slide, we look at the Medical and Scientific Imaging segment, you can see just continues to be spectacular.

The organic growth in the second quarter was up 12% after being up 7% in the first quarter, certainly led by medical.

Sunquest had an all-time record quarter.

This Meaningful Use implementation and our ability to improve Sunquest's ability to execute really paying huge dividends now.

A lot of upgrades in the hospitals.

We continue to invest very aggressively internally in Sunquest to capture more of the anatomic pathology and genomic testing opportunities that we see ahead.

That's a lot of internal investment in there, but we are also very active in the acquisition pipeline area around those areas.

We had very strong performance at MHA with a lot of new members acquired for both long-term care pharmacies and long-term care facilities.

Their results in the management area around facilities is very encouraging for them.

We also had double-digit growth at Verathon with new and enhanced products.

There are several things we've talked about.

And in the second half you'll see this titanium GlideScope, which is a breakthrough product for certain applications.

We will continue to drive that growth and enhance it in the second half.

Our Northern Digital business image-guided surgical had a phenomenal quarter.

And based on orders and their flow of activity looks to continue that throughout the second half of the year.

And scientific imaging continued to improve, up mid single digits in the quarter on a revenue basis.

In the second half of the year, we will probably come in just under double-digit growth just with imaging.

It continues to be a modest grower whereas the rest of medical we expect to have double-digit growth.

New and enhanced medical products and measurement were about Verathon's titanium GlideScope, being the biggest single product, but there are actually quite a few others: an enhancement of Amador BladderScan product.

Both Sunquest and MHA will deliver double-digit growth in the second half, and that certainly means more than 10%.

And, then, I would say, I would expect that you would see announcements from us throughout the year about possible things that will have occurred in the acquisition pipeline area.

There's a lot of very attractive smaller companies that we are working with, and a few larger ones, as well.

So, we are very encouraged by what's going on in this space.

Next slide, if we look at the guidance update, turn to the next slide, we are increasing the full-year DEPS guidance from $6.22 on the low end to $6.27, and on the high end to $6.37.

We think revenue growth should come in for the full year around 8% to 9%.

And organic growth should be around 6% to 7%.

No, the organic growth, when we started the year at the end of 2013's year-end report, we established organic guidance at 4% to 7%.

And then as we went into the second quarter, we moved the organic guidance up to 5% to 7%, as we had continued to see more strength.

And, then, now we are moving it up to 6% to 7% for the full year, with the 8% growth we enjoyed in the second quarter.

So, the organic growth has been very strong throughout the year for us.

Tax rate for the full year we think will be around 31%.

It was 30.4%, I believe, in Q2.

We have some FIN 48 roll-offs that occurred in the third quarter last year that are probably going to make it difficult to have a tax rate that's as low as the 30.3% we enjoyed last year.

So, we are going in with the assumption it will be about 32%, which will cost us a few pennies in the quarter.

Revenue growth in the third quarter, though, should be up 5% to 6%.

So, we established DEPS guidance here at $1.49 to $1.53.

And I think revenue in the third quarter will be somewhat similar, a little bit above hopefully the Q3, which is a typical behavior pattern for us.

But certainly up nicely from the third quarter of last year.

Next slide, if we look at the summary for the second quarter it was just an extraordinarily great quarter for us.

In addition to having all these nominal numbers of records with orders and revenue and backlog and net earnings and EBITDA, the variables were really good, with the revenue up 10%, gross margin up 120 bps to 59.1%, operating margins up 180 bps to 27.9%.

The leverage was just phenomenal in the quarter.

For those of you who want to flip out your calculator, you'll see our operating leverage was about 46% in the second quarter, which is why getting any nominal growth is so powerful here at Roper.

Our EBITDA was up 14% to $295 million.

And we've raised our full-year guidance.

And we had just an excellent first-half performance with these record margins and organic growth.

We think our full-year cash conversion will again be outstanding, like it was last year.

And our current acquisition discussions remain mostly in the medical and software.

They're very active, with lots of opportunity, and a very powerful balance sheet to take advantage of that.

So with that, John, I think we are positioned for both a record year and questions from the investment community.

Okay.

Tina, can you go ahead and start the question and answer period?

(Operator Instructions)

Matt Summerville, Keybanc.

Good morning.

A couple questions.

First, Brian, can you talk about the sustainability you see in the growth you're experiencing in Sunquest and MHA, just looking out over the next couple of years?

And also fold into that what you think is going on with market share.

And, I obviously recognize there's a large recurring revenue component here, so I just want to get a feel for where you think these normalize out.

We're going to expect double-digit growth for some time out of Sunquest.

The areas we're taking them into are very exciting areas.

There's a lot of opportunity.

In the short run you get the benefit from Meaningful Use requirements to take care of government regulation.

In the long run you get many new forms of testing with us, having just a very unique way to capture that.

So, we are very positive about the long-term prospects for Sunquest.

Whether it turns out to be a high single-digit grower over the next five years or a modest double-digit grower, or substantially more, it is hard to say.

It generates a lot of cash, so it gives us a lot of money to add from an acquisition viewpoint.

And certainly when I think about what we will do organically there, plus the acquisitions we are going to make in that space, it will be one, if not the most exciting business we have, along with MHA.

And then, just as a follow-up, you definitely seem more incrementally upbeat on your M&A prospects looking out over the next couple of quarters.

Can you talk about the relative size of the assets you're looking to acquire, the multiples that you might be willing to pay here, knowing this is a tough environment?

We could, but it wouldn't be in our interest to let sellers know what we might be willing to pay for anything, Matt, so it is hard to say.

We've said generally we like to not pay over 10 to 11 times first-year EBITDA, and that's something that's absolutely true.

Sometimes you may be a little higher and sometimes you may be lower.

But if you look at a blended basis we need to be investing at a clip that's $1 billion to $1.5 billion a year.

And sometimes we are ahead of that, behind it, and there will be different price values based on the kind of cash flows we can see from businesses.

But over time we still think of modeling our acquisition growth with debt to EBITDA somewhere around 3 or less.

Could be higher from time to time.

And looking to have a blended acquisition first-year number around 11, but it could be higher.

We are selling at a trailing 15 times enterprise value multiple.

The people that are like us in the marketplace, many of them are 20 to 25 times.

So, these are very high-valued assets.

But I would have to say that we're not seeing the difficulty in what we think will be our ability to close transactions in the next several months, having to do with pricing.

I think pricing's high but rational.

Great.

That's all I needed.

Thanks, Brian.

Deane Dray, Citi Research.

Thank you.

Good morning, everyone.

While we're on the topic of M&A, just if you would clarify one point here, Brian, because definitely you're sounding a little bit more positive in the ability to close deals.

So, what's changed in the past quarter in terms of your being more optimistic here?

It didn't sound like pricing has changed, but is it you have the availability of assets and more active discussions?

But just certainly you can see something's changed.

I would say we like the mix of the things that we are involved with.

And we feel like we are making a lot of progress in talking to people that hadn't decided whether they're ready to engage or not.

So, that all feels pretty good.

Usually when we get, as we get further and further down the line there's a lot of people that have an orientation around wanting to get something done before the end of the year.

So, it is getting closer to the end of the year.

There's a kind of seasonality that probably shouldn't be there that is.

And we've got things that we are involved with now that we really like.

The more diligence we do the better we feel about them.

So, those are all encouraging.

And there is just a lot for sale.

I think that we've got unbelievably powerful management teams in some of these arenas, in the medical arena and some of the software arenas that we have, that really give us an ability to make bolt-on things for these guys that, frankly, we didn't have before we had these two big legs in-house.

So, when you get back to being able to pick up some really great businesses, that not each one is $1.5 billion that we have to drive, it increases your confidence about being able to execute and deploy cash.

And we need to deploy cash in the next year.

We're not interested in sitting on a balance sheet with gross debt to EBITDA at 1.9, or net debt at 1.5.

That's, in our view, not acceptable.

Great, that's helpful.

And then could you clarify on the RF business, you mentioned there were some pull-ins related to project effectiveness.

Just flesh out that point.

What were the businesses?

And can you quantify that portion that was pulled in?

It is pretty much all the TransCore project businesses.

John, do you want to --?

Yes.

We have a number of projects that are underway in Virginia as well as in Florida.

I don't really think of them as pull-ins.

It's just that the revenue was recognized in the second quarter when we probably would have expected a little bit of that to be in the third quarter.

It wasn't anything that we tried to do, but just because of the effectiveness of completing and hitting milestones on those projects, we have a little more revenue than what we would've expected for the second quarter.

Would that be reflected in a lower third quarter for the TransCore business?

Or would we not see that blip?

No, but probably not as much growth as what we would have thought three months ago.

So, we had a little bit more in second quarter, maybe a little bit less in the third quarter.

But, still, for the year we continue to see our toll and traffic business performing extremely well, with very nice growth.

That's helpful.

Thank you.

Steve Tusa, JPMorgan.

Good morning.

Just on the guidance.

You tweaked up the organic growth rate for the year up to the high end.

You barely budged the EPS number.

With your conversion rates being extremely strong at 50% or so, I would have expected maybe at least a nickel or a dime with the additional revenue.

I don't think there's a change in tax rate.

Is there something on mix and margin that's going to change here in the second half?

I wouldn't say so.

What it is, is that our range of potential outcomes on the organic growth side, we just continue to move toward the higher end of that range because of the performance that we've been able to post in both the first and the second quarter.

So, we've been modestly better in the second quarter than what we expected.

But the second half still looks very consistent with what we've seen throughout the year.

So, I wouldn't read too much into that.

Okay.

And then just on the same line of questioning here, third quarter, I think it has been a while since your earnings didn't grow nicely from the second to the third quarter, just from a seasonal perspective.

Yet, you're guiding something that's more flattish to even maybe down a little bit.

Again, is there something, is there a specific couple of businesses on the margin front that we should be looking at to justify that?

Our tax business is expected to be higher.

So, our taxes are expected to be higher in the third quarter that they were --.

Right.

Okay.

So, it's a tax dynamic.

Sales, as well, though.

Your sales are guided to be flat, as well, flattish.

Yes, that's true.

And I think on a sequential basis sales will be a little higher than they were in the second quarter, but not dramatically higher than the second quarter.

And part of that is what we are saying where you've got some revenue recognition in the second quarter around TransCore projects.

So that does, in fact, take it away from the third quarter, that would be there.

So, if we look at the two quarters together, our guidance is about where it would have been before, although just we raised the bottom end quite a bit because it is already in the bag.

Right.

Okay, that makes sense.

And just one last quick one on the acquisition front.

I would say this is a material change versus what you were saying several months ago when you really were talking about the pricing environment being very tough.

And then you talked about the size of the deals, some smaller ones closing near term, larger ones next year.

Is it just it takes the larger ones longer to get done?

Or is that just something about how the way the M&A environment unfolds in cycles, where the smaller ones go first and then the larger ones come?

I don't know.

I'm just curious as to why the difference in comments around the size of the deals?

I don't think that there's any seasonality related to the size.

There is a desire for a lot of people, if they are in the market with an asset, they want to get it done generally before the end of the year, for lots of reasons.

So, there is an opportunity to close more towards the end of the year.

If you looked at our history over time, you'd see a lot of the things that happen, happen in the last quarter of the year.

In terms of the size of deals, most of the things that we've been looking at this year are relatively large.

But we have so many smaller things that we can tuck into an MHA, and to a Sunquest that we've been willing to look at those things, which, frankly, we wouldn't have paid a lot of energy to that because we would have felt that we didn't need another $100 million business here and another $80 million business here, unless we had a leadership team that can assimilate those in a very good way.

So, we are encouraged by that.

We've added an awful lot of strength to those two businesses in terms of people and leadership and capability.

That probably is as much a reason why I sound the way I do about that, because of our confidence in the leadership in those companies.

And, then, at the beginning of the year there certainly were large deals that we were interested in that we thought were going at high teens multiples from an adjusted EBITDA basis, that our diligence wasn't willing to buy into the adjustment.

So, I think there's a little bit more clarity on the part of people about what they think they are going to do for the balance of this year and what they're going to do for the balance of next year.

And the diligence process is coming in with a more realistic outcome, than guys trying to tell you the trees are going to the moon, and they are not.

They're a little more realistic.

And we've said for a long time that things like junk bonds and CCC debt and subordinated -- it is crazy, crazy, crazy.

Risk factors relative to where they trade on the price.

And you start to see some erosion in that, finally.

That changes attitudes instantly.

Right.

Great.

Thanks a lot.

Joe Ritchie, Goldman Sachs.

Hi, good morning, everyone.

The first question, just talking about M&A, it does sound pretty encouraging how optimistic you are about getting the deals done.

Is there a way you can quantify over the next 12 months how much you can get done?

Clearly your balance sheet is in great shape.

It seems like the pipeline is strong.

And the follow-on beyond that, the focus has really been on the medical and scientific imaging.

Is that squarely where you are looking at today?

Or are there areas across the rest of your portfolio where you're looking to do deals, as well?

We look at a lot of different areas, but the reality is that the economic performance and cash-on-cash returns in medical and software just blow away the stuff that is generally available in energy or in any kind of core industrial business.

So, we've enjoyed great growth in our pump businesses; record level growth.

But they take a lot of assets so they don't provide the same level of cash-on-cash return that our software businesses do, or that our medical businesses do.

So, we look at a lot of stuff, but the stuff that tends to get through the filter our overall Company has a cash return on its gross investment of over 100%.

If you look at probably the single best multi-industry guy, that company is in the 40%s.

So, we see a lot of incoming stuff, but, generally, if they are going to have cash returns in the 20%s they are not going to join our family.

It is just the dynamic of the economic performance of the businesses that keeps us so active in the medical and software.

And if you look at the next several quarters, over the next two years, you would expect that -- we said for a long time we'd deploy $5 billion over the next four or five years.

We'd expect to deploy at least $1 billion to $1.5 billion every year but it is always lumpy about when that will happen.

So, I think there are a few things that we'll probably do relatively quickly, and then there will be other things that will leach in over time.

Whether that happens in the next 6 months or the next 12 months is impossible to predict.

And whether you do something for $100 million or you do something for $1 billion, on the timeline of which comes next is also impossible to predict.

Because we will have offers to acquire things in which we are doing diligence, some of which will be at $100 million and others will be at $1 billion.

We are never in control of that dynamic.

That's helpful color, Brian.

My follow-on question is around the drop-through margins.

Clearly the incrementals were really strong this quarter at 46%.

I think last quarter we were talking about an incremental range of 35% to 40%.

So, my question, was there anything specific about the quarter that helped juice the margins this quarter?

And how should we then think about your incremental margins moving forward?

Is 35% to 40% the appropriate way to think about it?

Or are your businesses really just operating on all cylinders and maybe a higher range is appropriate at this time?

No, I think we think 35% to 40% is appropriate guidance for people over time.

You're always going to have mix variances.

Second quarter in our Company, it gets a lot of renewals in the software business.

A lot of things happen in Q2.

Q3 is really not as active.

Q4, then, gets to be really big because all kinds of year-end MRO and investments occur.

In the first quarter I think our leverage was something like 37%, and that was outstanding.

This is extraordinary and if it happens again we will take it.

And just one follow-on question on the margins for Industrial Tech.

This margin, you called out a few things in the quarter.

The operating margins have been down now for, I think, six quarters in a row on a year-over-year basis.

And things -- it sounds like they're getting better at Cornell Pump.

Should we start to see margin expansion in this business moving forward?

I always react to that because I believe that the operating margins in the business are pretty close to the gross margins of everybody that they compete with.

So, thinking about the 29.5% operating margins in that business and wondering if they can get better seems to me to be unrealistic.

But we could deliver it, you never know.

These are the best industrial businesses known to anyone I'm aware of.

If you've got anybody that's got margins that look like these, please send us, so we can see how they do it.

Thanks for taking my questions.

Chris Glynn, Oppenheimer.

You had very nice year-over-year expansion.

Just wondering how to think about the dynamic there of mix versus core incremental margins.

Clearly volume helped.

But we've talked about mix a lot with this business in the past.

I'm sorry, Chris, the first part of your question we didn't catch.

Which particular segment are you referring to?

Yes, John, this is RF.

Historically, as the margins have moved, mix has been a big part of the discussion.

So I'm just wondering if there's a way to think about core volume leverage since you did have good volumes and the margins were up nicely.

Yes, there really is not a good way to think about that because of the vast difference in the underlying margin structure across this segment.

The software businesses, the incrementals there come in much higher, particularly for their software renewals and the expansion of their software.

If it's installations it's lower.

And, of course, on the toll and traffic side you also have a similar dynamic in terms of whether it's tags and readers, which, because of the technology and the investments that have been made there, carry higher gross margins versus the service and ongoing work.

So, I'd love to give you a rule of thumb but I just don't have one.

It's really going to be based upon the relative contribution of our toll and traffic project business versus the technology that's delivered through hardware or software.

Right.

It just struck me with toll and traffic leading the growth, and then near record margins.

But, understood, there's mix within that, as well.

And, in fact, just to follow up on that, it was especially strong in terms of the delivery of hardware and tags.

Our Amtech business, which is part of toll and traffic, just had a phenomenal quarter, particularly with the continuing tag upgrade project in Florida.

Okay.

And then we got some good color on the long-run expectations from HA and Sunquest.

Verathon's got some things going on.

I was wondering if we could get a similar commentary on Verathon Northern Digital type businesses.

Both of those have very good tailwinds but for different reasons.

In terms of Northern Digital and the technology that they enable for image-guided surgery, they have just a pre-eminent position inside image-guided surgery for what they are able to accomplish.

And that's just a continuing growth in that market.

And because they are a dominant share they continue to benefit from that.

Verathon, on the other hand, is really more of an introduction of new and enhanced products and going through what is just a world-class sales organization.

For different reasons we expect both of those businesses to continue to have high single-digit growth going forward for quite a long time, I think.

Great, thanks for the color.

Jeff Sprague, Vertical Research.

Thank you.

Good morning, gentlemen.

Two questions.

Brian, we've heard you complain about your tax rate, for years actually.

To hear the discussion about M&A and a focus on healthcare, you probably know where my question is going.

Is there a way to do something a little bit more creative with the corporate structure, the tax structure of the Company?

The answer could be that there are a lot of different things.

The topic du jour, and specifically today with a few other people, of course, are more and more inversions with a portion of the Company or something.

We've had a bright path to the door from people trying to tell us about this, that, and the other.

Usually they are talking about businesses that are really pathetic.

So, the concept of doing something purely for taxes is not something we are going to do.

It needs to be a solid business.

It is hard for people to find businesses like ours.

It's pretty unique to find a multi-industry player that's got 59% gross margins and 33% EBITDA margins, and has more than 20% cash to sales, and find a partner with it.

We are still blessed with massive cash performance.

And, so, as interest costs goes up for other people that are doing acquisitions, prices come down.

And we are the biggest beneficiary, you know of this, because we self-fund most everything we do.

And if we went out and borrowed another $1 billion or $2 billion, right at the moment it is pretty modest.

So, we are in a very, very good position, probably the best we've ever been in, to do transactions.

And if something came along that was a partial inversion with one of the businesses, we wouldn't necessarily reject it.

But putting one of our great businesses with something that's not very exciting, because you might be able to save some tax in an environment that's pretty ambiguous, is not a good strategy, in our view.

What we've said, and will always say, is there ought to be a much better concept around corporate tax rates.

We are having to pay a tax rate like ours when we compete in a global market is tough.

But a lot of our businesses, even though 40% of the revenue is not in the United States, a lot of the best-performing cash-generative businesses are in the US, and it is a little harder to do something with that and meet the inversion requirements that the government has; let alone, the risk of retroactivity from the March number that you're seeing the politicians trying to bring to bear.

Right.

Then a follow-up, actually, on cash flow.

You had the cash tax noise in the quarter.

It looks year to date your cash taxes may have been $30 million or so above what went through on the GAAP P&L.

So, not a huge gap there.

With the structural amortization benefit you have, I would have thought cash would have been a little bit better year to date.

Is there anything else going on in working capital?

And the comment about closing the year strong, should we expect something in the 130% zip code for a cash conversion rate for the year?

Yes, I think it would help be at least that good.

We would expect it to probably do a little bit better than 130%.

Thank you.

Alex Blanton, Clear Harbor Asset Management.

Good morning.

I want to go into a little more along the lines of someone who was talking about the decline in earnings from the second quarter, as to the reasons.

I see the tax rate was 30.4% in the second quarter.

And that increase to 32% will cost you $0.04.

But you mentioned headwinds in TransCore and I don't think I heard anything more about that.

And, also, are there any acquisition expenses connected with FoodLink?

Any acquisition expenses that we have were recorded in the second quarter since we did close on that transaction on July 2. So, I wouldn't say that that's material but we do expect to have some acquisition expenses in the third quarter not related to FoodLink.

On the other hand, you did obviously pick up on the tax rate increase from Q2 to Q3.

And we just had very strong conversion, as Brian mentioned, for the second quarter.

Some of the software renewals that did happen during that time frame carry along with them very high margins.

So, we continue to see the second half somewhere in the 35% to 40% leverage an incremental growth.

So, it is very similar to what we had in the first half.

And what were the headwinds in TransCore that Brian referred to when he was talking about that segment but didn't go into any detail on it?

It's not really headwinds as much as timing associated with the milestones on the project.

So, as we mentioned, we had very strong performance for executing on those projects in Virginia, in Texas, and in Florida, and in other places.

And that comes along with some revenue recognition, profit recognition in the second quarter that was a little bit better than what we would have expected for the third quarter.

Okay.

Thank you.

That will end our question-and-answer session for today's call.

I will turn the call back over to John Humphrey for closing remarks.

Thanks, Tina.

And thank you all for joining us this morning.

We look forward to talking to you at the end of our third quarter.

This does conclude today's conference.

Thank you for your participation.