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

We have the Roper team with us. Neil and Jason are both with us, Zack as well in the front row, running IR. Gentlemen, thanks for joining. And Neil, if you can just maybe bring us up to speed on the story, kind of at a high level, top priors for this year, maybe for those that don't know the story as well, give us just a quick commercial on why you guys have been so successful and how the strategy is continuing to evolve.

Yes. Thanks for having us. It's great to be out here on the West Coast. So very briefly at Roper, we just brought a couple of slides. We're focused on cash flow growth, compounding cash flow and we do it 2 ways. We operate a portfolio of 27 technology and software companies, and we grow that business organically mid-single digit plus with operating leverage in the 45% plus or minus range. So you sort of see organic cash flow growth in the high single digits. And then we take all of the free cash flow for the businesses and put investment-grade leverage on that and then run a very disciplined process led acquisition strategy that gives us year in, year out, mid-teens cash flow compounding. So we're focused on the compounding of the cash flow. From a scale business, we're a $6 billion business, plus or minus $50 billion market cap, grow our revenue double digits, a solid Rule of 40 company, 75% of our business is vertical software, 25% is verticalized technology-enabled products. As you can see from our revenue breakdown here, this is last year's revenue, $6 billion is the midpoint of our guidance range for this year. Last year it was $5.4 billion. You can see the $4 billion of vertical software, $2.9 million of that is recurring, and of the $2.9 billion, $2.1 million is SaaS subscription and balance being on-premise maintenance that is over a long arc of time, a decade or so from now over the next decade or so rolling into the cloud and becoming SaaS as well. And then we -- the flywheel that we have is very simple. We have these market-leading businesses. While they're all in very different end markets. They're all very similar in there. Small markets, they're leaders, they compete on intimacy. What we do is deeply verticalized and specific and tuned for that end market. We then have an operating environment where they're wildly decentralized. We are -- since we compete on intimacy, we have to enable our 27 businesses to compete very nimbly with -- in the markets. So we have 27 presidents, 27 CFOs, 27 R&D strategies, we have 27 ERPs. And at the center, we have a series of coaches that help improve these businesses over a long arc of time. And then finally, to round out the flywheel we take all the free cash flow in the enterprise and deploy it very centrally from the center. You're looking at Jason and myself for 2 of the 4 or 5 of us that are the M&A team, if you will, it's in our job description as executives to deploy the capital. And when you put all that together, we're at mid-teens, very consistent mid-teens cash flow compounder over a long arc of time. We've done that for the last 20 years and have a model to continue to do it for the next 20. So that's a quick overview and delighted to get into your questions.

The secret sauce, everyone barbecue's but why is yours the better?

Well, having a -- you talk about barbecue, so I can give you stories about bad barbecue at home. But the -- I think there's many elements of what makes Roper special. I think the first is the fact that we allow our businesses to operate and compete locally against their competition. We provide them incentive to grow. And this is -- so most companies provide incentives to meet a budget or plan. Ours is growth-based. And when you do that, you have an environment where there's complete transparency about what's going on. There's no gamesmanship. We don't give them incentive and our companies in the center of the light to us, and we don't have a filter where we don't believe anything they say. So our culture is based on this in this vulnerability-based trust, this -- and bad news travels much faster than good news. So we just get to work on problems and get to root cause. That's part of it. The other part of it is that from a capital deployment point of view, one of the most liberating things that Jason and myself and the team get to do is we're not tied to an end market. And I know that's different from a lot of companies at this conference and many of the companies that are out there, but allows us enormous patience and discipline because we're not trying to be the greatest fill-in-the-blank company, type of company or end market-driven company. And so there might be an attractive asset. It might be bidding at a price. It's not that gets too high for us, and we're perfectly fine to move on to the next one. So there's so much discipline on our capital deployment approach because of the end market sort of indifference. So we like solid healthy end markets, but we're in media entertainment, we're in health care and utilities, insurance, to name a few. Anything you want to add to that?

Yes. The only thing I'd add is just the, I'd say, the culture at the corporate office is that we show a lot of [ restraint ] to get involved in the businesses. So there's areas where we want to help them improve, but we kind of go at their pace and just try to push them to do better. And so the type of people we hire are just got to have that fabric of allowing the businesses to thrive on their own but also finding opportunities to help them grow. And that's -- it's kind of -- it's more of an art that's been built over years.

And just to put that in perspective, we have 16,000 employees, 75 are at the center, right? So it's a very, very thin center intentionally by design.

The current M&A environment, it seems like a lot of companies we work with wanted to go faster. They haven't because the private sellers have been reluctant because they think the valuations are coming back, then they didn't come back. Now it seems like they're coming back. Like we're in this kind of weird spot, a lot of different crosswinds. How would you characterize the overall environment right now?

Yes. It's certainly for the last 3 or so quarters has been very, very slow. Again, the type of assets that we're investing and owning are the more mature on the spectrum, right? These are well-established businesses that have wonderful cash generation. So they have the benefit of the owners, the private equity owners have the benefit of just being patient. You don't have to do a raise to fund operations or do a down round, if you're earlier in the life cycle. It's starting to maybe thaw a little bit in the context that there's more processes that are in flight are initiating right now. I'm not so sure, like in the past, every process that started, everyone finished. That's certainly not going to be the case right now because I think the sellers are going to test to see if they can hit reserve prices. So I wouldn't expect 100% completion rate. Personally, I don't think that the market gets meaningfully improved until the Fed starts rolling over at lowering rates. So that's another, whatever, 9 or 12 months away at best. That's sort of market overlay. What our pattern recognition very clearly says, though, is in times of market uncertainty disruption, there will be opportunities that present themselves -- themselves on a bespoke basis. It happened in 2016 for us. It happened in 2020. We did our largest ever acquisition in August of 2020 when we were super comfortable with our cash flow capability and stability of our company, our investment-grade leverage and we're able to buy a terrific business for $5.5 billion when nobody else was in the market. Last year, it happened with our education business frontline, there's an opportunity. So we don't know exactly how it's going to present itself, but we're confident that it will in -- over the course of the future period.

You have a few billion to put to work, it sounds like?

We do. I mean this -- $4 billion is what's available at the moment based on our current leverage level, revolver, cash we'll generate for a balance of the year. But the model in this page here, the M&A motion is a $3 billion to $4 billion a year deployment. This year and year out based on our internal cash flow generation capability.

We had this chat earlier at coffee, and it's the #1 question we get is on AI. And everyone says, okay, if you're deploying today, you're having to make a pretty solid bet that these companies don't get disrupted by AI when IBM and all these companies are laying people off, because they think, AI can replace. What insulates you from AI? What gives you a tailwind from AI? Like talk through what -- where you're on the journey and what makes you different in this move?

Sure. It's -- I believe, and I think there's been a lot of research of recent since it's been like the thing to talk about for the last couple of months. It's clear to us, I mean -- well, I think -- let's step back. I think everybody would agree that all AI for it to be effective needs context, its needs training, it needs context. I think we can probably take that as like a given at this stage. And so what provides the best context is you have to be verticalized in what you do, right? So professional services automation just generally applied to any market is not particularly exciting. How do you use AI or generative AI to help the legal billing process that is unique and bespoke to the legal market, which we can get in, so we're going to spend 30 minutes just talking about that and how we actually take all these remarkably complicated billing rules and put them at the point of time entry or even do use AI to do time entry for the fee earner itself. Those are things that the context of that is why I think we're generally well-positioned. Like every other company, I'm super excited about the productivity that we'll get. Not just the easy ones like copilot or whatever it may be for R&D, but the productivity, any static algorithm you have in your business, if you can make it a dynamic algorithm, a learning algorithm, like how do you do lead scoring, lead generation, how do you route the leads to the best salesperson, how do you do all that? That becomes a learning loop and iterative through machine learning or generative or AI, it will be a productivity explosion. So we're thinking about how to deploy across all the workflows inside the company to drive productivity as well.

And is it -- this is my assumption not yours, but vertically aligned software in a particular industry with a business process and workflows seems more insulated to me than horizontal software.

We believe fundamentally that the verticalized nature is what provides context and therefore, provides the isolation -- or protection.

We get the question too, when you have 27 different operating units, they're not on a standard stack and they're taking their own thing. Is there -- is there a way to enforce, hey, here's a standard stack we can work with XYZ hyperscaler, we can work with this application provider. We can -- is there an opportunity here or you're just saying, hey, like, no, we -- this is not -- this isn't part of our playbook?

So it is only kind of our playbook. And let me just take a minute to explain. It is super important in our culture. I would submit for any culture that you have clear accountability for poor performance. We give resource allocation decision rights to our operating teams, to our presidents and their teams. We also have a complete accountability. In our case, there's 27 P&Ls and balance sheets. There's not $1 allocated from corporate into any of those P&Ls above EBITDA. So there's no place to hide. And so when it comes to decisions on which hyperscaler to use or which tech stack or which AI algorithm, we're not going to mandate that, because soon as we mandate a thing, then we've all of a sudden just pulled away the accountability and the transparency for result -- and accountability for results. Now that said, the way we balance this is we have 4 group -- we have coaches for our group executives. They have portfolios of 6 to 8 businesses each. They're just like your clients here, there's tons of pattern recognition in our business. These are coaches. We'll explain and will teach and will urge and will socratically sort of teach methods to what we think good looks like or great looks like. And then our business leaders, one of their characteristics that we hire for is they're just voracious learners and their competitors. And so they want to learn and they want to sort of get ahead. And so it's a nice way to sort of have complete and total accountability and authority at the local level, but then also teach and promulgate new ideas.

I just -- I would add that we do have some centralized contracts where it's obvious, right, for cloud providers. But we went to all 3 large cloud providers to give the company's option, so they didn't look like we were steering their decision-making. So we will do it in certain spend categories, but it's only at the sort of the businesses have to subscribe to whatever provider they're using.

You spent the last few years removing cyclicality out of the portfolio and most are nonfocus on markets like health care, education, utilities. Can you talk to how that's playing out?

Yes. So we -- our -- 40% of our 2018 revenues we've divested, but then basically from over the course of 2020 -- between 2019 to 2020, in the last year, Thanksgiving last year. The driving force behind that was to beat the cyclicality out of our business. We grew up as an industrial company, which had pumps and valves and exposure to energy markets and global industrial DP and auto. And so it was a small part of our [indiscernible] revenue, but it was highly, highly cyclical, and it made it hard for investors to understand, and it was somewhat hard for us to plan the business inside. And so our guiding force was to divest all that. We completed that over the course of 4 or 5 transactions. And so we're essentially cyclical free at this moment, because of what -- not only is there end markets that are customer we serve, our customers serve, but also our pricing model, everything we do is the mission-critical thing for our customers. So it's going to be the last thing that's turned off before a customer goes out of business, and we generally have subscription pricing versus transactions. There's layers to sort of protect the cyclicality. There are other benefits, by the way, we're now a higher growth. We have high recurring revenue or more asset light. And so we generate more cash flow as a result. But those are byproducts focused on beating the cyclicality out of the portfolio.

On education, what's the long-term vision of that portfolio?