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

It's my pleasure to have Roper here. I think all of you know,Neil and Jason, CEO and CFO. So I think we'll have a couple of introductory comments from Neil. And then go into questions thereafter.

It's our pleasure. Thanks for having us. long commute from Sarasota to Miami, so I appreciate the proximity. So glad to be here. Just a couple of pages, just a couple of minutes. So if you are new to our story or you just be reminded about what Roper technology is all about, and [ Aceite ] our ethos is we focus on compounding cash flow by acquiring and growing niche leading technology businesses. Each one of those words are specifically chosen with emphasis on compounding these -- the and growing these leading businesses that are in small markets. If you look at the composition of our revenue, it's really evolved. Over the course of the last 3 or 4 years, we've divested about 40% of our 2018 revenues to have a portfolio that looks like this, one that is meaningfully less cyclical, One that is more recurring in nature here . You can see that $2.9 billion of revenue is recurring in nature. It is a bit more growthy, so 5 years ago, 3.5%, 4% organic growth, last couple of years in the 8% to 9% range and guide to be 5% to 6%. And our core ethos has always been about asset intensity or the lack thereof is also meaningfully a meaningfully less asset-intensive portfolio of companies. You can see here the growth rate over time and the margin structure. So we're blessed to have a business that's plus or minus $6 billion of revenue and 40% EBITDA margins, a very large percentage of that converts to free cash flow and the portfolio is comprised 75% of vertical software, application-specific vertical software businesses across a variety of end markets, legal, education, health care, construction, transportation, media entertainment, education, a lot of insurance in there and then 25% technology-enabled or medical and water products, the largest water meter business and a handful of medical product businesses. And the way that we think about creating value is we have these businesses that are the market-leading, they're in these small, highly protected end market. The end markets are growing and where every one of our 27 businesses are either #1 or #2 in their markets. So quite defensible. We compete on this notion of customer intimacy. And so as a result, we have an organizational structure that is super autonomous. So we have a very small center, about 16,000 people in the company, only 75 at the center. And we have 27 everything. We have 27 Presidents, CFOs, ERP systems, strategies, operating frameworks. But we focus at the center on helping our businesses get better over the long arc of time, as I mentioned at the onset, and we do this by helping them think about their strategy. We help them think about how to execute strategy. We help them think about how to be at high performance out of their teams and really just focus on continuous business building and improvement. And then when we have these businesses that are in good markets, they get better over time, the organic growth rate improves. We take all that cash flow, and we have this very structured systematic center-led capital deployment approach to acquire the next great business and the loop continues. And so that's us in 3.5 minutes and perhaps we can get to your questions.

Thank you, Neil, for that. And that little deck speaks to a lot of the general strengths and appeal, I think, of the company to shareholders. Here it's Moss sort of industrial and generalist audience by nature. But clearly, there's more and more tech investors looking at the company as the portfolio has and continues to change. I don't know if there's any flavor or elements you'd highlight for tech investors in particular as to why this is a vehicle that they should focus on?

Well, I'd say that the concept or the notion of vertical software is not a new thing for the tech investor, right? So as a general matter, there's horizontal software and vertical. We're a portfolio of deeply verticalized software and there's a whole cohort of that. And investors like both, but the reasons they tend to like vertical software are the things that we just talked about. It's application-specific. So we don't do ERP broadly for professional services. We do ERP for law firms. We do ERP for architects. It comes out of the box, ready to go at very little if any customization or configuration that's required. So when you have that and you're competing on agency, vertical software companies generally are certainly do have very high gross retention, like very high, mid- to high 90s gross retention. So the book of business is very predictable. The -- and it's, again, it's competing on that customer intimacy. You trade away a little bit of the hyper growth for that stability, right? So vertical software businesses as a general matter are going to be more moderate growers which we would sort of view ourselves as that, but improving in our case, really when we'll talk. I think hopefully, a little you have some questions on how we've work to improve the organic growth outlook. Also, the tech investors like to look at this notion of the rule of blank right? So we're a Rule of 45, maybe at some point, a rule of 50 companies to add your margins, your growth rate . That's Organic.

That's just organic.

And so we're very much a rule of 45 business. And then I think the thing that we're most excited to tell that to the tech investor is most tech capital deployment, not all, but most is bespoke. There's not a software compounder. Like in the industrial setting, you have the whole lineage of old school GM, Danaher, Fortive, iDeCK, MTech. Roper about compounding models, that doesn't really exist in any meaningful way in the software landscape. So software business models are mostly blessed with the ability to generate a ton of cash flow, but then they don't have a great use for it. We have this go-to-market motion around capital deployment that is an enhancer to the TSR algorithm.

That's very helpful. And then just as a quick aside, this version didn't reflect it, but Jason, obviously, to had a recent promotion. So congratulations on that Chief Financial Officer. Change in another version but there we are. On the -- Getting back to the here and now. So there is that IT and software focus at the company now more than ever before. There are a lot of questions in general for a year now about the IT spending environment, very well-publicized headcount reductions of some large IT companies software and hardware. How would you characterize that IT spending environment and fully understand that your sort of niche focused rather than sort of generic systems?

So I'll explain it relative to Roper in our collection businesses, which is bespoke to us, right? So first, the whole point of our portfolio strategy is to work the cyclicality out of the portfolio. So we're in these end markets, I alluded to at the beginning, health care, legal, insurance, both property [ catal ] and life government contracting, On the name a few, you get the sense they're pretty stable through cycle end markets. So the customers are quite resilient. What we do for them is required -- our software is required to run their business. So we're not a discretionary spend on the edge, if you will, their IT ecosystem, we're the center of it. So as a result, our retention rate we expect to stay very, very high. Also, we tend to price based on a fixed subscription, not a transaction or volume-based model. There's a very small amount of that in our -- you saw in the revenue buildup slide. So even to the extent that our customers felt a little bit of cyclicality in their end markets, then our pricing model buffers that as a general matter. And so I just want to give you the characteristics of the way -- what we do and how we charge for what we do. The last couple of years, we grew sort of in the 8% to 9% range. Obviously, we've guided a little bit below that. So we do expect there to be a little bit of spending headwinds. Again, we don't expect it in any meaningful way to show up in retention. We expect it to show up a little bit in net new. So just a little bit more cautious IT spending. If you're unsure customers are unsure what the next 12 months look like, it's generally not when you're going to lay a lot of investment down. So a little bit of slowness there. And then also if the customers aren't expanding or growing themselves and we won't have the expansions or the cross-sell that happens as a result of that. So that would be the general reconciliation, if you will, between 8% or 9% growth and 5% to 6%...

Just DAT, right? We had a run-up in the freight match business for the last 3 or 4 years just with the adoption and some of the pricing and packaging we've done, I think that latter the pricing attaching will hold up, but the carriers have come out of the market a bit. So we saw a little bit of contraction in the fourth quarter. We're not expecting dramatic improvement in 2023. So that's the other piece.

Perfect. And Neil, you mentioned the sort of the broader efforts since you became CEO to drive up organic growth and make that more of a focus through the company? Maybe help us understand the progress on that front? How is your own way of trying to drive up organic growth. How has that changed as well, if at all, since you became CEO.

Sure. I've been CEO 4.5 years or so, and it was we first talked, it's like what are you going to do different than your predecessor? And it was really this notion of having been an operating person in the company for many years before, just seeing an all-you-can-eat a pay of opportunity relative to growth, right, and just not sort of trying to go grab it. So is this latent sort of value driver. And so we spent a lot of time organizing about how do we do it. We wanted to honor the autonomous structure but then have support from the center to be able to help our companies think about growth. And we're also cautious about, hey, we're talking about it, but we got -- we're going to see not some time to see if it proves out. Unfortunately, Covid got in the way of that. So we don't have perfectly clean visibility, but we feel very, very good about where we are, right? So 5 years ago, it was a 3.5% to 4% organic growth portfolio. If we said a couple of times 8%, 9% in the last couple of years in a down market, it's -- and we anticipate this year 5% or 6%. So we believe we have structurally improved the organic growth rate of the business by a little bit. And we still are still chipping away at it. We still think there's very much opportunity to continue to improve that. This portfolio be can the markets and the protective nature of the markets and what we do is not going to be a 15% organic growth portfolio, but very much can be a high single-digit organic growth portfolio. We're not there yet, but we're working at it and see a pathway to get there. And the way we do it is we're not -- this is not growth at all cost. Our margins have pretty most part, been flattish as we've improved the growth rate. So we've done it and translated to growth to margin to cash flow, and that's super important. We're not trying to create a revenue growth algorithm that doesn't translate to cash flow. I mean it is all about how do we increase the TSR compounding for our shareholders and translating and finding good growth in the right areas and adding to the TSR compounding.

Understood. And you mentioned the sort of 27 or so business units. When you look across all of that range, which are the ones that you might say Roper has enhanced the most in recent years in terms of organic growth or EBITDA margin profile?

Yes, we could -- I can almost ask you to pick a name out of a hat. I don't think I'm cherry picking, but I'll name a few. First of all,Yes, we could -- I can almost ask you to pick a name out of the hat. I don't think I'm cherry picking, but I'll name a few. First of all, when we sat in the room 5 years ago and said we're thinking about, we want to try to drive organic growth. How are we going to do it? We sort of looked at 2 distinctly different ways. Are we going to look at the portfolio and say there's 5 companies that possess the most potential and focus all the resources there? Are we going to do all tide lifts all boats and sort of work on structural systematic governance-related things. We very much chose the latter the second. So what I'm about to describe with a couple of incidents, a couple of examples is very much the case across 27 of our companies. I'll highlight a couple. The first and perhaps best is a medical product business that we have called Verathon Medical. They make ultrasound for bladder volume measurement, but then also intubation devices, small cameras on the end of a device to help anesthesiologists intubate. We bought this business in the 2009 time frame, a founder transition for a few years. It was very much a low single-digit organic growth business that was launching a product every 2 or 3 years. Today, that business is a low double-digit organic growth business. It's launching 3 plus new products a year. It's not just product extensions across those 2 franchises, but it's a third franchise around single-use bronchoscope where it gone from 0 market share 5 years ago to #2 in the U.S., we anticipate to be #1 in the U.S. this year in market share. And then it's about this product engine that is now super capable of creating and inventing and launching new products. And there's more, obviously, that are coming behind that, that we're excited about. So that's an example. Neptune, the conference here, I mean, it's our water meter business, it's been remarkable, where every year, we chip away and gain a bit of market share. And the evolution of that has been a little bit different. The current evolution is we've just been terrific on the product and the metering technology itself going from mechanical to ultrasonic and the team having the processes in place to invent an ultrasonic measuring technology that is precise at high and low flow rates, which is very, very hard to do. And for the most part, the competition has to calibrate to one end of the spectrum and or calibrate across the entire spectrum. But then it's -- then how do you get the meter bill -- the data off the meter. We've evolved from our proprietary protocols to cellular. And then when you have all this data that's not flowing off the meter, what do you do with it? So we have the software capability built in resonance of Neptune to capture and manage that data so you can turn it into cash flow at the utility. And as a result, that business was low single-digit growth, and now it's every bit of mid, maybe higher, right? So it's just -- and it is -- the result of that is just they do well with the market growth, but they're -- every year for a decade, they've chipped away market share and gained it. And we can go on and on, but I'll stop with those 2. I could give you some softer examples if you want to do that. But it's about the ability for us to build the businesses and build repeatable capabilities that then pay the dividend over a long arc of time. It's not can we launch a product and spike up growth for a couple of years and be like, oh, what? It's about systematic capability building.

That's helpful. And going -- or sticking with that point on organic growth and I guess looking at it differently in terms of how the costs of driving for that on something like R&D spend as an example. I know when there say, spinouts or transformations of industrial companies into a different field software or health care or tech, the sort of incumbent investors in that other market tend to be very skeptical.They always think of these assets from the industrial background, they undergo. There's been no investment. They're going to struggle to succeed it. Neither to say that view is wrong most of the time. But in Roper's case, how do you deal with that question mark around do they invest enough organically in R&D how do they ensure that they're getting a good return on the R&D dollars that they're spending?

Sure. So I'd start with a foundational element to our culture and our enterprise which is we pay all of our operators to grow organically. And I can't overemphasize the importance of that notion. We don't pay people to achieve a budget, we pay people to grow. And as they increase their growth rate, we do not move the goalpost on the growth. So if a company is -- starts earning at 5% growth and has Maximum sort of full potential earnings at 10%, and they inflect their growth rate they're growing 12%, and they're in overdrive into perpetuity, right? And there's no caps on the cash compensation side of our enterprise. So as an operator in our business, your incentive is to figure out how to drive EBITDA and cash flow growth in the business over a long arc of time and sustain it. And so if you're Amy or Earl or any of our operators running our businesses, you're like, how do I do that? And it's a deal matter to go to market motion or product motion, and if you -- if we're going through our strategy work or annual operating work and we need to invest more in R&D, and it's going to pay off in the future, then we're going to certainly underwrite that. For the most part, that's not what has to happen. Structurally our application software businesses are in the mid-teens. R&D as a percent of revenue. Our network businesses are sort of in the 10-ish percent range. That reflects the intensity of the code base. when you're building software that enterprises run on ERP software, it's just more intensive code. When you're building software to organize a network like DAT or a data informatics business like ConstructConnect, just the intensity of the code base is lower. So the investment required is less. But in some instances, like DAT, we see an opportunity to really unlock a ton of growth. We increased the R&D as a percent of that company from high single digits to low teens over the last 2 or 3 years because there's an opportunity. But for the most part, structurally, we feel that we're investing at the right level. And the final thing I'd say is the first look when we do think we need to do something better is around choice. So it's not about layering on the next 2 things. It's like, can we make a choice to stop doing something to then start doing something, right? We really lay in the notion of strategic choice. And so very rarely can you stop doing something to then fund something that's more important, and then obviously a productivity lock. I mean we are far from optimal in terms of how productive R&D capability is. Just like lean manufacturing, there's lean principles that are applied to get more lines of code developed and that certainly pervasive to our culture. Jason, you want to add that?

The only thing I'd add is that our presidents are primarily builders. They're not PE transactors. So our selection process sort of offsets any risk that they're going to underinvest in the business. And so -- and they're there for the long arc, so they're going to make those trade-offs and make the investments that are needed to sustain long-term growth.

Perfect. And just on the near term, the sort of the organic growth outlook, I think that the sort of nonrecurring software is just over 10% of the business, grew mid-single digits last year. What are you sort of dialing in for this year? Again, you're very cognizant that maybe some caution might be warranted for the macro. So maybe just honing on that nonrecurring piece -- and also, Jason, you mentioned the carrier and freight matching elements in network. How is that playing out? What's expected for '23 there specifically?.

Sure. So I'll start with nonrecurring. So about 2/3 of the revenue is service related. So a lot of that is either in backlog if we have commitments for the customer to execute on that. So that should grow in sort of the mid-singles for this year, which is consistent with history. When you get to the perpetual revenue, which is about 1/3 that what we're seeing, as we talked about earlier, just a little bit of slowing in the macro. That's one part of it. We talked about Deltek and GovCon. We expect some recovery out of time this year. And then just broadly, we have companies going -- our customers going to the cloud. So you're getting more uplift in SaaS and subscription than you would in perpetual license. So that's probably going to be down a little bit. So net-net, I would say, sort of low singles to flat for the nonrecurring business. And then on DAT, I think we talked about -- I alluded to sort of what the prevailing market says, which is going to be a recovery in the freight market in the spring time. That's certainly what DAT thinks. January looked a little bit better than that. So we're encouraged by that. But it's still early days. And so we'll see how things play out. We're definitely taking a more cautious view on VAT until we see it play out.

And just one, just to emphasize one point, we have, as we showed on that revenue build up about $900 million of on-premise maintenance -- and is that shifting to the cloud, that's going to lift the shift at 2 to 2.5x that base. So there's a billion plus revenue, latent revenue driver inside the organization that will manifest over a decade. And we're going at our customers pacing, as we've talked about, versus forcing it. So that's the good news, as Jason alluded to, as that migrates then the perpetual essentially go to 0, right? So the couple of hundred million of perpetual will go to 0. But that on balance as that happens, it's a meaningful net growth driver for the organization both on revenue and cash flow.

Got it. And you mentioned, Neil, the sort of focus on growth that's profitable, so margins are stable. So should we think about that growth algorithm as being mid-single digit to high single organic. The few points of acquired revenue growth on top then sort of flattish margin within that just as you bring new businesses in and keep reinvesting? Is that...

I would characterize it slightly different. So we feel from the organic piece, we feel the organic sort of cash flow, there's going to be a little bit of margin expansion over time, maybe incrementals in the 45% range over time versus the fleet of 40%, the margin of 40% on EBITDA -- and so that's going to sort of be very solidly high single-digit organic cash flow. And then when you look at the amount of capital we have to deploy and the way we do it, the type of assets, the improvement we've had with the businesses we're very, very comfortable and confident in the mid-teens cash flow compounding is how we would sort of orient to that question.

Helpful. And on the sort of the acquisition front, last year was an extremely challenging year for sort of global M&A in general and overall activity. What are you seeing this year to date, again, it's 7 weeks in, so probably not a huge change. But are you seeing more things bubbling up or no, it feels tough and so getting deals of size done is not going to be easy.

So if I may, just on '22, we feel terrific about '22. It was a hard environment, and we got $4 billion deployed with frontline plus 5 bolt-ons. -- and we feel fantastic about that cohort, both the quality of cohort, the value of the cohort, the growth potential, it's Roper asking in every sense. So we feel great in a very difficult environment, being able to get to $4 billion deployed on the back of all of the portfolio restructuring work that we did. The good news is that we -- I mean, it's -- we're still relatively small amount of capital we have to deploy $3 billion or $4 billion a year. It's not tens of billions a year against a backdrop of hundreds and hundreds of billions of tech deals that happen every year, right? So we're still have very large pool to fish in, which allows us to be patient and opportunistic. To your point about how this year is, it is early. I think we're talking about it yesterday. And on Monday, I would say in our Monday morning, Monday meetings about capital deployment. Feels like there might be like ever so slightly a little bit of falling, a little bit of realization around where asset prices really are, but our belief for this year is it's going to continue to be difficult because the dislocation between cost of capital and asset prices, especially in the private markets. But those will come in line at some point either capital asset prices will come down or cost of capital will go down based on what the Fed is doing. And we will continue to be super patient, but super opportunistic. I mean, the reason we're able to do front line, there are very bespoke reasons for the seller at that moment, and we could strike a deal that made sense from a value point of view. And we're super active. There's lots of activity in the market. The question is, they'll be deals that get made. And that's where I think there'll be fewer handshakes. 3 years ago, every deal in the market got done. Now every day in the market is not going to get done. It's going to be a much smaller percentage because of the bid-ask spread. Yes.

And when we think about sort of overall financial returns from future M&A at the company and maybe talk a little bit about the expected returns on the deals you enacted last year, kind of what should investors expect?

Yes. So our -- Julian, as you know, and our investors certainly appreciate our central guiding North Star -- Northern Star of value creation is a notional cash return on investment right? This notion of asset intensity goes down and you don't have all the calls on capital and therefore, there's more capital and cash flow available to the shareholders and that describes the higher value. We're going to show a page in our Investor Day in a month or so that shows that correlation. And so that continues to be our North Star. The -- but as we have built the capability over the last 5 years to improve the organic growth rate, improve the operational capabilities of our existing portfolio, that certainly translates to the way we think about getting even better returns for our capital deployment. And so we're excited about -- we've got a great track record of doing it and then now an option to have better returns going forward.

Perfect. And then I think lastly, on the questions before the audience response survey. The recurring revenue piece is obviously the bulk of the company's cash flow and revenue now. What's the kind of -- what are you driving for long-term growth for recurring revenue? And what are we thinking about that for this year?

Do you want to take a crack at that?

Yes. I mean, I think it's pretty consistent with our overall enterprise organic growth as we become more recurring even in our segment. We've got a lot of reoccurring business through Verathon, and you can argue a big piece of Neptune is reoccurring just because of the replacement cycle. So I'd say it's in line, especially as we go more to the cloud, there'll be less perpetual, less nonrecurring kind of comes in and out.

Perfect. And lastly, Industrial, I realize you don't have much of it, and we don't sort of see it really anymore in that the financials. What's the sort of paths or timing on monetization of the stake you retained?

Yes. So it's -- for those, we package up 16 of our industrial businesses and sold 51% the CD&R. The company has been named Indicor. The -- think of it as like -- so our partner, CD&R, they make money for their limited's by growing businesses and then getting liquidity in a 3- to 5-year period. We obviously have to work through a cycle. It's probably a public offering for the business. We've got a lot of stuff we have to do at the company level and the Board to sort of create a company that's that has the basis for being the next great industrial compounder. But think of it as a -- they underwrite the 3x plus money-on-money return. So that's sort of where we're headed at. So 3 to 5 years, maybe there's $2 billion or $3 billion plus or minus that will fall in our laps. We'll go to deploy that to buy the next great River company.

And then, yes, let's switch please to the audience response survey. The first question with the gray boxes. You currently own the stock. And for context, we normally get about 60%,70% -- 60% no as a typical response. More true believers in this audience and others. Secondly, general bias towards the stock right now?

You want to predict that one too?

Should be positive based on the first...

Can we vote?

Sure. Thirdly, this one is around through-cycle earnings growth. Now the peer set is obviously in flux to a degree, but this conference is U.S. industrial, if you like, would be the peer set rightly or wrongly to think about -- should be above consistent with history and the future. The next question, this one for Roper maybe less -- yes, it should be between 1 and 2. More clearly...

I guess there's a fine line between predicting and biasing, right?

On next question. And I'll be quiet. So is the question on what he should roper say that. 20x plus. And then the penultimate question next is around sort of what are the main reasons why more people don't own the stock or I think it should be 20x, not 30x, this kind of.

The count down stopped, okay, there you go.

So organic growth, the biggest question. And then lastly, I think is a question around ESG, a new question this year we'll see how the results look...

We appreciate the last question because we're allocating about 2/3 of Investor Day to the organic growth. So that's helpful. So...

There you go, That's worth Consistent with the other companies. So Neil and Jason . Thank you so much for being here.

Thank you.