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

Well, thank you guys for joining the Rollins management presentation. I'm Alex Shaner for Credit Suisse. I run our Boston sales desk, our business services analyst, Kevin McVeigh, couldn't be here today. So I'd like to introduce the Rollins management team, Ken Krause, the CFO; and Julie Bimmerman, VP of Finance and IR. I'll turn it over to you guys for the presentation, and we can follow up with some Q&A afterwards.

Great. Well, thanks. Thanks for having us, first of all, and great to be here. Julie is here with me as well. I'm Ken Krause, I'm the CFO at Rollins. I've been the CFO for all of just going on 3 months tomorrow, actually, 90 days. So September 1, I joined this great company and it's been a great run the last 90 days and looking forward to really helping participate in continuing to build this out -- all of these brands that we have. Julie is with me today. Julie heads up all the IR functions. She is the Group Vice President for Finance and Investor Relations at Rollins, and she'll be with me to answer questions here as we go through the presentation. Safe harbor here, just to start, we all know what the safe harbor is, but I just want to call that out and remind us all of the importance of the safe harbor. At Rollins, when we look at the Rollins business, there's 3 things that come to mind. First and foremost, people. We really are a people business. We realize the importance of an engaged workforce and how important that is to providing the second point, exceptional customer service. We focus on taking care of our customers each and every day and providing the best service and the most reliable service that we can provide. And we believe that a highly engaged workforce and technicians, highly engaged technician structure really results in high engagement, high customer retention and a happy customer. And those 2 things come together for my third point. The third point is consistency. When you look at the Rollins business, really one word that can describe it is consistent. Over the last 20 years, we've seen consistent growth each and every year, whether it be through a pandemic or whether it be through the great financial crisis back in 2008. We have consistently grown this business and not only have grown the business, but cash flows have consistently compounded at a very high rate. And I'll talk about that here shortly. But today, we're just under $3 billion of total revenue, EBITDA margins that are north of 20% and cash flow conversion that consistently has come in at above 100% of net income. When I look at the business and I look at the markets that we compete in, we compete in roughly a $20 billion global market. We do have a strong position in our markets that we serve around our globe, around the globe with a focus on 3 broad service offerings. One is residential pest control, second is the commercial pest control. And last but certainly not least is what we call termite and ancillary services, kind of a cross-sell market that we are very much focused on. We go to market through our brands. You won't see the Rollins brand out there servicing customers. But what you'll see is Orkin, you'll see Northwest, you'll see Clark Pest Control and others that are very active and highly engaged in the communities where we go to work and we serve our customers. The business has been built through acquisition. Rollins is the parent company. But over the last 6 or so years, we have built this business through acquisitions, whether it be the Orkin acquisition, where we originally were founded back in the early 1960s or more recently through our acquisitions of Northwest or Clark Pest Control or even back in the great financial crisis with our HomeTeam acquisition. HomeTeam actually us where Julie came through. And our current CEO or our CEO in waiting, Jerry Gahlhoff, which will be -- which we announced earlier in this year, where he will be taking over as the Chief Executive Officer starting in 2023, the early part of 2023. He came to us through the acquisition of HomeTeam. And so we continue to compete with our brands. We continue to go to market through our brands. And not only are we acquiring new brands, but we are also providing capital that these brands can continue to grow through acquisition. And so we continue to build out our portfolio across the residential, the commercial as well as the termite area of the business. It's interesting. We really focus on helping protect where we live, where we work and where we play on an ongoing basis. And not only do we help protect those areas, but we also help protect our customers' brands. We really -- on the commercial side, I think our services are highly valued in protecting the brands of our customers. Our customers and the leisure and hospitality markets, health care markets and logistics markets, just to name a few. When we think about the execution in the business, 3 or 4 major points here. One is consistent revenue growth. As I spoke earlier, we have consistently grown revenue through recessions, through pandemics and through other challenging environments. And we do enjoy a highly recurring revenue model. 80% or so of our business is under contract and is a recurring revenue that we enjoy in our business. We've consistently deployed capital for acquisitions. Year-to-date, we've seen just over 3% of our growth coming through acquisitions. Total growth in the first 9 months of north of 12%, with about 3% or so of acquisition-related growth. We've deployed about $110 million of capital this year for acquisitions. And we've continued to grow our cash flows this year, seeing about 60% growth in the third quarter, but about 15% year-over-year growth through the first 9 months, which is really consistent with what we've seen over the last 5 or 7 as well as over the last 20 years. And we just recently announced an increase to our regular quarterly dividend, a 30% increase to our regular quarterly dividend when we announced our earnings in the third quarter. Last but certainly not least, the company is highly focused on value creation. And when I speak of value creation, I'm speaking of margins and improvements in margins. We already enjoy a very strong and robust margin profile, but we also continue to look at productivity initiatives, pricing initiatives and other initiatives that are aimed at continuing to improve our margin profile. In the third quarter, we reported an incremental margin, on an as-reported basis of just under 30%. But when we add back some items that we incurred in the quarter that we don't expect to recur in the future, we saw an incremental margin of roughly 37%. And so with high gross margins, good strong growth, good pricing opportunities and productivity, we feel like we have a really nice opportunity to continue to improve upon our margin profile with our highly accretive incremental margins. Looking at the business model, it's hard to find a business model with this sort of trend. But over the last 20 or so years, we've seen growth in revenue in just about every year over the last 2 or so decades. 3 interesting points here. The great recession. We all struggled through the great recession, whether -- no matter what business you're in. But in the Rollins business, we saw a 5%-plus growth through the great recession. The industrial recession of 2015 and '16, again, we saw about 5% growth. And during COVID, we actually saw a bit of an inflection point in our business. With people staying at home and being more aware of the situation in their homes, we actually saw some improved growth, and that growth has continued to improve as we went into '21 and then '22 here, we're seeing 12%-or-so growth. So continuing to grow. And when we think about the markets that we compete in, there's a number of trends that provide us a bit of optimism for the future, whether it be the demographics with less and less people wanting to do this type of work themselves or whether it be in the overall changing environment, the warming of the climate. We're seeing new and new -- new pests emerge each year. It's interesting that we're all familiar with the bed bug situation a few short years ago. But what we're seeing right now is actually a changing dynamic with respect to mosquitoes. And so we continue to see improvements from our services that we're offering on the mosquito front. So we feel pretty good about our position in our business, our position in our markets and our ability to continue to drive improved growth. Cash generation is a major focus for us here at Rollins. Over the last 20 or so years, we've seen cash compound at north of 15% growth. And over the last 5 or so years, we've seen it also grow at about 15%. So pretty consistent growth in cash flows, really not a capital-intensive business. We have been able to turn over net income to north of -- at or above 100% of net income is turned over and converted into cash flow. As you can see here, during the last 6 or 7 years, we've consistently done that. And even going back before that, you saw some good performance on cash flow. And that's an important part of the equation when we think about the growth because a lot of the cash flow that we're using here, I'm sorry, we're generating is being used in M&A. And so when we look at the capital allocation strategy from 2017 to 2021, we've deployed just south of $2 billion of capital, which has been split pretty evenly between M&A and dividends. And so we share in our generation of cash flow through the use of a growing dividend. As I said earlier, we have a very low level of CapEx in the business. It doesn't take a lot of capital to run this business. And we have significant capacity to continue to fund our growth, to fund our ability to grow our dividend and also to continue to potentially look at share repurchase as we move forward into the future. Q3 performance update. Back in October, we announced our third quarter results and a couple of major points here. One is we had strong growth across all major product service lines. We talked about the fact that in the third quarter, we saw a bit of a slower growth in the residential market. We talked about the impact of the hurricane, unfortunate situation with the hurricane that hit us in late September. We talked about the fact that we expected good -- better growth here as we went into October. And I'll tell you, we did see that. We saw some good growth come through in October, in line with what we saw for the third quarter across our business. Margin improvement, we did see margin improvement in the quarter despite incurring about 140 basis points of headwind associated with what we call the casualty reserve. And that category reserve is primarily being driven by higher suits and resolution of claims associated with automobile accidents. Double-digit earnings growth and cash flow growth was -- we reported that in the third quarter with in excess of 100% of free cash flow conversion. And as I said earlier, we increased our regular dividend by 30%. We had historically had a focus on using special dividends. And as we looked at the special dividend as well as the regular recurring dividend, we made a decision to prioritize the regular dividend to provide shareholders with a more consistent return of capital into the future. And so summing it all up and looking at some of the major reasons why we would consider investing in Rollins. Well, first and foremost, it's about the growth. This business has consistently grown through all types of economic cycles. We've seen 20-plus years of consistent revenue growth, reliable mid-single to high single-digit sort of revenue growth with a high degree of recurring revenue, with about 80% of our business recurring on an ongoing basis. M&A has continued to play a very strong part in our growth profile, and we expect it to continue to play a part in our growth profile going forward. We've got a very robust pipeline. We're looking at opportunities that we can action as we go into 2023 and continue to bring in new brands and build-out our existing brand portfolio as we think about the future. Strong margins in the business, but we feel like there's opportunities to continue to lift those margins, as I talked about earlier with our focus on pricing, with our focus on productivity, with our focus on putting some new processes in place in our back-office support functions. We really feel like there's an opportunity to continue to build upon this already strong margin profile. Consistent growth in cash flow continues to remain a focus for us. We continue to focus on driving improvements in cash flow and opening up that cash and generating that cash and allowing us to continue to invest back in the business. And last, but certainly not least, we have a very healthy balance sheet. Today, we have essentially as we look at the results through October and November, we have a net cash position currently in the business. So we have a very healthy support level from which to continue to use our balance sheet, to grow our business, to fund the dividend and potentially buy back shares in the future. So very strong business model and consistent execution has delivered strong returns for our shareholders. With that, I'll open it up for any Q&A that there might be.

All right. I can kick it off and then hand it over to the audience. I was wondering if you could spend a little more time digging into resi versus commercial on a go forward because you would think that in some ways, if we see lower housing turnover, that could be a positive lower churn. I'm just kind of curious how those dynamics play in. And then on the commercial side, I don't know how that works with the offices not being full, remember it may be. So if you could spend a little time on those markets on the go forward given kind of where we are in the cycle?

Sure, sure. I'll take the first part, and I'll also ask Julie to weigh in as well. But as I said earlier, about 45% of our business is resi and north of 30% is commercial. Both are really fantastic markets for us, very sticky markets. Starting in the commercial side of the business, you're right, there's always a risk around recessions and people not coming back into the office. But I'll tell you, the markets that we have targeted, the logistics market, the health care market and the leisure and hospitality market, we're seeing continued robust levels of demand. And they're actually very diversified, very defensive. They're great markets to participate in. And so we haven't seen a major downturn or anything associated with a lack of return to the office. I mean we -- you might -- overall, you might see pockets of the business that might see a little bit of softness. But overall, our position across these end markets, these very favorable end markets has been beneficial for us to navigate that. And in fact, as I said earlier, we've seen a bit of an inflection point in our growth profile post COVID. That inflection point might be enabled through some of the things we're seeing on the commercial side. But there are also some things that we're seeing on the resi side. I think the company had talked about, prior to me joining them, the fact that more people being at home, more people are seeing the issues and more people want to take care of the issues and thus we get the phone call. And so that resi market has been a really good market for us. There could be challenges there as you go forward into recession. But as I said earlier, we've been able to execute and grow through all types of economic cycles in that -- in our business overall. And we feel pretty confident about our position to continue to grow our business into the future. Julie, I don't know if you want to add anything with respect to that.

Yes. I'll just -- as you said, on the commercial side of the business, we've really focused on going after verticals that are not as impacted and that can sustain better through these type of environments that we find ourselves in. And so that has definitely been beneficial and helped us. And then to your question on the residential side as far as with people that are staying in their homes. Traditionally our #1 reason for losing a residential customer in the past was due to moving. So yes, it is definitely beneficial from that standpoint. Hopefully over time we've worked to get better on catching them where they move, picking them up on the other side. But that would definitely…

Julie, that's an interesting point. Julie, as I said earlier, came to us through the HomeTeam acquisition. HomeTeam acquisition, I believe, correct me if I'm wrong, Julie, but I think it was 2008-2009?

2008.

And so Julie and Jerry both came to us through that as well as a number of our other leaders in the company. And that's an interesting business in that you partner with a homebuilder and during the building construction process, you put tubes in the walls of the home that are used to treat pests in the home. And whether -- no matter what happens to the individual that's living in the home, whether they stay there for 30 years or they stay there for 3, those tubes are in the home. And so those tubes have an opportunity for us to access and continue to provide service to that home no matter who's living in that home into the future. And so that's been a fantastic acquisition for us and really helps us navigate the challenges with respect to the residential market that we were talking about.

Any questions in the audience? Right. So on the acquisition pipeline, I was curious because on one of your slides that showed that, I think, percentage of capital allocation to acquisitions might be a lower percentage year-to-date than is overall. Can you just address the acquisition pipeline, if that is by design because you're raising your dividend or allocating capital elsewhere or is it just kind of opportunistic what's been available this year and going forward?

Yes. It's really opportunistic. I mean we've deployed, I want to call it $110 million of capital this year for acquisitions. And it might be a little bit lower than that overall 50% of free cash flow. But it's by no means indicative of us prioritizing a dividend or any other use of capital. It's really just timing. And I'll tell you, the pipeline is full. We're very actively looking at opportunities in the market today with the hopes of bringing more acquisitions into the fold as we go into 2023. So what I would say is just stay tuned. And there's a tremendous amount of acquisition opportunities that we continue to evaluate and continue to consider bringing into the fold as we go into 2023.

Yes. And that's one thing that's what just so you understand, we don't earmark and say we're going to spend x number of dollars. It's just when those right ones are available. And as Ken said, the pipeline is very full. Think about it this way, at least 4x the number of acquisitions that we close in every year, do we actually start looking at for due diligence. So I mean, there are so many more. We're very picky even though we had 27 acquisitions in the first 9 months of the year. So it sounds like we might not be, but we really are to make sure that they fit and they're a true culture fit for us.

Really a good point and that we're not tied to a certain percentage of capital being allocated. And we're not tied to a certain number of acquisitions any single year. We have a very -- we have a filtering mechanism that we have in place where we start very wide. And in the end, we narrow it down to be very selective with our acquisitions. And we've been successful. Fortunately, we've been very successful with acquisitions in the past. And we feel like that filter and our approach to acquisitions has certainly helped us create value for our shareholders.

And since we're on the capital allocation topic, you had mentioned share repo was part of kind of the discussion, but hasn't been a big part in the past? Can you just expound upon that a little bit?

Yes. So I mean, when you look at the business, I think there's been a number of things there. You look at the overall float with 50% of the company or so trading in the family's hands or lack of trading in the family's hands. And so there's not a large float there associated with it, one. 2, we've consistently grown the business. We've used the cash flow that's being generated in the business to fund growth. And then last but certainly not least, as we evaluate the use of excess cash, we've prioritized the dividend over other sorts of uses of capital. It doesn't mean that in the future, we won't buy shares back. But thus far we haven't had a need to do that.

And just competitively with the market in general, I know there's been consolidation with some of your larger competitors. Any commentary about the competitive nature of the business as it relates to your competitors consolidating and/or or just the market share shifts in general?

Yes. No. I mean we have a really -- we compete in a really good market and a very rational competitor set. We have a really good list of competitors that we compete against and fierce level of competition, quite frankly. It's a really good market to participate in. And it's hard to comment on what's going to happen over at Rentokil and Terminix. I mean that's a big deal. It's a big merger, transformational sort of merger. And those are challenging. And so it's -- we'll be watching it from afar. But I'll tell you, our focus isn't on what the competition is doing from an acquisition or a combination standpoint. But our focus is execution in our own business. And as you saw on the one slide I presented, our focus is execution. Our focus was driving growth, driving improved margins, acquiring good businesses and returning capital to our shareholders. And so that's going to be the focus. That will continue to be the focus as we go into the future. And so it's -- as I said, it's really -- it's an area that we just, we don't like to comment on the competition and what they're doing with respect to the acquisitions. Our focus is executing our playbook.

Anything from the audience? Well, just since it's topical, I know you kind of addressed it earlier, but you had the stat up there about growing through the prior downturn. And I guess I was just kind of curious just from the perspective of whether management initiatives or whatever it might have been to kind of drive that growth through the prior downturn or was it more just the nature of kind of your business and just kind of how you're thinking about going forward for the next few years? Because just with rates where they are, housing turnover turning down, like you would assume that you might end up in a similar scenario to the prior one?

It's interesting. I wasn't here in these prior recessions. But the one thing that I have consistently heard from senior leadership in the company that's been around for a long time, is taking care of the customer, taking care of our technicians, if we can create an experience for our customers that's valuable, that's providing the service they need, it becomes a very sticky business. And so what we found is if we focus on our techs and it's very well-known that we are one of the highest if not the highest paying company within our industry for our techs. And we firmly believe that providing that type of compensation structure results in a higher level of engagement, and that higher level of engagement provides a better customer experience. The business becomes more sticky through recessions, through good times, through bad times. And so that's the focus. And I think continuing that focus as we go into the future is really important, and we'll continue to pay dividends for us, one. And 2, the other aspect is we continue to buy really good businesses. We continue to look at businesses through a long-term lens. So oftentimes, it's easy to get excited about M&A in the year of acquisition. But the real question is, what's this business going to do in the next 3, 5 or even 7 years? And the HomeTeam acquisition was a good example of that. When you look at that business back in 2008 or '09, it probably had a higher degree of business that was tied to new housing starts. But looking at it and thinking about how you grow that position and you get scale in that position at one point, it turns into more of an annuity-based business, that's the right decision. And so taking the long-term view on some of these acquisitions, I think, has been very beneficial for this company and positions us well to whether economic downturns that might come in the future.

Yes. And then I'll just add on to that is -- and then we have planning for possibilities. It's all of our brand presence. They always have -- they have their playbooks, as we call them, on what -- how they will react, how they will address the business if we do have certain types of downturns so that it's not a question. You don't waste time trying to figure it out at that point, you're already acting.

And then I guess, lastly, I'll just ask, you mentioned kind of bed bugs versus mosquitoes or what you're doing with homebuilders on some of the initiatives. Anything else from kind of management's playbook that's worth calling out within the different brands or segments that's kind of new or different on what you guys are pushing?

We're all focused on a more sustainable environment. And green applications for pest control are important to us and they're important to our customers and thereby they're important to us. And Northwest, one of our acquisitions from a few short years ago, is highly focused on providing a green solution. And that's beneficial. We're seeing good demand there. And in fact, some of the sharing that we're doing with other brands is having a very positive impact on other brands that otherwise didn't have exposure into those markets. And so I think that's something that we're paying attention to and continuing to fund as we go into the future to name one of many areas that we continue to look at.

Great. Any other questions from the audience? All right. Well, great. With that, Ken, Julie, thank you for joining us today. I think we can wrap up.

Thank you.

Thank you. I appreciate it. Thanks for your time.

Thank you.