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Roper Industries Inc. (NYSE:ROP)

February 20, 2013 10:35 am ET

Executives

Brian D. Jellison - Chairman of The Board, Chief Executive Officer, President and Chairman of Executive Committee

Jason Conley - Director of Finance

Analysts

Scott R. Davis - Barclays Capital, Research Division

Scott R. Davis - Barclays Capital, Research Division

Okay. Folks, we're going to get kicked off in a second here with Roper. Okay. I don't think Brian Jellison needs much of an introduction as CEO of Roper. Obviously, he has had a tremendous track record of creating shareholder value and those of you in the audience who are shareholders, you're probably pretty happy people right now. Jason Conley is also with us as well who heads up the Investor Relations effort for Roper as well.

But what I -- Roper is a name that we have a buy rating on. We didn't always have buy rating on mostly because we didn't really understand the company. I've had a few epiphanies over the years, and the meetings we've had with Brian and John have been fairly enlightening in how they think about their businesses and how they think about gaining share and driving core growth in businesses that generally have very high gross margins. I think when you think about an environment like this, where growth rates are, for lack of a better word, growth rates are consolidating or, I should say, narrowing down into a pretty tight range, companies that can outgrow their peer groups and have fairly high margin structures could be big winners in that environment. So that's one of the reasons why we've been very supportive of the Roper story. In addition to, clearly, the M&A success and the quality of the deals that we've seen.

When we go out and we talk to investors about Roper, it's -- we get a lot of interesting comments. We get people that struggle with the sustainability of M&A stories. And some of the same people that used to question our views on Danaher, maybe 6 or 7 years ago, are the same folks who might come back now and say the M&A story is struggle -- at some level, at some size, they start to struggle to create proportional value.

The other issue we get, and Brian has mentioned this in the past here, he has his strong views on valuation, is really how to think about valuation in a company like Roper that does generate a lot of cash. I think, inherent not only in the Roper business model but also in the M&A model, you do generally tend to kick off a fair amount of cash, and so often times valuing on a cash basis can make more sense. And I think generally, investors are smart enough to see that. So -- but that's something we can talk about.

Anyways, I think given that Roper made a -- one of the largest if not the largest acquisitions in the company's history with Sunquest in the recent history and how important that acquisition is and the success of that acquisition is to the company, we clearly want to address that and I think get a general sense from Brian of what's working and what's not working and what can we expect in 2013. So whatever you want to kind of get out of the way and address up front, fine. Or we can go straight into Q&A. And obviously, we want to go through our audience response questions as well.

Brian D. Jellison

Well, good morning, everybody. The -- I wouldn't say that anything is fundamentally different. At any other time, we're sitting here with exceptionally strong balance sheet and rapidly accumulating 12 months EBITDA. So balance sheet looks better with each passing month, and we accumulate more cash. So we've got a $1.5 billion virtually undrawn revolver now, so we're sitting in a pretty attractive position. There's a lot of opportunities to invest and deploy capital. The organic nature of the business probably feels relatively okay. We were a little worried as we said at the year-end call. The fourth quarter, as we were meeting our individual businesses, we thought they were maybe a little more optimistic than we were at the enterprise level. But so far, their optimism has continued to be okay, not really seeing any early warning indicators of anything, and we don't have any real concentration anywhere. So on balance, we've already committed to a record performance in 2013, both from a revenue and cash flow basis. Margins continue to expand. We were able to convert incrementally last year at 55% rate, and we've got gross margins that are going to be pushing 56%. So basically, everything's right in Sarasota, a 38-minute flight from here. And we're open for questions.

Question-and-Answer Session

Scott R. Davis - Barclays Capital, Research Division

That's great. Let's start off with the audience response system and just get a sense of if this audience are shareowners or perspective shareowners. If you currently own the stock, I think most of you have done this by now. Yes, and you're over weight. 2 yes equal weight, 3 yes, but you're under weight, or 4 if you just don't own it, and please vote now.

[Voting]

Brian D. Jellison

How do you define over weight?

Scott R. Davis - Barclays Capital, Research Division

Over your benchmark. In your case it's mostly going to be binary. Okay. So a fair amount of potential shareholders in the audience. So let's go to the next question then. What is your general bias towards the stock? Remember, this is a bias towards the stock, not the bias towards the company. Positive, negative or neutral. Please vote.

[Voting]

Scott R. Davis - Barclays Capital, Research Division

Okay. That's a pretty similar ratio to what we saw at Danaher and Honeywell. So far it's been pretty consistent. While we're on it, let's go to the next question. This is very important. In your opinion, 3 cycle EPS growth for Roper will be above peers, in line with peers, below peers? Please vote.

[Voting]

Scott R. Davis - Barclays Capital, Research Division

Okay. That's a substantially a different result than what we got from most of the other companies. So people believe your growth part of your story. All right. So let's take a back -- a step backwards because M&A is such a big step of -- or a big part of the story out there.

Talk to us about the environment. And when I say environment, one of the things we've observed is that a lot of the assets we're seeing are coming out of private equity are kind of vintage 2007, 2008, haven't necessarily been run all that well. They overpaid for them when they bought them. Are you finding interesting transactions that kind of fit your criteria? Or how would you compare at least what you're seeing now to the last year or year before or historically?

Brian D. Jellison

Well, I think if you look at the 2011 and '12 period, that would have been the biggest headwind period we would have ever seen on a valuation basis, and yet we were able to do very good things because of the processes we have. So what you have is really a disciplined debt market. You can get a 7x debt staple with an all-in cost of probably 6.5%. That means that if you were a private equity player and you got a 7x staple and you want to put in 35% equity, you're at 10x. And if you want to put in more, you could be at a higher number. So there were more people competing for quality assets than there ever have been, but that's just a temporary aberration due to the inappropriate assignment of risk around these interest costs. There are a vast number of people who know that's absolutely true and are going to be exceptionally anxious to get out of Dodge in 2013. So we already have a much larger number of people ringing the bell here about get me out of this investment this year, while I think you'll have to pay a pretty decent price for it. We never pay over 10x or 11x first year EBITDA for anything because we don't need to. But it has been harder to get the valuation we want because a lot of people are overpaying for very mediocre assets. And we're not going to be doing that. You also had a lot of founder activity in 2011 and '12 because of basically, Obama's orientation around capital gains. And you had some people who are still worried about carried interest being taxed as ordinary income, which gets them motivated for this year depending on what's going to happen. So supply and demand, the supply side will be exceptionally strong in 2013. But you will have a lot of competition from private equity that can do deals at very low carrying costs.

Scott R. Davis - Barclays Capital, Research Division

When -- one of the things that got me interested in your story is, this dates back a number of years, but you explained how when you buy a business, how you get the company to think about gaining share and expanding their market and investing in the sales operation and marketing operation in the organization and generally funding it by taking costs out of the back office or less value add [ph]. I mean, I don't know if you can explain it without the chalkboard that you had here, but I think it's something that is valuable for the 2/3 of folks who don't own your stock, I guess, may not have heard how you think about being able to drive to a higher growth rate. And because you have a much higher gross margin than others, you don't need to drive to a tremendously high growth rate to create value. But if you can grow, outgrow your peer group by 100 to 300 basis points in core growth, it drives real earnings growth.

Brian D. Jellison

Well, a couple of things that there are sort of 2 pillars that are very important for somebody to understand about how our people manage well. The first is that we don't allow people to only use GAAP accounting and analytics because you make all kinds of mistakes with GAAP accounting. So we force people into a better understanding about economics. So people are going to learn about cost benefit analysis. They're going to learn about opportunity costs in addition to what you have to put down on the balance sheet about GAAP accounting. So as they become much more economically literate, it makes them feel clearer about where they want to invest for compound growth. And then the second component of that is we use a thing which looks quite simple on its surface, but it gets increasingly sophisticated as you get into it, which we call the product placement hit rate chart. So we asked each of the businesses to define their market, and we don't really give them a lot of advice about how to define their addressable market. Once they've done that, we've asked them and increasingly it gets vigorous about whether they have products that will serve that market. So what is their product coverage? Then we ask them if they have a willing channel partner that will sell their product at the expense of a competitor. And we know what their revenue is. So if you divide their revenue by the market that they've established, you immediately get [audio gap] a market share. So if they believe their product coverage is, say, 80% and their channel coverage is 60%, that would give them, as you multiply it, 48%. If their market share was 24%, you can solve for the under known, which is what is the hit rate of your channel. In that case, the hit rate of the channel is 50%. Most especially, in a multi-industry segment, a lot of these people are selling through multiple channels of distribution or as we generally sell, direct. Those distribution channels effectively are awarded for lying to you. So if they can get your price down or they can get you to make a green one or put one for free or whatever, that's their definition on how you get the hit rate. Our definition is to say when the guy comes in and says, "Wow the distribution channel says we need to improve our product coverage by 5% from 80 to 85%, that means, gee, tooling and probably cannibalization of existing product lines and what have you. I add 5 points. If I multiply that times channel coverage of 60%, I'm down to 3. And if my hit rate's 50%, I get 1.5 point of market share for busting my business model and trying to achieve what distributors told me I needed to do." What we do when people say, "Well, it's pretty good. The product coverage is 80%. We don't see anything wrong with that." You're probably avoiding certain markets because they would cannibalize other things or forcing you into pricing decisions you don't want. So let's work on the channel coverage. What if we got the channel coverage to 80% instead of 60%? If we do, I take 80 times 80 I'm at 64%. And if I still went half, I'd go to 33%. My market share goes from 24% to 33% by getting better channel coverage. If I then work on the hit rate of the channel so that they're more successful, if I'm at 80 and 80, I'm at 64. If I could get the channel up to 60% instead of 50%, I'm going to be like 40% market share versus 24%, and it's that simple. And then we just increasingly work on that. The third phase is that we show people where they are in their cash return world, and we'll show them for every point of organic growth and for every point of reduced investment in the business, what that does to their cash return, they get incented for constantly moving that up. And by looking at these little fractional incremental changes, they're always moving in the right direction. As they do that, that all comes back into a simple model, around where I should deploy my resources. Opposed to a typical company who doesn't do that, they just get very confused about where to put their next dollar investment internally.

Scott R. Davis - Barclays Capital, Research Division

Brian, can you help those of us that have never worked in manufacturing other than summer internships, I spent a couple of summers in factories but didn't learn a lot, mostly just drank beer and hung out. But help us understand why you care so much about break-even analysis and why when you're doing due diligence, you go 50 steps deeper than anyone else out there that we know on break-even analysis?

Brian D. Jellison

Well, most acquisitions are made by people who have a line person running a large segment or something who's pushing for the acquisition. And they're pushing for it because they think they're going to get greater absorption or they're going to get access to a product line they don't have or they're going to be able to buy some of their distribution or what have you. Those people will overcommit to synergies, and you'll go ahead and make investments under the theory that those people will deliver their synergies. We just sort of ignore that entire philosophy. We -- we really don't think GAAP accounting is very good at allocating true costs. So if you had -- and there are virtually a very limited number of people that really do ABC cost accounting. But if they're doing standard cost accounting, they're going to make all kinds of mistakes about allocating costs. And when you do that, you can't really see who's contributing what. You may have a business doing far better than you think. If you use a breakeven kind of analysis, which really comes out of economics, frankly, not out of GAAP accounting. you'll force a much tighter discussion around allocated costs. With every business we look at, we're looking at those kind of white space opportunities, where if you invested in a different way than they do, where they're kind of peanut buttering everything out there, you get a much higher leverage return, and it works pretty quickly in every business that we have. But if you looked at Neptune, which we acquired in '03, was very much focused on costs of making a water meter. That was good. We're happy, factory oriented kind of thing, great absorption, only lead free water meter available in the world made in the United States. But the opportunity arose that they were absolutely horrible at their firmware and in understanding how to do the electronic assembly because they're really a manufacturing engineering led organization. So we created a little opportunity in Mexico for them, and they've lowered their cost dramatically and probably more than doubled their performance in the time they've been here, while still keeping everything about their culture just from thinking differently. In the case of TransCore, we bought in '04, they had no recognition of the contribution of their Freight Matching business. They didn't understand it. People that they were talking to didn't understand it. We looked at it and said, "The Freight Matching businesses is worth more than TransCore." So let's not talk about that business. Let's just focus on TransCore and the tolling business, and we'll have everybody thinking about that, and eventually will tell them that the real reason we bought this is we got a SaaS software company and Freight Matching that nobody knew existed. And by having that, we wanted to have a leverage of that in these other SaaS businesses that we've been able to acquire in application software. So that's a long answer to what's a sophisticated question, unfortunately.

Scott R. Davis - Barclays Capital, Research Division

Yes. That makes a lot of sense. Maybe you can help the audience understand, and we can get into deeper questions and open it up to the audience after that, what you look for in an M&A target. What -- when I think about it -- well, I'm going to let you answer the question. I'm not going to answer it. But what do you look for? I mean, what are the initial kind of 4 or 5 things that are deal breakers or makers when you look at something?

Brian D. Jellison

That should be a great question because we have normally a slide on that. But basically, what we care about is we want to make sure that the business we think has an ability to really sustain itself. We want to it to have mobile pass to grow because we assume that there will be some forces at work that it can't foresee that could be difficult, that could close out one of its market. So we wouldn't tend to buy something that only had one avenue for success. Then we really want to understand if the people can work in our governance area. I mean, most of the deals we don't do are because we just don't think that the culture of the acquired company is compatible with how we work. So we're very difficult to deal with during the acquisition process. But once people are on board, we're actually easy to deal with. We don't really lose anybody. They stay with the enterprise building their business. Third thing is that we love buying private equity businesses because the people that are in them are really trying to improve their business. They're measuring their performance around that. So we're not a typical large-cap company that would look at building careers or people working in one product division for 2.5 years and they moved to another one for 3 years. You never really can measure their effectiveness because they're not in the job long enough to really know the long-term effect of it. And in our company, we -- the way you build your career is to build your business because we're not going to move you from a centripetal pump company to a medical software business. It's not going to happen. You're going to be in those businesses for a very long period of time. And if you want to have great work to motivate yourself and you're going to want to grow those businesses and invest in. So that just creates a different kind of a person. Not everybody can fit that mold. And then we want businesses that are going to be asset light, so that they can self fund any of their growth needs. We want them to contribute excess cash because it just makes our balance sheet easier to deploy capital into buying additional things. They don't have to grow dramatically. We'd be quite happy with double GDP growth on a global basis in perpetuity. But we don't want to have to reinvest in physical assets of the business because the opportunity cost of that keeps us from deploying cash to buy other compound growth assets.

Scott R. Davis - Barclays Capital, Research Division

Okay. Let's open it up to the audience. A question up front here.

Unknown Analyst

Brian, I just wonder if you could touch base a little bit on the -- on your organic growth. Just touch base on organic growth and how we should think about it going forward. I mean, over the past cycle, you have grown 1.5 to 2x GDP on the top line. The last several quarters have been more kind of 3%, we'll probably see that again in 1Q. How should we think about kind of building up to a 2x GDP growth number again? Arguably, it could be higher than last cycle because it's more software -- you had more software businesses this time around. So just any additional color, that would be helpful.

Brian D. Jellison

So on organic growth, one of the things that happens to us is we have, unfortunately, continued to outgrow people. Even though it might be down to a single-digit growth, but it's still better than anybody else by an order of magnitude. The thing that I think is not people aren't kind of thinking about is increasingly, you have to think about our net new business. So we probably have half of the enterprise, which has a recurring revenue now. That recurring revenue is not going to show any growth to you on the enterprise level other than a pricing opportunity it might have. So if we say we're going to grow at 3% to 5% but half of our business is recurring, we have to grow at 6% to 10% on our businesses to be able to yield the 3% to 5% because half is already in the base from last year. It's going to continue. So we'd be really delighted with double-digit GDP performance in perpetuity as we've got this dramatic increase in the recurring nature of the enterprise. Now as a rule, we've always said 1.5x to 2x GDP over a long cycle and we've always outperformed that. Last year, we kind of went with stronger organic guidance than I thought we might have, but it turned out to be okay. This year, we went in at 3 to 5 because at the time we were looking at it, we were fairly concerned about the first half of the year. We have some headwinds in the first half that are one-time events that won't recur that should or are likely to depress first half organic growth. And in the second half, those were gone. And so we'll be back to a more robust total. I think we do ask ourselves on these software acquisitions, these are basically networks of activity. And so they almost always are the -- they're either a monopoly or they're in a very small oligopoly, where they're competing with somebody that does it in-house and you need to get them into your network. They don't have super high intrinsic organic growth because something like Sunquest has 80% recurring revenue. So if it -- 20% that's net new grows at 20%, it only shows up as a 4% kind of thing. But it doesn't mean the markets aren't very dramatic -- dynamic and that they aren't growing a lot.

Scott R. Davis - Barclays Capital, Research Division

Next question please.

Unknown Analyst

You touched on this a little bit earlier. I'd love to get your deeper thoughts on just the multi-year view on interest rates. And more specifically, how the current rate environment has or hasn't changed your view on target businesses and strategy?

Brian D. Jellison

I missed the first part of that. The word cut you off, so...

Unknown Analyst

I think you touched at the very beginning in terms of your view on where the rate environment is going, so just that.

Brian D. Jellison

Well, I would say that we would have expected to see some uptick in interest, but that didn't appear to be true. So if you read -- pardon the competition here, but if you read Goldman Sachs' view on interest rates for the next couple of years, I've read it about 5x because I can't find anything wrong with it.

Scott R. Davis - Barclays Capital, Research Division

They may be trading against that, though.

Brian D. Jellison

They may be, they may be. But, man, if you read old John's [ph] report there, it's like -- gosh, I hate to think that we're going to be in this environment for another 1.5 years. But I think we are going to be in this environment for another 1.5 years. So you'd want to deploy capital when the cost of it is so astonishingly low. So it just encourages us to deploy our capital in a wise way and be very diligent about it, which we're doing. We've never had a balance sheet this strong when you've got a $1.5 billion revolver and, gosh, we could go out and do another debt offering here. It would not even cost us 3%. So all of that raises the multiples, right? So pretty much everything is good except the acquisition costs or multiples are higher than we'd like. If you had -- if people weren't doing junk bond stuff here all in at 6.5% if they had to pay 9%, you'd get a corresponding reduction immediately on those cap costs. They wouldn't be at 11%, they'd be at 8.5%. We'd like that.

Scott R. Davis - Barclays Capital, Research Division

Brian, when you think about portfolio management, I can't recall and there's probably been instances but -- where you've sold businesses and you've added -- I would say, over the last several years the quality of stuff that you bought seems to be very, very high. Maybe some of the legacy businesses aren't quite as high quality. Do you think in terms of optimizing at times and saying, let's take advantage of this rate environment and we can almost swap assets and take a business that's less attractive to you and allow private equity to go out and lever it up. And in exchange, you take something that is more interesting to you?

Brian D. Jellison

Yes. It's easier to do that with another public company. You're really not going to be successful swapping assets with private equity. So you're going to be stuck with either you could spin off a business to make it tax free or you could do these Reverse Morris Trusts that could be tax free. But if you sell it, the legacy businesses are just on the books for next to nothing. So you're going to pay capital gains tax, which is quite substantial. And the net proceeds after the tax likely won't be a positive reinvestment for you. The other thing about the legacy assets is they do perform better than comparable businesses. So if you look at the industrial segment, for instance, it has over 30% EBITDA. So those industrial businesses are competing people who have 35% gross margins. And our guys have 50% gross margins. So they're worth a lot. These are businesses which should be trading in a low double-digit enterprise value basis, say, 13x. The people who would want to acquire them don't trade that well because their performance isn't that good. So it's always a dilutive transaction for them, unless they're going to try to force them together. And there could be some equilibrium point in the future, where we'd say we ought to spin off some businesses in a tax-free way, primarily to allow them to grow more because they can do the same thing we do at the enterprise level with a different nondilutive orientation around investing in industrial activity. So if we're not doing that, then you're likely to continue to see us do medical and software acquisitions because the cash returns are accretive to us, whereas an industrial acquisition generally would be dilutive to us.

Scott R. Davis - Barclays Capital, Research Division

Brian, how come you're -- there's a question at the back, I'll ask a quick one and then we'll go to the back. You have one of the higher tax rates and I know your mix of U.S. sales to international is higher than most companies we cover, but you do have a fairly high tax rate versus your comps. Is there a strategy that you can employ to start to address that more aggressively?

Jason Conley

I think we have addressed it over the last few years. I mean, we were at -- in the 35% range a few years ago, so we've done quite a bit on the restructuring activity, and we'll continue to do those activities. But it is hard, and then when you get that natural upward bias with the acquisitions we've done in the U.S. so especially with Sunquest and they operate in a lot of states, too. So it's not just the federal, it's the state as well.

Brian D. Jellison

There certainly is an arbitrage we have that's very attractive that I know Scott's aware of. Our tax rate last year is 29.6%. Sunquest is a very, very high taxpayer, a very high taxpayer in the high 30s. So the reality is if you want to root for one thing and whatever the negotiated disposition of debt in the country is and you think there really is a chance for a corporate tax reform and you get that corporate rate down to 25% or 28%, you'd be looking at the biggest beneficiary you know sitting right here with Mr. Davis. So that's 5 or 7 points of pure cash to our bottom line if you get a lower corporate tax rate. We don't have a centralized shared services, and we haven't moved to offshore. We would have a great deal of work to do to run away and move over to Switzerland. We really have not been interested in doing any of those things. We haven't developed a lot of businesses outside the country. We don't arbitrarily reassign costs on an intercompany kind of basis that allows you to do various things to lower your tax payment, and I don't think we will do that. But I do think, over time, we'll get a slightly lower rate than we have now.

Scott R. Davis - Barclays Capital, Research Division

Let's take a question at the back.

Unknown Analyst

Brian, thanks for the time today. What end markets get you the most excited looking out 6 months, 1 year, 3 years? And then also, as far as internal investment, what type of returns are you getting the most attractive investments internally? And then how do you think about that relative to the external opportunities you're looking at?

Brian D. Jellison

Well, returns are always good just out of organic growth. So we've got 56% gross margins. And then we said this year we'd -- an incremental $1 revenue ought to give us about 40% pretax. So you're not going to add any assets to accomplish that. So you got exceptional cash-on-cash returns as a result of that. In terms of acquisitions, we look at things that we've talked about this morning that tend to be very high return businesses. They don't really have much assets. Their assets go home at night. And they have relatively low receivables. And a lot of the software businesses get paid in advance for the work they do, so they actually don't have any assets on their balance sheet. What we have in the enterprise, we used to be about a 20% cash return business, and we got that up to about 35% after the Neptune and TransCore acquisitions, and gradually got it up to about 50%. So our legacy businesses actually have higher cash returns than any other -- from all the industry. And then we've got all of the medical and software that have extraordinary returns. So if you do our cash return math where you take the net earnings plus depreciation, amortization minus maintenance CapEx, you divide it by the gross investment in the business, which is the gross PP&E number, so that adds back accumulated depreciation to your net PP&E on the balance sheet and net working capital, our total return on that is 100%. And I don't think you can show me another publicly traded company that's at 50%.

Scott R. Davis - Barclays Capital, Research Division

Any questions in the audience?

Unknown Analyst

Brian, I'm just curious if -- when you think about the business and you alluded to this earlier, with regard to maybe spinning some assets out to grow more. But is there a sort of a ceiling of -- or an area of total amount of sales or size of the company, where you think it does start to get different to do -- difficult to do meaningful deals and sort of a ceiling, if you will, or maybe not?

Brian D. Jellison

No. I don't think the scale or thing, it's like Scott opened up with Danaher at a $40 billion market cap versus our $12 billion market cap, and they're still slugging it out, right? So it's a lot harder for Larry than it would be for me, but it's very easy. Remember, why we do acquisitions is because we have a lot of free cash flow, right? So we're not a serial acquirer. That's not the game. So we're not trying to get to be big. We just get big accidentally because of the reinvestment of the cash. The cash is about $725 million. That's what we forecasted for free cash flow this year, maybe a little more. And that's kind of early in the year. So when you reinvest it at about 1.5 -- you get a multiplier effect if you lever it up, let's say 3x of the acquired EBITDA. So your $725 million becomes 1.5x that. That's why we think we'll invest the $1 billion this year because if we don't invest the $1 billion, we're not taking advantage of our cash deployment capability. So you start to compound that over time, and it is going to be a while before we're going to be at the $2 billion mark. I think once you get to having to invest $2 billion a year, it's a little bit harder. You got to do 2 billion-dollar deals instead of 1, but that's a lot easier than these guys that run around buying up $50 million businesses for $150 million and have to do 10 of them. That's something I would never want to have to do.

Scott R. Davis - Barclays Capital, Research Division

Next question, please. Over there.

Unknown Analyst

I have 2 related questions. I'd like to know who you believe are your peer group and who your peer group will be looking out 3 or 5 years or however long you want to look? And related to that, where do you see on a long-term basis your margins accreting to?

Brian D. Jellison

So the -- if you look at, let's take the margin question first because last year it was probably a zenith in terms of incremental change. All 4 of our segments improved their margins year-over-year in all 4 quarters. That's really remarkable because you always expect with a diverse family of businesses, when you have 40 P&Ls, some of them are not going to be doing well in any given year. But all of our internal disciplines are around incremental improvement. So if you got gross margins that are 50% and above, which we do in all 4 segments, they're going to contribute pretty good leverage. And that leverage is where you get the improvement in the margins. So we think that's sustainable for a long period of time. We don't have a particular goal, but we would expect positive incremental leverage out of everybody. Then when you get to -- the other question was around the types of acquisitions?

Scott R. Davis - Barclays Capital, Research Division

Peers.

Brian D. Jellison

The peers. That's hopeless for us, it's hopeless. We -- you've got to pick peers in your compensation discussion and analysis platform with ISS. So we were looking -- last year, we've had 96% and a 99% favorable shareholder vote on our compensation policies. So we have -- this peer group's ridiculous. I mean they have, look at this, one guy has got Regal Beloit in here and Hubbell. I mean, this -- we got -- it's got to be a smarter way to put your peers in, right? So we actually went out and did an investor survey this year, spent a good deal of time and effort with Jason providing some leadership and our long-only investors, which over half of the investors responded survey said that our peer group #1 was Danaher and then #2 was General Electric, Emerson Electric, United Technology [sic] United Technologies and Honeywell. Now I can't imagine that those 4 megacap companies have anything to do with our peer group, right? And then one guy, I don't know who because it's a generally anonymous survey, says, "well you really don't have any peers, which is what makes you attractive." And I personally agree with that. So if you think about it, maybe not all of you would like Bob Knight, but one of the things Bob always used to say and it's full disclosure I'm an Indiana undergrad, so I was very happy last night. And Bob was really about the game, right? So you just need to really do better against the game. So our peer is ourself and doing better than we think we can do. And the challenge is to focus on all the right things that will make us incrementally better on a sustainable basis. And we feel that the investments we've made are all incredibly good from a sustainability viewpoint. We have a very light footprint on the world. Your typical multi industry company has a very high cost of materials in their cost of goods sold. We have very little materials in our cost of goods sold, so we don't have cost to push risk inside the company. We have a very light peripheral factories, so we don't have to worry about absorption. When people don't have to worry about material acquisition and absorption accounting, they get really focused on where their costs are and what they can do to create more cash, and that's really what drives all of the thinking inside the enterprise. So I think it's a very sustainable long-term approach.

Unknown Analyst

If I could follow up, I might offer to you that I agree with you. None of the above represents your peer group. The work our analysts have done is to look at you as one of a series of companies who have moved from an asset-heavy model to an asset-light model irrespective of their industry. And in that context, one can then look at your valuation and do the type of work that security analysts want to do. I think that the mistake of falling into a trap of looking at an industrial company per se is that your valuation makes no sense relative to that because the market is saying you're not in that.

Brian D. Jellison

It's true. And this is one of the times I think, and one of these chalk talks I was having with Scott when he's in an epiphany, from a shareholder perspective, we're held back on valuation because of so many people writing about, "Okay, so I'll accept that it's the best of breed or whatever it is they want to call it." But it's already trading at a 50% premium to this wrong class of people who are peers. So you're capped on some kind of premium valuation to the wrong set of people, as opposed to looking at discounting cash flow over time and how that's going to grow. I think that when people look at this chart -- in the first years of the company, '92 to '97, we had operating cash flow of $149 million in that period. Then in the next 5-year period from '98 to '03, we had like $386 million. In the '03 to '07, we had $1.124 billion. And in the '08 to '12, we did $2.6 billion. So anybody who thinks we wouldn't do $4 billion or $5 billion in the next 5 years isn't paying attention. And it's not difficult. People think it's -- you can't sustain this. Well, why can't you sustain it? Can you grow 3% organically? Can you redeploy $1 billion a year in free cash flow and maintain your investment-grade status? You don't have to issue equity, you don't have to anything. The answer is, yes. It's not even difficult.

Scott R. Davis - Barclays Capital, Research Division

So let's finish off with these last couple of audience response questions because it's less relevant for Roper, but we want hear -- we want to compare the data from this year to last year. In your opinion, what should Roper do with excess cash, bolt-on M&A, larger M&A, share repo and dividends, debt pay down and internal investment. Obviously, some of these aren't relevant for Roper, but please vote now.

[Voting]

Scott R. Davis - Barclays Capital, Research Division

Because we compare this against last year, see if it's changed.

Brian D. Jellison

Price has held.

Scott R. Davis - Barclays Capital, Research Division

Okay. Very consistent with what we had thought. I'll have to take a look at last year and see if larger M&A was that high. And then next question, I think that this is the question that Brian always hates, but we have to do it anyways to cross compare. In your opinion, what multiple of 2013 earnings, and this is PE, should Roper trade? I've already walked through this, so please vote.

[Voting]

Scott R. Davis - Barclays Capital, Research Division

Okay. We'll compare that to last year, and we'll get a better sense of where that is. So it's not a surprise to me necessarily. And then last question please. What do you see the most significant investment issue for Roper: core growth, margin, capital deployment, execution strategy? This is a question that we've had some strange answers on today. This is the one that I think has had some surprises, so please let's vote on this now.

[Voting]

Scott R. Davis - Barclays Capital, Research Division

Okay. This is capital deployment. Okay. More people are putting in 1.

Brian D. Jellison

Yes, I guess that would be right. The lack of it.

Scott R. Davis - Barclays Capital, Research Division

Lack of it, yes. Which makes anybody who can outgrow a tight band is worth, not exponentially more, but a whole hell of a lot, right? Any DCF you can show that changed.

Okay. We got to wrap it up. No, I'm sorry. We can't take your question right now, Joe, but you can jump up stage if you want to ask these guys. I promised to keep everybody on schedule, so you can have lunch. Our lunch, just like last year, we do not have a presentation. It's a very casual luncheon, I believe, in the same room we had breakfast. And then we'll be back here and call it an hour for the afternoon session. Thank you, everybody. Thank you, guys.

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Source: Roper Industries Inc. Presents at Barclays Industrial Select Conference, Feb-20-2013 10:35 AM
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