Rollins, Inc. (ROL) Earnings Call Transcript & Summary

Good afternoon, everyone. I hope you had a good lunch out there. So my name is Justin Hauke. I'm the senior associate covering facility and industrial services here at Baird. And presenting next, we're going to have Rollins. We're very pleased to have you guys presenting with us once again. Company serves almost 3 million commercial and residential customers across the globe, providing pest elimination services. They've got a very strong balance sheet, a very consistent growth record. And presenting today is going to be Ken Krause, the company's newly appointed Chief Financial Officer just since September and then Julie Bimmerman, who was the Interim CFO, and she's been with the company forever and leads Vice President of Investor Relations. So we'll do a formal presentation. Ken will run us through it. And then if we have any time can, we'll do some Q&A.

Great. Well, thank you so much, and appreciate you all being here to hear the story about Rollins. As Justin indicated, I'm Ken Krause. Julie is with me. I've been with the company for just over 60 days. And it's really an interesting company. There's two things -- 2 or 3 things that I would emphasize to you all today that you want to think about as you think about Rollins. One is consistency. Justin talked about consistency. Well, we have been consistently growing revenue. We've been consistently growing earnings and cash flow for two decades, through a number of different economic cycles. And we've been really -- we've seen tremendous success in the business over that 20-year period. And I'll talk about that today. Second, the question might be, well, why? What's driving that change? Or what's driving that constant growth. The one thing that I attribute it to is the culture. And really, when I think about the culture, it's the people. We're in a people business. And it's all about servicing the customer. If our techs are engaged, if our techs are providing a superior customer service, the customers are going to stay with us and they're going to pay for a service that's valuable. And so that's really the difference maker when we think about Rollins. A couple of statistics I'll start with here today, just under $3 billion of annual revenues, a very strong margin profile north of 20% on the EBITDA line. But two things that really are part of that consistency story. One is recurring revenue. 80% of our business, roughly 80% of our business is under some form of a contract. So each day when we wake up and we go out there, roughly 80% of our business is under contract. It's a great position. And secondly, cash flow conversion. We have consistently converted north of 100% of our net income into free cash flow. And we've reinvested that on a consistent basis. So market leadership, recurring revenue, consistent growth and strong cash generation are really the key areas that we continue to emphasize and focus on at Rollins. When we think about the market we compete in, it's about a $20 billion total addressable market growing at a mid-single-digit clip. And we look at the market through the lens of three broad services: One is residential; second is commercial; and the third is the termite business. We've got strong brands. Many of you probably are well aware of the Orkin brand. It's been -- it was really how we were founded back in the early 1960s. We were founded through acquisition. We acquired the Orkin brand and we haven't stopped since. We've continued to bolt on additional brands whether it be the Northwest brand based down in Atlanta, Georgia or Clark out in the West Coast. We've consistently used our balance sheet to really improve in our market position. Our market position in a market that's an incredibly resistant market. It's grown as I started the conversation today through a number of different economic cycles and it's all about -- again, it's all about providing that level of customer service, at a high level of customer service to be able to provide value and get value from our customers. When we think about execution, the business model and how well we've been executing over a number of times, there's four broad areas that we look at here: One is growth. We've been growing the business at a 7% clip for just about 20 years. The 80% recurring revenue is certainly a big part of that story, but also the value creation. Something that I think many people maybe miss in this business is the margin profile. 50% gross margins roughly. But the incrementals as the third quarter call, I started to emphasize the incremental margin profile of the business. They're impressive. I mean, in the quarter, we had some one-off charges that hit us in the quarter. But taking that out and looking at it on a more recurring basis, we had 37% incrementals in the quarter. So it provides a bit of upside and runway opportunity when we think about the margin profile of this scaled business. The acquisition strategy, I'm familiar with acquisition strategies. And what I found our acquisition strategies that are built from the ground up, built in the business, that are owned by the business are the most successful. And Rollins has a tremendous acquisition strategy. The pipeline is full. We continue to quote new opportunities. And when we think about -- why -- the question might be is, why are we so successful with acquisitions? Well, kind of gets back to the people side. When people are looking to sell their business in this industry, they want -- and if they want to sell to a company that's going to take care of their people and their brand, that's Rollins. And we've been really successful there. And the pipeline, as I said, is full and I'll tell you, you look at the industry, there's 20,000 competitors in the U.S. alone. And so there's a really highly fragmented market for us to continue to deploy the cash flow that we've generated in the business. And speaking of cash flow, this year, we've invested about $110 million of acquisitions, but we've grown cash flows this year again by 15%. In the quarter, I think it was up 60%. And we increased our regular dividend here earlier this month by 30%. And so another year of increasing our dividend and sharing that capital as we continue to create and generate a significant amount of cash flow. Speaking of the business model here a bit and looking at the business model, going clear back to the year 2000, I think we're coming up on our 25th or so year of consecutive revenue growth. And it's not just revenue growth at 1% or 2%. But over this period of time that we're showing on the slide, we're seeing about 7% revenue growth. This year alone, we're seeing double-digit growth. I think it's close to 12%. We've got a little bit more price coming through. But even excluding some of that, we're still seeing robust levels of real organic growth in the business. And the thing, I think, as you look at this slide, it's hard to find a business that not only has grown over that period of time but has grown through different cycles. So today, we're all talking about recessions. We're all talking about a challenging macro environment. When you look at the business during the Great Recession, we grew 5%. When we look at the industrial recession in 2015 or '16 when oil was going from $130 a barrel clear down to $25 a barrel, we grew the business at 6%. And then when we look at COVID, we saw 7% growth during COVID. And so consistent growth year in and year out, no matter what the economic cycle, is really the focus when we think about the future. Cash flow generation here, I talked a little bit earlier, 15% CAGR in free cash flow from 2001. And 15%, not only is it over that long period of time, but no matter what time period you pick, it's a really impressive performance. So you can see from 2017 to 2021, we saw again about 15% compounded annual growth rate in our free cash flow. And it's interesting, you ask yourself maybe, well, what do you do with all that free cash flow? Well, it's really all about how do we reinvest it in our business and grow our business. And that 20,000 competitors that we see in the U.S. alone provides us some optimism that we have an ability to continue to deploy that cash flow to bring on accretive acquisitions. Cash flow conversion also very strong, very capital-light business, roughly 7% or so spent in working capital. So working capital percentage as a percentage of sales is about 7%, and cash and CapEx is extremely light as well. Looking at the capital allocation, from 2017 to 2021, we deployed about $2 billion of this cash flow. About half of that cash flow was deployed through acquisitions or to use in acquisitions. The other roughly 40 or so percent was shared in the form of a dividend. You can see there, CapEx is really a 7%. And really, when we think about capacity, debt capacity, we just haven't had a need to use debt capacity. We've been able to generate such a significant amount of cash flow. We've been able to reinvest that back into our business and avoid the use of debt in some instances. Not to say that we wouldn't use debt. We have used debt. We bought a couple of acquisitions, obviously, in the $300 million to $400 million range roughly. And we've used debt, but we've quickly delevered. The business generates a significant amount of cash flow and allows us the benefit of delevering really quickly. Looking at the performance in the third quarter as well as year-to-date, as I said, double-digit growth, good, strong, high single-digit organic growth. Adjusted EBITDA in Q3, up about 10 basis points despite incurring, about 140 basis points of headwind on some unfortunate auto claims that we incurred. GAAP net income was up double digits, about 15% in cash flow. In the quarter, it was up about 60%. There were some timing things that occurred between this year and last that we had. But year-to-date, cash flow is up about 15% again here in 2022. So continue to see pretty strong performance. What we did in the quarter is we issued an increase of 30% in our regular quarterly dividend. What we did is we've had a track record of using special dividends. What we did in the quarter was took the opportunity to build that special dividend into our recurring dividend, so our shareholders can expect that more regular recurring dividend as we go forward. So simply, when we close this out and before we open it up for questions, a couple of things when we think about why invest in Rollins, I started with the fact that it's consistent. This business is 80% of the business that's recurring each and every year. We have contract-based revenues. Some of our contracts are multiyear. Some of them are on an annual basis, but automatically renew. But nonetheless, they're under contract. The M&A track record is exceptionally strong. But not only is the track record around acquisition is strong, the pipeline is really strong. So we continue to be very active at looking at M&A opportunities in the business. There is an opportunity on the margins. Even though we have 23% EBITDA margins, I think with incrementals talked about earlier, it provides us some reason to be confident about our ability to improve our margin profile going forward. The consistent growth in cash flow, it just continues to create a lot of cash flow in the business. And our focus is to get that high level of return on invested capital, asset-light, cash flow intensive, strong earnings profile comes together to create a really nice return on invested capital. And then, of course, last but not least, we have a very healthy balance sheet. The balance sheet is certainly very healthy and provides us ample flexibility to continue to invest and grow our business. So with that, I'll open it up for questions you might have. And any further detail you want to dive into.

Yes. Sure. So we've got a fair amount of time here. So [email protected], if you have any questions, but I'll go ahead and kick us off, I guess. I guess I would probably -- maybe I just want to start with your people business, as you talked about. I know that with COVID, you had a little bit of a kind of a margin boost for a while. It seems like the margins have come back down a little bit as you had to kind of restaff. I guess just where are you on your staffing? Are you fully where you need to be? Has there been kind of margin pressure from labor expense coming up and just maybe update us on that?

Sure. First, on the labor, you're spot on. It's a people business. And when we look at our people, I'll look to Julie also to comment here. But our people, we're always looking for good people. And so I wouldn't say we're ever fully staffed. We're always trying to source really good people. And we've made some investments in some technologies, and that's helped us open up our available market of people at Rollins. In the quarter, we talked about an investment we made in some technology solutions where -- that allowed us to see over 30,000 new applicants coming into the business. So we're always looking. We're all -- we're growing. And in order to grow, we got to have people. People that will provide an exceptional level of customer service. And so for that reason, we're always looking for valuable people. I don't know, Julie, if you want to add anything to that?

Definitely. We're better staffed today than we have been in over two years. So staffing is not an issue for us as far as we've been working. But don't get me wrong, we work hard at that. And our management are always looking for that next right person for that service-centric person to be able to treat our customers. So think about we have double-digit growth. To do double-digit growth to complete that, we have to have the people in place fully trained to be able to handle that. So not saying it's easy, but we have been able to cover it so far.

Right. And speaking talk a little bit about labor or wages. We focus on providing our techs and our people the most competitive compensation package in the industry because we feel that that's directly correlated with engagement levels and those engagement levels are correlated to customer experience and a happy customer. And so that's really important to us. That relationship between the tech and the customer is a big part of the value proposition at Rollins in our marketplace. And so it's really important for us to take care of our people. With that said, a lot of the compensation is productivity measures or incentive measures. And so there's an opportunity to earn more as you do better. And that's a win-win, we believe. And it's been very helpful in beneficial as we think about our margin as well as our growth plans.

I guess the other source of maybe cost pressure or something that you guys have to fight would be fuel. You're not a route business, but you do run routes. I think one of the things that you guys have been really successful within the past is that the price elasticity of your business is pretty good where you able to capture pricing to accurately reflect your costs. I don't think you have any fuel surcharges that you put in place this year. But maybe just talk about maybe how big fuel is and pricing initiatives you have done this year?

Yes, there's three or four major input costs in the business. Materials, of course, to treat the past, there's people and then there's fleet, right, fleet cost and fuel cost. And it's been a challenge. We haven't implemented surcharges as I recall. But we have certainly tried to focus on the pricing side to pass along that increased price, unfortunately, to our customers. And you're right, we do benefit from a pretty elastic pricing curve which allows us to pass along those prices and get the value that's appropriate for the level of services that we're providing our customers. And so we certainly continue to focus on that. We did see that fuel cost debate a bit as we went throughout the year here. We were north of $100 in oil back in April. It came down through the third quarter down to low mid-80 range. Today, it's a little bit north of where that -- where we finished the third quarter. So we're keeping an eye on that. But we also -- when we look at -- there's two ways of price increases in the business. There's your annual contracts where you're increasing prices on the renewal, but there's also a rate card. So as fuel costs change, we use our rate card to adjust the pricing that customers or new customers are paying for those new services. And so we're really keeping a close eye on that, and we're evaluating further price opportunities as we go into 2023 in this inflationary environment.

Yes. I guess one of the other things you do have that differentiates you on that front as you've made a lot of IT investments. Your BOSS system that's basically been able to reduce your total fuel that you guys use? Do you have any metrics maybe you could share on kind of what that's provided from a margin perspective over the last couple of years?

Yes. The company has done a great job at implementing technologies. BOSS is one of many. A lot of people spend a lot of time on BOSS. But there's a number of different softwares that we've implemented. And it's really a testament to our CIO. Our CIO does such a great job at really thinking about growth, partnering with the business, not just compliance exercises. But how is he a better partner to our business, and it really pays off really. I don't know, Julie, if you want to share any maybe anecdotal information or examples of some things that we've seen done in savings we've seen, especially on the fleet side.

Yes. It's one of the big things, as you said, with BOSS on top of that, we've looked at our route scheduling from that standpoint. And with the initial path once we had the [ R&S ], our routing and scheduling systems through all of the work in the U.S., we were saving on average 45 minutes per day per technician. So think about that, a technician then in the normal 8-hour day, could see an additional customer every day before we would need to bring on another technician for the branch, which makes a big difference. In addition to that, the same technology was putting on iPhones in the hands of all of our technicians. The reason this is important is now my technician no longer needs to go to the office every day. The technician can go from home directly to customers and be able to post transactions through the phone, again, impacting the people at the office who are no longer having to hand see all the documentation. Hitting high level here, but the way this technology that everyone looks at only the routing and scheduling, it was actually impacting multiple people in their days for the position. That's where so much to what we -- the benefits that we've had.

Great. It does look like there's a couple of questions that came in. I'm going to -- they're related to each other, so I'm going to try to combine them. I think they mostly have to do with kind of M&A and barriers to entry in your industry. So one, just you talked about the 7% growth that you guys have had over time. If you could split how much of that has been organic versus acquired? And then maybe just talk about the metrics. Obviously, you guys have a very nice multiple, but how you think about the returns on acquisitions, how you source them?

Yes, sure. When we look at the financial metrics on acquisitions, something that I've employed in the past is a multifaceted assessment of acquisitions. One is around growth. Are we buying businesses or brands that will help us accelerate further growth? So for example, Northwest, we bought Northwest a few short years ago. And not only did we buy Northwest, but we bought Northwest who is now buying other businesses. So we bought a business that had further growth and consolidation opportunities in it. So buying businesses like that are really important. Margins. We would like to buy businesses that will -- that are or will be accretive to our overall margin profile. It's one thing to accrete to earnings per share. It's getting a little more challenging, I think, with higher interest rates for those that are using debt, but margin accretion and earnings accretion are paramount and very important that we show that on an ongoing basis. And then cash flow. We want to buy these businesses that aren't any more cash capital intensive and can generate more cash flow that we can then again use to reinvest in the business. And so I mean, those are the three or four kind of metrics that we look at that are really important to us when we think about the financial return metrics for acquisitions. When we think about the growth over the long term, it's not something that I have broken out as of yet in terms of overall acquisition versus organic growth. But what I can tell you is that this market generally grows at a low to mid-single-digit sort of range. And so as we think about the future, we think that's really -- certainly achievable, plus a few points of price plus some opportunities from acquisitions. And so as we think about the growth profile, we feel like there's an opportunity to continue to grow this business in a similar range that we've seen historically.

And I guess, I mean, to be clear, the Pareto chart that breaks down the market share, it drops off pretty dramatically. So the acquisitions you're doing are generally very small. They're in a local market.

There they are to a point. They're -- I would say it's very balanced. And so I mean, if you look at the one slide or even on the annual report you have there, I mean, you've got Clark. Clark was a big acquisition. Northwest was a sizable acquisition. The HomeTeam acquisition was a meaningful acquisition. So we've bought some nice platforms through the years, and we'll continue to buy good platforms. But we also look at acquisition opportunities that are tuck-ins and smaller opportunities as another way of growing it. So we're certainly open to both. And the tail is long. There are a number of opportunities that are more meaningful.

Just one comment. And one of the great things that these acquisitions are bringing us in addition to everything that Ken has gone over is the people. And we're only going to buy a company if it is a strong company. But we want every person that works there. We want all the frontline employees. We want the management because if this is a strong company, that they have strong people who know what they're doing. And this is -- that's one of the greatest benefits that we receive from these.

Good point. I mean it's you're buying people and you're buying customers. And so the people, as we started earlier, that's such an important part of the equation.

There is one more question here. Maybe just before we get to this one, just to stay on it. The one other acquisition that has been out there is with the merger of Terminix and Rentokil. That's really the only other kind of truly large global competitor to you guys. Just any comment on what you've seen or what you expect to be different from that kind of consolidation or...?

Yes, I hate to really comment too much on an acquisition in our space like that. But we're all focused on creating value, and they felt like that was the best way of creating value with their franchise and their enterprise. And so it's not something that keeps me up at night. I mean I think the company certainly continues to benefit from having such a fragmented market, but also a really strong position in our market. And so I just don't -- I really don't spend a lot of time, and I'm not overly concerned about the acquisition.

Yes. And I guess, I mean, also, your mix is maybe a little bit different to than what Terminix brought in. I mean you guys have a little bit more commercial exposure and...

That's a really good point. We have a very broad-based business that's fairly split between commercial, residential and in the termite business.

Okay. Another question that came in from the audience on the -- just maybe clarifying the dividend policy with the special. So the question is, is this the new run rate, the special and the regular dividend you expect to pay at that level? Or is it -- or are you expecting continued double-digit dividend growth to kind of maintain the payout?

Yes. So when we look at the dividend strategy, we've been employing the special dividend for years. And I'm not saying that we're moving totally away from the special dividend. We may use it in future years. We have the opportunity to use it. But our focus right now is to use the regular dividend to provide shareholders a more consistent return of capital that they can rely upon. And so when we look at the current base, we feel like it's a base from which we can continue to grow. But we certainly have to continue to look at our business, the value growth opportunities. But I think if history repeats itself, we'll continue to increase the dividend and share in that capital with our shareholders.

And I guess maybe the last question is, just given that you are in the role, and Gary Rollins, the CEO recently has also transitioned out, and I think these were well telegraphed and well known. But just kind of what's -- obviously, you guys are a well-run company, but just future direction, anything that would be expected to be different? Or what do you see as a vision?

Well, yes, sure. I mean Gary Rollins is still certainly involved in the business. And he's -- when he does retire as Chief Executive Officer next year, he'll still Chairman. And when we look at his successor, Jerry Gahlhoff, it's exciting. I'm looking forward to partnering with Jerry. Jerry is an industry veteran. He knows the industry. He is trained entomologist. And so I'm excited about what impact we can make together in this really incredibly exciting industry. And so I'm looking forward to that. I think it's really not -- the business isn't broke. It's not broken at all. It's a business that's incredibly strong. And so it's just how can you continue to create value? How do you continue to make a positive impact? And maybe there's a few tweaks you can make here and there, but it's really not a wholesale turnaround or major change. It's a real good business.

I think we'll end it on that note. That's a good positive place to stop. There will be a breakout session just around the corner. But thank you guys very much. Ken, it was great to meet you.

Great to meet you.

And we appreciate your support and being here at our conference.

Thank you so much.