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Executives

B. Jellison - Chairman, Chief Executive Officer, President and Member of Executive Committee

John Humphrey - Chief Financial Officer and Vice President

Analysts

Richard Eastman - Robert W. Baird & Co. Incorporated

Terry Darling - Goldman Sachs Group Inc.

Alexander Blanton - Clear Harbor Asset Management, LLC

Wendy Caplan - SunTrust Robinson Humphrey, Inc.

Matt Summerville - KeyBanc Capital Markets Inc.

Jeffrey Sprague - Citigroup

D. Mark Douglass - Longbow Research LLC

Christopher Glynn - Oppenheimer & Co. Inc.

Deane Dray - Citigroup Inc

Roper Industries (ROP) Q2 2011 Earnings Call July 25, 2011 8:30 AM ET

Operator

The Roper Industries Second Quarter 2011 Financial Results Conference Call will now begin. This call is being recorded. I'll now turn the call over to Mr. John Humphrey, Chief Financial Officer. Please go ahead.

John Humphrey

Thank you, Jennifer, and thank you all for joining us this morning as we discuss the results of our second quarter. Joining me this morning is Brian Jellison, Chairman, President and Chief Executive Officer; and Paul Soni, Vice President and Controller.

Earlier this morning, we issued a press release announcing our financial results. The press release also includes a replay information for today's call. We've 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 turn to Slide 2, we'd 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 in our SEC filings. You should listen to today's call in the context of that information as well as the filings.

And now if you'll please turn to Slide 3. I'll turn the call over to Brian Jellison, Chairman, President and Chief Executive Officer. After his prepared remarks, we'll take questions from our participants. Brian?

B. Jellison

Thanks, John, and good morning, everybody. Let me start here with the Slide 3 on my deck. We'll go through the second quarter financial results for the enterprise as a whole and then we'll dissect how the segments performed and what the outlook appears for each of the segment in the second half of the year. We'll talk about raising our guidance and then sort of summarize the quarter and its implications for the future and take your questions.

Next slide. The Q2 financial results here are really a spectacular quarter for us. We achieved a series of all-time company historical results around orders and sales and backlog and operating cash flow. And then in the quarter, our net earnings, EBITDA and free cash flow were outstanding.

Total sales for the quarter were up 23% and 16% of that was organic. We enjoyed again double-digit sales growth in each one of the 4 segments, which frankly was a little bit better than we expected going into the quarter. Our book-to-bill ratio is still above 1 for the eighth straight quarter, so that's resulting in continuing backlog. We've got record backlog at the end of the second quarter of $872 million, which is up $230 million from last year's second quarter.

Gross margins were very solid in the quarter. They hit 53.9%. And our EBITDA margins, when you exclude this remeasurement gain, which is required to be included here on a GAAP basis, but we've excluded it for looking at our leverage. So the EBITDA margin was up 280 basis points to 28.5%. Without that remeasurement gain, of course, if we left it, the margin would even be better.

NDI's acquisition was completed in the quarter. That's off to a good start. We've already begun the financial integration and had some marketplace meetings with our various people in medical and looked actually at some other acquisitions in that area with them. And then we were pleased to see the Moody's upgrade that we received in the quarter on all of our debt structure to Baa2.

Next slide. On the income statement, there's just not much to say about this, except we achieved another amazingly great quarter. Bookings, you can see book-to-bill at $708 million, it's 1.01 up, our eighth straight quarter. Net sales were $700 million in the quarter. First time we've done that. 23% increase. Gross profit up 70 basis points. Operating income was up 240 basis points from 21%. Second quarter of last year to 23.4% here. Our interest expense was flat. Tax rate in the quarter was actually headwind for us. We came in at 31.4% in Q2 this year versus 29.6% last year and that cost us a couple of pennies. Net earnings again, that's asterisked to show the net earnings number without the foreign currency remeasurement gain in the quarter. It was up 43%. And the diluted earnings per share, $1.03 versus $0.74. On a GAAP basis, it had to be reported at $1.08.

Next slide. The free cash flow in Q2 got back to where we expect it -- we'd like to be. We had terrific, terrific results, 21% of sales. Free cash flow was up 41% over the same quarter a year ago with a move up from $103 million to $145 million.

Next slide. If you look at the asset velocity performance in the quarter, it's one of the things I know everybody's very happy with inside the company. Despite having a 23% gain in revenue, actually inventory as a function of revenue improved by 10 basis points. So inventory last year was 7.6% of sales. Here, we are up 23% and inventory has dropped to 7.5% of sales. So we're very pleased with our results. Payable is about 5.5% with inventory at 7.5%. We're not having to invest very much to continue to maintain our growth, which is great news.

Next slide. If we look at the balance sheet of the company, we can honestly say the balance sheet's never been in better shape. We ended the quarter with $196 million in cash and that's after acquiring Northern Digital for $200 million, by the way. Our available liquidity, including the undrawn revolver at the end of quarter was $753 million, but it'll continue to move up here as we add cash rapidly now. That gives us a net debt of $1,050,000,000. And our net debt-to-net cap, you can see as 26%. We reported here debt-to-EBITDA, meaning gross debt-to-EBITDA because not all of that $196 million is immediately available without repatriation. So the gross debt-to-EBITDA number is 1.7x. If you look at the net debt, which includes all the cash, it drops that ratio to 1.4. Our EBITDA-to-interest expense coverage is about 11x. And despite investing $725 million in the last 12 months, we're really in wonderful shape going forward. And by the way, our trailing EBITDA now on a 12-month basis is up to $739 million. So as the trailing EBITDA grows rapidly, and you look at the debt situation being held constant, the balance sheet gets better and better.

Next slide. Now we want to take a look at the individual performance of the 4 segments and what we think they'll look like in the second half. Next slide. Here we're looking at the sort of consolidated segment-by-segment approach on gross margins and EBITDA in the quarter. Everybody at 50% or higher. The industrial EBITDA margins again are just breathtaking at 31%. Just terrific results in the quarter, including handling a portion of our industrial businesses that we'll talk more about.

Next slide. We start with RF Technology with the largest portion of reported sales in the quarter at 31% of revenue. You can see orders for RF were up 13%, sales were up 26% and operating margin was up 410 basis points to 24.1%. EBITDA in the quarter for RF, by the way, was 31% as we have a good deal of amortization in RF.

The second quarter, we wound up with organic sales of 13%. We had particularly strong growth in the U.K. with our water network monitoring products from Technolog and continued growth in Gaz de France installation project with Technolog in France. We had very strong double-digit sales increases out of CBORD, which was driven by deployments business we won earlier out of college and university environments, and that portion of the business is continuing to do really quite well despite what some people might think.

Very strong North American tag sales for transport throughout the second quarter. And then if we look to the second half of the year, we're going to have continued growth in both toll and traffic operations with more tags shipments out of TransCore, but also several traffic projects that we're putting in, in the United States. And then we have a significant expansion of electronic tolling in Puerto Rico where we're going to be converting from coin-operated technologies to electronic collection.

CBORD's backlog is very strong, so it's assuring ourselves a double-digit growth throughout the rest of this half of the year and very strong Q3 cash. And iTrade is continuing to do well. We've been encouraging them and investing in them to focus really on their core business on a global basis and that is going well, although we have to continue to beef up the nimbleness of our operations in Europe, which we're doing.

Next slide. In industrial technology, you can see we had again a spectacular performance. Orders were up 15%, sales up 26%, operating margin increased 160 basis points to 28.2%. EBITDA was 31% for them as well. We had exceptional growth in all of our pump and water fluid handling businesses, largely driven by oil and gas and irrigation projects. Our materials are used in all the shale activity that you see and we're doing a lot of dewatering and we're doing a lot of drilling support mechanisms for those projects. We have very strong demands for our material test business in Denmark and then we had double-digit growth again at Neptune, which was kind of, I wouldn't say a surprise, but it was pleasant to see because all of the indicators around those businesses would be less than exciting.

The next generation residential water meter that we developed at Neptune that some people have seen has been introduced and it's beginning to ship. It has a lower raw material content than our previous water meter had for residential applications, and it's a very easy product to install and incorporate our reading technology. Neptune already meets the 2014 federal lead-free standard associated with the Safe Water Drinking Act. I think this is something that's not talked about enough in the marketplace around just how important and critical that'll be. And we would encourage our investors to go online on YouTube, you'll see at www.shedthelead.com/video/. You'll see a 4 to 4.5 minute thing we put together basically for municipalities to help them try to understand what's going on and while there was this one standard, now there's another standard that has to be lead free. Neptune is the only really producer of lead-free water meters here in the United States. Quite a significant development for us. It's something that we've been working on throughout the last 10 years and feel that it's going to get widespread market acceptance going forward.

In the second half of the year, we expect Neptune's momentum to continue, which we would think will do at least as well on revenue in the second half of the year there as we did in the first half, even though in the third quarter, for Neptune, we have extremely difficult comp because last year we had a blowout favorable third quarter.

Our order trends and backlog continue to support all of our fluid handling businesses. They -- whether it's Roper or Cornell or Abel or Hansen, any of these are all doing just spectacularly well. New product introductions and a strong Q4 seasonality, we think, will continue to drive or stir us in Logitech [indiscernible] businesses also in the fourth quarter.

Next slide. When we look at the energy systems and controls business, here you can see orders up 19%, sales up 22%. The operating margin here was 25.9%, which is up 150 basis points. EBITDA came into the quarter at 29%. In the quarter, virtually all of our end markets were very strong. The diesel engine safety systems that we continue to advertise and push into the marketplace have had continuing growth in their adoption rate with the diesel engine manufacturers. They're going to reach record levels here in this third quarter coming up. The refining and petrochem market is doing much better for us again. Instruments sales have taken off. And then when we look at the sort of global industrial production and capacity utilization around the latex and tire manufacturing and analytics that we do in the rubber industry, those all are doing exceptionally well. And perhaps most importantly, we haven't seen any sign of any slowdown in that business, which, along with material test, have been the kind of 2 leading indicators for us about if there's any softness anywhere. And they both continue to grow.

In the second half of 2011, we've got a very strong backlog in energy, which assures our Q3 growth and all the indicators, which suggest a seasonally strong Q4 which is usually our best quarter in that segment.

The control systems business activity certainly should drive our second half record performance here. That activity and backlog has grown at a very fast pace, and shipments ought to start to manifest themselves here in the second half. And we expect continued margin expansion with great leverage throughout the segment in the second half of the year.

Next slide. The medical and scientific imaging segment, you can see was up 11% on orders and up 18% on revenue. Operating margin was up 180 basis points to 23.4%. There's quite a bit of noncash amortization here, so EBITDA was 29%. If you look at the medical in the second quarter, pretty much across the line performed very well. We've got faster adoption rates again in BladderScan and GlideScope. We think -- GlideScope is the intubation product. BladderScan is the product that helps avoid catheterization in the hospital, and that has taken off again this year. Very strong ultrasound consumables sales for CIVCO. Northern Digital, we completed that acquisition in the quarter. I will talk a little bit more about that in a second. And then our high-end products that we're driving for photonics that are really around our filters for Gatan and proprietary technology for Princeton are performing well as well.

In the second half of the year, if we look at the backlog that we go into, again we're kind of assured a very strong second half. We don't have to rely much on book and ship here. Continued strength throughout the medical platform. We've got the product introductions that Verathon has been working on with Velaport [ph], Heartscape and other products are basically on trend for where we want them to be for our 2012 launches. We think those products will carry our growth soundly into next year.

In Northern Digital, we'll add a little bit of income growth in the second half of the year. It's accretive nominally, maybe $0.01 in Q3 and then stronger in Q4 with $0.03 or so. That acquisition we thought we'd kind of introduce the product to you since we have that chance today and so the next slide here is really a detailed explanation about what Northern Digital does and I've asked John to explain that to you.

John Humphrey

Sure. Thanks, Brian. The Northern Digital acquisition that really adds to our growing medical platform using both sensors as well as cameras is the leading provider for both optical and electromagnetic tracking systems and in minimally invasive surgery where you really had to have very precise application of treatment in a nonline-of-sight situation. You really need to know exactly where the treatment is being applied. And Northern Digital provides the technology and the systems that allow the doctor to be able to do that. And this is really going into a part of the medical market that is growing very quickly around image-guided and minimally invasive surgery. And it really has a couple of different parts to it. You can see it's about 90% medical, and it's about 60% systems and 40% consumables. The consumables are the spheres, these very high-tech optical spheres that really provide the 3D location information back to the doctor. It's a unique and patented technology. It has asset-light business model as all of our acquisitions do. Really comes with a very strong and experienced management team led by Jamie Frazier. And it's once again a very nice addition to our growing medical platform and really in the image-guided part of our medical platform. You'll hear us talk about ultrasound applications with Verathon, ultrasound type of applications with CIVCO. This is another situation where the image-guided surgery is building on that ultrasound technology. So it's a very nice addition for us.

And with that, I'll turn it back over to Brian to talk about the new guidance for the year.

B. Jellison

Thanks, John. We turn that page. So we're raising guidance, most importantly, on our cash flow. We now think that operating cash flow should exceed $575 million for the full year. Our full year DEPS number now is going to be $4.20 to $4.30, which includes the GAAP $0.05 from Q2, and that's up from $3.97 to $4.12 last quarter. In the third quarter, we expect to earn between $1.05 and a $1.09, which is up about 25% from the $0.87 that we earned in the third quarter last year. And I'd remind you actually that third quarter last year was an exceptionally strong quarter. So we think that's quite good performance around the guidance going forward given the strength of last year's third quarter.

Next slide. If we look at how Q2 then shapes up in terms of a summary, we wound up with all-time historical quarter performance for any quarter in our history, even better than the fourth quarter of last year for order sales, backlog and operating cash flow. The very broad-based momentum throughout the enterprise, we have a number of small niche P&Ls and almost all of them are up. Total sales growth at 23%, the gross margin up 70 basis points. Operating margin, where you can really see the leverage, was up 240 basis points. So on the incremental, operating margin against the incremental sales, our leverage in the quarter was 34%. EBITDA, because of the noncash amortization that hits the OP margin, EBITDA was up higher at 280 basis points to 28.5% and that excludes the remeasurement gain. Of course, if we kept that in there under GAAP we'd have even higher leverage. So the leverage on EBITDA was 40% of the new revenue.

Record backlog ended the quarter at $872 million. We raised the guidance to $4.20 to $4.30. And I think most importantly, when you see what's happening here is that our niche business focus continues to deliver these outstanding results. When so many people concentrate on what are you going to do about the BRICS? What are you doing about that? What are you doing this? Our sales into the BRICS were about 5% of revenue in the second quarter this year and they were about 5% of revenue in the second quarter last year, maybe a little less. So that's helpful, but that's not what's absolutely required for us to continue to grow. It was another just terrific quarter and we're positioned of course for a record year.

And with that, I think we can open up to Q&A.

Question-and-Answer Session

Operator

[Operator Instructions] Our first question comes from Jeffrey Sprague with Vertical Investment Research.

Jeffrey Sprague - Citigroup

Brian, I'm wondering if you could give us a little more color on the tag and traffic opportunities that you're referring to in the second quarter. Obviously, there's some municipal secrecy around it. We understand that, but if there's some additional color you could give us there, would be helpful.

B. Jellison

No, we just -- we continue to migrate people to smaller and easier to apply sticker tags and those tend to replace the hard case tag technologies at a relatively fast pace. So this is more growth in our core markets: Texas, Oklahoma, Florida. We have the benefit of North Carolina rolling out in second half of the year. And then we'll have some international development in the Middle East that will improve shipments. So all those things help. So I think one thing that has really been sort of encouraging, it's counterintuitive to how we would think about municipal spending is that we've got a number of design projects that we're doing, some in the Far West, an important one that we just won around Pennsylvania on a conversion project. So our traffic business is actually doing pretty well. And I think we probably commented in here relative to -- we would have expected it to be a headwind. And it's been certainly neutral to modest upside for us.

Jeffrey Sprague - Citigroup

Great. And just for John. John, you gave us the organic for RF. Could you give us just kind of high-level kind of the organic level? The organic sales reach of the other segments?

John Humphrey

Sure. Yes, I can do that. The organic growth by segment for industrial technology was 23%. For the medical and imaging, it was 12%. For RF Technology, it was 13% and for our energy systems and controls it's 18%.

Operator

We'll hear next from Deane Dray of Citi.

Deane Dray - Citigroup Inc

I want to follow up in the RF segment with a couple questions, the first on CBORD. It was interesting that you're recognizing higher sales for the college and universities. It was my sense that maybe it's the timing of when you actually do the installations during the summer months. So maybe it's a revenue recognition on these orders, but is the understanding that you're doing most of the deployments during the summer months?

John Humphrey

Deane, it is true that we do most of the deployments during the summer months. However, because of the software recognition rules that we have and the fact that we really sell the software on a 1-year license basis, we actually defer that revenue over a 12-month period. So there's a little bit of benefit during the installation phase associated with the products. But by and large, CBORD is a software business. It accounts for well over 2/3 of their revenue is software and naturally spread ratably over the year. So the growth that we're seeing there is not because of installations. It's because of new wins and the continued deployment of software into other areas like security application in a campus environment.

Deane Dray - Citigroup Inc

Great, that's helpful. And then On CBORD, one of the comps was Blackboard and I was hoping Brian could comment on the sale into private equity of Blackboard. I mean, obviously, there's a validation of the value of CBORD, but are there any other implications?

John Humphrey

Well, I think it validates that not everybody has picked up on how valuable all of our software-as-a-service solution businesses are. I mean, these businesses in public markets routinely trade at 20x to 25x enterprise by EBITDA. And the last time I looked, we weren't quite there yet in our multiple. So we just encourage people to realize how important these businesses are and how valuable they are. Eventually, I think maybe somebody will catch up to us on that. So we see a lot of upside for recognition on what we're doing and how we're doing it.

Deane Dray - Citigroup Inc

And then just a last one for me on iTrade. Hopefully, you could comment on or expand your comments. Two things you said interesting. One is that you wanted to see them keep to their core business and then also maybe clarify what you meant about being more nimble in Europe?

B. Jellison

Well, we won this major project in Europe. We -- I don't know if we're ever going to be able to say who it is until somebody figures that out. It's getting business -- it's like dealing with some of our favorite customers here in the U.S. who never want us to say anything. But it's a big deal and we have to improve our infrastructure there to do that. I think that we're learning that trying to do that out of our U.S. locations is a little bit difficult. So getting global reach and the integration around the global reach is we're moving at a very fast pace and adding executive talent to help us in Europe in that respect. And we felt as we've been going through the business that some of the projects that people were looking at were a little less exciting, we felt, than getting the global growth out of the core business. So we've encouraged them to worry a little less about certain types of things and invest more in the things that they can really control and I think that, that'll produce really good results for us in 2012.

Operator

We'll hear next from Alex Blanton of Clear Harbor Asset Management.

Alexander Blanton - Clear Harbor Asset Management, LLC

Brian, listen, what are you going to do when the economy recovers? I mean...

B. Jellison

Well, we're a little excited about that ourselves. But the economy, to be fair, I mean the industrial business, that portion of the economy has recovered, and the energy business is certainly recovering even though it should be better in the second half.

Alexander Blanton - Clear Harbor Asset Management, LLC

Yes. You referred to the BRICS and 5% of sales being there. And yet there is -- for a lot of the products that you have, it seems to me there's tremendous opportunity there. I suggest that you don't have time to address those opportunities and because you're growing so rapidly elsewhere, because other companies are in the position of having to go to the BRICS in order to get any growth at all some of them. So you don't have that problem.

B. Jellison

I think that's the difference between having products that are really mature products and looking for geographic expansion with those mature products versus ourselves, which are primarily solution providers with a lot of application engineering and very few standard products. And so in order for us to -- let's take India, for instance, where our bid activity and channel development is expanding most rapidly. Again, our markets are pretty small, right? So it's pretty hard to make a major investment in India that might drive $10 million in growth for 3 of the pump companies. It's just not pragmatic and the things that we do are so application-specific that you probably got to have to rely on local distribution for what happens, and we're probably the most conservative people you'll meet on how we look at distribution channels and assuring that we're very comfortable with all the activity that create revenue in these countries.

Alexander Blanton - Clear Harbor Asset Management, LLC

Yes, I can see that. Are there any opportunities at all in China for you, do you think?

B. Jellison

Oh, absolutely. China's growing rather dramatically. And maybe John, you want to comment on the growth in China?

John Humphrey

Sure. In effect, China represents one of the BRIC countries. Obviously, China is the largest for us and we have a variety of things that we're doing there, both selling sort of our industrial products, whether it be our sensors and instruments for the plastic and latex businesses or our marine applications out of AMOT and valves there. And if they continue to adopt more safety standards, we look at that as a growing opportunity for some of our diesel engine safety systems as well as some of the compressed controllers. So we'll continue to be there. We have people on the ground there. We have direct sales force looking at applications there, but it's a growth area as are many other areas where our technology can be applied. It's not going to be the sole or even major driver for our growth going forward.

Alexander Blanton - Clear Harbor Asset Management, LLC

Okay, and one more thing. You mentioned that you have the only lead-free meter in the U.S., water meter.

B. Jellison

Yes.

Alexander Blanton - Clear Harbor Asset Management, LLC

How did that -- why aren't your competitors developing that? And also what about the world?

B. Jellison

Oh, we can't speak to the competitors. But I believe that those people who haven't yet figured out a source for a lead-free water meter will be doing so pretty quickly. Check out that shedthelead.com/video/ for 4.5 minutes. It's quite interesting and it's a nontechnical video. It's actually been made for municipal water companies. There's thousands of these in the country and for them to kind of understand the innuendo that's been occurring the last couple of years is a bit difficult. This is a very simple way of trying to get people to say, oh gee, now I get it.

Operator

We'll move next to Mark Douglass with Longbow Research.

D. Mark Douglass - Longbow Research LLC

Brian, you mentioned that shale projects in the U.S. driving a lot of at least the pump businesses and industrial tech. Is energy systems also seeing a net benefit from that activity? Has it been a material contributor to your end-market demand?

B. Jellison

Well, it's different in the 2 cases. In the case of Roper pump, it affects growing operations. In the case of Cornell, it's dewatering pumps. When you get to energy, it's more around our what we call a DESS [ph] business, which is -- are these control technologies to assure that the diesel engines shut off. And we continue to work both with OSHA here in the U.S. and various agencies around the world about the importance of these shutoff valves and the recognition continues to grow, and we've got the best mousetrap on this in the world. So that's helping us a lot. So certainly, any place you're going to have oil shale activity, we're going to get benefited in energy and real directly in our fluid handling business.

D. Mark Douglass - Longbow Research LLC

I've been looking at industrial tech, continues to impress on the operating margin line. Is 20% what you're thinking is kind of a sustainable level over the next cycle here or is another 100 bps or so available? If you think about you said that you're reducing the raw material content in your water meters, which obviously Neptune's a big portion of that segment, do you still see upside there? Are your recovering your costs from the copper spikes?

B. Jellison

Yes, I'd say that we've done a great job in managing through the cost increases in copper. I mean, I can remember when it used to be $0.74 a pound or something, and here it is at $4.39. And now, there's almost 2 pounds of copper in every meter, so it's a big deal when you got a product that maybe sells for $20 or something. So we would give them great credit for how they're performing. Now we continue to make a commitment that we're going to have lead-free water meters that are bronze-based technologies as opposed to some people who are looking at going to plastic, which we think is a long way from being a safe installation project for people. In the pump businesses, we generally have enough pricing power that if we've got cost-push inflation on materials side that we can pass that through and not mark it up, it's almost just a separate side matter of things. So it hasn't really hurt us in any event. I think we continue to get leverage as revenue goes up, so on the OP line you could see we got 34% leverage in the quarter. And in both industrial and energy, we don't have very much noncash amortization that's coming off of those. So that kind of 30%, 35% leverage, I think, continues with us. That ought to be a perpetual opportunity as long as revenue is expanding.

Operator

We'll hear next from Christopher Glynn of Oppenheimer.

Christopher Glynn - Oppenheimer & Co. Inc.

I had a question on CBORD. Wondering if you could update what you see as the public school opportunity and some rollout there or if that adoption really doesn't seem to be a current story?

B. Jellison

Well, we think about 2 different things maybe. I'm not sure we understand your question. CBORD is primarily focused on college and university environments, so it wouldn't matter whether that was a state school or a private institution. Horizon is focused on elementary education and K through 12, and there, most of that business is public business. It's really driven by nutrition management and by sorting out how much the free lunch program is going to be paid for individual people and the proof of that. And so Horizon has very large public institution contracts like Dallas, Philadelphia, Los Angeles, things like that and bids large contracts in that arena and then also does somewhat smaller domain places as well.

Christopher Glynn - Oppenheimer & Co. Inc.

Okay, thanks for the clarification. And just the second half tax rate built into the guidance?

John Humphrey

Second half tax rate, we're expecting to be in the range of 30%, bringing the full year to also in the range of 30%. So kind of through the first half we're at 30.4%. And then just timing related, we probably expect Q3 to be a little bit better than that, and Q4 we'll have to see.

Operator

We'll move next to Terry Darling with Goldman Sachs.

Terry Darling - Goldman Sachs Group Inc.

Hey, Brian, wonder if you'd talk about the M&A landscape from the perspective of the different platforms where you see maybe more activity relatively speaking? And then maybe you can remind us where this Software-as-a-Service, as a percentage of the total company, is today and where you see that going over the next 3 to 5 years?

B. Jellison

Well, let's say from a software -- we continue to see a lot of opportunities in what we call network technologies. And it's a very ironic thing about -- as we look at all of our businesses on a niche basis and we want to keep focused on a P&L basis and customer profitability basis, I think we do a great job in that arena. And as a result of their kind of customer intimacy, they don't lend themselves to forced synergies from a physical asset basis. So in our pump, we've got a great centrifugal pump company, we got a great piston pump company. You can't put those factories together, they fundamentally do different kind of things. In the network arena, that's actually not true. I mean it's very ironic, but in fact they're doing a lot of data storage, they've got a lot of things that are really quite similar in the back end of an enterprise that you can nimbly get a lot of synergies around. So it's absolutely positive to get cost synergies out of software network businesses that we can't get out of the industrial and energy businesses. So that makes them pretty attractive. And as long as these small network opportunities are available, we think it's an attractive place to invest. Now we're not trying to turn Roper into a single-use software network application company, so we believe our focus around that has been opportunistic. They generate more cash than the other businesses do and they require less assets and they virtually never have anything that depreciates, and their assets go home at night. And as long as you motivate them, you get a wonderful cash-on-cash return over a long period of time. Today, John, I don't know if you've provided much guidance around overall revenue, but that it's getting to be certainly a very significant portion of the RF business. At some point, we're going to split this out for you so that you'll see the tolling business completely separate from all the rest of the RF business. That's something I expect we would probably do for 2012, so that it's easier for everybody to see the variance in the 2 because you do have this terribly lumpy TransCore order input situation that's up terrifically in Q1 and down a little bit in Q2, but over the first half of the year it's double-digit growth. But it certainly makes it confusing. So we just have to do a few things to get that in place to be able to respond to your question clearly, which we'll do for next year.

Terry Darling - Goldman Sachs Group Inc.

Okay. And on the M&A landscape?

B. Jellison

Well, the M&A landscape, we think people that are doing public company deals continue to generally overpay for them. We've had a lot of stuff in the pipeline. I think that it's not necessarily that we're focused on the medical product arena and the network software arena, but that's what we're seeing more of than other assets. We haven't seen energy assets other than very small bolt-on type things that we think have been priced at a level that we'd be comfortable with. And the industrial asset arena, we continue to grow internally for the most part as opposed to looking at asset acquisitions. So I think that the next acquisitions you'll see from us are likely to be in network technology or additional medical build-out.

Terry Darling - Goldman Sachs Group Inc.

Okay. And then in terms of the second half guidance on just the organic side, it sounds like you're seeing or expecting a pretty similar rate, 3Q versus 4Q, but I want to make sure I cleanly translated some comments on a couple of segments in that context.

B. Jellison

We'll have better, but we would expect to have better growth in Q3 on a revenue basis than we would in Q4, and our guidance really would indicate that. So if markets were as good as they've been recently and trends continue, then maybe there'd be some upside in Q4. But our view is Q3 is going to be better than we would have originally expected. Q2 was better than we certainly expected. So both Q3 and 4 are very difficult comps. We had just a blowout in the fourth quarter last year it's going to be tough to do substantially better than that. But we've had other tough challenges, too.

Operator

We'll move next to Richard Eastman with Robert W. Baird.

Richard Eastman - Robert W. Baird & Co. Incorporated

John, could you just provide maybe a little bit more guidance on the Northern Digital kind of business metrics. I mean, what kind of revenue run rate do we expect there, for instance? And also just maybe a growth rate here over the next couple of years?

John Humphrey

Sure. I mean what we've said about that is that revenue should be in the $50 million to $60 million range for the next 12 months. It's been growing substantially as more image-guided surgery utilizes the equipment and the consumables that they have and so we expect their double-digit growth rate to continue at least for the next few years and we'll have to look at it beyond that. But all of the trends with their technology and the trends in the marketplace around having less invasive, more image-guided surgery are favorable for them.

Richard Eastman - Robert W. Baird & Co. Incorporated

And is this kind of a GAAP EBIT contributor in terms of double digit, in terms of over 20% plus, in terms of kind of GAAP to EBIT as it drops in contribution margin?

John Humphrey

It will be in that range, yes.

Richard Eastman - Robert W. Baird & Co. Incorporated

Okay, all right. And then also Brian, how do you feel about iTrade's revenue run rate here? I know you talked a little bit to the opportunities and the bidding opportunities, especially international. How do you feel about their iTrade's revenue run rate as it stood for the first 6 months of the year?

B. Jellison

It's been lower than what we would've liked to have seen. But on the other hand, there were a couple things that they were doing in data analytics that are interesting to do. But they've got an absolutely great core program and we'd like to see that core program grow and expand rapidly, and so I think they probably could have grown a little better than they have, so we've been refocusing on what we consider to be the most important customer opportunities. They're probably running a few million under what we would have expected that they would do, but it's still a fantastic group of people and a wonderful business and it's already created a lot of shareholder value, and it will create more in the future.

Richard Eastman - Robert W. Baird & Co. Incorporated

Is their core revenue -- is the volatility maybe there or what they can deliver on a quarterly basis? Is that more a function of their customer base and the volumes to their customer base? I mean the way I understand that business model, it's not a function of how many new accounts you're signing up, rather what's the underlying business activity? Is that how to think about their revenue on a quarterly run rate?

John Humphrey

No, it's not actually around how much activity is running through their network. It's really around how many people are subscribed. So think of it as a subscription-type business and the more that their customers will deploy this to their suppliers. So it's really around how quickly the customers are able to bring their suppliers onto the network, which is not a huge technical challenge. It's really a business process challenge for the customer, not really for iTrade. So our growth is, a, dependent on getting new customers which we continue to do, and then how quickly those customers roll this solution out to their supply base.

Richard Eastman - Robert W. Baird & Co. Incorporated

Okay, and then just a last question. When I looked at the orders number, the $707.6 million, what was the core growth rate in orders versus the $14.3 million?

John Humphrey

From an organic standpoint, it was about 8% up and the book-to-bill ratio was just over -- under 1%.

Operator

Our next question comes from Matt Summerville with KeyBanc.

Matt Summerville - KeyBanc Capital Markets Inc.

A couple of questions I want to talk about the RF Tech business for a minute. The operating margins performance you had in Q2 was probably the best you've had in the last 10 or 12 quarters. I now it's a mix-sensitive business. So can you talk a little bit about the mix dynamics that you encountered in Q2 and kind of what the project activities that's on the board for the back half of the year? How should we think about RF Tech margins proceeding from here?

B. Jellison

Well, the worst margins are always going to be in the transport traffic segment, which is heavy administrative activity, violation processing and lane expansion and moving traffic lights and those type of things. Whenever we have growth in the other portions of the activity at much faster rate than those business grow, then we get a whole lot better contribution because, I mean, you're looking at an order of magnitude several times the difference there. So the other thing that's happening, of course, is we get more embedded growth out of the software businesses at the expense of the TransCore tolling and traffic business, and so as you get that, you get a higher margin capture and better cash. And lastly, when the tag shipments occur, then that tends to be better than the administrative margin activity does. So the administrative activity hasn't grown. In fact, it was down a little bit, I believe, in the second quarter year-over-year and so that's bad news on revenue, good news on margins.

Matt Summerville - KeyBanc Capital Markets Inc.

And then just in the medical life sciences-related area, specifically with Verathon, you talk about kind of the new product pipeline for 2012 and moving forward with Heartscape. And now that you're kind of few quarters into that process, have you thought about it or can you give us some sort of parameter around what you think these next-generation products out of Verathon can add incrementally to revenue next year?

B. Jellison

I think you probably got to wait for another quarter or 2. I mean we're finished with the -- the trials are completed and done and accepted on Heartscape, but it takes a while to get that into the marketplace. The reaction has been very favorable to people as we explain it to them and demo it at hospitals. But we're not going to provide guidance on that for another probably 2 quarters.

Operator

We'll move next to Wendy Caplan of SunTrust Robinson Humphrey.

Wendy Caplan - SunTrust Robinson Humphrey, Inc.

If we look at CBORD and Horizon and Neptune and TransCore and iTrade, have there been any meaningful market share shifts in any of those businesses as far as you can tell at this point?

B. Jellison

Well, each one will be a bit different, right? I mean Neptune clearly has been up double digits in the first half of the year. Some of the other public companies, they either have debt or publicly traded have reported degradation in numbers. So whether that's project related or us gaining share is always hard to answer, but we've certainly been outperforming people this year, so I'd say they're gaining share. But I think, for us, what we're encouraged by is we ought to gain more share in the future because I think we've got a clearly superior lead-free technology to people. On the Technolog front, I mean that's something that certainly gains share, but it's like a turnkey thing and then you fill it out right, so it's doing fine. On CBORD, it's certainly -- I believe most people would agree that it has gained share at the expense of people with universities that it's taken over that used to be covered by different folks. So it's definitely gaining share. I think it's so focused rather than being somebody that's in a diverse area. I think we're really proud of the team we have and the customer intimacy they have and the follow-up they have with customers and their ability to get things integrated online. So I think they'll continue to gain share. And I'd say the same with Horizon. The Horizon activity is very better than we would have hoped for given the difficulty with educational spending. I think if you ever got any relief around funding in the K through 12 arena, which you may or may not get, if you get it, it's probably because of nutrition. We see a lot of build-out opportunities where we can do things beside the meal platform of what happens in K through 12 education around data gathering, and we have a number of new software developments that we're putting in place around how a school can manage its kind of inflow of cash from families. Our MealpayPlus program, it's a homerun, but it can get applied to a lot of new avenues, and they're working hard on that now.

Wendy Caplan - SunTrust Robinson Humphrey, Inc.

And finally an update on Freight Matching?

B. Jellison

Freight Matching continues to be a spectacular business. It's doing well. It's got growth this year. It's certainly having all of its normalized renewals that continue, so not a massive revenue number but a fantastic cash-on-cash growth number and we're very glad to own it.

Operator

That will end our question-and-answer session for this call. We now return back to John Humphrey for any closing remarks.

John Humphrey

Thank you, Jennifer. And thank you, all, for joining us this morning. We looking forward to talking to you again in October.

Operator

And again that does conclude our conference. Thank you, all, for your participation.

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