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

[Audio Gap] Group Head of Diversified Industrial Research at Stifel, and it's my pleasure to welcome with us Rollins, Inc. and our first time on stage together, in your new role, is the CFO, Ken. This is Ken Krause, CFO at Rollins. Many of you may remember him, he was the CFO for a long time at MSA. So welcome to your new job in the last year. It's been almost a year, and thank you for being here.

Well, thank you, Michael. I appreciate it. Great to be here. Great to be back at the Stifel Conference and just to share a little bit about Rollins.

Terrific. So I'd like to sort of ask the question about -- so in the pest control business weather matters. And last year, we had a very cold and wet spring. And this year, we kind of started off like when we started mowing, I have a farm when we started mowing the fields a month early and then it got cold again. So how would you frame the first 5 months, 6 months -- 5 months of the year weather? Is it better relative to last year, but are we a little softer seasonal start because it's been not cold and wet but chilly.

Great question. I oftentimes say, this business is more correlated to weather cycles than economic cycles. And that's probably a good thing just coming out of Barry's recent discussion over lunch. It sounds like you...

Did he scare the hell out of you?

It's going to be a really tough day. But no, all ...

Did you understand him? I don't understand him, so...

I'd ask [ Casey ]. He was with me, my Head of FP&A who's here with me, I had to ask him for some interpretation of those charts, but no, all joking aside, the business is certainly a strong business and definitely is correlated to the weather patterns. And we are seeing a very solid start to the year. We finished Q1 with just about 9% organic revenue growth. We saw an uptick in our residential sector of our business. So we're continuing to see really robust levels of demand and services. We entered this period in the current year from a period -- from a point of strength. And what I mean by that is our labor levels were very healthy. If you go back to the Q3 time period of last year, we talked about record number of applicants coming into the business. And we certainly saw that. And the benefits of that came through in Q1, and they're continuing to come through as we enter the busy season of the pest control market here in Q2 with the warmer climates that we're all seeing. And so we're staffed very well. And the demand level, I think, which is somewhat correlated to the weather pattern is certainly helping us drive some nice solid results for our shareholders.

So 2022 is an interesting labor year for direct workforces. And everybody basically described it, it was really tough in the beginning and got a little bit better in the back end. Would -- as part of yours that the housing -- rate of change in housing starts had compressed enough that -- because it isn't that typically a pool of candidates, somebody comes out of construction, might come in and do be a technician. Do you think there is correlation there?

That certainly could be a part of the correlation. I also do think that we talked last year in Q3 about a new software that we were employing from the standpoint of recruiting. And so I think that also combined with maybe a better availability in the talent pool was beneficial in us being able to recruit new people coming into the business.

So -- and this is sourcing software, this is sort of giving you access to a broader pool?

That's right. And it also makes it easier for applicants to apply for roles at Rollins. And so we all know that not only do you need a pool of available talent, we got to make it easy for people to apply and to be eligible for participation for employment at Rollins. And so that certainly was helpful. The other thing that's been helpful for us, Michael, is coming out of COVID. During COVID, we all remember those tough days where you had the social distance. And coming out of COVID, we've been able to get techs back and do ride-alongs. So what does that mean? That means that we were able to -- as part of our hiring practices, when we hire a tech, we have a requirement that they do a ride-along, a day in the life of a tech, understand what you're signing up for. And we've been able to employ that again as we've come out of COVID, helping our retention rates with new techs, knowing what they sign up for, helping them get back in and we're having less loss when it comes to new techs that are coming on to the job which is very helpful.

And that early turnover happens when, how fast does that happen?

That can happen as soon as the first week. If somebody comes in and they haven't had the opportunity to do a ride-along and they don't know really what they're signing up for, that's not helpful or beneficial for them or for Rollins or our customers. And so we certainly -- during COVID, we saw robust levels or higher levels of turnover earlier on. We started to see that moderate. That's helped us as well from a staffing perspective.

So a couple of years ago, before you gotten there, Rollins had found itself in a scenario where they had onboarded a lot of the seasonal techs early then got caught in a tough seasonal period. This sounds like you all onboarded early again. And so has there been a change of thinking about the timing of this? Or is it the -- there was such a good pool that you were taking advantage of don't -- the cookie jar is going to bite -- grab a cookie when it's there.

No. I think you got to be opportunistic but also you got to be strategic and think about demand levels in your business. We'll look at demand levels on a daily basis. We have the opportunity to see into a bulk of our business and monitor our backlog levels because we realized if we go out and sell a service, but we don't perform the service in a short order, there's a risk of that service getting canceled. So it's important for us to monitor that backlog. And we feel like our staffing levels are appropriate and healthy based upon the demand level we're seeing in our business today.

Okay. So can we talk a little bit about organic growth and sort of frame how you see the underlying structure of the market growth? What your potential is to either match or exceed it? And then what are the mixes of the pieces between price new customer and cross-selling? So if we frame North American pests because this is 90-plus percent of the company, we frame North American pests, how would you frame what Rollins' perspective on the market growth is?

Yes, industry research and a lot of public information indicates that this market is growing in that 3% to 5% sort of range, that low to mid-single-digit sort of range on an ongoing basis. And we feel like that's probably about the right level of market growth. We feel like we're in a very attractive market, I mean a very large market. You look at the market globally, it's about $20-plus billion. In the U.S. alone, it's $10-plus billion and growing at 3% to 5%. It's really hard to find a market as attractive as the pest control market. And as a result, we are certainly focused in on that core market. We're not ready to make a student body shift right or left away from that market, but we really are focused in on being the best pest control company out there.

And so from that perspective, what do you think makes up the 3% to 5%? It's new -- that's actually new customers coming into the market because it's -- the same data we're probably both reading is -- I think it's a little bit bigger today, I think it's closer to [ $12 billion and $22 ]. But it also is suggesting out of 120 million households, only about half of those are truly addressable market and only about half of those are actually buying a service. So as part of this, that 30 million that's not buying the service is starting to buy it or that there's more services being added within the 30 million or a combination of those two...?

I think it's a combination of not only the new households that are signing up for the service because for whatever secular trend that's occurring, the weather or the warming of the climate or what have you. And then you also have an element of just the overall market growing from the standpoint of a number of other secular trends. And so it's really hard to put a fine point on what percent of the 3 to 5 is new customers coming in. But we do know, based upon some of the -- some of our experience that it is certainly is new customers coming into the fold, a new customer base that we don't do business with today.

Okay. And then incrementally adding, so they're adding mosquito and tick and things of that...

no doubt about it. No doubt about it -- I mean you see, a couple of months ago, there was a story run in the Wall Street Journal around ticks sent it to Jerry, our CEO and talked a little bit about our work in that area. We do work in that area. I think that story was run again yesterday in the Wall Street Journal actually, investor pointed that out to me earlier this morning. But that's interesting. Pest -- ticks are interesting. The mosquito business, you talk about mosquito. That business is growing significantly. It's far outpacing the rate of growth in our overall business, and it's been pacing in that manner for a number of years now. And so we have the opportunity not only to go in and to sell our customers the traditional pest control but bolt-on that additional service, that additional mosquito service, additional tick service, the Critter Control business is a really attractive business for us. If you're in an area where you have a raccoon that would enter your home, your fireplace, we're able to deploy our Critter Control business and franchise to go after and help you respond to that need. And that's a really attractive business as well. So yes, we certainly are seeing the new customers come in but also an expansion in the share of wallet of our existing customer base.

So when you think of total revenues, I mean, Critter Control strikes to me as that's a onetime event where mosquito, tick, traditional pest, termite at the resident are recurring and then the combinations of what it would be applicable in commercial. I mean the Critter Control is a nice business but a small base. It's not -- I mean it's not 10% or 15% of revenues?

No, it's a nice business. It's not 10% to 15% of business. But the thing about Critter Control that maybe we're missing is that you're right that it could be more of a transactional sort of business. But when we go in and we're called in for the Critter Control franchise, we're able to tap into a customer potentially that we don't have today. And so there's an opportunity to when they call upon our services for Critter Control to sell additional pest control in that market. So they may not have a mosquito service or they may not have a tick service or they may not have other sorts of services, so that opens up a potentially new customer for Rollins when we're not supplying the traditional pest control.

Okay. So you have talked about since your arrival that you think that Rollins ought to be able to sustain at least slightly better than the underlying market growth. Share with the market or share with the room that what are you all doing structurally, whether it's your go-to-market strategy, customer acquisition, the speed which you service, the nature of the service, what is it you're doing that's allowing you to take that incremental share gain?

So we're doing a number of things. If you look at the business through 2 or 3 different lenses. One is our M&A strategy. We continue to take and make significant investments in our M&A strategy, bringing new brands into the fold, new potential customers into the fold, which continues to allow us to sell additional services to that customer base. So we certainly are doing a lot on that front. We're doing a lot on the advertising front. It's important to be top of mind at the right time. And so what do I mean by that? Well, it's important to deploy your advertising dollars when there's a demand for the service. So in the peak seasons of the year. So we've certainly started to do more of that. We've also -- going back to the M&A strategy, the recent acquisition of Fox. We're not a door-to-door business. We haven't traditionally been a door-to-door business. But the Fox business brings in a new way of reaching potential customers .

Just help everybody when you say door-to-door is literally hiring college kids and what have you they go knock on the doors.

Knock on doors. And so Fox is -- it's interesting. That industry -- Jerry did some work a couple of years back prior to my joining. And he went out and he did some research on the door-to-door business and how big that business might be, how big that market might be? And he quickly determined that there's a very significant opportunity in that business. It's -- and so as a result, we started to go down the road to evaluate what opportunity would be most appealing. And we determined that Fox had a great culture. The churn is not any greater than what we have in our traditional business. And it felt like an opportunity to be able to leverage that business model in our existing business. And let me give an example. Well, HomeTeam business, which has TUBES IN THE WALL. HomeTeam is a pest control business we bought well over a decade ago, incredibly successful. It's been a great acquisition.

Just for the room, they're installing infrastructure inside the frame of the house to sort of introduce the pest controls?

That's right. And it's a proprietary technique for providing pest control to customers, very strong position. And so it goes into a new home, a customer has it, they use it. And as we all know, customers move from one home to another maybe every 5, 6 or 7 years. So when a customer leaves a home, sometimes those tubes go dead, they're legacy tubes. They're not being utilized. But we know where those tubes are, and we're able to then deploy the resources at a company like Fox to go after and engage in that customer -- potentially a new customer. So there's a real opportunity there. And we're excited to have Fox in. We're excited to have that culture, have that business, have that team as part of Rollins as we think about the future.

Okay. So if I pulled on that thread a little bit, and I don't want to run down too big of a rabbit hole. But if I pull down the thread, I mean, you have a whole customer service group, why couldn't that sales force have done the same thing because you have the same data. So what's the difference in somebody knocking on the door versus I know this house had a customer, who doesn't have a house -- have HomeTeam in it, why aren't you...?

Yes. We just haven't -- quite frankly, we haven't prioritized it. I mean we haven't made it a priority until late. And so it's an opportunity, an upside opportunity to drive our revenue growth a bit higher as we think about the future. It was really one of those opportunities we just didn't get to. And now with the resources we have with Fox, it enables us to get to that opportunity and to really realize some of the growth potential that might be in that market.

Okay. So back to the 6% saying that, that's better than the market. And I'm thinking about this is just organic and the M&A would be incremental to that. How would you break that out in new customer add price versus a cross-sell within the existing customer. And then to the latter, if I think of the number of services you could offer, so particularly in residential where are you in the -- if pest is the core, there's the incremental add.

Sure. I mean when I look at it, you're using a 6% number. I'll go to the more recent quarter at 9%. I'll go -- that's organic growth. I'll go to last year where we, I think, delivered something in the levels of 7% to 8% of organic growth. And so we've seen an uptick in our organic growth. It's been a great market with people moving in some of the more warmer climates of the country, with the winters being much more mild than they've been. We're seeing an uptick in our organic growth. If I look at the 9% and I unpack the 9% in our more recent quarter, we talked about a 4% price increase a year ago. We raised prices again this year at around 4%. And so about just under half of that 9%, 3% to 4% is probably price. So that means the remainder that 5% to 6% is volume growth. And we know that based upon research and based upon what we just talked about, our markets are growing in that 3% to 5%. So you can see that we certainly are successful at gaining share, and we're gaining share across our market. But also in addition to gaining share, our focus is reducing churn, reducing the churn we have in our business. And so we're focused on reducing churn because the less customers we lose, the less customers we need to add. And so that's certainly a focus for us. And then last but not least, this cross-sell opportunity. We're incentivizing our techs, we're incentivizing our sales folks to go after the cross-sell and those existing customer relationships that we have. So there's a combination of things that are really driving that 5% to 6% of volume or nominal growth that we're seeing in our business.

And if you thought about the installed base, and we'll stick to the residential side as the example, what's the one point what number of services that installed base of residential has today?

Yes. We haven't disclosed it publicly, but it's less than 2. It's -- and it's a real opportunity for us as we think about the future.

So you had a peer company that before it was acquired talked about that as a true opportunity as well and framed it as 1/10 point of improvement with $60 million in revenue and at that time, their size is slightly smaller than you. Is that math hold up if I sort of proportion it to Rollins size? Is that the way to think about it?

It's hard to correlate the peer company that was there previously to Rollins. What I can tell you is give us a little bit of time. I think we're looking at potentially doing a more widely communicated Investor Day as we go throughout the year later in the year. And so as we get through the next, say, 6 to 9 months, we might be willing to share a little bit more around that. But today, let's just give us a little bit of time just to think about that a little bit more.

Okay. So this is what I do for living, so I got to tease this out a little bit. So I get less than 2 -- more than 1 less than 2 pick whatever. Is it practical to talk about that this can be a [ 2 ] integrator? Or is it more like it's somewhere -- it's a good, strong 1 to 2?

Yes. It's hard to say. I would be -- my more optimistic side would say we'd like to be above 2, but I also am realistic in saying that small changes are impactful in this area. And so that's important. The other thing that we're missing in the conversation is the fact that there is this ancillary aspect, which can be transactional, can be onetime in nature. But we've consistently in the last 12 to 18 months have seen really a nice uptick in our termite and ancillary business. Some of that's termite but a lot of that is our ancillary. So crawlspace, gutters, insulation that's another area that's really producing some strong results for us when we think about the revenue growth.

And is there an explanation for why the rate of change improved there?

Yes, I think we're just deploying a lot of focus, and we're intentionally focusing in on incentivizing our teams to focus in on that area because it's a real opportunity. When we go in and we see an issue related to pests, we want to help prevent that issue and help our customers not have to deal with that issue in the future. And we can take care of the pests. But unless we prevent the pest from entering the home or we take care of it in that manner, we're going to be back. And so we want to try and help our customers provide a longer-term sustainable solution.

Okay. M&A is part of the growth story, has been for a long time. If we're agreeing, we're a $12 billion domestic business, you're something in the mid-20s is share. One, have you run into issues where Justice is starting to be scrutinizing you more given that you're approaching that magic 30% number they like to focus on? Is that becoming more of a challenge? Or secondarily, are there fewer chunky bits to buy, and therefore, you're not bumping up against that anyway than there's a lot of little?

No, it's interesting. We're not seeing any constraints with respect to that to date. Not to say we won't in the future. But to date, we certainly haven't saw any constraints related to regulatory compliance with respect to acquisitions. It's a very fragmented market, 20,000 competitors or oftentimes referred to as 20,000 competitors across this space. And so -- and they range in scale from very small to more significant, more meaningful competitors. And so we're going to continue to be active in this area. We feel like it's a very competitive market. We've got a number of formidable competitors in our space, and we feel like it's a very competitive dynamic.

So we did -- I alluded to a merger earlier. So the Terminix-Rentokil transaction -- Rentokil-Terminix transactions is done. When it was initially announced, one, there was speculation they would have divestments they didn't. But then follow-on speculation was, well, things like this have to be disruptive in many ways. But from your perspective sitting in your seat, has it resulted in opportunities? Or is it just now a better-run, bigger competitor?

Any time you're around -- I've been around transformational mergers and acquisitions in my former life, in this life. And any time you go through a transformational acquisition, there's always opportunities in the market. There's disruption. And so we're seeing opportunities in the market. We feel like -- we don't feel like it's hindering our ability to grow our business, and we're seeing additional opportunities for growth coming through. I wouldn't say as a result of the acquisition but we certainly continue to see our fair share of opportunities for growth.

Okay. So labor is your biggest cost. It's over 50% of the cost. So if you're trying to find points of utilization leverage, it would be around labor. You've introduced different forms of technology to drive better vehicle miles travel, sort of reducing routing. Where are we in that transition, if you will, around use of technology on literally just around the driving aspect, windshield time, get the tech in front of the customer often?

Yes. We have got a really nice internally generated and developed software. Our BOSS system continues to be a really nice route-based sort of system that we use to manage that. We're conscientious of windshield time. We know windshield time is the enemy of productivity and the enemy of improvement in profitability. And so we're trying to do everything we can with that system as well as other systems to really manage the windshield time. And you're right, 50% of every dollar we generate is normally spent in labor. And so people are our biggest cost. And for that reason, we're not only focused on our tech and our folks that are servicing our customers, well, we're looking across the spectrum of all of our costs. You probably have heard me talk about recently our aspiration around going after and taking costs out of the business, upgrading our talent, making investments in our talent. Well, we are certainly focusing on that, not only on the front end but also in the back office. When we look at our business, there's a real opportunity to continue to look at our back office, improve our processes across finance, HR, IT, legal, which will make us a better, more efficient company. And not only make us a better, more efficient company, it will make us better and more prepared to do acquisitions and generate the synergies that we think we can create by reducing back office cost in some of these acquisitions.

So let me take that to the next piece, I want to come back a little bit to what we're talking about. But historically, the industry participants would talk about low 20s margins sort of 21%, 22%, combination of residential and commercial. You all have been running it better than that, more like 22% plus. What I'm hearing you talk about is are we removing that sort of artificial ceiling that used to exist and that -- is it 23%, 24%?

When I look at the business, my focus is to continue to improve the business. One of our core values at Rollins is continuous improvement. And when I apply that value to margin opportunities, I oftentimes look across the entire P&L. And so if I start at the top, our gross margins are roughly 50%, 51%, 52%. But our EBITDA margins, as you so well indicated, is around 22%. So that means there's about 28% of cost in between the gross and the EBITDA line. And so when I think about that, that sounds like and feels like a pretty significant number. When I compare that to top quartile or top decile, it seems like it's a little bit strong. And so 30% of cost of revenue as a percentage of -- for SG&A feels a little bit high. And so when I look at it, I do think there's an opportunity not to reduce it from 30% to 23% but to reduce it several hundred basis points by a focus on improving productivity, focus on improving some of our systems, focus on improving some of our talent and the pipeline we have in our talent, especially in our back offices. And so there's -- I think there's an opportunity. When you have a business that generates an incremental margin of 30% to 40%, and we've done that, you should have opportunities to lift margins higher than 20% or 22%.

Right. Okay. So back to my technology question, but now moving over towards commercial and labor because it's -- that's a different windshield conversation because the tech might go into one location, be there all day, for example. Is there -- is -- again, this competitor's predominately on the international scene where the marketplace is more commercial than it is residential talk often about a technology deployment to try and find that labor utilization. Is that something that the North American market, one, is receptive to? And two, what are you all doing in regard to sort of addressing moves in that direction?

Yes. We're early on in that space, but we're certainly evaluating it. We feel like there's potentially opportunities to improve what we do with respect to that. We're not where we need to be, but we certainly are evaluating opportunities for improvement around that. We always want to improve the technicians' experience because if we were able to reduce windshield time, reducing efficiencies with the tech, the tech is going to service the customer more effectively. And that's what it all gets back to servicing your customer. If you service that customer, you earn the right to keep that customer and enjoy the benefits of a long-term relationship with your customer base.

Okay. Inflation was an issue. Actually, it was [indiscernible] before you got there, but it was something you've seen is predominantly around fleet. It's a combination of availability and then obviously fuel. So there's a couple of pieces to this. One, has the fleet availability begin to improve that your aging is coming down, therefore the repair and maintenance numbers coming in. Two, industry hasn't historically embraced a fuel surcharge. Well, lots of routed businesses have. Is that something that should be explored? So that's getting at the inflation question that was around fleet.

Yes. Let me start at a high level on that. And what I've talked about in the first quarter was, we've been able to recently see benefits with respect to fleet costs and materials and people costs as a percentage of sales. So we're seeing our price increases helping us offset some of that inflation that we're seeing in our business. And what also helps offset the inflation is we have an incentive-based compensation structure for a lot of our tech, which is different than maybe what others do. And as a result, we're not so heavily dependent upon a fixed base salary for our techs and that helps us manage that inflationary experience a little bit more effectively. I think that's also -- that's an interesting thing to think about when it comes to the inflationary cycle and how it impacts our business.

Okay. So what I'm hearing is you're getting more trucks, so that's lowering the age, that's lowering repair and maintenance but where are we philosophically around fuel surcharge?

So from a fuel secure perspective, if you ask me about surcharges, I'm never a supporter of surcharges. Surcharges come and they go. I want to be in a business where I can price, I can pass along price, it's based upon the value of the service that we're providing our customers. And we've been able to successfully do that. And I think the focus for us at Rollins going forward is to maintain that strong focus on pricing and effectively pricing the value of our services for our customer. So we're not in that rollback period around surcharges and having that kind of conversation with our customer base. We'd rather just charge an appropriate value for the service based upon the cycle that we're in.

All right. Well, we're at the end of our time. I want to thank you, Ken, for, one, congratulations on your new position here coming up to your first anniversary, and thank you for being here.

Thank you, Michael. I appreciate it.