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ROP > SEC Filings for ROP > Form 10-K on 21-Feb-2014All Recent SEC Filings

Show all filings for ROPER INDUSTRIES INC

Form 10-K for ROPER INDUSTRIES INC


21-Feb-2014

Annual Report


ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS

You should read the following discussion in conjunction with "Selected Financial Data" and our Consolidated Financial Statements and related notes included in this Annual Report.

Overview

We are a diversified growth company that designs, manufactures and distributes medical and scientific imaging products and software, radio frequency ("RF") products, services and application software, industrial technology products and energy systems and controls products and solutions. We market these products and services to a broad range of markets including RF applications, medical, water, energy, research, education, software-as-a-service ("SaaS")-based information networks, security and other niche markets.

We pursue consistent and sustainable growth in earnings and cash flow by emphasizing continuous improvement in the operating performance of our existing businesses and by acquiring other carefully selected businesses. Our acquisitions have represented both bolt-ons and new strategic platforms.

On May 1, 2013, we purchased the shares of Managed Health Care Associates, Inc. ("MHA"), a leading provider of services and technologies to support the diverse and complex needs of alternate site health care providers who deliver services outside of an acute care hospital setting. The acquisition of MHA complements and expands our medical software and services platform. On October 4, 2013, we acquired the shares of Advanced Sensors, Ltd. ("Advanced Sensors"), which manufactures oil-in-water analyzers for the oil and gas industries.

Application of Critical Accounting Policies

Our Consolidated Financial Statements are prepared in conformity with generally accepted accounting principles in the United States ("GAAP"). A discussion of our significant accounting policies can also be found in the notes to our Consolidated Financial Statements for the year ended December 31, 2013 included in this Annual Report.

GAAP offers acceptable alternative methods for accounting for certain issues affecting our financial results, such as determining inventory cost, depreciating long-lived assets and recognizing revenue. We have not changed the application of acceptable accounting methods or the significant estimates affecting the application of these principles in the last three years in a manner that had a material effect on our financial statements.

The preparation of financial statements in accordance with GAAP requires the use of estimates, assumptions, judgments and interpretations that can affect the reported amounts of assets, liabilities, revenues and expenses, the disclosure of contingent assets and liabilities and other supplemental disclosures.

The development of accounting estimates is the responsibility of our management. Our management discusses those areas that require significant judgments with the audit committee of our Board of Directors. The audit committee has reviewed all financial disclosures in our annual filings with the SEC. Although we believe the positions we have taken with regard to uncertainties are reasonable, others might reach different conclusions and our positions can change over time as more information becomes available. If an accounting estimate changes, its effects are accounted for prospectively or through a cumulative catch up adjustment.

Our most significant accounting uncertainties are encountered in the areas of accounts receivable collectibility, inventory valuation, future warranty obligations, revenue recognition (percentage-of-completion), income taxes and goodwill and indefinite-lived asset analyses. These issues affect each of our business segments and are evaluated using a combination of historical experience, current conditions and relatively short-term forecasting.

Accounts receivable collectibility is based on the economic circumstances of customers and credits given to customers after shipment of products, including in certain cases credits for returned products. Accounts receivable are regularly reviewed to determine customers who have not paid within agreed upon terms, whether these amounts are consistent with past experiences, what historical experience has been with amounts deemed uncollectible and the impact that economic conditions might have on collection efforts in general and with specific customers. The returns and other sales credit allowance is an estimate of customer returns, exchanges, discounts or other forms of anticipated concessions and is treated as a reduction in revenue. The returns and other sales credits histories are analyzed to determine likely future rates for such credits. At December 31, 2013, our allowance for doubtful accounts receivable was $11.4 million and our allowance for sales returns and sales credits was $3.6 million, for a total of $15.0 million, or 2.8% of total gross accounts receivable. This percentage is influenced by the risk profile of the underlying receivables, and the timing of write-offs of accounts deemed uncollectible. The total allowance at December 31, 2013 was $1.0 million lower than at December 31, 2012. The allowance will continue to fluctuate as a percentage of sales based on specific identification of allowances needed due to changes in our business, the write-off of uncollectible receivables, and the addition of reserve balances at acquired businesses.

We regularly compare inventory quantities on hand against anticipated future usage, which we determine as a function of historical usage or forecasts related to specific items in order to evaluate obsolescence and excessive quantities. When we use historical usage, this information is also qualitatively compared to business trends to evaluate the reasonableness of using historical information as an estimate of future usage. At December 31, 2013, inventory reserves for excess and obsolete inventory were $43.5 million, or 17.5% of gross inventory cost, as compared to $42.0 million, or 18.0% of gross inventory cost, at December 31, 2012. The inventory reserve as a percent of gross inventory cost will continue to fluctuate based upon specific identification of reserves needed based upon changes in our business as well as the physical disposal of obsolete inventory.

Most of our sales are covered by warranty provisions that generally provide for the repair or replacement of qualifying defective items for a specified period after the time of sale, typically 12 months. Future warranty obligations are evaluated using, among other factors, historical cost experience, product evolution and customer feedback. Our expense for warranty obligations was less than 1% of net sales for each of the years ended December 31, 2013, 2012, and 2011.

Revenues related to the use of the percentage-of-completion method of accounting are dependent on total costs incurred compared with total estimated costs for a project. During the year ended December 31, 2013, we recognized revenue of $205.0 million using this method, primarily for major turn-key, longer term toll and traffic and energy projects and installations of large software application products. We recognized $145.5 million and $151.5 million of revenue using this method during the years ended December 31, 2012 and December 31, 2011, respectively. At December 31, 2013, $222.1 million of revenue related to unfinished percentage-of-completion contracts had yet to be recognized. Contracts accounted for under this method are generally not significantly different in profitability from revenues accounted for under other methods.

Income taxes can be affected by estimates of whether and within which jurisdictions future earnings will occur and if, how and when cash is repatriated to the U.S., combined with other aspects of an overall income tax strategy. Additionally, taxing jurisdictions could retroactively disagree with our tax treatment of certain items, and some historical transactions have income tax effects going forward. Accounting rules require these future effects to be evaluated using current laws, rules and regulations, each of which can change at any time and in an unpredictable manner. During 2013, our effective income tax rate was 28.6%, which was slightly lower than the 2012 rate of 29.6% due in part to the enactment of the American Taxpayer Relief Act of 2012 ("ATRA") on January 2, 2013 which retroactively reinstated and extended certain tax provisions to January 1, 2012. As a result, our income tax provision for the first quarter of 2013 included discrete tax benefits totaling $6 million. We expect the effective tax rate to increase in 2014 due to a continued increase in revenues and resulting pretax income in higher tax jurisdictions as well as the non-recurrence of the $6 million tax benefit taken in 2013.

We account for goodwill in a purchase business combination as the excess of the cost over the estimated fair value of net assets acquired. Goodwill, which is not amortized, is tested for impairment on an annual basis (or an interim basis if an event occurs or circumstances change that would more likely than not reduce the fair value of a reporting unit below its carrying value) using a two-step process. The first step utilizes both an income approach (discounted cash flows) and a market approach consisting of a comparable company earnings multiples methodology to estimate the fair value of a reporting unit. To determine the reasonableness of the estimated fair values, we review the assumptions to ensure that neither the income approach nor the market approach provides significantly different valuations. If the estimated fair value exceeds the carrying value, no further work is required and no impairment loss is recognized. If the carrying value exceeds the estimated fair value, the goodwill of the reporting unit is potentially impaired and then the second step would be completed to measure the impairment loss by calculating the implied fair value of goodwill by deducting the fair value of all tangible and intangible net assets (including unrecognized intangible assets) of the reporting unit from the fair value of the reporting unit. If the implied fair value of goodwill is less than the carrying value of goodwill, an impairment loss would be recognized.

Key assumptions used in the income and market approaches are updated when the analysis is performed for each reporting unit. Various assumptions are utilized including forecasted operating results, strategic plans, economic projections, anticipated future cash flows, the weighted-average cost of capital, comparable transactions, market data and earnings multiples. While we use reasonable and timely information to prepare our cash flow and discount rate assumptions, actual future cash flows or market conditions could differ significantly and could result in future non-cash impairment charges related to recorded goodwill balances.

We have 28 reporting units with individual goodwill amounts ranging from zero to $988 million. We concluded that the fair value of each of our reporting units was in excess of its carrying value, with no impairment indicated as of December 31, 2013. However, the fair value of one of our reporting units in the RF Technology segment was less than 5% above its carrying value at December 31, 2013 using the discounted cash flow methodology. The decrease from the prior year's results was due to lower growth assumptions in the current year's testing. The weighted average cost of capital utilized in 2013 was consistent with the prior year's testing. We believe the market value of this unit to be significantly in excess of its carrying value based upon observed market data.
Negative industry or economic trends, disruptions to our business, actual results significantly below projections, unexpected significant changes or planned changes in the use of the assets, divestitures and market capitalization declines may have a negative effect on the fair value of our reporting units.

Business combinations can also result in other intangible assets being recognized. Amortization of intangible assets, if applicable, occurs over their estimated useful lives. Trade names that are determined to have an indefinite useful economic life are not amortized, but separately tested for impairment during the fourth quarter of the fiscal year or on an interim basis if an event occurs that indicates the fair value is more likely than not below the carrying value. We conduct these reviews for all of our reporting units using the relief-from-royalty method, which we believe to be an acceptable methodology due to its common use by valuations specialists in determining the fair value of intangible assets. This methodology assumes that, in lieu of ownership, a third party would be willing to pay a royalty in order to exploit the related benefits of these assets. The fair value of each trade name is determined by applying a royalty rate to a projection of net sales discounted using a risk adjusted rate of capital. Each royalty rate is determined based on the profitability of the reporting unit to which it relates and observed market royalty rates. Sales growth rates are determined after considering current and future economic conditions, recent sales trends, discussions with customers, planned timing of new product launches or other variables. Reporting units resulting from recent acquisitions generally represent the highest risk of impairment, which typically decreases as the businesses are integrated into our enterprise and positioned for improved future sales growth.

The assessment of fair value for impairment purposes requires significant judgments to be made by management. Although our forecasts are based on assumptions that are considered reasonable by management and consistent with the plans and estimates management is using to operate the underlying businesses, there is significant judgment in determining the expected results attributable to the reporting units. Changes in estimates or the application of alternative assumptions could produce significantly different results. No impairment resulted from the annual reviews performed in 2013; however, the fair value of the trade names of one of our reporting units in the RF Technology segment could have fallen below the carrying value at December 31, 2013, had the assumed sales growth been less than that used in the assessment. We do not believe that impairment is probable; however, it is possible that the trade name could become impaired in the future, at which point we would be required to record a non-cash impairment charge to reduce the carrying level of the trade name at the reporting unit.

We evaluate whether there has been an impairment of identifiable intangible assets with definite useful economic lives, or of the remaining life of such assets, when certain indicators of impairment are present. In the event that facts and circumstances indicate that the cost or remaining period of amortization of any asset may be impaired, an evaluation of recoverability would be performed. If an evaluation is required, the estimated future gross, undiscounted cash flows associated with the asset would be compared to the asset's carrying amount to determine if a write-down to fair value or a revision in the remaining amortization period is required.


Results of Operations

The following table sets forth selected information for the years indicated.
Dollar amounts are in thousands and percentages are of net sales. Amounts may not foot due to rounding.

                                                    Years ended December 31,
                                             2013               2012              2011
Net sales
Industrial Technology                  $        779,564    $       795,240    $    737,356
Energy Systems and Controls(1)                  651,920            646,116         597,802
Medical and Scientific Imaging(2)               902,281            703,835         610,617
RF Technology                                   904,363            848,298         851,314
Total                                  $      3,238,128    $     2,993,489    $  2,797,089

Gross profit:
Industrial Technology                              51.1 %             51.6 %          49.8 %
Energy Systems and Controls                        57.4               56.3            55.5
Medical and Scientific Imaging                     69.3               64.4            63.3
RF Technology                                      53.7               52.4            50.6
Total                                              58.1               55.8            54.2

Operating profit:
Industrial Technology                              28.6 %             30.8 %          28.2 %
Energy Systems and Controls                        28.2               27.8            26.4
Medical and Scientific Imaging                     29.7               26.6            24.3
RF Technology                                      28.0               26.3            23.8
Total                                              28.7               27.9            25.6

Corporate administrative expenses                  (2.7 )%            (2.6 )%         (2.0 )%
Income from continuing operations                  26.0               25.3            23.6
Interest expense, net                              (2.7 )             (2.3 )          (2.3 )
Other income/(expense)                                -               (0.1 )           0.3
Income from continuing operations
before taxes                                       23.3               22.9            21.6
Income taxes                                       (6.7 )             (6.8 )          (6.4 )

Net earnings                                       16.6 %             16.1 %          15.3 %

(1) Includes results from the acquisition of United Controls Group, Inc. from September 26, 2011 and Advanced Sensors from October 4, 2013.

(2) Includes results from the acquisitions of NDI Holding Corp. from June 3, 2011, Sunquest Information Systems, Inc. from August 22, 2012 and MHA from May 1, 2013.

Year Ended December 31, 2013 Compared to Year Ended December 31, 2012

Net sales for the year ended December 31, 2013 were $3.24 billion as compared to sales of $2.99 billion for the year ended December 31, 2012, an increase of 8%. The increase was the result of contributions from acquisitions of 7% and organic sales growth of 1%.

Our Medical and Scientific Imaging segment reported a $198 million or 28% increase in net sales for the year ended December 31, 2013 over the year ended December 31, 2012. Acquisitions added $208 million in sales, while organic sales decreased 1% due to a $20 million decrease in camera sales which was offset in part by increased sales in our medical businesses of $15 million.
Gross margin increased to 69.3% in the year ended December 31, 2013 from 64.4% in the year ended December 31, 2012, due primarily to additional sales from medical products which have a higher gross margin. Selling, general and administrative ("SG&A") expenses as a percentage of net sales increased to 39.5% in the year ended December 31, 2013 as compared to 37.8% in the year ended December 31, 2012 due to higher SG&A expense structures at our medical businesses as well as SG&A expenses at MHA in which the corresponding revenues were not recognizable under GAAP (See Note 2 of the notes to Consolidated Financial Statements included in this Annual Report). Operating margin was 29.7% in the year ended December 31, 2013 as compared to 26.6% in the year ended December 31, 2012.

In our RF Technology segment, net sales for the year ended December 31, 2013 increased by $56 million or 7% over the year ended December 31, 2012. The increase was due primarily to growth in our toll and traffic, university card systems and security solutions businesses. Gross margin was 53.7% in 2013 as compared to 52.4% in the prior year due to operating leverage on higher sales volume. SG&A expenses as a percentage of sales in the year ended December 31, 2013 were 25.6%, a decrease from 26.1% in the prior year due to operating leverage on higher sales volume. Operating profit margin was 28.0% in 2013 as compared to 26.3% in 2012.

Net sales for our Industrial Technology segment decreased by $16 million or 2% for the year ended December 31, 2013 over the year ended December 31, 2012. The decrease was due primarily to the loss of a customer at our water metering business and lower sales at our materials testing business. Gross margin was 51.1% for the year ended December 31, 2013 as compared to 51.6% in the year ended December 31, 2012 due to negative operating leverage on lower sales volume as well as the inclusion in 2012 of a one-time $5.5 million reduction to cost of goods sold at one of our businesses. SG&A expenses as a percentage of net sales were 22.5%, as compared to 20.8% in the prior year, due primarily to a $9.1 million pretax charge for warranty expense at one of our subsidiaries, Hansen Technologies, to provide its customers with replacements for refrigeration valves that included a vendor-supplied component that did not meet Roper quality standards. The resulting operating profit margin was 28.6% in the year ended December 31, 2013 as compared to 30.8% in the year ended December 31, 2012.

In our Energy Systems and Controls segment, net sales for the year ended December 31, 2013 increased by $6 million or 1% over the year ended December 31, 2012, due primarily to acquisitions. Organic sales were impacted by lower sales of non-destructive testing systems for nuclear plants and pressure sensors for industrial applications, offset by increased demand for control systems for oil and gas applications. Gross margin was 57.4% in the year ended December 31, 2013, compared to 56.3% in the year ended December 31, 2012, due to product mix. SG&A expenses as a percentage of net sales were 29.2% as compared to 28.4% in the prior year due to product mix. Operating profit margin was 28.2% in the year ended December 31, 2013 as compared to 27.8% in the year ended December 31, 2012.

Corporate expenses increased by $8.6 million to $86.1 million, or 2.7% of sales, in 2013 as compared to $77.5 million, or 2.6% of sales, in 2012. The increase was due to higher equity compensation (primarily as a result of higher stock prices), offset in part by a decrease in acquisition-related expenses.

Interest expense increased $20.5 million, or 30.4%, for the year ended December 31, 2013 compared to the year ended December 31, 2012. The increase is due primarily to higher average debt balances offset in part by lower average interest rates throughout 2013.

Other expense of $0.2 million for the year ended December 31, 2013 was composed of foreign exchange losses at our non-U.S. based companies, offset in part by proceeds from a legal settlement. Other expense for the year ended December 31, 2012 was $2.3 million, primarily due to foreign exchange losses at our non-U.S. based companies.

During 2013, our effective income tax rate was 28.6% versus 29.6% in 2012. The reduction was due to $6 million in discrete tax benefits related to the enactment of the American Taxpayer Relief Act of 2012 ("ATRA"), as well as a $6 million benefit from the correction of an out of period adjustment of tax balances which were immaterial to any covered period, offset in part by increased revenues and resulting pretax income in higher tax jurisdictions, primarily the United States. We expect the effective tax rate to increase in 2014 due to a continued increase in revenues and resulting pretax income in higher tax jurisdictions as well as the non-recurrence of the $6 million tax benefit taken in 2013.

At December 31, 2013, the functional currencies of most of our European subsidiaries were stronger and our Canadian and United Kingdom subsidiaries were weaker against the U.S. dollar compared to currency exchange rates at December 31, 2012. The net result of these changes led to a pre-tax decrease in the foreign exchange component of comprehensive earnings of $17.9 million in the year ended December 31, 2013. Approximately $9.5 million of this amount related to goodwill and is not expected to directly affect our projected future cash flows. For the entire year of 2013, operating profit decreased by less than 1% due to fluctuations in non-U.S. currencies.

The following table summarizes our net order information for the years ended December 31, 2013 and 2012 (dollar amounts in thousands).

                                            2013          2012       change
          Industrial Technology          $   772,337   $   783,362     (1.4 )%
          Energy Systems and Controls        673,569       634,051      6.2
          Medical and Scientific Imaging     958,830       703,034     36.4
          RF Technology                      943,757       871,225      8.3
          Total                          $ 3,348,493   $ 2,991,672     11.9 %

The increase in orders was due to internal growth of 4%, as well as orders from acquisitions which added 8%. Our Energy Systems and Controls and RF Technology segments experienced strong internal growth throughout 2013. Our Medical and Scientific Imaging segment experienced internal growth of 3%, as well as orders from recent acquisitions.

The following table summarizes order backlog information at December 31, 2013 and 2012 (dollar amounts in thousands). We include in backlog only orders that are expected to be recognized as revenue within twelve months.

                                             2013         2012      change
           Industrial Technology          $   121,943   $ 131,621     (7.4 )%
           Energy Systems and Controls        131,799     109,885     19.9
           Medical and Scientific Imaging     290,435     234,526     23.8
           RF Technology                      510,553     471,185      8.4
           Total                          $ 1,054,730   $ 947,217     11.4 %

Year Ended December 31, 2012 Compared to Year Ended December 31, 2011

Net sales for the year ended December 31, 2012 were $2.99 billion as compared to sales of $2.80 billion for the year ended December 31, 2011, an increase of 7%. The increase was the result of organic sales growth of 4%, contributions from acquisitions of 4% and an unfavorable effect from foreign exchange of 1%.

Our Medical and Scientific Imaging segment reported a $93 million or 15% increase in net sales for the year ended December 31, 2012 over the year ended December 31, 2011. Acquisitions added $94 million in sales, while organic sales increased 1% due to increased sales in our medical and electron microscopy businesses, offset by declines in sales of scientific imaging products. The impact from foreign exchange was a negative 1%. Gross margin increased to 64.4% in the year ended December 31, 2012 from 63.3% in the year ended December 31, 2011, due primarily to additional sales from medical products which have a higher gross margin. Selling, general and administrative expenses ("SG&A") as a percentage of net sales decreased to 37.8% in the year ended December 31, 2012 as compared to 39.0% in the year ended December 31, 2011 due to investments in new products in the medical businesses in 2011 that did not recur in 2012. Operating margin was 26.6% in the year ended December 31, 2012 as compared to 24.3% in the year ended December 31, 2011.

In our Energy Systems and Controls segment, net sales for the year ended December 31, 2012 increased by $48 million or 8% over the year ended December 31, 2011. Organic sales increased 7% while acquisitions added $19 million, or 3%. The increase in organic sales was primarily due to increased demand in industrial process and nuclear plant inspection end markets. The impact from foreign exchange was a negative 2%. Gross margin was 56.3% in the year ended December 31, 2012, compared to 55.5% in the year ended December 31, 2011, due to operating leverage from higher sales volume. SG&A expenses as a percentage of net sales were 28.4% as compared to 29.1% in the prior year due to operating leverage from higher sales volume. Operating margin was 27.8% in the year ended December 31, 2012 as compared to 26.4% in the year ended December 31, 2011.

Net sales for our Industrial Technology segment increased by $58 million or 8% for the year ended December 31, 2012 over the year ended December 31, 2011. The . . .

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