Roper Technologies [ROP] Conference call transcript for 2022 q4
2023-01-27 12:21:06
Fiscal: 2022 q4
Operator: Good morning. The Roper Technologies Conference Call will now begin. Today's call is being recorded. . I would now like to turn the call over to Zack Moxcey, Vice President, Investor Relations. Please go ahead.
Zack Moxcey: Good morning, and thank you all for joining us as we discuss the fourth quarter and full year financial results for Roper Technologies. Joining me on the call this morning are Neil Hunn, President and Chief Executive Officer; Jason Conley, Incoming Executive Vice President and Chief Financial Officer; Rob Crisci, Executive Vice President and Chief Financial Officer; Brandon Cross, Incoming Vice President and Principal Accounting Officer; and Shannon O'Callaghan, Vice President of Finance. Earlier this morning, we issued 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. Unless otherwise noted, we will discuss our results and guidance on an adjusted non-GAAP and continuing operations basis. For the fourth quarter, the difference between our GAAP results and adjusted results consists of the following items: amortization of acquisition-related intangible assets; purchase accounting adjustments to commission expense; a legal charge related to the settlement of the Boral versus Verathon patent litigation matter. The case related to the sale of certain Verathon products from 2004 through 2016, there are no future financial obligations for Verathon related to this matter. Next, transaction-related expenses for completed acquisitions, and lastly, we have adjusted our cash flow statement to exclude the cash taxes paid related to our divestiture activity. GAAP requires these payments to be classified as operating cash flow items even though they are related to divestitures. 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: Thanks, Zack, and good morning, everyone. As we turn to Page 4, we'll walk through our usual year-end agenda, highlights for the most recent quarter and full year, followed by color commentary for each of our segments and then the initiation of our 2023 guidance. Let's go and get started. Next slide, please. As we heard on Page 5, the main takeaways for today's call are First, we delivered another great year of strategic, operational and financial progress. To this end, we concluded our multiyear divestiture program, which was centered on improving the quality of remaining portfolio, namely emphasizing less cyclical, more asset-light and higher-growth businesses. In addition, we successfully deployed $4.3 billion towards market-leading and application-specific software businesses. More on this later, but we also continue to have substantial M&A firepower well north of $4 billion. Organically, we grew just shy of 10% for the year while simultaneously improving the underlying quality of the enterprise. During the course of the year, our businesses did a terrific job of innovating and capturing share, which leads us to our second main takeaway for today's call that we're well positioned for another solid year of performance in 2023. Our higher quality, less cyclical and more highly recurring nature of our portfolio will serve us well during 2023. Now as I hand the call over to our Incoming CFO, Jason Conley, let me take a moment and thank Rob Crisci for all he's done for Roper and for me. Rob has been a significant contributor to our success and an important member of our executive team with meaningful insights and contributions across a variety of topics, including our most recent portfolio repositioning. We're excited to welcome Jason to his new role. Many of you know, Jason, for those of you who do not, Jason has been with Roper for 16 years. He started in corporate IR and FP&A, then the operating CFO at MHA or one of our businesses and most recently serving as Roper's Chief Accounting Officer. Since he has returned to corporate, he has been a member of our capital allocation team and has attended every Board meeting. The team and I are excited to partner with Jason for the next leg of our evolution. So, with that, looking forward to the partnership, Jason, and thank you, Rob, for all of you done to make Roper better than when you joined. Jason, let me turn the call over to you, can walk through the fourth quarter and the full year financial summary. Jason?
Jason Conley: Thanks, Neil. I am very excited and incredibly grateful for the opportunity to work with you and the team in this new role. And of course, thanks, Rob, for your awesome partnership and mentorship over the years. It's been just a great experience working together. So first, I'd like to introduce Brandon Cross as our new Principal Accounting Officer. Brandon joined Roper about five years ago, progressing to our Assistant Controller and more recently, has led and transformed our audit services function. He has significant M&A and integration experience. So this is a natural and well-earned promotion for him. Brandon, I look forward to working together in your new role.
Brandon Cross: Thanks, Jason.
Jason Conley: If you indulge me, I'll rip on Roper for a few seconds. I've been blessed to help guide and execute our evolution from Roper Industries to Roper Technologies, which has been underpinned by our North Star belief that cash is the best measure of performance. And as we enter 2023, our best years are ahead of us. We have a family of market-leading businesses with durable growth drivers and terrific free cash flow margins. Further, the leadership teams and talent processes at our businesses are the best in the company's history. And finally, we have significant capacity to execute our proven and disciplined M&A strategy that I've been a part of for many years. I anticipate being quite active on the road this year. So for those on the call, I look forward to either meeting you or reconnecting in the coming months. All right. Let's get into the financials. Turning to Slide 6. We'll do a quick review of our Q4 performance. We capped off a solid year of growth with revenue of over $1.4 billion, which was 14% higher over prior year. Organic growth was 7% with strength across the portfolio, which was enhanced by 10% software recurring revenue growth. Acquisitions added eight points of growth, led by our Frontline business that closed in early October, and currency was a two-point headwind. EBITDA of $592 million, was up 17% over the prior year. We experienced strong operating leverage across the enterprise and improving gross margins in our TEP segment to finish out the year. DEPS came in at $3.92, which was 17% against prior year and $0.18 above the midpoint of our guidance range. Next, we'll look at free cash flow. free cash flow. Free cash flow of $457 million was down 8% over the prior year. Excluding the Section 174 impact, we were down 3%. And factoring out a $30 million Vertafore tax benefit in 2021 that doesn't repeat, we're up about 3% to 4% in the quarter. Taking a broader view, you can see we compounded cash 11% over a four-year period, despite the Section 174 headwind, and we're well positioned for double-digit cash flow compounding going forward. Turning to Slide 7. We'll now do a quick overview of our Q4 segment results, as Neil will unpack more detail on the full year a bit later. We had a nice finish to a great year across the three segments. For Application Software, revenue was up 22% to $740 million, with organic growth of 7%. EBITDA margin increased to 45.6% in the quarter. We had strong SaaS bookings growth and overall solid net retention throughout the year, which is just naturally rolling through recurring revenue in the quarter. Growth was broad-based across the segment, aside from some delayed decision-making in the large government contract in space within Deltek. On margin, we had lower incentive-based SG&A and employee medical costs, so some favorability in the quarter. If you look at the full year margin of 44%, that's about where we would expect to be over a longer horizon. Our Network Software segment grew nicely in the quarter, with revenue up 9% to $350 million and EBITDA also up 9% to $189 million or 54% of revenue. Growth was led by our freight matching businesses, which continued driving higher ARPU from premium offerings to offset moderating carry activity as we expected. Tech-enabled products revenue was $340 million and grew 5% organically in the quarter. Demand remained strong, and we had some orders that didn't get delivered toward the end of the quarter, which will benefit Q1. EBITDA grew 7% to $119 million, resulting in EBITDA margin of 34.9% or 100 basis points over prior year, with strong operating leverage as the price cost dynamic was neutralized in the quarter. Turning to the full year 2022 performance on Slide 8. Revenue was 11% higher than prior year to $5.4 billion, with 9% organic growth. EBITDA was 12% better to nearly $2.2 billion, with EBITDA margin coming in at 40.4%. The of $14.28, was 15% over prior year and reflected strong P&L leverage against the 11% revenue growth. Notably, compared to our 2018 pre-divestiture financial profile, our revenue is about $175 million higher, while EBITDA is nearly $365 million higher. So, through a combination of organic growth and capital deployment, we've grown despite divesting about 40% of our 2018 revenue. And most importantly, the composition of our portfolio today positions us for higher and more durable growth going forward. Free cash flow came in at about $1.5 billion, so down 7% versus prior year. It's a bit of the same situation as our fourth quarter with both the 2022 headwinds of Section 174 of nearly $100 million and the nonrepeating of the 2021 Vertafore tax benefit of $117 million. If we normalize for those items, free cash flow grew about 8%. We've had a bit of an inventory build within our tech segment as supply has become more available. This is not a new normal, and we certainly expect that to improve in 2023. If we kind of take this up to a multiyear view, you can see we've compounded cash at 15% over a four-year period. And as we look forward, the impact from Section 174 will be fairly neutral, and we expect to convert plus or minus 80% of flow. So, we're clearly well positioned for double-digit growth. Turning to Slide 9. Let's take a look at our financial position. We certainly had a lot going on in Q4. On November 22, we completed the majority sale of our industrial businesses, which are now operating under the name Indicor and received $2.6 billion in upfront proceeds. Also, in the quarter, we paid $270 million, representing all taxes due related to the majority sale. So, this yielded us net proceeds of over $2.3 billion, a very good outcome here indeed. Related to our stake in Indicor, this is now appearing as an equity investment on our balance sheet. We will be updating the fair value of the equity investment each quarter going forward. To provide a clearer picture of our continuing operations, we will provide a non-GAAP adjustment for this fair value accounting and any tax expense related to this investment. So just looking at our balance sheet, even after our $3.7 billion Frontline acquisition, which was completed in October, our net debt-to-EBITDA ratio stands at 2.7 times. So, our solid leverage profile, coupled with strong free cash flow generation and an undrawn revolver of $3.5 billion, gives us $4 billion plus of M&A capacity. Clearly, we are very well positioned for disciplined capital deployment in 2023. And with that, I will turn the call back over to Neil to go through our segment details. Neil?
Neil Hunn: Thanks, Jason, and well done. Let's turn to Page 11 and walk through our 2022 highlights for our Application Software segment. Revenues here were $2.64 billion, up 7% on an organic basis, and EBITDA margins were 44.1%. Performance across this segment was just solid in 2022. Vertafore, our software business that tech enables property and casualty insurance agencies accelerated their growth, led by continued strength in their enterprise class segment. In addition, the two Vertafore bolt-on acquisitions are strategically on point, integrated and performing well. As we've been discussing, SaaS migrations have been a key theme for us over the past few years, and 2022 was no different. Both Aderant and Deltek continued their SaaS migration momentum and both grew nicely based on solid customer adds and strong retention. Deltek was particularly strong in their private sector end markets. But as Jason mentioned, Deltek did see some slower decision-making specific to new bookings in the enterprise segment for their GovCon solutions. At our upcoming March 21 Investor Day, you'll get an opportunity to hear directly from the leaders at Vertafore, Deltek and Aderant about how they're competing and consistently winning in the market. As it relates to Power Plant, we liked what we saw last year. PowerPlan was strong given their refocused and narrowed strategy combined with a highly aligned team. As a result, PowerPlan crossed a meaningful milestone, launching a SaaS solution for their flagship product, tax fixed assets. Congrats to the team for a great 2022 and looking forward to more great things in 2023. 2022 is a very good year for application health care IT businesses as well. Strata's combination with EPSI has just been great. The integration is complete and the number of EPSI, the Strata has conversions and upsell, cross-sell are both meaningfully ahead of our deal expectations. Clinisys and Data Innovations continue to win in the marketplace. The internal combination of Clinisys and Sunquest has rejuvenated and energized their high-performance culture, which is enabling the business to more effectively compete and win in the marketplace. Data Innovations continues to gain share and evolve to become the de facto standard as it relates to Lab Middleware. Finally, Frontline, our cornerstone 2022 acquisition is off to a solid start. We look forward to sharing the strategic and financial success of this business in the quarters and years to come. I'd like to reiterate with what we started with. Performance here strategically, operationally and financially was just great in 2022. Very proud of the team and the performance. Congrats and thanks. Looking to the outlook for 2023, we expect to see organic growth in the mid-single-digit area based on our market positions and growth in recurring revenues. Turning to Page 12. Revenues in 2022 for our Network Software segment were $1.38 billion, up 13% on an organic basis, and EBITDA margins were strong at 53.3%. As we dig into business-specific performance, our U.S. and Canadian freight matching businesses were great in 2022. Their exceptional growth is based on many factors, certainly favorable market conditions, but also continued product and network innovations as well as terrific product and package designs that drove increased value for the network participants. iPipeline and iTrade network were stellar performers throughout 2022 and benefited from having strong renewal and expansion activity. iPipeline like that a PowerPlan is benefiting from having a narrowed and more focused strategy, namely tech-enabling the life insurance and annuity distribution network. Moving to Foundry, which had another great year as part of Roper. Foundry continues to be the market-leading software in postproduction media entertainment. During 2022, Foundry's product innovations were impressive with several new features focused on ML-based automation. Starting in 2023, Foundry's flagship product Nuke will begin its subscription transition, so looking forward for solid progress on that front. Growth in our businesses that focus on alternate site health care was led by SHP and SoftWriters and importantly, retention rates across SHP, SoftWriters and MHA remained extremely high. Broadly, the performance across this segment was great. Congrats to the teams for this terrific year of financial performance. Turning to the outlook for 2023. We expect to see mid-single-digit organic growth for this segment based on broad and sustained growth across the group and a normalization of market conditions for freight and logistics applications. As we turn to Page 13, revenues in 2022 for our Tech-enabled Products segment were $1.35 billion, up 10% on an organic basis. EBITDA margins for this segment were 35.4% for the year. As expected, EBITDA margins expanded in the second half of the year as pricing and supply chain improvements flow through. Let's start with Neptune, our water meter and technology product business. This past year was just terrific with very strong growth based on strong margin conditions, strong share gains and strong adoption of their static ultrasonic meter technology. In addition, Neptune launched their cellular connectivity solution and did a fantastic job migrating a large chunk of their customer base to their newest data management solution. Spectacular job Neptune, congrats you and your team. Northern Digital, which is our precision measurement tech company, continued to see terrific demand for their optical and EM solutions. NDI benefits from having a strategy that is laser-focused on health care applications and an R&D capability that is unmatched in the industry. NDI's core tech is using countless life-saving procedures on a daily basis across the globe. Verathon turned in another solid year performance in 2022 as well. The growth is based on momentum across their video innovation and single-use bronchoscope product lines. As you saw in the press release, we did take the opportunity to clean up a legacy patent dispute. Make no mistake, the innovation capability at Verathon is nothing short of exceptional, and we cannot be more confident about their most recent product launches and the new concepts in the development pipeline. As it relates to the single-use rock space, we hope to see Verathon capture the number one market position in North America in 2023. Our outlook for the year in this segment is in the high single-digit area and is based on continued strength in backlog at Neptune as well as continued growth across our medical product businesses. Specific to the first quarter, we do have easier comps versus a year ago. Now please turn to Page 15, and let's review our 2023 and Q1 guidance. For 2023, we're initiating our DEPS guidance to be in the range of $15.90 and $16.20. Underpinning this guidance is expected organic growth of 5% to 6% and a tax rate in the 21% to 22% area. Specific to the first quarter, we're establishing our DEPS guidance to be in the $3.80 to $3.84 range. Now please turn with us to our final page, Page 16. As we turn to this page, we want to leave you with the same key points with which we started. First, 2022 was a year of great accomplishment for our teams and our enterprise. We grew revenue 11%, 9% on an organic basis. And we did this while continuing to increase the underlying quality of our revenue base. In fact, we delivered double-digit increases in our Software organic recurring revenue during 2022. EBITDA grew 12%. Our EBITDA margins expanded 20 basis points to 40.4%. Also, we successfully concluded our multiyear divestiture program and deployed $4.3 billion against our long-standing capital deployment strategy, headlined by Frontline Education. The second key takeaway is that we're well positioned for double-digit cash flow compounding in 2023 based on our organic revenue growth outlook, contributions from our 2022 acquisition cohort and having well north of $4 billion of M&A capacity. To this end, we continue to be very active in the M&A markets. But as you saw during 2022 and as always, we will remain super patient and highly disciplined to ensure optimal deployment of our available capital. Finally, and perhaps the most important, the new higher quality Roper portfolio is becoming increasingly more evident, and we've never been more excited about the future of enterprise. As we open up to your questions, we'd like to take this opportunity to remind everyone that we're hosting an Investor Day on Tuesday, March 21, in New York. We look forward to seeing many of you there. So with that, letâs open it up to your questions.
Operator: Today's first question comes from Deane Dray at RBC Capital Markets. Please go ahead.
Deane Dray: Thank you. Good morning, everyone. Just start with the best wishes to Rob. I remember when he was a starting as a rookie Investor Relations professional and just wish him all the best. Thank you.
Robert Crisci: Thank you, Deane, I appreciate it. It's been a great decade.
Deane Dray: It's fabulous. And then, Jason, I think you've been on every one of our callbacks for the 16 years. So you're absolutely -- we know exactly who you are and your experience. And so congrats on the new role.
Jason Conley: Thanks, Deane. Appreciated.
Deane Dray: All right. So for a question, maybe we can start with a bit of a macroeconomic sensitivity because you typically, you don't see much of this within Roper, but just called out the Deltek delayed decision-making, Neil, is there any change in the pace of like new customer adds or the migration, new logos? Anything that you would point to that perhaps there is some economic sensitivity reading through in that kind of the pace of business?
Neil Hunn: Yes. I think the -- if I take it at the highest level, we've been 8% to 10% organic. The last couple of years, obviously, are guiding a little bit below that for 2023. So I think you see it in our guidance model reading through as a general matter. If you take the Software businesses, our retention rates will stay very high. We expect that as to the intimacy and the criticality of our applications. So retention rates to be very high. But as our customers, I mean, across all these end markets, I mean, if there's macroeconomic sort of headwinds or slowdown, then they're going to be affected to some degree, so we expect customer expansion activity maybe a little bit of net new to be slowed a little bit. The Software businesses will be great. They'll grow for sure, but a little bit slower. From an end market perspective, we're in a number of end markets that are generally macro insensitive. There's a little bit, obviously, in our transportation business is that we called out on the call. That will be a little bit slower. But there's some hedges inside the portfolio. ConstructConnect should be good in the slower economic environment and also our medical product businesses as staffing levels and hospitals gets a little bit easier. Patient volume should come back and that should help those businesses. And then from a product, Neptune has got a gigantic amount of backlog, which will carry them through much of this year. So we feel pretty well set up. It doesn't mean that we're completely insensitive to macro, but relatively insensitive.
Deane Dray: That's real helpful. And then let's just switch over to free cash flow and maybe I'll be accused of quibbling. The $161 million free cash flow conversion is still elite, but it did lag your five-year average. And I know there's some dynamics here, and you touched on them in the remarks, the Section 174 and the comparison from the tax benefit last year. Anything that on the working capital side or maybe the Frontline contribution because they're on a different school year, so maybe more of a third quarter collection. But is there any change in the seasonal tilt on free cash flow conversion?
Robert Crisci: Yes, Deane, good question. I think you're spot on. So we typically convert on -- from an EBITDA to free cash flow will be in the 90s typically and Section 174. If we adjust for that, we are in the 80s. And so you're right. Frontline has a very seasonal sort of cash collection cadence. So the third quarters when all the renewals and upsells happen, so most of their cash comes in the third quarter. So in the fourth, you won't see that converting to cash from EBITDA. So that's exactly what you saw. So we're looking forward to next year and especially in the third quarter will be a little bit more weighted than normal.
Deane Dray: Thatâs great. Thatâs exactly what weâre looking for. Thanks.
Operator: Our next question today comes from Scott Davis of Melius Research. Please go ahead.
Scott Davis: Good morning, guys. Congrats, Rob, and good luck, Jason, et cetera. I wish you guys well, but . Jason you get to work a few more years with Neil. Good luck.
Jason Conley: Fair enough.
Neil Hunn: Thank you.
Scott Davis: I can say that, I guess. But anyways, I don't want to climb in a minutia here, but I know there's no one particular asset that moves the needle in a huge way. But can we walk back and talk a little bit about PowerPlan? I mean you mentioned the narrower product focus. I think, I heard you say, which didn't really understand what that meant. And the cloud rollout, again, like is that -- how relevant is that to the business? And -- but maybe if we just go back and you can explain to us again what kind of drives PowerPlan? And I'll just leave it there and leave it behind.
Neil Hunn: I appreciate the opportunity to talk about, anyway our businesses, it's been a while since we've been able to do a double-click on PowerPlan. So just remind you what they do, right? So PowerPlan software and services live at the intersection of the financial system and the asset tracking system for these large utilities, investor-owned and public utilities. And when the PowerPlan software has a perfectly curated view of what the assets look like inside our customer base. When you have that perfectly curated view and these assets are constantly being updated and changed, they're not static, right? And so that's why you have to live between these two systems. And we have this perfectly curated view of what the assets are, then you get the most appropriate tax treatment you can, the most appropriate lease accounting and a series of other financial benefits associated with that. We bought the business. The business was doing that, but it was also reaching outside its core customer base and the core products I just described, looking for growth sort of in all the wrong places, if you will. And then we -- what we did when we did our strategy work with them going back probably a year, 1.5 years ago is the amount of opportunity inside the core of what they do was large enough to support the growth thesis for many years to come. So it's just refocusing back on the core. That's a common theme. We talked about that. I think you'll see that increasingly more inside of Ropers as we do our strategy work, right? So not getting too far away from the core and getting distracted. So that's what they've done. The first impact of that is they now have this 100% SaaS solution for their principal product fixed assets just released in Q4. And we're excited by that because as you lift and shift your customer base from an on-premise to a cloud solution, there's a tremendous value capture opportunity, and it will unlock some growth for the business.
Scott Davis: And can you get pricing in the process? Or is this just more about retention?
Neil Hunn: No, that's the value unlock, right? So we're doing more for our customers with the SaaS solution, right? So we're not just hosting it. There's more features. You're on the latest release, where certainly, we know how to operate our software ourselves better than third parties. And so it's the efficiency and the uptime is higher. And as a result of all that, you do get price. We'll see we talked about there's roughly $900 million in legacy on-premise maintenance in our revenue base. And as that is lifting and shifting to the cloud over a long arc of time, that should lift and shift north of 2 times, right? So there's $1 billion of growth that's latent inside the portfolio as we lift and shift that on-premise maintenance to the cloud.
Scott Davis: Okay. I look forward to the Analyst Day. I'm going to pass it on. Thanks, guys. Congrats on another good year. See you on Analyst Day.
Operator: And our next question today comes from Julian Mitchell at Barclays.
Julian Mitchell: Hi, good morning. Thank you, Rob. And I look forward to working with you, Jason. So maybe my first question, just to try and home in a little bit more on the sort of macro framework in the guide. Maybe specifically, I think about 25% of your Software revenue is reoccurring and non-recurring, so maybe more cyclical kind of talk. Maybe just remind us sort of what the organic growth of those two in aggregate was last year and what you're dialing in for 2023 or any flavor of that? And then within Network Software specifically, transport and freight, it's almost 1.25 of the revenue. And you mentioned you're dialing in, I think, normalization was your phrase. Maybe just any finer point on what that means exactly of growth this year versus last?
Neil Hunn: Yes. So let me take -- let's take those, Jason, I take those in sequence. So I'll set up what the difference between recurring and reoccurring revenue is in our base. I'll let Jason talk about the relative growth rate, then we'll tackle the DAT freight question you're raising. So just to level set what everybody is, if we have a recurring revenue is subscription, contractual recurring revenue, reoccurring revenue is principally located at our MHA business. We take a percentage of the drug and food spend that goes to the network and so it's not technically recurring, it's highly reoccurring. So it's not -- and that's probably the most -- one of the most stable parts of our portfolio, long-term care, health care, residents and buildings, consuming food and pharmaceuticals, right? So it's highly secure for lack of a better word. It's not transactional relative to a macroeconomic sort of situation. So I'll stop just in terms of framing recurring versus reoccurring. I'll let Jason take the relative growth rate question.
Jason Conley: Yes, sure, glad to. So MHA, as Neil mentioned, it's really about drug purchases from the pharmacies, and they have very strong retention in those businesses from a customer standpoint. We always sort of think about the business being at the -- maybe at the bottom end of the mid-single digits, maybe a little bit low singles. And that's sort of what we experienced this year, and that's kind of what we're baking in for next year.
Neil Hunn: Great. Okay. Now let's take to your freight and logistics around DAT specifically. So to remind you, there's this tension between the cyclical freight dynamic and a secular push or a secular benefit that DAT and DAT's customers are experiencing relative to the spot market becoming a more efficient place to place freight. So there's tension between those two. From a cyclical point of view, we expected and have seen the carrier side of the network reduce a little bit. And it's -- and we expect it to reduce over the course or shrink or get a little bit smaller over the course of this year. DAT grew through the 2019 freight recession. I think DAT has grown every year since 2010. So the business is talking about the rate of growth at DAT, not does it expand and contract. It tends to be much more stickier than that. As an early read, January is actually a little bit better. I mean the number of carriers in the network is sort of flattish through January and not declining. And the people in the industry that sort of call like the freight timing and if there's going to be a freight recession, I actually think there's a queuing for a large spring shipping season, mostly around -- this triggered by produce. And we might start to be seeing a little bit of that bleed in, but we'll have to see how the next couple of quarters play out.
Julian Mitchell: That's very helpful. Thank you for the color. And then just within TEP, I understand the recurring piece is minimal there in its 99% product-related. Any flavor you'd give us on the sort of what you're seeing in medical versus Neptune for 2023, any major difference in kind of visibility between the 2two or the growth rate expected?
Neil Hunn: Yes. So we have the most visibility we've ever had at Neptune. That's right. The order volume continues to flow. The order duration, meaning the longer date orders continues to flow. And so we feel quite comfortable and good how 2023 is shaping for Neptune. For medical products, there's actually -- I think we've talked about a few quarters ago, the reoccurring elements of Verathon became the largest part of the revenue stream. There's a lot of consumable pull-through in the capital equipment there. Northern Digital has a decently high amount of consumables that are pulled through that zip code . And so it is more procedure and patient driven. And we like I said a few minutes ago, we feel that were decently well set up there, but it's not in our base case. So we saw 6% to 8% declines in patient volumes in the areas in which we service in 2022, all tied to hospital staffing levels. And we're cautiously optimistic that as the labor market solution, hospitals be able to staff and be able to see patient volumes pick back up the prior levels.
Julian Mitchell: Great. Thank you.
Operator: Our next question today comes from Steve Tusa at JPMorgan. Please go ahead.
Steve Tusa: Good morning. Congrats to all. Rob and Jason, I'm looking forward to working with you. Just on the free cash, you mentioned plus or minus 80% conversion to EBITDA. Obviously, the last couple of years have been a bit volatile around all these tax items. But in '21, I think you had a decent number of deferred revenue benefit on the cash flow statement. Maybe just give us a little bit of color looking into next year with concerns around the macro that can be a pretty big variable. I mean are you going to be around that 80% in '23? Or will you be kind of more in between what you did in '21 and '22, I think, adjusted around 70%? Maybe just a bit of color on the free cash, and then I have a follow-up on Frontline.
Jason Conley: Yes, happy to. No, I think we're feeling very good about the 80% Our deferred revenue, our renewals were really strong this quarter, and we felt good how it moved up sequentially, how was up year-over-year. And just what we're hearing from our businesses, we feel good about the renewals. And then we're going to have -- we expect -- I think I said on the call that we'll get some improvement on our inventory ratios next year. We had a little bit of build at the end of this year. Frontline will certainly help with our negative working capital profile. They're at negative 40%. Like I said, most of that will hit in the third quarter when all the renewals take place. Of course, if Section 174 gets repealed, this will be a home run year, but we're not banking on that for now.
Steve Tusa: So like something in the $1.8 billion range for free cash for next year?
Jason Conley: I'll let you come to your math on that.
Neil Hunn: Okay. We will.
Steve Tusa: And then just Frontline, revenues roughly $95 million this quarter. Is that about right?
Jason Conley: No. They were somewhere in the '80s. We had a few days knocked off at the beginning of the quarter because we closed on the 4th.
Steve Tusa: Okay. By the way, I really appreciate all the discussion on the businesses and looking forward to the Investor Day, learning more on this portfolio. So very helpful detail on the moving parts of all the different businesses.
Operator: And our next question today comes from Allison Poliniak with Wells Fargo. Please go ahead.
Allison Poliniak: Good morning. Just want to circle back on DAT. I know you talked about it growing historically through cycles, but it's certainly been an unusual one. A lot of new entrants here. Is there any risk to the retention rate should that spot rate not hold in terms of stabilization in some of those new entrants, I guess, can't survive? And then I guess along with that, that premium offering, in this type of uncertainty, does that drive maybe more increase or interest in that premium offering versus just to gain some visibility here in an uncertain market? Just any thoughts there?
Neil Hunn: Yes. So in terms of the number of -- when you say new entrants, I assume you're referring to the number of new carriers that are in the network as opposed to a competitive entry or the sort because there really are no new competitive entrants. Relative to the carriers, yes, I mean, it was -- it's been just a tremendous last couple of years, driven by the things we've talked about for a couple of years, which is the fluidity and the liquidity in the spot market, which is a secular tailwind and then obviously, a huge boom on the cyclical piece. We -- historically, when you look at like peak carriers to trough carriers through cycle, it sort of goes carriers declines by plus or minus 10%. We've assumed that it will decline by more than that in our guidance model because the buildup was unprecedented. But -- so that's sort of -- we think we have this conservatively planned in our outlook, but it's unprecedented ramp up leading up to this. We do take some early confidence in the carrier count in the first couple of weeks of January. So the fact that we're flattish versus continuing to see some declines is certainly encouraging, but it's only a handful of data points we want to see take together. In terms of the premium offering, I mean, DAT has just done a tremendous job creating product and package designs that have more value for all the network participants. It's helped drive some ARPU increases because there's more value that the participants are getting.
Jason Conley: So different packages, different features and functionality that they've upsold.
Neil Hunn: That's right.
Allison Poliniak: Great. No, that's helpful. And then just in terms of the M&A pipeline, are you still under the new portfolio, PE primarily your source of opportunities here? Have you expanded it? And if I guess if you have, are you looking -- I know CRI is your metric that is your foundation. But are you providing any other controls with maybe some new opportunities out there? Just any thoughts there?
Neil Hunn: Yes. You're right. We've obviously historically sourced all. But in my time here, I think one meaningful deal from private equity. One was from a small founder or founder, and that has been sort of the pod in which we fish. But we're -- that's not exclusively where we have business development activities going on. We've always looked in public markets. We just haven't found anything that's been compelling from a value point of view yet. We'll continue to look there. You could see us get a little bit earlier in the cycle and try to compete a little bit more with private equity sort of half a click earlier in the company's life cycle. So when we did the Vertafore transaction and the Frontline transaction, many of our investors said, why didn't you buy it when the first you bought it from a private equity firm, you bought it from bought it. And so that's something that you could see us explore in the right situations. But still, all that being said, the predominance of what we're going to do is what we've done for the last 20 years, which is sort of lower risk of highly recurring software -- application software businesses from private equity.
Allison Poliniak: Great. Thank you.
Operator: And our next question today comes from Brent Hewitt with Wolfe Research. Please go ahead.
Brent Hewitt : Hi, thank you. And good morning. You noted that your adjusted EPS calculation will include the fair value accounting and tax impact of Indicor. But why would you not include the minority interest contribution as well? Just wondering what is the logical downside not including that, shouldn't it be a positive and growing contribution?
Jason Conley: Well, it's a calculation that's going to be based on many variables, right? It's mainly an accounting exercise. We don't think that it's going to -- we'd rather see the outcome when we do the exit. We think that's the better reflection of what the economics are going to be. We feel really good about what that's going to look like. We've worked with CD&R on a strategy there. They typically look at several multiples of return on investment, and that's what we're playing for upon exit.
Brent Hewitt: Okay. Great. That's helpful. And then in terms of price contribution in Q4, what did that look like? And then also how much pricing is embedded in your 2023 guidance?
Neil Hunn: So price for us, I mean, it's an important lever to our growth algorithm, not just for '22 and '23, but all prior years and all forward years. Teasing out specifically how much is price is a very, very difficult thing across our 27 companies and rolling it up to a number that is meaningful. And so we're not going to share a specific number in that regard. I'll tell you the pricing, the value capture that we have, given what we do, the criticality of what we do, we've always had pricing power and pricing value capture and there's nothing different with that. Do you want to add anything to that, Jason? Perhaps, we go to the next question?
Operator: Our next question today comes from Brendan Luke with Bernstein. Please go ahead.
Brendan Luke: Good morning. Just wanted to take a quick look at macro, question here. I was wondering if you could offer any color on your exposure to construction end markets? And how that's playing into your growth expectations for FY '23. And I guess, specifically, I'd be curious around Deltek, ConstructConnect and Neptune as well.
Neil Hunn: Yes. So I appreciate the opportunity there. So let's just take it by those three. So ConstructConnect, to remind you what it is, right, so we have a near perfect database of all the construction -- commercial construction projects that are in the planning phase across North America. As a result, when -- it has a bit of countercyclical demand attached to it. So when there is a tremendous amount of new projects and you're a subcontractor general contract and building product manufacturing and business is flowing from everywhere, then you don't have to look too hard for what you're going to do next. When there's fewer projects, then you subscribe to the subscription service of ConstructConnect so you can identify what projects are coming down the pipe that you want to try to bid for and win. And so the ConstructConnect has been a modestly good performer for us over the years. We expect it to actually have a good run here in '23 as a result. Deltek does have -- it's been a strategic focus of Deltek. Deltek is 60% government contracting, 40% private sector and private sector. The smallest sliver is construction and we sell software to large contractors. That's what we do. That business, we -- in our prepared comments, we talked about how the private sector was very strong in Q4 for Deltek. We would expect and do anticipate some softening on the construction side for Deltek in 2023, and we think we have that fully covered in our guidance. And then Neptune, we believe strongly Neptune is not a cyclical business. As you sell water meters and water meter technology to the municipalities when they're -- they tend to have a budget for meters. When there is a large new residential new construction, then a higher percentage of the budget goes to install new meters. When there's fewer new starts, the budget stays the same, but they take the meters and they do the retrofits and trade outs of the aging fleet and infrastructure. So that is a general cross-cycle sort of view of Neptune, But then we're further -- our confidence is further buoyed by the fact that we have this just unprecedented amount of backlog at Neptune for 2023. So we think that Neptune will perform well for us this year.
Brendan Luke: Very useful. Thank you.
Operator: And our next question today comes from Rob Mason at Baird. Please go ahead.
RobMason: Yes, good morning. And congrats as well to Jason and Rob. Maybe just stick on the technology-enabled products area. I think the -- there was a mention of some products didn't ship in the quarter maybe got pushed. Just to step back, maybe update us where you think you are around supply chain just on the product side in your businesses? And then I'm curious what kind of impact that those deferral shipments might have had in the fourth quarter?
Neil Hunn: Let me just set it up, and I'll hand it over to Jason. So in TEP, we talk obviously -- about Neptune, we talk about medical process. There's also a small cohort of RF product businesses and RF Ideas. The fourth quarter was particularly brutal supply chain wise on those RF product businesses. And so with that, I'll give it to Jason to sort of talk through anything you'd like to.
Jason Conley: Yes. It wasn't significant. It was probably in the $5 million to $10 million range, and it was across a number of businesses. So I think we expect the first quarter for TEP to be up a little bit more than the rest of the year because of that and because of some of the easier comps. So maybe low double digits in the first quarter, but that's sort of the range. So yes, a lot of this is in the rearview. Of course, things do pop up here and there, but we're not hearing as much sort of meaningful impact in the quarters.
Neil Hunn: And as a general matter, we're not the only ones that. But supply chain is generally, as Jason just said, improving and there's essentially the chip shortage and chip issues. There's more of a globally is just -- but we're not -- you're not just hearing that from us. We do think this -- the supply chain issues abate over '23.
Rob Mason: Sure, sure. Neil, you've made several references to Neptune through the call and share gains and the strength in your backlog. And that tends to be a business where share doesn't move around that dramatically. I'm just -- could you expound a little bit just on how what's going on there? What you've done, whether it relates to ultrasonic adoption or the introduction of cellular? Or is this a broader effort at Neptune that's driving that?
Neil Hunn: Neptune has been just a steady and consistent share gainer made the whole time I've been here, right? I mean, for a decade. And the reasons for that are manifold, but they have a product orientation that starts with, they never want to strand their existing customers with technology. So for instance, this goes back to the prior iteration of communication software, but the proprietary protocols between mobile and fixed point, Neptune has a solution where if you're a municipality and you can have one fixed point, roaming points and still have some manual reads and the master data management software package in Neptune can ingest all that data and you don't strand a customer having to pick piece of technology for the totality of what they have to do. So it comes from a product orientation that starts with flexibility. The second thing is the products are just well thought out for the long arc of what the customer wants to do. For instance, on the large commercial meters for ultrasonic, you have to be able to read high flow and low flow equally accurate our products do that. So think about a big hotel application, a trickle that happened 3 in the morning versus the high flow takes their showers in the morning, our ultrasonic meter will perfectly read the low flow and the high flow and the competitive products have to tend to be focused on one or the other for the precision. More so for that application when the ultrasonic -- the battery that drives the ultrasonic technology needs to be replaced. In our case, it's essentially a drop in battery, the competitors you have to cut the meter out and replace the meter. So it's small things -- it's seemingly small things like that, that help drive market share gains over a long arc of time. Final thing I would say, in 2022, it was particularly beneficial for us because we had product availability throughout the totality of the year. And so some of our competitors were quoting year plus lead times. I think our lead times went from like 8 to 12 weeks. And so just some accounts that we typically have not had any presence in, they need meters, we can deliver meters, all of a sudden, you have presence and the opportunity to compete in that account. So that's helped gain some market share in the relative short term.
Rob Mason: Great. Thatâs very helpful. Thank you.
Operator: And our next question today comes from Alex Blanton Clear Harbor Asset Management. Please go ahead.
AlexBlanton: Thank you. Good morning. First, I just want to say that I think your format for the slide presentation this time is probably the best ever. And I think you should stick with it. It's really a great presentation.
Neil Hunn: Noted.
Alex Blanton: Now most of my questions have been answered, but something came up from one of the other participants regarding the business that accumulates commercial construction plans. And Barry Sternick, who's the CEO of Starwood was on CNBC yesterday, saying that in his business and across the board really in commercial construction, as interest rates have gone up, people will complete the projects they have, but hold off on starting new ones. And so that's why he's looking for a big drop in commercial construction in the second half of this year because new projects are sliding. Do you see that in your statistics?
Neil Hunn: So it's interesting. So I can add Zach -- ConstructConnect publishes, look at that quarterly, quarterly the macro of what they're seeing from a construction planning point of view, and I can have Zack for that to you. I have not read the -- personally, I've not read the most recent report yet, so I don't want to comment on its content, but we can send that to you.
Alex Blanton: Okay. Because it would seem that if new construction projects are not being put into implementation, it would show up in those numbers, wouldn't it?
Neil Hunn: So here's the countercyclical nature of that. And so if you have several hundred thousand construction workers, construction, small subcontracting firms ConstructConnect has tens of thousands of customers. So as those hundreds of thousands are looking for work, it only takes a small percentage of that cohort to become a customer of ours to exhibit countercyclical growth behavior, which is what's happened in every prior slowdown in the history that we've been able to observe with ConstructConnect.
Alex Blanton: Okay. So you're really talking about your business and market share rather than the overall trend of that market.
Neil Hunn: Correct.
Alex Blanton: Yes. Okay, thank you.
Operator: And ladies and gentlemen, this concludes our question-and-answer session. We will now return back to Zack Moxcey for any closing remarks.
Zack Moxcey: Thank you, everyone, for joining us today, and we hope to see you all at our Investor Day on March 21 in New York.
Operator: Thank you. The conference has now concluded. Thank you for attending today's presentation. You may now disconnect your lines, and have a wonderful day.
