Roper Technologies, Inc. (ROP) Earnings Call Transcript & Summary

Thanks. Great. Well, welcome back, everyone, after lunch. We're excited to have next Roper Technologies: Neil Hunn, President and CEO; and Rob Crisci, EVP and CFO. Maybe just to start things off, Neil, obviously, Roper has a somewhat different business model for many companies at the conference today and tomorrow. So maybe just remind us what's unique about Roper's business model maybe vis-à-vis a lot of the sort of regular multi-industry companies here.

Appreciate the question. Appreciate, as always, Julian, the opportunity to be here. Thanks for joining us. So Roper is a bit different than most of the companies here. Our strategy for 2 decades now has been singularly focused on how to compound our cash flow, and as a result, the TSR at the highest possible rate that's sort of risk managed and sustainable. And the way that we do that is we operate a portfolio today of 45 different businesses. The end markets are wildly different. Water meters and tolling to half our portfolio now is software, about half products, half software. But the 45 business models are highly similar. All the businesses are in niche markets. We love the niche markets because they protect us from the sort of disruptive competition. These TAMs that all the businesses in are very small. Some TAMs are $100 million. Maybe the largest TAMs are $1 billion, $1.5 billion. So they're very small served markets. All the businesses tend to be the leader in what they do. And so in these markets, we tend to compete on what we term as customer intimacy. So being very close to what our customers do. Most of our products or software that they buy is core to what it is our customers do. And so they give us feedback all the time about how to continue to evolve and develop the products and serve the markets. Then all 45 businesses also tend to have a higher -- a relatively high degree of recurring or reoccurring revenue. And then perhaps the most -- the hallmark staple characteristic of these businesses is they don't require capital to grow. For almost 2 decades, CapEx in this business has been about 1% of revenue. So these are wonderfully asset-light businesses. In fact, our working capital as a percent of revenue now is negative 4%, 5% and our fixed assets in total are somewhere in the 7% or 8% of revenue. So it's a very, very asset-light model. Now the asset selection is just a part of the story, right? We have a very unique operating structure that allows these businesses to thrive. And so we have 45. We operate this very decentralized approach, which we think is a necessity with these types of assets, right? And so we have 45 of everything: 45 executive teams, ERPs, development centers, locations, whatever, 45 of everything. And the reason that we bear the cost of that infrastructure is these businesses have to act extremely nimbly in these small served markets because the competitors are small competitors, family run or private equity owned, for the most part, or small divisions of larger companies. So they're acting nimbly, so we have to act equally, if not more, nimbly. So this org structure enables that, right? There's no better example of that in the real world as how our energy business has reacted here last year. In the fourth quarter, margins -- or full year, the margins were up in the face of headwinds. And so those businesses were able to shed the costs very quickly. Do it and then tell us they did versus ask for permission or ask if they should do it. But there's a difference in the way that we operate. We have this org structure, and -- but -- and just because we're decentralized, we're far from passive owners. So we have a group executive layer. Each group executive, of which there are 5, have a portfolio of 7 to 10 companies each, and their job is to be a thought partner/coach about how to evolve our businesses to be great, really great in the way they actually develop strategy, the way they execute strategy and the way they run a talent offense. And over a long arc of time, we expect to see our businesses improve their cash returns and improve their organic growth rates and improve their margins, which has largely been the case. And then finally, and perhaps the most important part of our org structure, is the way we pay people. We pay the entire organization based on growth. Most companies here, I would suspect, pay people and their teams based on some sort of budget, plan performance. And for us, it's super important culturally because if you pay people based on a plan or budget, you provided your operating teams an incentive to lie to you, and you have a filter not to believe anything they say. So I would submit you can't have a culture of trust or, for that matter, accountability. So all the tough stuff, the problems get elevated in our organization because we're there all to try to solve because those are the barriers to growth typically. And so these businesses and this org structure generate about $1.5 billion of free cash flow. And because they're so asset light, they have no way to deploy it back in their business. And so the third hallmark of our enterprise and our strategy is a very centralized approach to deploying the capital. It's -- we have a very small staff in Sarasota, about 55 or 60 people. The vast majority of that is sort of the administrative overhead of being a public company. And then there's a couple of handfuls of executives, and it's our responsibility to deploy the capital. So we don't outsource this to our operating companies. We don't outsource it to an M&A team. We are the ones doing the capital deployment and it's very process ridden. Does it meet our cash returns? Yes or no? Does it meet our organic growth thresholds? Yes or no? Do we like the management team? Are they builders? And then is it a type of business we like? And those are the characteristics I started with. When you put all that together, we have a -- that strategy, which has been in place for nearly 2 decades, has yielded in the neighborhood of 19% or 20% TSR compounded for 2 decades. And so we -- as we play that forward in our models, basically the same returns are modeled for us. And so a lot of our focus is how do we sustain that strategy and the execution against that strategy.

That's helpful. And in terms of that notion of sustaining this outsized TSR, since you've become Chief Executive, you've made -- starting to implement maybe 1 or 2 changes, things that you think a CEO can improve the company and the TSR over time. Maybe talk a little bit about some of those initiatives or things that you're focused on.

Sure. Well, it's one change with a sort of 1A and 1B component. So it's my belief that the enterprise can do a little bit better in its organic growth execution. Now mind you, this portfolio was built principally for durable businesses that have very limited risk of going backwards, and we actively made a trade-off to trade away outsized organic growth. And so we have this mid-single-digit, 4%, 5% organic growing sort of history. Yet having grown up in the operating side of this business, since 2011 I've not met a Roper business that optimized its growth sort of outlook, organic growth outlook. And so the objective there is how do we get a little bit more organic revenue growth that is accretive, a double underscore, triple underscore accretive to our cash returns. This is not a growth at all cost. This is not at risk to the enterprise. If there were not CRI-accretive growth options in front of us, we would not pursue it. It's my belief that it exists in virtually every one of our businesses. We've just not asked the businesses for it. We have an -- we've had an incentive system but haven't culturally asked for the growth. And so it's about the sustainability of the growth, and then that's 1A and 1B is having a talent offense to match that, sort of a pool of talent in the businesses that have a growth mindset to execute that strategy. Now why do we want to target the growth? It is purely because we know in our models 100 basis points of organic growth gives 225 basis points of TSR. It's purely more return for our shareholders if it's done right. That's the reason why we're attacking this. It could be successful, it could not. What we know, if it's not successful, we're no worse off than what we are now. We're not going to be a lower cash returning business, we're not going to invest more money and have it fail. If we're successful, then there'll be 200 to 300 basis points of TSR that our shareholders will benefit from.

And how do you go about sort of implementing the mean to that end? Because as you said these 45 businesses are used to running autonomously. They still are, of course, but maybe there's some greater degree of guidance or direction.

Yes. Well, it's still -- it's implementing. And I don't know if it'll ever be in the past tense, right? This is always an ongoing thing. I'll say beginning of this was really in the 2011, 2012 period when I came on as a group executive, the nature of the cultural change from being more of a group finance leader or controller to now a growth-oriented coach, if you will. And now the 5 group executives that we have are sort of molded in that model. And so we have the right leadership at the corporate layer to engage with our businesses about what great looks like in -- across the various dimensions of growth whether it's product development or channel execution. So that's one. Two is we've spent the last 2 years, almost 2 years, educating basically everybody in our business that makes a meaningful resource allocation decision what cash return is, how do you fuse that as your filter of optimizing your decisions because we need to make sure everybody is singularly focused on what it is we're trying to optimize, which is cash return. So we don't run the risk of growth at any cost or bad growth. We go through example after example of public companies that have achieved growth and ruined their balance sheet and deteriorated or destroyed value for their shareholders, and that is what we're not going to do. And then we show them what we are going to do. And then there's a toolkit that we have. I talked about it briefly earlier, about the tools about how to develop a market-based strategy in your niche; importantly, the tools about how to execute the strategy, which we could spend the whole time and more talking about; and then how do you enable talent to execute those things. That's really the mindset of the group executives, that they're communicating and laying into the organization. Now this is all that -- these are all opt-in sort of modules, if you will, or thinking for executives. But when you ask an executive, would you like to learn how to grow faster, sustainably and more talent, they're going to generally say yes, right? So it's an easy conversation.

And if you think about the shape of the portfolio today, one of the very common things, I guess, that happens with a lot of multi-industry companies is you had a change in chief executive or leadership and portfolio review and a bunch of stuff is cut loose. It's one way of showing, I guess, that there's a new approach. Gatan has come out of the company. How are you assessing, with that done, other businesses that may be worth exiting? Or the point would be, well, if there was something, it would have happened already because the portfolio review is sort of over now.

Yes. I would say that we have always said, ever since I've been here, and I would assume for the decades that my predecessors ran the company before I joined, we've always been in a portfolio review, right? We're extraordinarily mathematical. If we think -- in the case of way back when, ABEL Pumps or the camera business or Gatan last year, if there is a sale and pay the taxes and a redeployment mathematical option that leaves our shareholders in a better spot, we're always going to consider that and entertain it. And so it's just a continuation of that theme. It's a constant review of the math against the -- a review of what the opportunities are, and there's no change there. And maybe it's worth also saying, if I didn't say it before, a lot of the reason Rob and I have the opportunity to have the jobs that we have is because we understand not only the components of our strategy but how they're so intricately weaved together. And our job is to not change a lot of that. It's been working. And so it's -- we're not -- I'm not here as a new CEO and Rob as a new CFO saying, we need to change because fundamentally, the Roper model has delivered against its commitment.

One aspect around the sort of software, as you said, is over half of earnings now for the company. A lot of industrial companies when they buy software assets, I think the assumption from investors is, if you're buying software, you better grow double digit. That's not the type of asset that Roper has gone for, I think. Maybe explain why the CRI math tends not to work or to be more at risk by buying high-growth software assets.

We'd love to buy the highest-growth business we possibly can.

Yes. I mean it's not CRI per se. CRI talks about and describes the asset intensity to the cash flow orientation of a business and do you have a economic relationship with your customers where you get paid at a time and an economic relationship with your vendors or your infrastructure where you don't have to own it, you can rent it. That's sort of what CRI tells you is the nature of the business model. And then all things being equal, businesses that grow faster or better are more valued than ones that grow slower because they compound cash flow faster. That's obvious. It thus then becomes, if you're a forever holder and you're in these small niches, vertically oriented application software, it's our belief that if you're growing in the teens, there is some thematic trend that you're playing into or some likely temporal technology advantage, temporary technology advantage that you're availing yourself to sort of the benefits of that, that are accruing to you, both of which have a half-life. In our view, the businesses that are these mid-single to high single-digit growth application software businesses, it's our belief that the -- that half a dozen or so growth drivers in these business are durable into the very long term, where -- and it's different by company: a few points of price, a little bit of attrition offsets price, a little bit of cross-sell, the ability to innovate a little new product and monetize that. And you put that together, you get a very sustainable mid- to high single-digit growth rate without a lot, if any, technology risk and no sort of tailwinds, secular changing risk on you. And so it's just a very defensible, compounding way of looking at asset selection versus I want to grow for 5 years and I'll deal with years 6 to 10 later. Our mindset is different.

And the point would be that the double-digit growth may be reflective of some kind of tide that happens to be rising now and can easily...

Right. And we're also only buying businesses, as you know, that are highly profitable with strong EBITDA margins and strong cash flow performance. So you're not buying the SaaS business that maybe is growing 20% that's not profitable yet that you hope in 4 or 5 years could be this wonderful, great thing. Maybe it is, maybe it isn't, but you're taking on quite a risk by doing that versus selecting the assets that have already proven to be profitable in niche markets, #1, #2 player. Those businesses can continue to compound cash flow, as Neil said, mid to high single digits with much less risk. And then we're not underwriting future growth that could potentially go backwards, right? If you need the business to grow 15%, 20% in order for your model to work, that's great if it does grow 15%, 20%. But if it doesn't, then you just destroyed value. And we take what we would view as a much lower risk approach to M&A.

And not just M&A. But sort of TSR compounding.

Right.

I mean it's -- we're a high 10s TSR compounder on what is a very low-risk operational model in our view.

And how do you assess the M&A environment right now? I mean, I think Roper has benefited down the years from having private assets that pull businesses out of private valuation like public ones have obviously moved higher. Maybe just update us on the status.

I would say the market conditions, the vast majority of the assets we buy come from private equity. Occasional founder and even rarer, small public company, we did once in our history. For the last 5 or 6 years, maybe even longer, it's been the same dynamic, lots of capital chasing lots of opportunities and valuations being relatively high versus the long arc of time. Lower interest rates help the private equity firms drive valuations higher. We actually modestly root for higher interest rates because the vast majority of our acquisition deployment comes from our cash that we generate. I think it's $9 billion of the last $11 billion we deployed has come from our cash flow. So as interest rates go up, our competitors, the private equity competitors, they can't pay as much so valuations go down and we compound faster, right? But the environment today is basically the way it has been for the last 5 years in terms of competing for deals. Really no meaningful change.

Do you come across many industrial companies trying to emulate the software push or they're mostly looking at bigger kind of thematic trends when they're scoping for software assets?

It's a very rare occasion that an asset that we're looking at is ultimately acquired by an industrial-type business there. Obviously, Fortive bought Accruent a couple of years ago. That's an asset that we were looking at. That's the singular example I can think of in my time at Roper where that's happened because we're so -- we're agnostic on the end market, right? And so we can look at lots of different things and do look at lots of different things where I think a lot more -- most other companies are in market or thematic driven, and there's just not probably an intersection of those 2 in a meaningful way.

How do we think about, within software, that transition of the sort of license bases, subscription bases? Are there things that -- so investors have to be wary of depending on how that transition ebbs and flows?

Sure. So our portfolio today is, of the half that is software, about half is perpetual or on-premise and about half is subscription or SaaS or cloud, whatever terminology you want to use, or rental versus buy model of the software. All of our businesses are in different stage of evolution. There are some that are all SaaS, some that are still all perpetual and many that are in a transition towards a SaaS or cloud model. For us, our experience historically -- well, actually, back up. We're pacing that shift at the pace of our customers. There is no mandate from us and there's no mandates from our companies to their customers to say, we're going to the cloud so come with us. It's more the customers pulling, saying I'm ready to go. So it's a natural progression. It's a slower progression and not a forced march. And so based on that concept and premise, our experience has been that there's a bad guy and a good guy that happens when you go through this. The bad guy is when you substitute a SaaS sale for a perpetual. The other way, you have a SaaS sale instead of a perpetual deal. In the year of that, that's a bad guy, right? So instead of taking 100% of the revenue in year 1 or minute 1, you take a percentage of that. That's the classic J curve. At the end of that, your recurring revenue is always better. You just have to experience this negative J curve. To offset that J curve is we have all these businesses are migrating a large installed recurring revenue maintenance base to the cloud. Because you're delivering more value than just providing maintenance, you're providing hosting and release management and you charge more, and so you get a 2 to 2.5x uplift on the maintenance when you take a maintenance customer to the cloud. So that's a good guy. And so when you balance all this out, for Deltek it's been a modest growth driver when you put the 2 together in -- over the course of the years. And so it's not a meaningful headwind, it's not a meaningful growth driver. Importantly, it's this balanced sort of approach. And it's a by-product of the way we're rolling it out. It's not a -- that's not an engineered outcome. It's a by-product relating to customers' paces.

You're not trying to incentivize the sales force to start pushing?

It's a -- one of our group executives, Satish Maripuri, is in the office. One of the things that -- excuse me, in the audience. One of the things that he's been working with our software companies is how do you have a proper incentive structure with the sales teams to sell both the same solution delivered on-premise or in the cloud without incenting one or the other and having right incentives. And so there's learnings that we share across the organization in that regard.

And we're sort of 20 minutes in. I haven't yet mentioned TransCore, which I guess is the very popular topic the last 6 months. Maybe give us some context as to how large the addressable market for that type of product, that type of contract could be. How disciplined is the competitive set? You get some of those odd companies from different backgrounds competing in it. So does that run the risk of crazy pricing on the sort of marquee projects? And how risky you think this type of work is for Roper?

Is it specific to congestion pricing or broader to TransCore, your question?

Broader to TransCore really.

Okay.

And if you could see that congestion pricing, that scale of business be replicated?

Yes. Sure. So think of TransCore has principally 2 legacy businesses or parts of it and now emerging in the congestion pricing. One is doing tolling infrastructure projects. So there's hardware, in lane and gantries and cameras and tags and readers and all that and civil engineering to go with that and tolling existing infrastructure. That has been -- that's not a new market. There's lots of -- there are several new projects in a given year. We're mostly North American based in that business, not wholly but mostly. That's one part of the business. The other part of the business is operating the software -- deploying the software and operating the back office. So how do you assign the accounts out? How do you do collections? How do you post money? How do you -- the whole back office. Once you toll somebody, how do you collect the money? So the business has those 2 parts. And then third now is congestion pricing in New York, which is largely a large tolling project from an infrastructure point of view.

Yes.

It's a project-based business. It's been a low to mid-single-digit organic grower through the project lumpiness over a very long arc of time. In terms of the competitive set, it is a remarkably small set of competitors. There's one European-based hardware competitor. There's a few competitors on the service and software side that in the recent quarters and years have had a hard time delivering, which has been a short-term benefit for our business. And in terms of sort of pricing discipline in the market, where TransCore competes, they are the one vendor in this broader space that basically has no failed projects, right? So TransCore bids knowing they're going to have a successful outcome. And it tends to be the lower-risk option for the customer. And very rarely if ever, I think, Rob, are we the low price bidder, right?

Right.

And so we were not the low price bidder on the New York City congestion pricing project, but certainly, the low-risk sort of bidder.