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

Okay. Welcome, everyone, to day 3, the final day of Citi's Global TMT Conference. We, of course, save the best for last. We have the team from Roper here, Neil and Jason. Welcome.

Thanks.

Thanks for having us. Yes.

Maybe just to start, Roper is a company that has undergone several evolutions in its history. If you could just walk us through the high-level journey for anyone kind of newer to the story and then where the business is today and how you think about setting up for the next phase.

Thanks for having us, and thanks for the opportunity to just go through a little bit of the transformation of the enterprise. Most may not know this, but we grew up as an industrial business, right? And so Jason joined 20 years ago, I joined 15. We're 75%, 80% industrial pumps and valves then. But -- and then we closed that chapter really in 2022. We divested all those businesses, about 40% of our enterprise revenue-wise. We divested those businesses and went full towards vertical market software and technology-enabled products that were not cyclical. The history, though, between sort of the old and the new is there's still a lot of common components. In Industrial days to the current portfolio, it's been we like leaders in small markets where there's strong product market fit, high gross margins. So we compete on customer intimacy, a tremendous amount of asset efficiency, so high cash flow generative assets. So those have been consistent between the 2 chapters. Once we divested the industrial businesses, then it really became about growth. And so we've been on this growth transformation about leadership, growth mindset, the assets in the portfolio, the enablement of growth. We can get into that later. I'm sure you'll have some questions. And then obviously, a couple of years ago, it's another transformation to become AI native in everything we do. And so it's been the one constant for the last decade or so in Roper has been this pace of change. We've come very comfortable with it. But there -- again, there's this steady but through line of the portfolio, leaders, small markets, customer intimacy, high gross margin, high gross retention, compete on intimacy. The enterprise today is about $8.5 billion of revenue, 40% EBITDA margins, 30-ish percent free cash flow margins. We then take all that cash flow that the 29 business units generate, then we bring it to the center and we deploy it on the next best idea, whether it's a new acquisition, tuck-in or platform or the buyback. And taken together, it's a mid-teens cash flow per share compounding sort of low range of outcome enterprise. And we go to work every day to sort of turn that into a high teens. We're not there yet consistently, but we're working to make the double rate every 4 years versus every 5.

Great. And I think that's a great overview. When I think about the Roper model, decentralization is one of the first things that comes to mind. It's been one of the core defining characteristics of the business. And yet as you kind of alluded to, there's been a lot of work under the hood of developing these kind of shared infrastructure that these different portfolio businesses can lean on. You already kind of alluded to some of these pieces, but maybe you could talk about that journey of the development under the hood, kind of how you still think about this decentralized approach versus how you're kind of supporting these businesses from the center.

Sure. So first, just the context for why decentralization. So as I've said now twice, the portfolio construct is we're the largest player in a small market which means, by definition, all of our competitors are smaller, right? It's a common thing they all have, which means probably they're able to execute at a fast, nimble pace. So to match the pace of the competitive environment in which we compete, we need to be highly nimble and fast in execution and a huge byproduct of being decentralized is we have massive amounts of accountability, like ownership, entrepreneurial-based accountability. So we match the portfolio construct and the competitive environment with the organizational structure. So we're deeply committed to it. About 20,000 people in the company, and there's about 130-ish at the corporate center, right, to give you a sense of the scale of this. Now at the same time, we have 29 businesses that while the end markets are very different, the business model is remarkably similar. So there's tons of pattern recognition on what the best practices are in terms of how to build a business that is very effective in improving its organic growth rate over the arc of time. How do you do strategy well? How do you run a talent offense? How do you run a structured operating environment? How do you build it on principles of continuous improvement? How do you become AI native in everything you do? How do you drive faster product velocity, commercial excellence. And so this growth system is something that we sort of put together over the arc of time, and it's very much the combination of the and. How do you lean into this decentralized local accountability, highly autonomous structure, but then avail all these sort of best practices of the portfolio to these leaders so they can be most effective in the way they operate their business.

Got it. One of the pieces here you referenced was talent offense. I think that's maybe, I would argue, one of the more underappreciated parts of the Roper journey over the last few years. If you could just talk about maybe some of the more specific impactful recent hires as you see it and then more generally, kind of the infrastructure of identifying and developing and placing leadership.

So we have been working on this for a long time for a decade. I mean, 8 or 9 years, we've sort of introduced the concept of a town offense to our business units. We have a lot of admiration for a company called Stryker. It's a medical products business, like a remarkable business and a lot of their success is built on their town offense, and we best benchmark that, worked with their -- understood from their CEO and their teams what they do and brought a lot of the core principles to what we do. And I will say that like most things in business, this is not like a particularly novel idea, but the execution or the brilliance or the good things that come from it accrue because you're consistently applying the principles with a great -- a high degree of rigor. And so we've done this in all 29 businesses runs a talent offense is focused on employee engagement, employee selection, employee development. At the leader level and the employee base, there's management routines around this. I think every business twice a year, 4 to 6 hours is a deep talent review where they're making commitments across all these dimensions. We've seen the enterprise engagement score as measured by Gallup across the enterprise go from like the mid-50s to the mid-70s over this period of time. So becoming a truly top quartile in terms of employee engagement and sort of what you get the discretionary effort. And so this has been like a consistent thing. Now when we see these things happen, better selection that's objective, better engagement, better development of the high potential talent, you see a very clear corresponding increase in business results in the business. And so you see employee attrition go down. You see product velocity go up, you see commercial excellence go up, you ultimately see growth go up. This is very clear connection. But it takes time. There's no like silver bullet. This just takes the grinding effort of building sort of a true sort of talent DNA in the business. On top of that, when we said in the second transition or transformation here going from the industrial business to a more growth-oriented software business, we've had to re sort of think what a growth-oriented leader looks like inside the business. And so we're very behavioral-based. We hire leaders that are competitive, intensely competitive, curious learners that love to build that can connect the long term to what every person organization does tomorrow. And so we hire on these attributes, and we get this intense growth mindset at our leader level, that then sort of sets into their organizations. And so it's -- you can have a growth system and all the best practice sharing, but if you don't have a growth-oriented leader, it's for not. And so when we look at our portfolio of leaders, it's substantially more growth-oriented today than 6 or 7 years ago. We're seeing more internal promotions from leader from CEO to CEO. I think 4 of the last 6 or 7 CEO promotions or hires have been internal. And then finally, on a talent perspective, we've supplemented from an AI perspective, a tremendous team of about 30 people that then is an accelerator team that's now working with our technical teams across our portfolio to sort of go faster. So yes, talent is a huge focus for us. Anything you want to add to that? I covered a -- okay.

Okay. Great. Yes. Maybe we can segue there into that AI centralized resources and the team that you've developed there, the accelerator team. Maybe if you could just talk about the components of the value that they're delivering to the portfolio of businesses? How far does that extend? And what do you see as kind of the long-term vision?

Do you want to start?

Sure. Yes, I can start. So we've hired around 30 folks. We started with 2 last October. So it's been a -- I'd say, successful. So they're -- the model is they're either going to be -- it's kind of a continuum of providing consultative support all the way to like working shoulder to shoulder with our technical teams, as Neil said. And really, it is the businesses are serving up all their ideas around agentic workflow that can be agentified and then our teams are helping to actually help build their teaching and then helping to build. And then the goal is for them after they've teached and they've built to then dismount and go to the next company. So that's really the process. And I would say, so far, it's gone really well. You're always going to skin your knees a couple of times with maybe some folks in the business that maybe don't work at the same speed as this team. But what you're also seeing is there's others in the organizations that have raised their hand and say, I want to be part of this, right? I want to be part of this next wave of development. So they're working at sort of 10x in terms of agentic development of code, and that's also been an accelerator across the portfolio.

I think there's clearly an opportunity there on the product development side. I'm curious now it seems like the main or an increasing focus is the commercialization side. Is there a component of that centralized resource today or maybe in the future that can help your businesses kind of come up the curve on that piece of it?

So the short answer is yes. Are we equipped to do it today? No, right? So it's been about -- what we've added to the central sort of kit, if you will, in the last 12 to 18 months is a true point of view on product velocity, like organizationally, how do you drive faster product velocity. This is more than just using the models. It's like the whole organizational design approach, team structure, what they focus on proximity to the customer. So product velocity that obviously the enablement of the agentic use cases with the Center team. We're going through a massive amount of commercial learnings right now. Now that we have products, agentic products that are hitting the market across 13 to 15 -- 12 to 15 of our 21 software companies. Now we're starting to see the patterns emerge about how do you sell, how do you price, how do you deploy? How do you drive utilization? And we very much could envision in the growth system, if you will, a commercial excellence function or capability. I don't want to overstate it. I mean these are like 1 or 2 or 3 people. These are like calling best practices and then teaching them. It's not like they're doing it. But yes, we could definitely see commercial excellence as part of the kit.

Got it. When you think about -- there's been a few notable successes in the portfolio businesses in terms of development starting to come up the curve and on the commercial side, seeing some notable impacts. When you think about how to broaden that across the portfolio, how that journey has gone, what kind of comes to mind in terms of maybe patterns where you're seeing more and less success and how to kind of bring the medium company up more quickly?

Just to make sure we answer the exact question. On the commercial side or development side or both?

Maybe both.

Okay. So on the development side, I mean, again, the good news is vertical market, our pattern is vertical markets, leaders in vertical markets, there is just -- and the surface area or the remit of software has just expanded massively because of AI. Obviously, AI is about what software can do versus just how it's delivered, which is on-prem mobility and SaaS. So it's about what software can do. And it just can do more. And when you're close to these [indiscernible] have to go do is like incredible, like high ROI ideas. So that's not the gating problem. The gating problem then -- the next gating problem is then how do we get to these products fast and furious, hence, the velocity in the AI team. I think some of the patterns, by the way, is smaller teams are better than large, obviously. Closer to the customer is better than not. Solving problems versus creating features is what the objective should be. And Jason said it a few times, probably ultimately a smaller number of total development headcount, but the dollars might not be less because you're going to pay more for the 10x engineers and they're going to obviously have the token cost of sort of companions with them. So we're not viewing this as like a productivity as a savings, but more how do you get more throughput out of the system. On commercialization, I think the early patterns are how to monetize and how to price. What's very clear across the portfolio from our customer conversations is it's not going to be straight consumption-based. Customers have to have some sense of what the budget is going to be, what the spend is going to be. And the bulk of what we're doing is, I'll call it like an old-school cell phone or mobile plan, which is you buy a chunk of credits or usage capability against the tool, but it's going to be a fixed amount, whatever the number is, $50,000 a year for x amount of consumption. But it's going to be use it or lose it, so we can take it as recurring as opposed to reoccurring revenue. And then as you go through that, you need to buy the next bolus, you'll buy another sort of subscription tier on top of that another $20 or $50 or whatever number. So you have some sense of planning and predictability. You also get commitment from the customer. This is not about like just trialing and testing. It's like making a commitment that I'm going to change my workflows to do this automated task, you're going to make some commitment to the dollars. So we would expect -- I think that's the pattern that's very clear. There'll be some exceptions to that on the tails of the portfolio, but that appears to be like the primary monetization sort of methodology.

Interesting. You referenced kind of high ROI workflows. I think that's been kind of a core theme debate at this conference in terms of how do we think about quantifying and capturing the ROI from these AI products. When you think about the most tangible proof points, the highest impact use cases that you've seen, what are some things that come to mind?

I'll give you a couple. I'll give you -- 3 come to mind in this example of like low dollar, high volume, like relatively high dollar medium volume and then very high dollar low volume, but the use case is slightly different. So we have a business that's in pharmacy automation for pharmacies that serve long-term care and skilled nursing facilities. These are not like the retail pharmacies that you wouldn't even see a sign on the door, but they're basically factories that are -- sort of tens of thousands of prescriptions get pumped out on a daily basis. Every one of those prescriptions has to be verified by a pharmacist today, manually verified. The time and motion study on that, it costs $1 to $2 of human labor to verify one of these prescriptions. Our first agentic tool does that at a quality level that's higher than a human, and we charge about $0.30. So it gives you a sense of the value capture and the value share with the customer. So very tangible hard ROI from the day you turn on the product. Similar concept, different end market in transportation, we are today, those that know us, we own a business called DAT. It is the organizing force network for the spot market in North America for trucking. So we organize all the brokers and all the carriers in the marketplace, and we're the hitching post to where 750,000 loads are brokered or advertised every day, unique loads. We monetize that today on the subscription on both sides. To make a load of brokerage happen, it takes about 10 phone calls between the broker and the carrier. There's about $100 to $200 of labor on the side of the broker to make that happen. We have the capability in market today to do the full matching, the full sort of transaction closing, the factoring of that transaction, the financial sort of reconciliation of that transaction for $40 to $60 depending on the transaction. So again, very hard ROI. The final one I would say is in our utility business. So we have -- they're talking about like a niche of a niche. So we're the leader in tax accounting software for investor-owned utilities for their assets. Like it's a niche within a niche within a niche. And there's a process that has to happen. All these utilities are investing all their capital and they can only get a return on the capital once they -- in the rate base once they sort of get it sort of perfect -- I'm sorry?

In service.

In service and they sort of perfect the asset. They get it, and so that's when they start getting a return on it. Today, to sort of put the assets in service and sort of curate the asset, it's a consulting project. So that's why these utilities have billions of dollars of WIP that they're not earning a return on. So we have an agentic use case that's releasing right now that does that for the customers in lieu of a consulting service. And that's a button that will be pressed a few times a year, but has high value as opposed to the button that's pressed thousands of times a day in the pharmacy automation, but you get a sense of a range of hard value that happens.

Interesting. To shift gears a little bit. Last earnings call, you called out an expectation for maybe a potential warming of the M&A environment. It's obviously been slow this year. Maybe you could just talk through your confidence there of maybe potentially seeing some activity towards the back end of this year and into next year? What are kind of the tangible points that you're seeing there?

Yes. I think, well, we've been talking about this for years, right? It's -- the DPI pressure continues. The hold periods continue. There's not many transactions that have happened this year in software, as we all know. There's credit cliffs that are coming in the next couple of years as well. So to be able to recap is going to be very difficult for the sponsor. So all those -- that's sort of at the macro, I'd say, and kind of what we're observing on the ground is just much more constructive conversations about value. We're getting a lot of access management meetings sort of on a one-off basis, getting a lot more access to information than we normally would. So I do think to keep the to keep the wheels moving in private equity, there does need to be some transactions. So we feel good. Again, just time has been our benefit. We're going to be super patient. If I -- on the bolt-ons, that's been much more liquid, much more active for us right now. We're putting a lot of deposits for platforms. We think that's probably going to be more of a '27 time line versus later this year, but that's sort of what we're seeing on the [ round ].

On your approach to identifying and selecting potential targets, obviously, it is a very dynamic time in software. You guys have historically had more of a risk-averse mindset, trying to bat 1,000 as best you can. How is maybe that targeting changed at all? How do you think about incorporating a company's AI strategy? What are kind of the things you would look for to say, we think this company is maybe better or worse positioned?