Oct 28, 2013
Executives
John Humphrey - Chief Financial Officer and Executive Vice President Brian D. Jellison - Chairman, Chief Executive Officer, President and Chairman of Executive Committee
Analysts
Matt J. Summerville - KeyBanc Capital Markets Inc., Research Division Joseph Ritchie - Goldman Sachs Group Inc., Research Division Christopher Glynn - Oppenheimer & Co.
Inc., Research Division Deane M. Dray - Citigroup Inc, Research Division Richard C.
Eastman - Robert W. Baird & Co.
Incorporated, Research Division Mark Douglass - Longbow Research LLC Charles Stephen Tusa - JP Morgan Chase & Co, Research Division Chip Moore - Canaccord Genuity, Research Division Alexander M. Blanton - Clear Harbor Asset Management, LLC
Operator
The Roper Industries Third Quarter 2013 Financial Results Conference Call will now begin. I will now turn the call over to John Humphrey, Chief Financial Officer.
John Humphrey
Thank you, Alicia, and thank you, all, for joining us this morning as we discuss the results of our third quarter. Joining me this morning is Brian Jellison, Chairman, President and Chief Executive Officer; Paul Soni, Vice President and Controller; and Rob Crisci, who heads up Planning and Investor Relations for us.
Earlier this morning, we issued a press release announcing our financial results. The press release also includes replay information for today's call.
In addition, we prepared slides to accompany today's call, which are available through the webcast and also available on our website at www.roperind.com. 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 be making forward-looking statements, which are subject to risks and uncertainties as described on this page and as detailed on our SEC filings. You should listen to today's call in the context of that information.
Now if you'll please turn to Slide 3. Today, we will be discussing our income statement results for the quarter, primarily on an adjusted basis.
A full reconciliation between GAAP and adjusted measures is in our press release this morning, and also included as a part of this presentation on our website. For the third quarter, the difference between GAAP and adjusted consists of 2 discrete items.
First, a fair value adjustment to acquire deferred revenue at Sunquest. For the quarter, this impact was $1 million to revenue and operating profit.
And this also represents the last time we'll be talking about this adjustment, as we've now completed our 12 months and this deferred revenue adjustment is now completed. This adjustment does represent revenue that, absent our acquisition, Sunquest would have recognized.
Second, a fair value adjustment to revenue for MHA totaling $7.9 million. Again, this represents revenue that, absent our acquisition, MHA would have recognized.
We believe showing our results on this basis provides additional insight into the ongoing and recurring results of the business. Now if you'll please turn to Slide 4, I will turn the call over to Brian Jellison, Chairman, President and Chief Executive Officer.
After his prepared remarks, we will take questions from our telephone participants. Brian?
Brian D. Jellison
Thank you, John, and good morning, everyone. So the first slide here is the quarter 3 enterprise financial results.
We achieved record results in the third quarter across almost every important line, and these are substantial increases in orders, in backlog, in revenue, in net earnings, in EBITDA and in cash flow. Our orders were $846 million.
Revenue was $837 million, with a book-to-bill of 1.01x, and backlog ended the quarter at $1.04 billion. Gross margin was really spectacular in the quarter, up 280 points to 58.7%.
Our EBITDA was up 20% to $278 million in the quarter. EBITDA margin was also spectacular, up 240 basis points to 33.2%.
Our diluted earnings per share were up 15% on the adjusted basis, and I think it was 17% on a GAAP basis. The GAAP operating cash flow was up 25% to $256 million.
We'll talk a little bit more about how that positions us so well going forward. Very compelling margins and cash flow in the quarter.
Next slide. If we look at the Q3 income statement, you'll see orders increased by $126 million from last year, from $720 million to $846 million, an 18% increase in orders, with organic orders up 7%.
Our revenue was up 11%, with organic at 3%. We'll talk a little bit about that, as that was a little less than we'd like to have seen on organic.
Our gross margin was up sharply, as I said, to 58.7%. Our operating margin, which we probably ought to talk more about, was up another 160 basis points to 27.3%.
Now our tax rate actually was a $0.02 headwind in the quarter compared to the prior year actual as it increased from 29.4% to 30.3%, but that was somewhat consistent with what we expected. Net earnings, that figure is up 15% to $142 million.
Now in the $142 million, we'll talk, when we get into the segment detail, about Zetec, which, against our expectations, as weak as they were, still delivered a $0.03 miss in the quarter. Next slide.
The EBITDA growth and margin expansion that we continued to have for a long period of time is still very sustainable, and you see it continue to grow. So here, if you look at 2011, our trailing third quarter EBITDA for the past 12 months was $779 million.
It increased $93 million in the 12-month period from the third quarter of '11 to '12 and now has skyrocketed up another $170 million in the last 12 months, ending this quarter at $1,042,000,000. That's $263 million of increase in the last 2 years on a revenue variance of $461 million.
So you can run your own leverage, but it's well above 50%. If we look at the EBITDA margin, that continues to expand.
In 2011, it was 28.5%. This trailing 12-month period ended at 32.6%, with actual third quarter results at 33.2%.
So a 410-basis-point improvement in our EBITDA performance. And really, I suppose, on this slide, we should be detailing the other kind of margin improvements with gross margin and operating margin that continues to expand.
And EBITDA -- or EBITA margins, if we look at just eliminating the D portion and look at EBITA, it was 32% in the quarter. So those amortization things, which are noncash, always are important.
This is how we look at how we're doing and how we're getting all this cash. Next slide.
If we look at cash flow results, you can see they just continue to move on up. Frankly, spectacular in the third quarter, $244 million of free cash flow is 29% of revenue.
Now you're not going to do that every quarter, but if you look at the year-to-date results, which is what we're stressing here because of the -- trying to provide some balance, our year-to-date cash flow is up $101 million from this point last year to $567 million. That gives us a year-to-date operating cash flow of 24%, and CapEx was only $33 million year-to-date.
So free cash flow is $534 million year-to-date. And of course, we continue to trend up.
So even though you see year-to-date at 24%, in the third quarter only, the operating cash flow was 31%. Cash conversion is just exceptional.
Next slide. We look at the balance sheet here, which continues to improve, even with our transactions.
We finished the quarter with cash of $460 million and the undrawn revolver of $1,110,000,000. EBITDA, as we said, on a trailing basis is $1,042,000,000.
If you look the gross debt number at $2,606 million and take away the $460 million in cash, our net debt number is only $2,146,000,000 against $1,042,000,000 in EBITDA, which is a net debt-to-EBITDA ratio of 2.06x. So we feel we're in a very strong position from a flexibility viewpoint.
Next slide. Here, we'll take a look at the individual segment details, which are really quite interesting in the quarter.
Next slide. So on Energy Systems & Controls, starting from the smallest segment to the largest, they certainly had a devastatingly difficult period with the Zetec nuclear business.
We had sort of indicated we thought it could be down for the balance of the year maybe $10 million. We were hoping it wouldn't be that bad, but it's actually much worse.
The Zetec number in the third quarter was down 44% from the corresponding period a year ago because of this activity around shutting down various plants and not testing at the moment. And that wiped out our ability to have organic growth in the Energy segment in the third quarter.
If we exclude Zetec, the segment revenue in the quarter actually would have been up 4%, not down 2%. So it's very unusual for us to have something like that, that has a distortion of the quality in the underlying businesses.
All of this eventually turns into a various -- a variable positive in 2014, because these things will be tested and there will be activity. But it's just not going to happen in the second half of this year.
We also saw reduced activity in upstream areas in North American oil and gas, which was more severe than we expected. That affects not only energy, but it also affects our Roper Pump business, which reports through the Fluid Handling area.
Not a -- certainly, still decent business, but very disappointing in terms of organic growth in the third quarter and probably in the fourth quarter as well. That was really more than offset, though, with improving contributions from our Compressor Controls business, which really is much more of a software company, frankly, and PAC, which is focused more on the midstream and downstream oil and gas areas.
If we look at orders in the quarter, they were only up 1%. But if you exclude Zetec, our orders in the quarter were up 7%.
So really, without Zetec, orders up 7% and revenue up 4% would have been a satisfactory result. If we look at the fourth quarter, we did an acquisition just right here at the beginning, the first week in October, of an Irish company called Advanced Sensors, which has a new proprietary technology for remote reading of information offshore.
It's a very exciting technology. We very much like the people involved in this and think they're going to add to our online reading capability of a variety of things that PAC does.
We see, in the fourth quarter, continued strength at Compressor Controls. We would expect record performance there.
And PAC, really started to rebound in the third quarter, even though it was off of our expectations for growth, yet still was up nominally, and it will be up again in the fourth quarter. Unfortunately, the nuclear weakness looks to continue.
I think it's going to be down 40% here in the second half of the year before it starts to grow off of a ridiculously easy comp in 2014. And then the segment as a whole, we think will have kind of a mid-single-digit, 5%-plus growth in the fourth quarter.
Next slide. In the Industrial Technology arena, we see there's a little bit of carryover here, with the upstream activity in oil and gas affecting Roper Pump, and to a much less degree, the dewatering pumps at Cornell.
We had a decent performance there, but that coiled tubing section that goes into drilling at Roper Pump was down sharply, cost us about $5 million in revenue in the quarter. Orders, though, were up 1% reported.
This will be the last quarter we have that variance around Neptune's nonrenewal on the customer side. It would have been up about 3% without that.
We had very strong performance in Neptune again. It's certainly not fair to exclude the lost customer scenario, but without that, year-to-date, we'd be up nearly 11%.
They had a very good quarter, very much bolstered by continued strength in Toronto, and the U.S. homebuilding gives us an opportunity to get more renewals and just add on normal replacement of water meters, plus the starts.
And then this has been an extraordinary year in winning a large number of small-sized communities. I think when we -- we looked at a targeted approach that was nearing 20 and we've gotten all but one, so very successful.
I think our lead-free meter experience and the cost structures we have to produce it are really demonstrating the strength we have in this unique company, because its margins are certainly similar to the segment, where other competitors are talking about gross margins in the 30s and operating margins of 15%. So it still remains the class of the water metering and technology issue.
Material analysis growth, very strong in consumables at Struers, which was helpful. A slight decline in instrument sales.
But in the first half of the year, their instrument sales were down more. They had very strong sales in Asia, with Japan and China, and it looks like they've turned the corner on the trend in instrument sales.
We had terrific margin performance, operating margin at 30.3%, even though there was very limited sales growth in the quarter. These 30% operating margins, I think, just demonstrate the sustainability of the quality of these businesses.
If we look at fourth quarter, we don't see any improvement yet in the upstream oil and gas drilling activity. If that happened, that would be helpful.
We see continued growth for Neptune because of the housing starts and the growing use of lead-free meters in North America. We think that the material analysis businesses will be a little better, as we see continued improvement in instruments.
And then contributions at Cornell, they've done a remarkable job this year of adding new customers, which traditionally they hadn't gone after. And those additions of new customers are starting to produce more internal organic growth, and they look to have a little bit of a rebound in the rental market in the fourth quarter.
So we're feeling -- even though the performance is quite good, we think it will get to be a little bit better. Next slide.
If we look at RF Technology, it's certainly had a remarkable quarter. Orders were up 13%.
All of that is organic. So that's a terrific leg up, positioning us for 2014.
Really, everybody in there is growing for the most part. We have broad-based improvement in toll and traffic; in the various software businesses, whether they're the subscription businesses or just licensed software; and the RF products businesses.
The products are really around Inovonics, security-focused activity, and Technolog, which is our European data collection technology, they get sales[ph] through products. Toll and traffic did better, which helps account for the revenue growth of 8% and increase in OP and margin improvement, at 28.3%.
And even though it was good, it was actually a little bit under what we expected in the quarter because we thought that the Virginia project would get started early. It really didn't get started until September.
So what happens is that, that then rolls forward to a certain capacity constraint that the state or the authority will have and we'll have a strong fourth quarter. And then what that really means is the expectation around the third quarter will get moved to the fourth quarter -- first quarter of next year, so first half of next year will be stronger than we expected around the Virginia project, we think stronger than we expected around Texas projects and Florida.
We had a terrific quarter in the campus software business, with CBORD and security applications, as we continued to get more wins from another company that's struggling at the moment. And then we have product expansion in our software businesses and continued subscriber growth.
In the fourth quarter, we expect double-digit growth in the segment, certainly above 10%. The toll and traffic projects continue to ramp up.
And plus, they'll carryover into 2014, so it's a great setup for us for next year. The Florida tag technology upgrade has been accelerating, where we're putting multiple protocol deployments around various places in the state so that they can read different types of tags.
And they're also upgrading to a tag which has an entirely different footprint than you have been used to seeing. It's a very small tag, probably not even an inch tall and maybe 2.5 inches wide and totally flat.
It's a really exciting technology for them. And we also launched, at the IBTTA conference in September, our go-anywhere pass, which, I think, people are delighted to see.
There's a lot of -- we used to talk about HOV lanes, meaning high-occupancy vehicles. And now what people are talking about are managed lanes that allow people to move into a lane on a time-of-day basis or for some specific reason, and you can collect the fee off the tag.
And that's opening up a number of new projects for us throughout the U.S. We think we'll have mid-single-digit growth in the software businesses and continued strength in these RF-product businesses, so a great story.
Next slide. Here, we're looking at the medical and imaging business, sort of a tale of 2 different kinds of activity, but just amazing results.
Orders are up 52%. Organic orders were up 9%.
MHA contributed exactly what we expected, very strong cash flow, a wonderful leadership team, extremely motivated people. Substantial number of wins for Sunquest.
I mean, their building book for 2014 is really ahead of schedule. I will talk more about that here when we look at the fourth quarter.
We had double-digit growth in our image-guided surgical businesses, which includes Northern Digital and CIVCO. And the segment, because of imaging declining, was down about 5% in the quarter.
Medical was up in the high-single-digit range to offset that. So we wound up with 3% organic growth.
And of course, when we look at the overall business, revenue was up 40%, with the acquisitions' operating profit up 64% and OP margins now at 32.8% for the segment. In the fourth quarter, we expect MHA to contribute the same way as it has, and we think organic growth in medical will be sort of similar, mid digit -- mid-single-digit types of numbers on the product side.
Imaging end markets are going to continue to be challenging. We think they're going to be down 10% to 12% in the fourth quarter, but we'll be able to offset that with strength in medical.
Sunquest in the fourth quarter finally becomes organic. We didn't sort of split that as part of the quarter in the third quarter.
And that organic growth will help our measurement when we're talking about just organic growth. Very strong pipeline of opportunities in Sunquest.
We're going to enter the year with a substantial backlog around meaningful use and lab upgrades, which is driving demand. And the key for us will be our ability to execute with the implementation teams, and we're adding rapidly to those now.
Next slide. Here, we get to the guidance update.
Next slide. If you look at the numbers, what we've tried to do is sort of segregate this little T-account for you so that you can see what's changed on the left-hand side, what remains the same about the company and what the effect of that is.
Our operating cash flow, we maintained at -- saying we're going to reaffirm we'll do over $800 million in operating cash flow despite reduction in the Q4 DEPS guidance. Our DEPS, we came in at $5.57 to $5.63 versus $5.72 to $5.86 in the past.
Q4 adjusted DEPS then are $1.57 to $1.63, and we've already earned $4 year-to-date, I believe. So what's changed?
Well, the Zetec nuclear business is going to be down 40%, maybe worse, in the second half. We had expected that maybe, over the second half period, we could have a $10 million headwind.
But year-over-year, we're going to be down $20 million in Zetec, which was certainly not anything we ever imagined. Now the good thing about Zetec is that, from time to time, it's lumpy.
And if you're off a lot, there is a permanent reduction in some aspects of it because of the closedown of 3 different reactors. But that said, they've got to test the stuff, and we're going to get that business.
So it will help us next year. Oil and gas drilling activity, we think, is going to continue to be weaker than expected in the fourth quarter.
That's been kind of a double-digit millions, more than $10 million headwind in the third quarter and still more than a $10 million headwind in the fourth quarter. But we're still, in both the third quarter and the fourth quarter, above last year's actual.
So it's really been more a reduction in our different businesses expectations about delivery, and it's all delayed -- it's all around the upstream, nothing in the midstream or downstream is negative. Modest changes in the other end markets, mostly imaging, which is another headwind, as we said, down 10% to 12% perhaps.
I guess the truth of that is that you are seeing some sequestration effect around that. Those businesses tend to be a little lower margin, so don't have as big an effect.
That said, we think that fourth quarter organic growth will come in around 3% to 4%, and that's down from the 6% to 9% we had hoped for in the fourth quarter previously. But the reality is what it is, and we have to recognize that.
So what remains the same about the company? Well, most of the great things that we do.
Organic growth will continue to improve throughout the year. In the first quarter, we reported negative 3% organic growth and then second, up 1%.
In the third now, we're up 3%, and in the fourth quarter, we expect to do better on organic growth than we did in the third. And that sort of bodes well for 2014.
We've got key areas that are delivering organic growth continually, whether that's medical, it's toll and traffic, it's the water meter business and the systems around collecting data for the water meters and the midstream and downstream oil and gas and all of the software businesses. So those all are in fine shape and will do quite well.
We've got this exceptional margin performance, with increasing leverage. I think probably something that hasn't gotten enough attention, which is our fault, our gross margins in the third quarter in 2011 were 53.7%.
Our gross margins today are 58.7%, a 500-basis-point improvement in gross margin. And what that does for variable revenue and leverage is quite outstanding.
Our cash flow is still going to be $800 million, as we said, and our disciplined deployment around cash, which we've demonstrated with both MHA and Sunquest, at a time when other people are saying it's tough to do deals. We got a lot of opportunities in our pipeline.
We remain excited about what's going on in our M&A front. Next slide.
So if we look at a summary of the quarter, we hate the fact that we had to lower DEPS guidance in the fourth quarter, but it doesn't mask the record Q3 results and the great setup we have for 2014. We achieved record third quarter results, and these weren't just, well, we beat by $1, these were substantial improvements in orders, backlog, revenue, net earnings, EBITDA and cash flow.
Orders, remember, we're up 18%, 7% of which was organic; revenue up 11%; and backlog at $1 billion; gross margins at 58.7%; EBITDA margins at 33.2%; and a $278 million contribution of EBITDA. DEPS up 15%, but operating cash flow up 25%.
And our year-to-date conversion on operating cash flows, 156%. Free cash flow was up 24% to $244 million, and our year-to-date free cash flow conversion is 143%.
So with that, we'd like to open it up for questions.
Operator
[Operator Instructions] We'll go first to Matt Summerville of KeyBanc.
Matt J. Summerville - KeyBanc Capital Markets Inc., Research Division
Just to put this Zetec thing to bed a bit, Brian. If you look at the $0.19 reduction in EPS guidance at the midpoint, how much of that $0.19 is being driven by Zetec?
Brian D. Jellison
Well, it's quite a bit. I mean, in the second half of the year, it's going to be off at least $15 million.
And so you have to use whatever assumption about its contribution would be. So it's not hard to see how it could be down $8 million or $10 million at least, and tax, it could be worse than that.
So it's a significant -- it's the single biggest portion of what's going on, and then you got kind of a nut on the upstream oil and gas, which is -- caught us offguard, I'd say.
Matt J. Summerville - KeyBanc Capital Markets Inc., Research Division
With regards to drilling activity, I mean, it hasn't been super robust for a while. However, you had launched some new products in the market at Roper Pump.
There was a pretty attractive market share story going on there. Is that still true in that regard?
Have you anniversary-ed that launch and now you're seeing more of a broader market impact? Is that what's going on here?
Brian D. Jellison
No. That's a great question.
The new product is called DuraTorque. It's doing very well.
It's more around the directional drilling. It has a lot of different things, whether it's a mixture of wet product or dry product or gas only.
It's a certain kind of thing, but our coiled tubing product, which much more is gas-oriented, is what didn't meet our expectations. We actually were up.
We had year-over-year improvement. It's just that we had expected substantially more.
Now the new product is doing well on certain sizes, and we're opening a new facility in Texas, which -- I mean, it's actually sort of open now, but it's all getting geared up. That will allow us to sell larger sizes.
That's not yet in production, won't get in production until the first quarter of next year. So that's a positive, the -- as we gain market share with that technology in the larger sizes, but we can't produce those in Commerce.
They're physically too large for our equipment.
Matt J. Summerville - KeyBanc Capital Markets Inc., Research Division
And then just lastly, what do you think has to happen in the marketplace for you to start to see a turn in your imaging business, as this has continued to cycled down?
Brian D. Jellison
I'm looking at John. It's cycling down, but it's still -- it's better than anybody else's.
It has high gross margins. It's contributing positive cash.
Parts of it are really pretty good. I just don't think that the camera portion of what it is we do is a secular growth story.
It requires government investment and research spending. We're in a period where that's under high scrutiny, and so there's not a lot of end-market-derived demand.
There's nothing you can do to push elasticity in demand for cameras. People have to have grant money available.
When they do, we get a disproportionate share of that. But if you look at any of the other people in these spaces, there aren't very many, it's kind of an oligopoly, you'll see they're all doing very poorly.
Operator
We'll go next to Joe Ritchie of Goldman Sachs.
Joseph Ritchie - Goldman Sachs Group Inc., Research Division
Brian, thanks for the color on the variance on 4Q. I just want to dive in to Zetec a little bit.
Last quarter, you mentioned that there were -- I believe, you mentioned 4 nuclear plants that weren't going to come back. And so I'm trying to understand what the big variance was relative to your expectations for this quarter.
So perhaps maybe we can start there, if you could provide a little bit more color.
Brian D. Jellison
Well, I think that people had certain expectations around various things. The San Onofre thing was a big variable that we sort of understood, and had factored that into the guidance.
But these other things that have happened and not doing testing in the third quarter, fourth quarter, rolling it into 2014, was not expected. We also do a big business in Korea with that, and they've had some political issues over there with information reporting.
And so the normalized business we would have expected there didn't occur. There -- it's just been sort of a dark period, if you will, in the second half.
Our people in that business, I mean, we -- in our quarterly review, they detailed a bridge down to $100,000 of variance from a walk last year. So it's one of the things -- they tell you exactly what didn't work and in terms of why, and they would say, "Well, it's just external things we have no control over, and we'll get most of it back next year."
But it certainly -- it's not a growth business. It's more of a cash cow.
But next year, because of this ridiculous collapse of its revenue in 2013, it will be a temporary growth business.
Joseph Ritchie - Goldman Sachs Group Inc., Research Division
So is this something that then continues to bleed into the first half of next year because, really, the problem started surfacing last quarter?
Brian D. Jellison
Well, it's not expected to at all. It's expected that these things that are not happening in the second half would begin to happen again, favorably, in the first half, although I don't think they know what the detailed schedules are.
We took quite a few people out of this business, I think like 24 or something like that, and didn't comment on that in terms of the cost to take them out. But that's about as much as you could do without eating into people that are really field service engineering people and guys that work on the algorithms and analysis for everybody.
But the cooling towers are still in operation, and there are mandatory checks and they'll happen. So it's certainly not a part of our growth strategy.
It's just been an unfortunate problem for us in the second half of the year.
Joseph Ritchie - Goldman Sachs Group Inc., Research Division
That's helpful. I think just switching gears a little bit into some of the tolling projects.
I think, last quarter, you mentioned that the Florida tag was moving into 4Q, could slip into 1Q. I missed your comments earlier.
Perhaps you can talk a little bit about that confidence that you have in Florida tag, specifically for 4Q. What's embedded into expectations?
Or has that slipped out into 1Q? And maybe some commentary around Virginia and Texas as well.
Brian D. Jellison
Well, we're going to have a terrific fourth quarter in toll and traffic. I mean, it's going to be very, very, very strong.
The dynamic for the second half of the year, though, was we've had some projects that we expected would start earlier in the third quarter than they did. And so third quarter was good, but could have been substantially better.
The ability of these agencies to deploy various things is kind of a fixed deployment. And so we'll have an exceptional fourth quarter, but that will then carry over into a very strong first half of the year for toll and traffic.
I mean, I think John's going to be comfortable to say toll and traffic is going to be up over 15%, maybe more, in the fourth quarter of this year. So there really aren't any problems there.
It's just a slower start than we expected.
Operator
We'll go next to Christopher Glynn of Oppenheimer.
Christopher Glynn - Oppenheimer & Co. Inc., Research Division
Just looking at the RF and how the backlog and quotation activity is maybe setting up for the 2014 top line. If you could comment on that.
And is there any sense that 2014 could be pretty front-end loaded in terms of the full year expectation?
Brian D. Jellison
Oh, I wouldn't say -- I mean, we're not going to give you a lot of guidance around '14, but we're going to feel pretty good about it. So John, why don't you...
John Humphrey
Yes. And the projects that we have going on that, of course, started to revenue in the third quarter but really ramp-up a little bit more in the fourth, which is Virginia, as well as the Houston project, where we're replacing an awful lot of lane equipment with some of our proprietary lane equipment, in addition to the continuing Florida tag upgrade project.
Those things started to ramp in Q3. They kind of reach a steady-state level in Q4.
We expect that steady-state level to continue into Q1. And then we'll just -- I vow[ph] that they'll all have various times when they start to complete, but I don't think any of those projects will be completed even in the first quarter of next year.
Christopher Glynn - Oppenheimer & Co. Inc., Research Division
Okay. And then a big-picture question on operating margins for you guys.
They're very high, obviously, across the segments. And just wondering if you could comment, what are the drivers from here in terms of mix, volume, leverage, et cetera.
If you can kind of tackle that question on a segment-by-segment basis.
John Humphrey
Sure. So I think the place to look for insight into that is what the gross margin is for each of the 4 segments.
So I think if you look at our medical and imaging segment, where our gross margin has now reached 70%, I think it's fair to say that every incremental dollar of revenue there means more than it does, say, in our industrial business. We love our industrial businesses, but we have gross margins there that are right at 50%.
So you have a different level of contribution that's going to come from growth in our core medical area. And also, once you start to look over at RF, where our gross margins are also pretty high, largely as a result of our SaaS and software businesses.
So in those areas where we have outsized growth, software, medical, MHA and Sunquest and things like that, then that -- I mean, that should convert at probably 50%, or maybe even a little more. In those areas like industrial and our core energy businesses, those things are probably closer into the 35% range.
And so I think as you start to see us continue to build in some of those areas, I think you'll see the incremental leverage associated with that, and that's really what's going to drive the operating profit improvement as we go forward.
Operator
We'll go next Deane Dray of Citi Research.
Deane M. Dray - Citigroup Inc, Research Division
Brian, back in September, you were describing the M&A environment and specifically, pricing of assets. I think the word you were using was horrendous.
Maybe give us an update on the pipeline. And as your leverage comes down now well below your normalized leverage rates, do you have a Plan B in terms of capital allocation or you just want to keep all the gunpowder dry?
Brian D. Jellison
Oh, no. I mean, we're always involved in something.
I would say that the pricing and seller expectations are as horrendous as they were before, which is why you're seeing a lot of things not getting done out in the marketplace. I mean, we're fortunate to continue to find things that we think are great additions to the family, and we can do that by offering people opportunities to be part of Roper in a way that works for them and still doesn't blow out pricing multiples.
Their -- the pipeline is really quite large. There are a lot of different things that we're -- it would be a rare moment that we're not looking at 3 or 4 things simultaneously.
And so I -- we don't have, like, a budgeted thing like, "Gee, you did a $1 billion deal in the first quarter. Are you're going do another one in the fourth quarter?"
It doesn't work like that. I mean, we do them when everything sort of aligns.
We like the management team, we like the core market, we think we can add some value to it, we think it's a cultural fit and we think the numbers work out over time. And we're definitely seeing things like that.
Now that said, when the debt staples are as enormous as they are, oftentimes 7x debt-to-EBITDA, it gets stapled to a transaction. And junk bond, kind of high yield, if you want to call it that, is still very low, so it drives up the multiples.
And that's as horrendous now as it was whenever I made that comment.
Deane M. Dray - Citigroup Inc, Research Division
Okay. And then I know this was a knit last quarter, but is the chapter closed on the Hansen refrigeration valve story?
John Humphrey
No, it's not. And so we continue to go through that process.
We've shipped out roughly half of the affected valves, but we have not received as many back. So that process, for the field and for our installation partners, is still continuing as far as them being out in the field and replacing those products.
But we're fully engaged on that. We expect to be about 90% completed with that part of the project by the end of the year.
And we're still in the process of discussing with the supplier, the -- any restitution. So we will call that out once anything like that happens.
As Brian mentioned back at the second quarter call, it's a pretty small company, not a lot of capital there. But we're still looking for the ability to offset some of this $9 million that we're having to spend in order to make sure our customers stay whole.
Operator
We'll go next to Richard Eastman of Robert W. Baird.
Richard C. Eastman - Robert W. Baird & Co. Incorporated, Research Division
Brian, could you just talk for a couple of minutes about both MHA and then also Sunquest? You had mentioned Sunquest's backlog pipeline was strong.
Does Sunquest now start to look like a mid-single-digit grower as it becomes core sales? And then the follow-up question to that is, if you look at those 2 acquisitions, MHA and Sunquest, if I make some estimates as to what their contribution margin in the quarter was, does the core business in med scientific, did they make progress on their margins or they slipped a little bit?
John Humphrey
So I'll address at least the first one of those, talking a little bit about our expectations for Sunquest. They've built, I mean, just a tremendous backlog with not only upgrades but also new facilities, so new badges as well, particularly as hospitals are continuing to comply with meaningful use regulations in order to be able to drive additional revenue into the hospital system.
One of the ways that they can do that is better utilization of information, and MHA -- and Sunquest allows them to do that. So that's quite a bit of the backlog that we've been able to build there, and we expect that to start to deliver.
It's already started deliver, but continue to ramp up deliveries against that in 2014, even in 2015. So I think -- I mean, you mentioned the mid-single-digit growth area.
I would definitely expect that, and we would actually hope for a little bit more than that. And as we look forward -- so even if you exclude the contributions of both MHA and Sunquest, we did have margin expansion across the company.
We had good incremental leverage on our -- on the 3% growth. Of course, it was 3% growth, so that incremental leverage works out to be, I think, in the mid-30% range, if my recollection is correct.
Richard C. Eastman - Robert W. Baird & Co. Incorporated, Research Division
Okay. So the core in medical scientific, the incrementals is still kind of mid-30s there despite the weakness on the imaging side?
John Humphrey
Yes, that's correct. That's correct.
It's really because -- actually, because -- even if you exclude the contributions of MHA and Sunquest, so talking specifically just for that segment, we still had net organic growth there, largely driven by our image-guided medical products.
Richard C. Eastman - Robert W. Baird & Co. Incorporated, Research Division
Okay. And then just a real quick question.
This Advanced Sensors business that you acquired, could you just give an approximate revenue size for that?
Brian D. Jellison
Well, it's really a new technology. So it's -- I mean, they have an expectation that they would be in excess of $10 million, but it could be really substantially better than that.
They have a very substantial ramp that they think they'll get, and we'd like to believe they're right. But it's a [indiscernible] margin business.
And they really do have a proprietary technology that when you see it, it's remarkable because, today, the way people get information at the wellhead or on the platform is archaic. And you could be sitting somewhere else and getting this information feed basically through a very different type of access technology.
And it's where -- I mean people kind of see it and don't believe it. It was introduced in the second half of this year at a trade show, and they are under siege for people wanting to buy the product, which was one of the reasons that we were able to come in and acquire the company, because it requires some investment and has very interesting forward prospects.
Operator
We'll go next to Mark Douglass of Longbow Research.
Mark Douglass - Longbow Research LLC
Brian, as we think about the risk to organic growth, not only in fourth quarter, but also looking to '14. Guidance taken down a couple of times.
35% organic growth guide earlier this year, not going to hit it. Obviously, Zetec is a big part of that, oil and gas.
Are there other parts of your business where you're just lacking real strong confidence that things are going to turn? Or can you just talk about other risks in other businesses?
Brian D. Jellison
Well, in the fourth quarter, it's really driven quite substantially by these 3 things: the sort of almost freeze on nuclear activity, and then the upstream oil and gas, and then the camera reductions. Those make up the lion's share of everything.
When you look about 2014, we're going to get solid growth out of all the RF businesses, we expect, and solid growth out of our existing medical product businesses and really, sort of everything in that capacity. Energy has had a somewhat disappointing year in 2013.
So it sets up for pretty easy comps in 2014. And then you have industrial, which will have capacity that we don't have today for higher-diameter DuraTorque products in Texas.
We think -- we've had 2 or 3 things this year that aren't going to repeat. So you ask this customer renewal situation, which was millions and millions of dollars, and you've got -- you're past the Zetec situation, which is millions of dollars.
So we're setup for comps in '14 better. Now we haven't gone through our planning with all the field people, but we're looking forward to a strong year.
Mark Douglass - Longbow Research LLC
Okay. But nothing -- I mean, any areas where you're just getting perpetually weaker without any of these big kind of onetime...
Brian D. Jellison
No, not at all. I think what you have is just you've got a pretty slow growth macro economy.
And so there are guys who are looking to grow at twice GDP. You're looking at a pretty lousy GDP base off of which to grow.
So if you get 3%, 3.5% GDP growth that some people think you'd get in '14, I mean, that's going to help some of those kind of businesses.
Operator
We'll go next to Steve Tusa of JPMorgan.
Charles Stephen Tusa - JP Morgan Chase & Co, Research Division
On that gross margin improvement, obviously, another great quarter there. Is there anything -- I know there's a mix dynamic because you've been buying stuff that's a little more high gross margin.
What would you point to as kind of the 1 to 2 things that you're doing there? Is it mix?
Is it -- it's kind of hard to -- for us to reach in and analyze that gross margin. It's just so strong that maybe if you could talk about a couple of the big drivers there over the long -- over the last couple of years.
Brian D. Jellison
Well, I think there's 2 different things, right? So the kind of things we've been acquiring have been high-margin businesses.
Many of them get paid in advance for what they do, which drives so much of the positive you see here around cash. The other businesses have sort of focused on different kinds of disciplines around our market share and customer profitability.
So they work very hard on making sure they're serving customers that make sense for them to serve, and not wasting time selling to people that are high maintenance and low margin. Our guys have a very disciplined approach around product development, and when they're looking at their product roadmaps, they're looking at ways to have contributions from the new products that are higher than contributions they had from the old products.
So that continues to sort of anniversary beneficially to us. Now when you move 500 basis points up in 2 years, from the 53.7% to 58.7%, certainly, some of that is due to Sunquest and due to MHA a little bit in the third quarter.
But pretty much everybody has improving gross margins.
Charles Stephen Tusa - JP Morgan Chase & Co, Research Division
Right, right, yes. No, it's definitely pretty broad-based when you look back over the last couple of years.
There's not really 1 segment that's carrying you there. On the leverage, is there a target where you would get more aggressive?
Or are you pretty comfortable here deploying capital at 2.5x -- I think it's gross -- 2.5x gross?
Brian D. Jellison
Yes. I think we've said 2.5x, but 2.5x to 3x because we have so much cash.
It really assembles so quickly for us. We wouldn't have any problem being at 3x or slightly above 3x for a temporary period, if we had a clear pathway to reduce it back.
But from a sort of planning or modeling viewpoint, we'd like to think we're more like 2.5x debt-to-EBITDA on a gross basis. But we're not uncomfortable at a little over 3x as long as it doesn't stay there.
Operator
We'll go next John Quealy of Canaccord.
Chip Moore - Canaccord Genuity, Research Division
It's Chip Moore for John. On Zetec, it sounds like you have pretty good visibility on things coming back next year.
Can you just talk a little bit about historical precedents, if you've ever seen delays like this?
John Humphrey
Not to this magnitude, no, where you have both a little bit of an impact from plant shutdowns and actually mothballing some nuclear facilities, in addition to what is a little more normal for Zetec, which is lumpiness. So quarter-to-quarter, lumpiness for Zetec is not a surprise.
What we're seeing here in the second half is more than what we've seen in the past. So when you talk about visibility, it's one of those things that when I look 12 months out and look at what's going to happen over a 12-month period, there's actually better visibilty than looking out over a 3-month period, just because some of these things can be pushed or delayed, but they can't be eliminated, right?
You still have to -- I mean, there are still regulations around shutting down and testing the cooling tower and the tubes and the other parts of the process. So that part can't be eliminated, but it can be postponed sometimes.
And so that part is not unusual, but what we're seeing this time is unusual.
Chip Moore - Canaccord Genuity, Research Division
Okay, that's helpful. And just a follow-up to that.
You've mentioned taking some costs out there as you look forward. Assuming it bounces back next year, what kind of benefit can that have?
Brian D. Jellison
It's a modest benefit. People are not that expensive.
It's 24 people times whatever, and some of them would be variable, you'd bring them back. So not material to anything Roper does.
John Humphrey
Right.
Operator
We'll take our next question from Alex Blanton of Clear Harbor Asset Management.
Alexander M. Blanton - Clear Harbor Asset Management, LLC
This is sort of a nonquantitative question. You've had a lot of those so far today.
But given the unusual nature of some of the problems that you've had here in the second half, I mean, you don't usually have misses in earnings estimates and guidance. How much of a distraction have these problems been, if any, to management in pursuing its acquisition program?
Because that seems to have slowed a bit at the same time as some of these problems cropped up. Has there been a problem or not?
Brian D. Jellison
Not a problem at all, and I'm not sure how you could say it slowed. I mean, we invested $1 billion this year in the MHA acquisition.
And that's...
Alexander M. Blanton - Clear Harbor Asset Management, LLC
Well, that's true, but I mean in the fourth quarter. In fourth quarter, we didn't see much.
Brian D. Jellison
Well, hold on. I mean, this is the most aggressive acquisition investment deployment policy in the history of the enterprise in the last 2 years, over $2.5 billion.
And we just announced the bolt-on now. So good Lord, what would you want in acquisitions.
So our capital deployment is just off the charts compared to anybody else.
Alexander M. Blanton - Clear Harbor Asset Management, LLC
Okay, okay. So you anticipate some good stuff coming in 2014, that I gather from that?
Brian D. Jellison
We always expect good stuff to come. I mean, we are going to deploy capital.
We have proven that for a long number of years, and we're going to continue to deploy capital in great opportunities.
Alexander M. Blanton - Clear Harbor Asset Management, LLC
And would you say that you've got the operating management in place to handle the problems you've had effectively and minimize them?
Brian D. Jellison
I do think that. I think that these are macro trends and upstream stuff that has nothing to do with the quality of the management that we have at Viatran and the diesel engine shutoff valve business and some of the core AMOT businesses and certainly, the coiled tubing aspect at Roper Pump or dewatering pumps or any of these things.
The underlying nature of those businesses is outstanding. You can see it by the sustained operating profit margin they have and their product roadmap.
So I think that's fine. And any acquisitions we do, frankly, come with quality management teams.
So assimilating them isn't very risky. So I think we're -- I mean, I could tell you that we have the best leadership group here at Roper right now that we've ever had, and it's stronger today than it was 5 years ago.
So I don't think it has anything to do with sort of taking your eye off of anything. It's really the incredible negative reaction to people who were going to bring up nuclear power plants, who aren't the people who are mothballing them, and the big falloff in gas activity and sort of modest falloff in rig counts.
Operator
That will end our question-and-answer session for this call. We will now return back to John Humphrey for any closing remarks.
John Humphrey
Thank you, Alicia, and I thank all of you for joining us today. And we look forward to talking to you again in 3 months, when we finish up the fourth quarter.
Operator
That does conclude today's conference. We thank you for your participation.