Roper Technologies, Inc. (ROP) on Frontline Education Acquisition (Transcript) – Seeking Alpha

Roper Technologies, Inc. (NYSE:ROP) Frontline Education Acquisition Call August 30, 2022 8:30 AM ET
Company Participants
Zack Moxcey – Vice President, Investor Relations
Neil Hunn – President and Chief Executive Officer
Rob Crisci – Executive Vice President and Chief Financial Officer
Conference Call Participants
Deane Dray – RBC Capital Markets
Christopher Glynn – Oppenheimer
Julian Mitchell – Barclays
Joe Giordano – Cowen
Steve Tusa – JPMorgan
Rob Mason – Baird
Operator
Good morning. The Roper Technologies Conference Call will now begin. Today’s call is being recorded. All participants will be in a listen only mode. [Operator Instructions] At this time, I’d like to turn the conference call over to Zack Moxcey, Vice President of Investor Relations. Please go ahead.
Zack Moxcey
Good morning and thank you all for joining us as we discuss our acquisition of Frontline Education. Joining me on the call this morning are Neil Hunn, President and Chief Executive Officer; Rob Crisci, Executive Vice President and Chief Financial Officer; Jason Conley, Vice President and Chief Accounting Officer; and Shannon O’Callaghan, Vice President of Finance.
Earlier this morning, we issued a press release announcing our definitive agreement to acquire Frontline. The press release also includes replay information for today’s call. We have prepared a short presentation to accompany today’s call, which is available through the webcast and is also available on our website.
Now, if you’ll please turn to Slide 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 if you please turn to Slide 3, I will turn the call over to Neil. After his prepared remarks, we will take questions from our telephone participants. Neil?
Neil Hunn
Thanks, Zack, and good morning, everyone. Thanks for joining us on short notice. This morning, we’re excited to share with you the details of our most recent acquisition, Frontline Education. Briefly, Frontline is a leading provider of SaaS software solutions targeted to the U.S. K-12 education market. We’re buying the business for 3.725 billion from Thoma Bravo.
As part of the transaction, we received an approximate 350 million net present value tax benefit, which yields a net purchase price of 3.375 billion or about 19x their 2023 EBITDA. Frontline is an exceptional business. The business is characterized by having high single-digit organic growth with north of 90% of the revenues being recurring in nature. This business has a great networking capital profile at negative 40% as a percentage of revenue.
Given this net working capital profile and the 15 year tax benefit, Frontline will have unlevered free cash flow equal to roughly [that of] [ph] EBITDA, really exciting growth and cash conversion characteristics here. Importantly, Frontline has built a very capable bolt-on acquisition capability, a capability we expect to invest behind going forward.
For calendar 2023, we expect this business to have revenue in the 370 million range and EBITDA around 175 million yielding EBITDA margins north of 47%. We’ll finance this transaction with a combination of cash on hand and the use of our revolving credit facility, the magnitude of which will depend on the timing of the closing of our industrial divestiture to CD&R.
Pro forma for the Frontline and industrial transactions, our net leverage will be around 2.5x. We expect the deal to close in the fourth quarter and be reported in our Application Software segment. Not surprisingly, Frontline meets all our acquisition criteria. To name a few, Frontline is a leader in the resilient K-12 education software market. This market, like so many others, is one that is undergoing significant digital transformation.
Frontline serves an important role helping school systems operate more efficiently. We very much like the fact that Frontline has multiple durable growth drivers. They have very high gross retention rates in the mid-90% range and net retention rates in the 107 to 108 zip code. We [love] [ph] the stickiness of their solutions and the durable diversified growth drivers.
They have north of 90% recurring revenue, significantly negative net working capital, which yields very strong cash conversion, and a dedicated, seasoned, and passionate leadership team and employee base that comes to work every day excited to help improve the country’s education system and develop the next generation of learners. So, this is just another perfect fit relative to our capital deployment and corporate strategy.
Let’s turn to the next page. Page 4, an outline what Frontline does. Next slide, please. Frontline is a leading provider of mission critical K-12 administrative software. Their comprehensive K-12 administrative software is highly trusted and widely used that delivers real impact to school districts across the United States. Frontline has a national footprint with 10,000 K-12 districts, serves millions of educators and has a product portfolio comprised of 30 products.
The company’s products are bundled in the three categories: human capital management or HCM, business operations management, and student management. As we look their the HCM offerings, which represents about half of their ARR, Frontline has a comprehensive state-by-state compliance set of offerings that helps districts recruit, hire, train, and develop staff, as well as the leading tool that helps with absence or substitute teacher management.
For instance, last year, Frontline’s tech offerings helped place about 29 million substitutes. Relative to business operations, Frontline offers purpose built ERP for state and school district needs, including capabilities to manage the increasing fleet complex landscape of district assets. This product category is about 20% of the company’s ARR. Next is Frontline student management segment, about 30% of ARR. The company offers special program management solutions and student information systems.
Finally, the company has invested in and is launching a powerful suite of data and analytical solutions with more to come on this in the future. The secular trend that cuts across all that Frontline offers is that K-12 districts are in the early stages of automating the workflows and processes.
As we wrap-up and turn to your questions, Frontline is purpose built for the K-12 education market, a market that is highly regulated on a state-by-state basis. Frontline has a national footprint of customers and a national distribution capability. They have high-single-digit organic growth profile that is underpinned with fantastic retention rates, 90% plus recurring revenues and long-term secular demand.
And finally, they have a tremendous working capital and cash conversion profile. We’re delighted to welcome Frontline to the Roper family where we will be their permanent home going forward.
Now, let’s turn to your questions.
Question-and-Answer Session
Operator
We will now go to our question-and-answer portion of the call. [Operator Instructions] Our first question today comes from Deane Dray from RBC Capital Markets. Please go ahead with your question.
Deane Dray
Thank you. Good morning, everyone.
Neil Hunn
Good morning, Deane.
Deane Dray
It isn’t often that you get an acquisition that does overlap at least in end markets with an existing business. We’ve seen it with Sunquest, but here, there is potentially some overlap with Seaboard, which has a bit more exposure to the college market, but just, are there overlaps with Seaboard? Are there any synergies? Any scale there?
Neil Hunn
Very minimal. It’s really the horizon part, the K-12 part of Seaboard where there’s potentially a little bit of cross-selling opportunity for us. It’s something that we very lightly explore to the diligence process, something that both Seaboard and Frontline are excited to explore, but as you know, in the Roper way, that’ll only happen if they’re in their own self-interest for their company’s benefit, they agree to do. It’ll be nothing that’s forced from the center, but there is potentially to push the – or if you will to the sell-through the horizon capability through the large national footprint of Frontline.
Deane Dray
That’s helpful. And then just as the follow-up, since the K-12 is a very highly regulated environment, as you said, are there any like certifications at a state level regulations that Frontline has to meet? And then for Rob, just anything about that tax benefit and the tax horizon for that would be helpful. Thanks.
Neil Hunn
Sure. I’ll take the state regulatory one and obviously Rob on the tax benefit. So, it’s one of the characteristics we like is the fact that the company told us, so they told us once in the diligence process, they told us 100x that states are like countries. So, education in this country is regulated state-by-state. It is something that the software portfolio that Frontline has deals with the complexity of that regulation that’s ever changing. It’s also an enormous barrier to entry for the more horizontal players or that would, sort of prevent them from coming into the K-12 education space.
Rob Crisci
Yes. On the tax benefit, so it is over 15 years. It’s about 35 million a year on average for the first 10 years and then it’s less, sort of for the last five and really the first five years maybe a touch higher than that, so maybe in the $35 million to $40 million range for the first five years.
Deane Dray
Thank you.
Rob Crisci
Thank you.
Operator
Our next question comes from Christopher Glynn from Oppenheimer. Please go ahead with your question.
Christopher Glynn
Thank you. Good morning and congrats. Thank you very much. So, on the free cash flow conversion of EBIT, I don’t recall any other deals, kind of hovering in the 100% range. I’m curious just to affirm that’s the long-term profile and what’s particularly different from the other deals you’ve done that maybe 80% to 90% free cash conversion in terms of their flows and how that works?
Rob Crisci
Yes. So, it is over the long-term. So, there’s two – there’s two good guys here if you will, right. One is the tax benefit I just mentioned [indiscernible] with Deane that 35 million to 40 million a year. The second one is, because of the very negative net working capital that Neil mentioned, you get, you know as the businesses is growing high single digits, you sort of get an extra 15 million to 20 million a year in cash from that, sort of change in deferred revenue line where you’re getting the cash in advance. And so that helps, sort of drive the faster flow compounding, if you will.
Christopher Glynn
Great. And then just curious on the competition, the relative leadership of this position, is it an absolute pole position or kind of more of the out by a nose?
Neil Hunn
Well, there’s many categories of education software. I mean, there’s the categories that Frontline has, but there’s other categories that are in the classroom, the content, the classroom software in terms of – so there’s a wide array of types of software that are sold. It’s a very – as a general matter, it’s a very fragmented ecosystem, but less than half the market is vended. So, as we go to the [tech] [ph] enablement of the entire K-12 system, there is a long runway of tech enablement to occur. As it relates to the areas that Frontline [plays in] [ph], at the administrative fees there and they’re the leader in that part.
Christopher Glynn
Thank you.
Operator
Our next question comes from Julian Mitchell from Barclays. Please go ahead with your question.
Julian Mitchell
Thanks a lot and congratulations. Maybe just my first question would be around what’s been the, sort of recent historical organic sales rate? Is it consistent with the high single digit projection? And [also maybe] [ph] to help us understand the underpinnings of that growth, do you have a sense for how automated the K-12 market is today and how much, sort of penetration uptake there is left? And then also, kind of help us understand a little bit more clearly, what are Frontline’s competitive advantages? It’s sort of hard from the outside to have a sense of that.
Neil Hunn
Okay. I’ll try to tick through each of those. If we miss one, certainly come back or hit us in after call. So, yes, the short answer to the first question is, their historic organic growth rate over the last five or so years has been equal to that of what we’re projecting going forward, sort of in the high single digit space, maybe a touch higher. In terms of the growth algorithm, I talked about in the prepared remarks that there are many growth drivers that have durability.
That’s where we spent, as we do with most of our acquisitions of the vast preponderance of our diligence effort is on not just what they – the growth drivers are, but the durability of each. As I talked about in the prepared remarks, they have mid-90% gross retention 107, 108 net if they’re going to grow single digit to see that roughly 80% of their new bookings, if you will, come from cross-selling [or their] [ph] customer base, which has been a decided part of their strategy over the last four, five years as a number of apps per customer have gone from just around two to just about three today again against the cohort of 30 products that they sell.
In terms of the market, it’s depending on if – there’s a lot of different cuts of the size of the market, roughly plus or minus 6 billion is the opportunity, less than half of that is vended today. The company reports that 85% of their deals are “not competitive”, so they’re not in [RFP] [ph] situations and they’re just, sort of chewing up the tech enablement for their customers.
Julian Mitchell
That’s helpful. Thank you. And then just a more brief follow-up question. The EBITDA margins are in the high-40s today. Maybe help us understand, kind of where have they moved from under Thoma Bravo ownership? And where do you think the, sort of long-term margin rate should settle [indiscernible]?
Neil Hunn
Yes, those have been pretty steady EBITDA margins over the past several years. I mean, the business invests a lot. I mean R&D is mid-teens as a percent of revenue. So, I mean those are very stable margins for high single digit organic growth business in this segment. So, our goal under ownership as always will be to see what we can do to accelerate that growth and continue to have strong margin performance.
Julian Mitchell
Great. Thank you.
Neil Hunn
Thank you. Our next question comes from Joe Giordano from Cowen. Please go ahead with your question.
Joe Giordano
Hey, guys. Good morning.
Neil Hunn
Good morning.
Joe Giordano
You talked about growth into this like what has COVID done for the business in terms of changes? Has it, kind of raised awareness for this type of technology? Has it changed anything strategically that Frontline has had to do?
Neil Hunn
The short answer is not really. I mean there has been obviously a lot of COVID funding that has gone – probably federal funding has gone to the states and those dollars are still there. The vast, vast majority of that funding has been used by the K-12 systems on one-time type items the principal item going – being getting devices to be one-to-one, one device to one student, something like 95% of school districts now are one-to-one.
So, there has been no discernible historical boost to the demand or the bookings trend for Frontline from COVID funding and we don’t expect there to be a tailwind, sort of for the last couple of years of the remaining funding, but there has been more front of classroom benefit from that funding.
Rob Crisci
Yes. And I would just add, you know the availability of teachers, certainly teacher shortages as we’ve gone through COVID and the importance of finding great teachers for all these districts and that’s part of what our software enables.
Joe Giordano
Can you talk about the ability to drive price? I mean, you talk about net retention is higher, significantly higher than growth. So, obviously, there is [some ability] [ph]. I’m just curious if that’s like on a like-for-like basis or if it’s just getting more programs per person into that? Like just into a more budget constrained environment, what’s the ability to consistently look at price there?
Neil Hunn
Yes. So, certainly price is part of that algorithm. They historically have been in, sort of the [4%-ish] [ph] range and that’s where we’d expect it to be going forward. Maybe a touch more in the next couple of years because their ability to move price in their contracts, lags inflation, so we might have a little – the company will have a little bit higher pricing for the next year or two and then revert back in the 4% range. So that’s the sense on pricing and they didn’t value capture.
Joe Giordano
And if I can just sneak one, and you mentioned like the M&A environment, they have their own bolt-on capabilities, like what kind of areas are they – have they historically looked at and are looking at now? Thank you.
Neil Hunn
Yes. So, it’s – as most companies M&A function, it’s – they look at two different avenues. One is, essentially how do they find product categories to continue opening up [TAM] [ph] if you will. So, that’s been a decided focus of their capability. The other one is just how do you find opportunities to buy products and push through the national distribution capability of the company.
Operator
And our next question comes from Steve Tusa from JPMorgan. Please go ahead with your question.
Steve Tusa
Hi, good morning.
Neil Hunn
Good morning.
Steve Tusa
Congrats. What’s the employee base for these guys?
Rob Crisci
It’s in the – it’s a little bit north of a thousand. They have – and it’s quite national and they have offshore development capability.
Steve Tusa
Okay. And when you were talking about the organic of being high single digit, I mean, [and a touch] [ph] about that? I mean, should we think like 7 to 8, is that kind of the right framework high-single-digit can be, I don’t know, 9% to 10%, maybe or something like that. What is a little more precision on what they did not?
Neil Hunn
Yes, I mean, we think of HSD as 7 to 9.
Steve Tusa
Yes, okay. That makes sense. What is the – in the last couple of years, what’s the biggest deal that they’ve done? I mean, what – they’ve done a bunch of deals, what’s – any of them more sizable than the other?
Neil Hunn
They’ve done – in the Thoma ownership, they completed six acquisitions. They were all small-ish. I mean, they were all – they’ll give you a sense, Thoma, as at least as I believe did not put any equity into those deals, so they’re all flooded off the company’s balance sheet. So, they’re bolt-on size for the company.
Steve Tusa
Okay. Got it. And then had you been looking at these – one last question. Have you been looking at these guys for a while? I know in prior deals, we would, you kind of looked at some of these transactions for a little while. How long have you been [cultivating these guys] [ph]?
Rob Crisci
We saw the book in 2017 when Thoma bought the business, but did not engage at any level of depth given where our balance sheet was coming off the Deltek and ConstructConnect deals. So, yes, we had the historical information, but no real intimacy with the company until a handful of months ago.
Steve Tusa
Awesome. Thank you.
Rob Crisci
Thank you.
Operator
And our next question comes from Rob Mason from Baird. Please go ahead with your question.
Rob Mason
Yes. Good morning. Thanks for taking the question. I wanted to go back to the three main buckets that you identified, Neil, that they participate in. My understanding is, maybe the legacy of the business originally is more in the human capital management. Could you just speak to the relative level of penetration you think each of those three buckets are in?
Neil Hunn
Sure. I’m delighted to do it. You’re right. The legacy of the business is in the HCM space, still a long way to go there. They have [8,000-ish] [ph] customers in that space, [indiscernible]. They’re [indiscernible] in human capital management, the average penetration is 2. In business operations, it’s a little over 2 of 8, for instance; and student management, it’s a little under 2 of 12. So, there’s a lot of runway inside of each product silo and then across the product silos.
Rob Mason
Fine. And just to go back to the competition question, there’s several public comparables out there as well. I guess, my understanding maybe PowerSchool is the most comparable? I’m just curious if you would agree with that and if that’s the case, how do you draw any kind of distinctions between their direct competitors?
Neil Hunn
Sure. So, the PowerSchool’s maybe the most direct investor comparable, but not really from a competitive point of view. There is a little bit of overlap competitively, but in a decidedly small minority of the deals that frontline competes into, they actually compete against PowerSchool. PowerSchool think of them more student information system, classroom-ish oriented, and Frontline is more administrative back office oriented.
Rob Mason
Very good. Thank you.
Neil Hunn
Thank you.
Operator
This concludes our question-and-answer session. We will now turn the call back over to Zack Moxcey for any closing remarks.
Zack Moxcey
Thank you everyone for joining us this morning. We look forward to speaking with you during our next earnings call.
Operator
The conference has now concluded. We do thank you for joining today’s presentation. You may now disconnect your lines.

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