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

Well, thanks very much, everyone, for coming in. It's my pleasure to have up next Roper Technologies: Neil Hunn, President and CEO; Rob Crisci, EVP and CFO. As a reminder, on that QR code, please take 30, 25 seconds or so to answer some audience survey questions, and we'll obviously distribute the results of that in due course. Feel free as well to submit any questions via that app.

So I think maybe to start off, first off, Neil, maybe describe to us what you think makes Roper unique versus, say, a lot of the other companies around this event? Of course, thank you very much for coming to us.

It's our pleasure. It's easy coming from the other side of the state, and it's great to be with human beings in person again. I'm sure most people are saying that. So Roper -- I was reading the transcript from a couple of years ago, on the opening comment, we're quite different than other companies that are here. In a nutshell, think of Roper in three pillars. The first pillar is the construct of our portfolio. So today, we have a portfolio of about 45 businesses. They're smaller businesses, right? The meat of the bell curve is $150 million, $200 million of revenue. They all share -- well, the end markets are very different. About 2/3 of the revenue, it comes from software businesses, 1/3 comes from product-oriented businesses, the end markets are vastly different. Software for law firm, software for architects, software for spot trucking, products in health care, et cetera, they all share remarkably similar business model characteristics. They're in small markets. They are clear leaders, #1 or #2 in the thing they do in the small market. In those markets, we compete on customer intimacy, right? So solving a very specific customer problem. We don't compete on scale, we don't compete on price. The basis of competition is on intimacy. They all have incredibly asset-light business models, meaning that we're paid ahead by the customers. We have a very large deferred revenue balance. We don't require capital to run these, but the businesses don't require capital to grow. It requires intellectual capital, not physical capital. So they all have those characteristics, higher levels of recurring revenue. Then we have a -- so you have this collective portfolio of end market businesses. So we've designed a operating and governance system that enables those businesses to get better over a long arc of time, right? So we're deeply decentralized in the operations. So there's 45 businesses. There's 45 everything: Presidents, CFOs, ERP systems, R&D road maps, go-to-market strategies, et cetera, which -- so there's nowhere to hide. And we believe in this high trust autonomous model, but we also believe that we have the pattern recognition and years of seeing how these businesses get better over a long arc of time. That centers in the elements of strategy, execution of strategy and running a talent offense. And importantly, there's an overlay of what we call group executives or operating executives that help deploy that governance system. Maybe the last thing that's a cultural statement about what makes Roper special is our incentive system, which is we pay people to grow. We don't pay people based on budgets. There's no budgets. There's no plans. There's no compensation tied to that. And it sounds like a financial mechanic, it's really a cultural statement. We would submit -- if you pay people based on a plan, then we give them an incentive to lie to us, and we have a filter to believe anything they say. So then how can you have a culture that's deep in trust, vulnerability-based trust and really tackling the hard problem about getting better and growing faster? Then the final leg and the third leg is we take this incredible portfolio of companies that are highly cash generative, super highly cash generative, and then we take all the excess free cash flow and centrally out of the headquarter operation, about 12 of us, we don't have an M&A team, it's in our job descriptions as executives to deploy that capital to buy the next great business and put it back in the same flywheel. When you push that all together, over 10, 15, 20 years of compounded -- the share price, I think it's 19% compounded over that period of time with a very balanced mechanism between organic growth and the capital deployment. So it's a little bit different. So we're much less industrial, although we started there, with 2/3 being software today.

Neil. And maybe one hallmark of Roper and driving that TSR has been the acquisition track record and certainly, you and Rob have brought in a ton of businesses from the outside. One question we kind of get from investors is what does -- Roper seems to buy very high-margin businesses without obvious synergy to the existing base. So like what do you -- do you do anything to that business to improve it? Or it sits there in this decentralized structure doing its own thing? So maybe just any thoughts around that.

Delighted you asked. Certainly ask Rob to add some color. I can answer that on two different vectors. The first vector is the thesis by which we're deploying capital. Our thesis is different than most. We're trying to buy businesses that are structurally better than our existing enterprise. So just let that sink in, right? So we're buying a business that has high recurring revenue than our enterprise. That's hopefully a little bit more organic growthy than enterprise. It certainly is more asset light than our enterprise. And so as over this 10, 15 years of capital deployment that Rob and I have been involved with, we have structurally improved the quality of portfolio by virtue of that mindset. We don't believe that we can structurally operate a business better than the prior owner. That's vector one. Vector two, though, is we don't set and forget the businesses. We absolutely have developed for this category of business, again, this $200 million to $400 million business that is 30% to -- 35% to 45% EBITDA margin, mid-single-digit, application-specific, niche leader, that style of business, what we found is the businesses can get better over a long arc of time, not within 1 or 2 years, but in 5-plus years if we do strategy right, answering the questions of where to play and how to win and doing it analytically outside and importantly, enabling the execution of that strategy in a repeatable, consistent way. And then finally, running this talent offense around selection, development and retention and engagement. And when you do that, we've seen businesses that -- like Verathon, a medical product business that we've had, where we've been experimenting with this approach now for 7 or 8 years, that business is not a low single-digit organic growth business anymore. It's very much a high, maybe a low double-digit organic growth business structurally. But there's no magic elixir. It doesn't happen quickly. This is about building sustainable capability that is strategically on point.

And I would just add to that, right. It's a long-term focused model, right? So we're buying these businesses oftentimes from private equity, usually from private equity. And those businesses are used to that sort of 2-, 3-year cycle where it might invest, but they know there's going to be another transaction in a couple of years and they're not so focused on what's going to happen 5 years from now. Well, we view ourselves as permanent owners for these businesses. We don't assume and never expect there'll be an exit when we buy a new business. And so that's a new mindset for the people that run our businesses and generally, there's a ton of great opportunity. But again, it's not going to pay off next year. It's going to really pay off down the road. And so you take a business that already grows very nicely, mid-single digit organically, usually maybe a little bit better. And if you can if you can invest right, then you can accelerate that. But it's not built into our initial model when we buy the business. So it's a much lower risk investment model than sort of someone who goes and has to get synergies in order to make this deal work.

Understood. And that's sort of the inorganic front. Maybe on the organic front, we've seen things like R&D to revenue much higher over the year, does that software proportion of the business up. So there's no sort of right number for R&D to sales, but just give us some thoughts as to the pace that you think that rises and maybe how you ensure or create the conditions to ensure that extra investment, there is a good return on it? It's not 300 bps of R&D to sales, but half of it's on the hobby go nowhere.

So if I can -- let me set some context for R&D and how we think about it first. So it goes back to the way that we look at strategically governing these businesses, right? So we go through a 2- or 3-year strategic cycle with each business about where they're going to plant their flag and how they're going to compete and when oversimplifying execution, you can only do that by either building a product or executing some go-to-market approach. I mean it's super simplified, but that there's really just two levers. But each business, again, is paid to grow and increase the growth rate to compete, win and take market share. That's the incentive system. So we're all aligned on what the best way to do that is. That said, when -- so it's bespoke to each company. There may be an arc in the strategic cycle, Vertafore right now, most recent acquisition. And the arc of that strategic cycle right now, it's a very heavy R&D-focused arc, right? That is the right thing to do at this moment in time because the problem that they're trying to solve for the industry is tech-enabling the insurance workflows. So it's a lot of product. Maybe 5 years from now, it becomes more of a go-to-market sort of latent version or arc of the strategy. And so you could see -- but when you roll all that up, what you see across Roper is R&D a percent of revenue going from 7% to 8% to 9% or 10% now. That's across the whole portfolio. But if you look at the software businesses, the application software businesses are in the mid-teens, the network software businesses are in the low double digits and the product businesses are in the 4%, 5% range. And you put it all together, it's a 9%, 9.5% range. But it's very bespoke to the type of business model you have and how you compete and win and also intersecting with the strategy. But nothing top down. It's not like we say, here's 10% of revenue, let's dole it out. That's not...

And so just to add a point to that, right? So the businesses are paid off of their ability to grow EBITDA organically. And so they're making investments to maximize their ability to grow EBITDA organically over a decade, right? The people who run our businesses are generally running the business over the long term. So they then can make those value decisions, and they are the ones who should make the value decision because they're closer to the customers. We would never have the ability to allocate R&D investment on a centralized basis. We would make big mistakes doing that. And so we don't.

And to your pet project question, I'm not trying to ignore that one. It's -- we rely on the incentive system, right? So if there's some pet project that's not going to pay off, ultimately, it's going to be at the expense of that leadership compensation. But we also have this group executive overlay that really understands the strategy and the product road map. And there's a lot -- in the last 3 or 4 years, there's been a lot of efficiency gains especially on the R&D side, where we're actually just doing less waste and more productivity. So there's been -- it's not just more dollars, it's more productivity, lean thinking in the software space.

And on that point that Rob made around growing EBITDA organically and you mentioned the group executives, Neil, I think something certainly, so to say, 4 or 5 years ago at Roper, investors hear more about an organic growth focus in general and also about the group executive structure and talent development [indiscernible]. And maybe talk about sort of how satisfied you are with that progress on organic growth and on talent development, some of the types of things that can give [ hiring ] that role more as how has that changed?

I don't think you'll ever hear me say that I'm satisfied because it's always evolving, and you can always do better and improve. But have we come a long way? You bet. And are we much better today than we were 3 or 4 years ago? You bet. I think where we have meaningfully strengthened across the organization is at the corporate operating level, the group executive team we have today is the best we've ever seen in terms of their ability to coach and mentor and help the businesses get better over a long arc of time. I think we are meaningfully better at the company level, the business unit level, strategic work. And we're probably made the greatest gains at the company level talent level, especially as it relates to the selection of our leaders like the presidents and the engagement of the workforce. And so those are the gains we made in 3 or 4 years. We've got a long way to go around selection of the rank and file to sort of employee base and the development and the [indiscernible] and all that, but there's a lot to do. So it's an all-you-can-eat-buffet opportunity and sort of picking the highest priority items.

And how does that -- the sort of the vector of group executives, but you have a decentralized structure. Like how do those things sort of look on those...

So at the very tippy top of our governance model are the words high trust, autonomous model. So everything we do, it serves against that. So our group executives are there as coaches and mentors and thought partners. If there ever was a time when one of our leaders, business unit leaders and a group executive were at loggerheads and couldn't agree on something and they came to me, almost without hearing the case and we're going with the business unit. So that's for the point of accountability. That's where the compensation line is, that's where -- that's the high trust autonomous model. That said, when you sit at the corporate entity and look and see 45 businesses, they're hey -- businesses hit the breaking news here. It's not that complicated, right? So there's a lot of pattern recognition in the business. And so we get to share that pattern recognition across businesses and coach and mentor, but it's maybe a sports analogy. We want our group executives as coaches, more like golf coaches, like occasionally a swing thought, but it's mostly a psychiatrist or psychologist. But occasionally, you got to become Bill Belichick. It sort of scripted plays for a little bit of time. But if you live in the Bill Belichick coaching era, you probably have [ the wrong ] leader, right? So it doesn't last very long while you get to it.

That's helpful. And as there's one topic tying into that point around organic growth. And as multi-industry companies have sort of made a recent push into software to try to get their organic -- that mechanism, how do you assess the sort of the progress of Roper software business growth? I think a lot of the companies at this conference will try and buy a software company [indiscernible] than different perspectives on what they expect and look for in software. Maybe explain your approach on...

Yes. So it goes way back to the one of the first questions you asked around the portfolio construct and the way we -- our capital deployment strategy and mindset. We recognize analytically that 7 out of 10 companies that deploy an M&A-driven strategy, deliver results that are below the benchmark. So there's 3 out of 10 of us that are able to do this above. And everybody that does has their unique special way of doing it. In our case, it's a very risk-off approach. So when we're selecting these businesses, we buy businesses in these small markets. Why? Two reasons. One, it doesn't invite a lot of competition because the markets are small, so the price is small. But two, it's this intimacy point where we're interwoven with the daily operations of what our customers do to make money and serve their customers. And so it's a very intimate relationship, right? And so it's -- that gives you sort of protection. A byproduct of that is you don't have $1 trillion TAMs where you can grow 30% a year. But sort of clocking in every year mid-single to high single-digit organic growth revenue, a little bit of operating leverage in the M&A flywheel resulting in sort of the mid- to high teens compounding is what our model has been, but it's been a risk-managed model. When you get to businesses, software businesses, not a comment to the other companies that are here and they're not specific to their -- companies they bought. But organic growth is not risk-free. You're in a gigantic market growing 30% a year, you're inviting competition left, right and center into that space, which is just a different element of risk, right? And so we manage that risk a little different than others.

And yes, just as a reminder, please open up that code for the audience survey response questions. I think one point moving perhaps away from the top line for a second, operating leverage, some investors are sort of surprised that your comment on margin expansion [indiscernible] the volume leverage. When you look at Roper's gross margins, it's very, very strong [indiscernible] environment. So how do you think about the right placeholder, if there is one trading...

Yes. I think it's a little bit different, sort of getting back to Neil's point about business model, the businesses that we own. I mean these are software businesses that have 40% or so EBITDA margin, right? And so when you're investing double-digit R&D when you're investing in go to market, right, we want to have as much organic growth as possible at those margins. So yes, we expect margins [ as were ] tick up over time. But right, it's not a situation where you have the cyclicality where you go backwards for a couple of years and marginally get lower, and then you get a lot of leverage on the way back up. So it's very consistent. We say 40% plus EBITDA leverage on revenue. Certainly, in some of our product businesses, some of our more cyclical businesses, you might get a little bit better margin right in this sort of environment. But I mean, to Neil's earlier point, we could certainly increase margins more in the software businesses and not invest and right and have 1 or 2 years we look at all that margin improvement. But the idea is to continually to grow these businesses mid-single digit moving to high single digit with some of our businesses over time. And so we want to invest to do that. Again, we're playing the long-term strategy, it's not about sort of the next year.

I think it's also joint set in context as well. Everything, I agree 100% with what Rob just said. But also in 2000, we went down 1% organically, and our margins were up. So we didn't go down. We weren't...

2020.

2020. Sorry. I said that, right?

Yes. Close enough. Whatever.

We -- sorry. We did -- we essentially did go down, our margin went up. Everybody else at this conference went down, and margins were down, so obviously, they're going to -- margins are going to come back. So on a relative peer comparison basis and one point of time, okay, but look at it over a couple of years, and I think it does give you the sense of the durability of our business.

And where are we now on that sort of recurring revenue share of [ INF ] critical to that low cyclical volatility?

Sure. So a couple of ways we think about that. First, if you look at the composition of our business, about 15%, maybe a touch more now with the pending divestiture of TransCore, we would book it as a cyclical part of the enterprise. That's the process technology in the industrial part of our EMEA segment. In terms of recurring, 62% of Roper's revenue on a continuing ops basis is software-related. Of the software, about 90 -- about 80% of it is recurring. That gives you a software recurring as a percentage of the total Roper revenue is about half, and that excludes the reoccurring product consumable revenue, the Verathon, the consumables, the Neptune sort of consumables and repeatable reoccurring purchases. If you add that, you're sort of not maybe 60% to 65% recurring or reoccurring, is the nature of the recurring stream.

And on the portfolio front, I suppose people have been disarmed recently because you had that very strong multi-decade M&A approach and then recently, very recent, let's say, not much M&A, but several divest. But people often ask, is something changing strategically in the way Roper thinks about portfolio?

So first on the capital deployment, we bought -- acquired Vertafore in the some, May, June of...

August 2020.

August?

2020. Yes.

2020. And we made a commitment to our Ecuador shareholders and our debt holders that we would deleverage following that acquisition.

Yes.

And that required us a year, 1.5 years to do that, which we stayed disciplined to and did that. So that's...

And it has nothing to do with the divestitures.

Nothing to do with the divestitures there's a commitment that we made basically doing 2 years of capital deployment, 1 deal with Vertafore. As it looks -- we look at the divestiture, pending the divestiture of TransCore and then the 2 smaller ones, Zetec and CIVCO. There's nothing that's changed strategically, right? Roper is all about this improving the quality of the portfolio over time that we've talked about. We've done it historically through the buy side. This is just the way to do it through the sell side. For instance, TransCore, their future is super bright around smart city and mobility, but it's going to -- it's a very capital-intensive future, right? So we are not the right best owner for that business to execute its strategy. To give you a sense, TransCore, that one asset is about half of our net working capital of all of Roper, just given the dynamics of their customer relationships and the way you have to contract in that space. And we think it only gets worse from this point going forward given the strategy. And the owner, the future owner, that is their business. governmental, large infrastructure -- and so TransCore will sort of thrive with a new owner and then we'll take the capital and redeploy it more in a way that's consistent. But the concepts are the same, just how do you improve the quality of the portfolio.

And when you look at the ability to get M&A done in an environment that, at least until very, very [indiscernible] very expensive, very low, maybe that your life more harder for you. How do you characterize the environment on M&A now that you've done that delevering, particularly with the divestments on top of that original?

Well, you summarized it, right? So there's a large -- I mean, the ocean of opportunities has always been quite large. It's never a lack of opportunity. Valuations are high, no doubt about it. It feels like they are high. They're probably going to stay high for a while, but they're not -- doesn't appear to be increasing at this stage, right, in -- at least, in the private markets. In our case, your comment about interest rates, we believe that interest -- higher interest rates are actually a net benefit for us on the acquisition side. If you look over, I believe it's the last 15 years, about 70% of our total capital deployed has been from our cash we generated, 30% from the balance sheet. Our people we compete against private equity, it's inverted, right, in terms of the way they use debt versus the equity piece. So we think that's incrementally helpful for us over a long arc of time. And the final thing I would say is where we hunt for and compete best for assets, which is what we want, again, these mid- to high single-digit organic growth, 35% to 45% margin, $200 million or whatever $300 million businesses. There might be a little Goldilock zone around valuation because there's not -- the competitors can't do a lot to improve them in the short run in their horizon. There's not -- the strategics can't do a lot of things in the short run to sort of -- that their return thresholds. And so there might be a little Goldilock zone here, but we'll see over the course of the next 12 to 18 months as we try to deploy this $5 billion.

And yes, you mentioned that $5 billion number, tough to sort of quantify these things. But let's say a year from now, what level of spend would you be say disappointed [indiscernible] if you spend 0 and [indiscernible]. How much do people expected just...

Shockingly, I think I wouldn't be disappointed if it was 0 because it was 0, it's for good reason, right? I mean we -- the opportunities that present themselves in a way that we deem actionable. Because again, when we're buying something, we look at it as a forever investment, right? There's not a terminal value that we're trying to sort of manipulate in the math to figure out if -- how we exit. So when you're making these forever decisions in the portfolio, you've got to buy the very best businesses that you can. And so you have to be patient to do that. So we hope we're going to work as hard as we possibly can to deploy the capital in a smart logical way. But if we can't, we can't, and we'll do it, when we can. As my predecessor said, our discipline is only outmatched by our patience.

And if we look at that -- let's say, for some reason, those acquisitions become -- remain tough to do or get more difficult to win that. And let's say that has a negative impact on Roper's relative share price performance. What is -- is there any appetite to do buybacks? We've seen one or two other acquisitive companies in our sector in recent days, pivot to buybacks away from M&A at least now. What are your thoughts on that?

Yes. Our thoughts are very clear. We do not have an ideological opposition to a buyback. We've never done one, but it's not an ideological thing. It's just about the math. Unadultered math. Is it better to buy this company at this price with this future compounding characteristics or to do a buyback? The reality is that when we look at it, right, wrong or -- so the way we and our board look at it over a long hard time, at least a 7-year time horizon. So we look at what the compounded effect is of the decision today, not with the decision 6 months or 12 months are going to be decision today. And so in that case, almost always the math says to deploy capital on the asset than to buyback. That's just our approach. But it's just math. If prices got to such a point where the math inverted, then you'd see do a buyback growth.

And on that point on sort of -- you talked about going into market niches and that's where the competitive sort of dynamics are most attractive. There's also the aspect of as Roper in those software niches gets a bigger company, bigger revenue base in software. Does it make those niches kind of harder to find when you're deploying capital? Or that's a problem for x years out, it's not...

I'd said the pipeline is incredibly strong. So there are a ton of assets that fit all of our criteria, and that's going to -- will feed us for many, many years. Obviously, when you get double, triple the size, you will, at some point, get to a point where it's harder to find the assets -- deploy the capital. But I mean, it hasn't been a problem today.

The only thing I would add is two things. One is, say, for the divestiture proceeds we have to redeploy the run rate capital deployment right now is $2 billion, $2.5 billion a year. And 7 years from now, it's a little bit north of $3.5 billion -- $3 billion, $3.5 billion. So that gives you a sense of how much we have to deploy. So it's not that hard. It's not that much. And then the second thing, in addition to just the pipeline always been full, innovation is just an awesome thing. I mean, things that we would not have dreamed of that you'd see a $300 million business with a $100 million EBITDA that didn't even know you needed that 10 years ago. It's just we see these things all the time. And so I have a lot of confidence in the innovation engine and venture capital, we're graduating the private equity and developing assets and become niche leaders and niches that what 10 years from now, it doesn't even exist today and it's a meaningful niche. So there's plenty of opportunities.

Do you see more competition within that opportunity? So yes, there's more target becoming available, but there's more buyers trying to crowd in on those.

It's hard to know. We don't get like perfect visibility in the depth of the pool. I will say that it's always been -- the whole time I've been at Roper, it's been a competitive process, right? It's not like we were the only ones who understood software 8 years ago, it's been competitive for a long time.

But very much more so from private equity, right? There's more and more dollars going to private equity, so that makes them a tougher competitor. Other multi-industry companies is very rare to run against to the type of assets...

Yes. Great. Well, thank you very much Neil and Rob for a very interesting discussion. And yes, please, anyone keep filling out those polls. Thank you very much Neil and Rob.

Great. Thank you.

Thanks so much. Thank you all.