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

Good morning. The Roper Technologies Conference Call will now begin. Today's call is being recorded. [Operator Instructions] I would now like to turn the call over to Zack Moxcey, Vice President, Investor Relations. Please go ahead, Mr. Moxcey.

Good morning, and thank you all for joining us. Joining me on the call this morning are Neil Hunn, President and Chief Executive Officer; Rob Crisci, Executive Vice President and Chief Financial Officer; Jason Conley, Vice President and Chief Accounting Officer; and Shannon O'Callaghan, Vice President of Finance. Earlier this morning, we issued a press release announcing that we have agreed to sell a majority stake in Roper's 16 industrial businesses to CD&R. The press release also includes replay information for today's call. We have prepared a presentation to accompany today's call, which is available through the webcast and is also available on our website. Now if you please turn to Page 2. We begin with our safe harbor statement. During the course of today's call, we will make forward-looking statements, which are subject to risks and uncertainties as described on this page, in our press release and in our SEC filings. You should listen to today's call in the context of that information. And now if you please turn to Page 3, I will turn the call over to Neil. After his prepared remarks, we will take questions from our telephone participants. Neil?

Thanks, Zack, and good morning, everyone. Thanks for joining us on short notice. This morning, we are so excited to announce that we've reached an agreement to sell a majority stake in our 16 industrial and process technology businesses to private equity firm, Clayton, Dubilier & Rice. The specific businesses are referenced on the right-hand side of this page. Importantly, this marks the final step in our multiyear strategy to meaningfully reduce the cyclicality and asset intensity of our portfolio. Roper will be receiving approximately $2.6 billion in cash proceeds at closing and will retain a 49% stake in the newly created entity. Once completed, this transaction will meaningfully improve the quality of our portfolio and create additional M&A firepower for enterprise. Before we turn to the next page, I want to take a moment to compliment and thank the leadership teams from each of these businesses. You've done an amazing job of building our business, investing for long-term organic growth and building great teams. We're excited for you as this next chapter unfolds. Let's turn to the next slide and walk through the transactional details. As you turn to Page 4, let's go through the details. As you see, we are selling a majority stake in these 16 businesses to our new partner, CD&R. We will receive approximately $2.6 billion in cash proceeds at closing and retain a 49% stake in the new stand-alone entity. We're excited and honored to partner with CD&R. CD&R has a strong track record of partnering with corporations, standing up new enterprises the right way and creating tremendous shareholder value. John Stroup, a CD&R operating adviser, will be the inaugural CEO of the newly formed entity. Many of you have good history with John, given his strong value creation runs at both Danaher and Belden. In addition, Roper will have a meaningful role on the Board of Directors for the new entity. CD&R shares our belief in the strength and niche market leadership and greatly values our company's customer intimacy. CD&R's views towards value creation are completely aligned with ours, rooted in continued organic growth investments, which will be complemented by a newly created M&A capability. Because of these factors, we're excited about our ability to generate significant additional cash proceeds as we monetize our minority stake down the road. As it relates to these businesses, starting in the second quarter, they will be excluded from guidance and reported in discontinued operations. We expect to close the transaction by the end of 2022. Now turn with us to Page 5. As we turn to Page 5, we highlight that the quality of our portfolio, once the transaction is closed, will be significantly improved across several dimensions. First, we will be meaningfully less cyclical with 75% of our portfolio being software and the balance being medical and water products. Second, we'll have higher levels of recurring revenue with 80% of our software revenue being recurring in nature. Also, a large percentage of our product revenue is reoccurring in nature, such as Neptune's replacement demand and our medical product consumables. And third, we'll be even more asset-light, given a vastly improved working capital profile, one that generates significant cash as we grow. Finally, and worth noting, we'll have over $7 billion of M&A firepower to help further improve the quality and scale of our enterprise, exciting indeed. Next page, please. Turning to Page 6. We highlight the impact of our portfolio transformational strategy. As you'll note, in 2018, prior to our divestiture activity, nearly 40% of our portfolio is either cyclical or project-oriented. After today's transaction closes, we'll have exited these businesses entirely. So again, Roper is now 75% software and 25% medical and water products, a much higher-quality and higher-value portfolio of businesses. Next slide, please. As we turn to Page 7, we highlight for you both the higher organic growth rate and the less cyclical nature of our go-forward revenue base. Importantly, we continue to work with each of our businesses to even further improve the organic growth profile of our enterprise. As you turn to Page 8, we show you the progression of our asset-light transformation punctuated by the go-forward business having negative 18% net working capital as a percentage of revenue. This asset-light business model enables us to generate tremendous cash conversion as our businesses grow in scale. Please turn to Page 9. On this page, you will see the high-level financial profile for our go-forward enterprise. For 2022, revenues at the midpoint of our guidance range, which we've updated during the Q1 call, is approximately $5.2 billion. In addition, our go-forward enterprise will have EBITDA of roughly $2.1 billion and have EBITDA margins of approximately 40%, an impressive financial profile for sure. Not included in these numbers, and worth noting, is the scale and quality of the enterprise that will be further aided as we deploy our $7 billion plus of M&A firepower. As we turn to the final 2 slides, we remind everyone that our strategy is the same. We compound cash flow by acquiring and growing niche market-leading technology businesses. This is what we've done for over 20 years and will continue to do. In addition, as highlighted on Page 11, our value creation and governance model remains unchanged. We operate a portfolio of market-leading businesses and defensible niches. Each of our businesses has high levels of recurring revenue, strong margins and competes based on customer intimacy, which yields highly resilient organic growth rates. We operate a highly decentralized operational structure that focuses on long-term business building. Our culture sets a very high bar for performance and focuses on continually improving. We're all paid to grow, which reinforces our culture of transparency, nimbleness and humility. Finally, we redeployed the vast majority of our capital to acquire the next great business. We do this with a centralized corporate resource team in a highly disciplined and analytical manner. This strategy unchanged delivers compounded and long-term shareholder value. Now let's turn to our final page, Page 12, and get to your questions. To summarize, today, we are excited to announce the final step of our divestiture strategy, which has been focused on reducing the cyclicality and the asset intensity of our portfolio. Our go-forward portfolio is a higher organic growth rate profile, which has meaningfully less cyclicality, is higher quality given the higher levels of recurring revenue and meaningfully more asset light. Roper will be even further benefited as we deploy our $7 billion plus of available M&A firepower. And finally, we'll receive additional cash proceeds down the road as we exit our minority interest in the newly created entity, which will further help our shareholder value compounding to continue. So as we turn to your questions, we're super proud of the work our leaders and employees for these 16 businesses and excited for what the future holds. With that, let's open it up to your questions.

[Operator Instructions] The first question today comes from Allison Poliniak with Wells Fargo.

Neil, you had mentioned in the last part of your remarks, consistent Roper strategy. And I know CRI has been a big lens which you view future acquisitions. Does that approach get altered anyway, just given the asset light certainly of the current business model at this point? Just any thoughts there?

No. The concept of cash return on investment, or CRI, is how do you build a business that grows faster and higher margins with less asset intensity is what the core principles of CRI teaches us through our investment strategy and our operating discipline. So no, it's core and bedrock to what Roper is about.

And then you certainly -- you're keeping some product businesses there. You mentioned the recurring revenue. I'm assuming they're less project-oriented. Expand on why you're keeping those businesses versus divesting them as well.

Yes. So as we think about the guiding principles of what we're trying to do, right, it wasn't to eliminate product businesses. It was to eliminate cyclicality and asset intensity and along with that with TransCore for the project orientation. So as we did that, we applied those guiding principles to the portfolio, it was very clear. The software businesses are in, the medical product businesses are in, the RF Tech businesses are in, Neptune is in. And then the businesses that we've communicated over the last 3 years, we decided to go a different direction.

The next question comes from Julian Mitchell with Barclays.

Maybe just a first question around a couple of sort of financial points. One would be -- are we thinking it's around just over $2 billion in net proceeds that you'll get upfront? And then also, as we think about the sort of minority interest and the go-forward entity, just clarify maybe how much debt is being put on that new entity, please.

Yes. So it will be a $2.6 billion, of course, of proceeds upfront. On an after-tax basis, we chose the structure because it's an attractive structure. So we'd expect well over $2 billion of after-tax proceeds upfront. And then yes, it will be a levered entity. I think it's 6 to 7x debt on the new entity. And then we're certainly excited about the prospects for that and the proceeds we'll get down the road on a future exit off of our 49%.

And then just a quick follow-up. I wondered if you could give any color on the sort of the free cash flow margin of what's left, looking at those numbers on Slide 9 or the sort of EBITDA conversion into free cash at the RemainCo.

Yes. So it's been very strong, and it should be as we move forward, even stronger based on the working capital, right? You see on that slide now our net working capital is negative 18%, so that's a boost to cash conversion. So I think as we look forward, we're even better positioned. And as you know, we convert our EBITDA to free cash flow consistently at a very high level.

The next question comes from Joe Giordano with Cowen.

So kind of like on the line with like Allison's initial question, like something like Neptune, clearly a good business, but why does that fit now with the new kind of go-forward portfolio? Or is this something that you have to evaluate independently?

No. I mean, this is the final -- many messages today and one of the clear ones is this is the end of the portfolio of work that we've been embarked on over the last 3, 3.5 years. Neptune specifically, if you run through the characteristics of the business model, it's remarkably asset light. I think it's got like plus or minus $20 million of net working capital, where TransCore was a couple of hundred million, right? It's highly reoccurring. It's not contractually recurring but highly reoccurring in its orientation because of replacement meters. It's not cyclical. The behavior is that when the economy is booming, there's housing starts, the meters go there. When it slows down, it's replacement meters. So it's principally not cyclical. Its organic profile has been robust for quite some time and continues to gain share year in, year out against in the marketplace. It's a great end market. And then importantly, as you think about the Neptune strategy going forward, it's a combination of the meter reading technology but increasingly data and software about what you do with the content that comes off the meter, which plays right into the core of what Roper is about.

And then the same with the medical products businesses, right, they share all the same criteria that Neil mentioned there. They're asset-light, they've got a lot of reoccurring revenue. They've got consumables. They've got great organic growth. I mean they fit everything that Roper looks but they're in great niche markets. So that answer applies to all of our product businesses.

Cool. And then this might be more of like a moment-in-time type question, but you're selling these businesses at a good multiple, right? But it's pretty similar to what you're currently trading at, and you're probably going to be redeploying into, I would assume, software businesses that have a higher multiple to acquire. So can you kind of just talk through the kind of thought process around that?

Yes. Sure. Sorry. Sorry, talk me there for a second. If you just think about what Roper has been about for 20 years, it's been about increasing the quality of the enterprise through our capital deployment, right? It's all been about CRI, asset-light recurring revenue. And as the business has portfolio is sort of pivoted in that direction, it's a more valuable enterprise, right? And so through this, all this portfolio work, it is the remaining business and -- which will be supplemented by the $7 billion of capital deployment over time. The timetable when that gets deployed, we're going to do it the right patient way. It's just a meaningfully better, higher-quality business that, therefore, is worth more on a relative basis where we started. So that's what the strategy has been. It's unchanged and our guiding principles are that.

And just lastly, Rob, is there any opportunity to like -- I mean if a lot of M&A doesn't come up real quick, is there opportunity to kind of restructure the debt profile or anything like that with the proceeds?

Yes. Sure. So we won't receive these proceeds right until the end of the year. So we're always expecting to deploy capital. But as there are opportunities on the debt side, we'll certainly always look to do whatever is best for the shareholders.

The next question comes from Jeff Sprague with Vertical Research.

Just first, back on the tax question or tax leakage question. Rob, a little unclear what well over $2 billion means, but I guess it's $2.2 billion. Should we expect the same amount of tax leakage on the remaining pieces as they come out. Have you structured this in a way that you're kind of deferring tax liability up front, but it's more back-end loaded?

Yes. So I just -- I don't want to quantify the exact after-tax proceeds until we get the transaction closed. So certainly well over $2 billion. And then down the road, certainly, there'll be, again, great after-tax proceeds once we exit the 49%.

And just to be clear on what you're now going to report, right, on -- it sounds like you're taking the whole thing to disc ops, right, so you're raising all those earnings, but you're not giving yourself credit for the minority interest until post close. Is that right? We're taking it all out for a couple of quarters and then bringing back the 49% at the time of the close?

Yes. Yes, that's correct. But I think it will be excluded from guidance, even post close, is the way we're planning to handle it. But certainly will be reported as required by GAAP standards.

Right. But your guidance, once you close, will include minority interest, right? So we're...

No, we're planning -- so the concept -- these are -- I'll use maybe some bad accounting terms, but we're going to move these in the discontinued ops. We're going to guide to RemainCo and -- or go-forward-co, whatever, Roper without these items. And then once the transaction closes, we're reporting the minority interest, we're going to still guide and talk to the company at the same level, the RemainCo level. Obviously, in the financial statements, you'll see what's happening to the minority interest, which is not mark to market, by the way, because it's a private thing. So it will just be a slug of assets sitting there until it gets monetized. So there won't be a ton of visibility.

Earnings will flow through.

A little bit of earnings that flow through, but we're going to talk to the business and guide to it as sort of without the impact of either the discontinued ops or the minority interest.

This concludes our question-and-answer session. We will now return back to Zack Moxcey for any closing remarks.

Thank you, everyone, for joining us today. We look forward to speaking with you during our next earnings call.

The conference has now concluded. Thank you for attending today's presentation. You may now disconnect.