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

Good morning or good afternoon, everyone. I'm John Mazzone, 1 of the equity analysts here at Wells Fargo. I'm here to introduce Rollins' CFO, Kenneth Krause; and he has a few opening remarks before we dig a little bit deeper into the company.

Great, John. Thanks for having me. Great to be here with you again. To start here with the safe harbor. We're all aware of the safe harbor, if you could just pay attention to that. And then, of course, as we go through the discussion, we'll talk about non-GAAP measures. There's a reconciliation to all the GAAP presented figures in the appendix and on our website. Great to be here, again, as I said, a couple of things just to start with. Consistency and continuous improvement is what Roland is all about. How do we continue to consistently grow and how do we continue to make changes and improvements in our overall margin profile to inflect profitability higher. We continue to compete in a very attractive market, a growing market. Global market size is $20-plus billion. In the U.S. alone, a lot of folks call out a $12 billion market. It's growing at 3% to 5%. So a very attractive growth profile. We have a very nice diversified business across three major service offerings. We have, first and foremost, the residential market. That's our biggest market for us. It's our biggest service lines. It includes a number of different services. We also have commercial markets that we serve, and we also have the termite business and ancillary markets that's continuing to see robust levels of growth. Really attractive financial profile with just under $3 billion of annual revenue, EBITDA margins north of 22%. Free cash flow conversion has consistently been above 100%, and we've continued to compound cash flow at north of 15% for a very long time. When we look at the market and we think about the size of our market, there's a number of secular growth trends that continue to drive our markets higher and stronger, whether it be the continued warming of our climates or the continued migration of our population to the south or the rising middle class and the awareness and importance of health and safety, all very important trends for our markets and continuing to make our attractive -- our markets even that more attractive. When we think about our business, not only do we compete in a very attractive market, but execution has been incredibly strong across the business for a while here now, and most notably here in the first quarter, where we posted a very strong robust revenue growth, attractive incremental margins. We closed on our second largest acquisition, and we continue to fund our increasing dividend. When we think about the most recent acquisition that I just mentioned, the Fox acquisition, second largest acquisition in the history of our company and a very appealing and compelling transaction for us. We are really looking forward to bringing in the associates of Fox into the fold at Rollins and really helping them continuing to grow their careers and grow their brands while helping us grow our organic business. There's a really nice synergy and cross-sell opportunity here with this acquisition where we bring in some of their marketing efforts at Fox. We couple it with our organic business, especially at HomeTeam and we're pretty excited about the growth opportunities that we see for the business. It's off to a really strong start. We bought it. We closed in April -- April and May, good performance, good growth, good demand for services. So we're seeing robust levels of growth. As we think about the second quarter here, we continue to execute well. Demand continues to be pretty robust. After a slow start to April, May started to pick up, and we continue to see some improvements in demand. As I said back in the first quarter, we expected to invest in marketing costs and advertising as the season starts to heat up and the business demand starts to improve. And we have continued to do that here as we go through the second quarter. So we're disproportionately investing in advertising and marketing because we have a really strong market that we're competing in currently. And that's driving really consistent revenue growth over a very long period of time. You can see here over the last 20 years, we've consistently grown through industrial recession, great recession and through COVID. And we continue to inflect higher more recently, post COVID with a very attractive growth profile that's emerged for us. We also -- in addition to having a strong growth profile, we continue to have opportunities on the margin profile. We have an attractive margin at a gross margin north of 50% and EBITDA margin is north of 20%, but there's about 30% of sales that's spent in SG&A. G&A is certainly a focus for us as we think about improving the efficiency of the business. S is an important part of it as well. The selling costs in order to -- and measuring the effectiveness of our selling spend. And so we continue to really intensify the focus there. But I fully believe and expect margins to continue to improve as we move forward. The incremental margin profile is 30% to 40%. So organic growth is going to continue to hopefully bring through a very attractive margin profile. And then on -- in addition to that, we're looking at how we can continue to improve the business and take some additional costs out of our business as we go forward. Cash flow here, as I said earlier, compounding at 15-plus percent over the long term as well as more of the near term. Conversion of net income to free cash flow has consistently been above 100%. And our focus is on how can we continue to drive cash flow higher, how can we continue to convert net income to cash at 100-plus percent. That will help enable this mid-teens sort of growth and cash flow going forward. We're also focused on modernization. I joined the company last September and since September to today, we've focused on a number of things. First and foremost, last fall, we announced an increase to our regular dividend. We priced in our special dividend. We raised our regular dividend by 30%. So we're committed to funding that dividend. And as you saw on the prior slide, we've generated about $2 billion of cash flow over the last 5 years. 45% of that cash flow is -- went to funding the dividend, 50% of us went to M&A and 5% of it has -- went to CapEx. So very light CapEx and really a focus on investing for growth and returning cash to the shareholders through the dividend. The second thing that we did was we refinanced our revolver back in January, went from 2 banks to 8 banks, $175 million to $1 billion, gives us a lot of flexibility. We changed our auditor in March, went from Grant Thornton to Deloitte. After 19 years with Grant, we decided to move to Deloitte with the relationship, and we're looking forward to partnering with Deloitte as we go forward. We closed on our second largest acquisition in April, as I said earlier. And then we've consistently focused on hiring key talent. Casey Forrest is with me in the back of the room. He heads up at FP&A and strategy. He's new to Rollins. Tracy Hornfeck, the new Chief Accounting Officer, a couple of years back. And Andrew Light, I just hired as a head of tax, and we're continuing to look at additional positions and people to bring in to really help modernize us. The other thing that we did recently last Monday, we announced the shelf filing. We filed a shelf with the SEC that has 2 components, a primary component where we would be able to raise $1.5 billion of additional capital through a number of different securities. We also registered the entire family position. Family owns just over 50% of the company. It was not registered. We registered it as part of the shelf filing. So that's north of $10 billion of ownership we registered. We also entered into a registration rights agreement with the family that will allow us to work more closely with the family as we move forward. The 1 thing that I was a little surprised about after joining last fall was when we went through, we saw some block trades, we saw some 144 sales. And I was surprised to see we didn't have something like this in place before. And so I set a target that as we go through and we get done with the revolver, we get done with the auditor change, we get done with the acquisition, the shelf filing was the next thing that I wanted to take care of. And we put that behind us. We filed that for approval with the SEC just over a week ago now. And so we're hopeful that we'll get that in place. And it will provide even more optionality going forward. And so just to close it out, Rollins remains a very attractive investment. Consistent revenue growth. We're investing in M&A, continuing to consolidate this highly fragmented market. We have robust margin opportunities as we move forward. Focused on driving cash flow and maintaining an investment-grade profile across our -- on our balance sheet. So with that, I'll open it up, Jonathan, any questions you might have.

Thanks, Ken. That's great color. And maybe just to recap. It seems like Rollins has this storied history over 100 years of operations. Obviously, a very kind of strong presence in the markets they serve. And as we think about kind of 80% recurring revenues and the defensiveness of the business, could you just remind us on how the business is more defensive than during prior downturns, more focus on 2008 rather than 2020, which was a bit of an anomaly. But any impacts in kind of the COVID era for potential residential uplift would also be helpful as we kind of think about, one, the defensiveness and two, just the business profile itself.

So when I think about defensiveness, the thing that comes to mind for me are 2 things. One is essential. So we -- looks like a lot of businesses, quite frankly, classify ourselves as essential. But we certainly are essential because we're helping protect the brand of business. The last thing you'd want to do is if you get a box from a person you're doing business with, the last thing you want to do is open it up and have a bug jump out of that box. And so helping protect brands by providing pest control at logistics centers, providing it in health care institutions, helping the travel and tourism industry, help protect their brands, it's essential. Whether it be -- as well as in the residential side. You think about termite, and the property damage that comes through termite is enormous. So the last thing you want to do is move away from that service. The risk reward equation in that is upside down. So why would you move away from termites, which is costing you? The other side of this is the cost of this is such a low portion of a budget. So why would you move away for that for what return, for damage to your property. It just doesn't add up. And so it's an essential service, and it's a very low portion of spend for our customer. And so that's a really important combination of factors because that is -- it provides us a lot of opportunities from a pricing perspective. So it's -- I think those are the 2 things that come to mind when I think about the defensiveness of our business and why it's so resilient to all cycles.

That's great color. And then maybe also moving to kind of the topic of you are just competition with 1 of your major competitors merging 2 of them. Have you seen anything shifted in the competitive landscape? And also, if you want to add any more color on Fox and kind of the underserved market opportunity because that was also kind of a compelling deal from what we've seen.

Yes. The market continues to be a very attractive market. It's highly fragmented. Despite seeing the recent combination of Rentokil and Terminix, and we continue to operate in a very fragmented market. And we also feel like it's a very rational market. And so we all understand that there's a value associated with the services that we're providing our customers. And very rarely are you competing on price. You're competing on what kind of service and what value are you providing to the customer. And so I think that's important to us. It's hard to comment on the Rentokil-Terminix merger. I know it's a big deal. And it's -- I don't envy where they are in the integration. There's a lot of hard work and a lot of effort to go through a transaction like that. But we're also focused on continuing to invest in our business, continuing to target our advertising dollars into areas where there may be some disruption with the customer base because that's an opportunity for any of our brands -- any 1 of our brands to be successful. And so we're certainly focused on that as we think about that more recent acquisition that's occurred in our space.

That's great. And maybe just to follow up on that, Rollins is a bit of a household name. But as we think about advertising, can you talk about the digital channels and other types of maybe more surgical advertising methods perhaps through maybe TikTok or something else that is a nontraditional

Sure. No, we -- I was asked earlier today, and we are certainly active on a number of different social media platforms. We're obviously active on television. But as many of you know, and probably if I did a survey of you all in the room, probably a few of you probably never even access cable television and you're on streaming. And so -- so our advertising would not necessarily hit you, and you wouldn't get your response if you were on streaming. So as a result, we also advertise across TikTok and Instagram and other social media platforms. And it's been a really successful outlet for us. We've seen good demand coming through a number of those different platforms. So we continue to ramp up the intensity at which we advertise. But we also -- the flip side of this is we have this Fox acquisition that we just closed. Fox acquisition is a door knocking business. So they're out there working neighborhoods and knocking on doors and selling pest control services. And it's been an incredible business model. They've done extremely well. And we're coupling that now with our HomeTeam acquisition. So our HomeTeam business has what we call tubes-in-the-wall. So Taexx tubes, they're in the walls. They -- when you build a new home in certain parts of the country, a builder will contract with HomeTeam to put tubes in the walls that are proprietary to HomeTeam that we can deliver pest control services through. And as we all know, homeowners don't stay in their home forever. And you may only see a homeowner stand a home for 3, 5 or 7 years and then they move. And so those tubes stay in the walls. And so oftentimes, those tubes go unused after the first homeowner. We know where those tubes are. There's a tremendous amount of those tubes. And so now we're focused on how we might provide Fox with the opportunity to go in and knock on those doors as a HomeTeam employee to bring those tubes back online. And so there's a really good opportunity to really bring that really significant customer base back in. HomeTeam continues to perform. It's a great business, but it could be even better through the combination with Fox.

That's great color. And then maybe just on that same vein, can you talk about the cross-sell opportunity as well as selling kind of termite, wildlife, insulation and other types of kind of opportunities into the core customer set?

Sure. Growth is paramount with us. And focus -- I mean we have very much a growth mindset in our business. And so when I think about growth mindset, there are 2 or 3 things that come to mind. And Jonathan points 1 out that's really important, and that's cross-sell. Most of our customers don't have more than 1 or 2 services. But we have 3, 4 or 5 different service lines that we can provide them. We can not only do termite, we can do general pests. We can do mosquito services. We can help actually with exclusion services because part of the reason why they got pest issues is because there's access points in the crawl space, so we can seal that. We can do work around insulation in the attic. And we can also do work around what we call critter control. So assume a squirrel gets into your attic or a raccoon gets into your fireplace. The last thing I'd want to do is go take care of that raccoon or squirrel. I'm the last guy that's going to do that for you. But we've got people that are really good at doing that kind of work. And we found that customers are willing to pay for that incredible value. And so we certainly have seen great demand. So there's an opportunity to expand the share of wallet with the customer. There's also an opportunity to reduce churn. Churn in a recurring business is a big focus. You want to reduce the amount of churn you have that comes through your business on any given year. And what we found is in order to reduce churn, we've got to focus on our techs. We got to make sure turnover of techs is low. We've got to train our techs, so that when they're working with the customer, they're providing a superior customer service. They're living up to their commitments. And if they do all that, the Net Promoter Score goes up, the churn goes down and the retention is very healthy on the customer base. So churn and cross-sell are 2 really big important areas for us as we think about growing our business.

Great. Yes. And it seems like it does tie into the fact around the training centers as well as the technicians. Maybe could you just quickly touch on labor and what you're seeing. Previously, there were some kind of staffing constraints in prior peak selling cycles, but what are you seeing as we going into kind of this summer?

So labor is obviously a really important part of our business and is the key ingredient to growth. We've got to have people that are trained and that are qualified, available to us when we enter in a peak season. And so this year, for example, in the first quarter, we reported pretty robust growth. And when question on the call, we were responsive in that -- in saying that a big reason why the growth came through was because we had the people to provide the service. We're a people business. And without those people, without them engaged in our business, we can't provide the service that our customers require. And so we have a very healthy level of staffing to enter the second quarter. We -- and that's helping us enable even further growth as we go throughout the quarter. We feel like we're staffed very well. Going -- it really goes back to the third quarter of last year. I want to say the third quarter, that's my first quarter with being with Rollins. And I was on the call, and I heard the statistics thrown out about new applicants. We had a robust level of new applicants and that was a leading indicator for our staffing levels going into Q1 of this year and then also our revenue growth that we had. And so we entered with a very healthy level of applicants. We hired a really strong pool of talent and we entered a very strong season with a very healthy labor position, helped us grow nicely.

Of course. And then there's -- no conversation is complete without talking about margins. So how sustainable is the 30% incremental? And maybe if you could just hit on kind of the big buckets, materials and supplies and insurance kind of complete...

The incremental margin of 30% to 40% is the right range. I mean, if you're generating 22% EBITDA margins, you're generating low 50% range of gross margins, you should certainly leverage every additional dollar of growth through the model at 30-plus percent. You've got fixed costs that are in the equation that you're going to leverage and drive the 30% to 40% incremental margin. So we certainly feel like it's sustainable and it's a focus for us. Not only is it a focus to deliver those margins going forward, but it's also a focus to continue to improve our business model, take cost out, really focus on making it as efficient as possible.

Great. And then as we kind of look in terms of technology and what any would you characterize the company in terms of automated kind of routing software, other types of technology such as a customer app, the website, things like that?

I think we're coming along. We're not where we need to be. There's opportunities to improve upon the use of technology. We've got some really nice route-based software, whether it be our BOSS system or we use other vendor software that we procure from vendors. But we feel like we're positioned pretty well in the route-based software, but there's things that we're looking at around how can we make our tech lives easier, the technicians' lives easier. It's a hard job. And so whatever we can do to make their lives easier, will drive a higher level of engagement and a better customer experience. How can we interface with the customer more effectively? And so we're looking at the use of technology there. So there's a number of things that are certainly on the horizon in years to come that we feel like we can continue to leverage. And that will help us to drive down the -- drive the margin profile higher, drive down the cost in our business. And so that's a big focus for us. When I look at the business and I look at the major areas of spend, you've got materials, you've got people, you've got fleet cost. Those are the big 3 when it comes to our cost of sales. Insurance and claims, we talk a lot about that because there are a lot of drivers on the road. And unfortunately, we have accidents, but we're focused on doing some things different with the use of technology that will drive a more behavioral-based safety environment and help improve our experience in that area. So we're gaining leverage in materials. We're gaining leverage in fleet and people. The area where we haven't gained as much leverage of late has been in the insurance and claims area.

Got it. And maybe a quick follow-up on that. Has there been any kind of updates in terms of the electrification of the fleet or any other longer-term ESG targets, which could potentially be kind of something we should look out for in the future?

Yes. There's a number of things that we're doing with respect to ESG. We're evaluating the use of the electric vehicle, the EV, and we're looking at a whole lot of other things. The other thing that we continue to do a really nice job with is being recognized as an employer of choice. So for example, in the city of Atlanta and across the state of Georgia, we've been consistently recognized as an employer of choice. Across the country, more recently, we were named an employer of choice, a top workplace through an independent research agency. And so that's really good to see. We're committed to investing in diversity. We've got a number of different platforms and groups that we certainly are funding. And we also are partnering with our communities. And so there's a number of things, whether it be on the E, whether it be on the S or whether it be on the G, that we're trying to ramp up and increase our focus upon.

Great color. And then maybe just shifting gears. You talked about the shelf, you talked about the capital structure optimization. Is there any shift in capital kind of allocation philosophy? Are there any other larger deals out there? When you say the employer of choice, it also seems like Rollins is the acquirer of choice when it comes to M&A. But how should we think about kind of capital allocation as a whole?

Yes. It's interesting. I inherited an incredibly valuable balance sheet, very little debt, but incredible opportunities. Just because we put a $1 billion revolver in place and we put this shelf in place, doesn't mean that Jerry and how are going to go on a spending spree and lever up 2 or 3x. But what we're trying to do is create optionality. I think it's important to have optionality so that in the right environment, we can execute. And so stay tuned on that front. But no, that my focus is investment grade. We want to continue to maintain investment grade, but we also want to take advantage of the opportunities and the options that should be available to an investment-grade company. And so that's why the last 9 or so months, we focused on good corporate housekeeping, modernization, because I think those are the things that are going to enable even more improvements to come through this business model in years to come.

That's great. And then if we think about the major buckets of investment, is it largely going to be within the BOSS system? Will you have more in the people side or as we just think longer term, how do you prioritize investments within the business itself?

Yes. First and foremost, you always think about how you -- we're here for the customer. So how do you service the customer? So what are the things that we can do to make BOSS better or other software we're using on the routes better. That certainly gets priority. Focusing in on how we can deploy the right advertising dollars, in my mind, in our business, advertising is like R&D and a manufacturing business. How do -- there's a direct correlation between the effectiveness of our advertising spend and the growth -- the organic growth in our business. And so we're certainly focused on trying to identify those areas, those opportunities where we can place the right investments in advertising and customer acquisition activities. Providing our employees the right training, investing in training, so that when we bring those folks on, they're ramping up at the right pace and the right cadence to support the customer. And so all 3 of those major areas are areas of focused investment in our business. Not to mention, you look at some of the things we're doing in back office. We're looking at -- back office, I would say, is an area that we have not invested in that greatly at Rollins. And when I joined, I identified an opportunity to make some investments in our finance, accounting, HR, IT, legal areas that will allow us to be better service providers to our brands, better shared service functions. If we can do things there better, we can be a better acquirer of businesses. We can bring businesses in and create more value through the use of a shared service center. To date, we really haven't done that. And that, I think, is 1 of the biggest opportunities going forward to improve margin profile.

Yes, that's definitely very compelling. And then also just kind of zooming out a little bit. You talked about some of the megatrends such as a warmer climate, such as population. Could you maybe just talk about maybe the high level where the company is focusing more, be it in the Sunbelt states or areas that are seeing more growth or areas that might be more kind of, I would say, bug friendly?

Yes. So that's a great question. When I look at the strategy, again, it starts with growth. And it starts with focusing in on those areas like the U.S. where we're strongest. A lot of people ask me about international growth and other growth avenues, new markets. I'm here to tell you, we don't need to shift away from our core market. The core market is big enough, it's growing fast enough. And there's enough opportunity for us to grow in this core pest control market that we're in today. And what's also really good to see is the opportunity to grow in the U.S. We continue to intensify the investments that we're making in Florida, Georgia, Texas, the Carolinas, California, across all those areas because we see a really big opportunity to continue to drive robust levels of growth in those regions as population expands in many of those regions. That's 1 thing that's certainly a focus for us. The second thing is new areas. The Midwest, we're in Chicago today. The Midwest is a great market. But I would say we're underpenetrated in the Midwest. There's an opportunity in Illinois, Indiana, Michigan, Wisconsin, to make some more investments to go after additional growth. So in the U.S. alone, there's opportunities in areas where we're already strong, but some new opportunities where we're not as strong as we are in other areas. And then in addition, the international side. I started the point with saying that international is an opportunity. It may not be as high on the list as the U.S., but it is an opportunity. It will continue to be an opportunity. We've invested in the U.K., Australia, Singapore, Canada. We'll continue to invest in those regions, but we'll also continue to evaluate new opportunities for growth for us as well.

Great. And then maybe just my last question before we wrap it up. You joined about 9 months ago, and really, what are the things that get you most excited about the company? And what have you been your biggest surprises, either positive or negative?

Yes. The thing that is really exciting for me is the opportunity to make a bigger impact. And so when I think about Rollins, I'm inheriting a very valuable business with an incredible market position in a very attractive market. It's 1 thing to have a good market position. It's another 1 to have it in a market that's growing at mid-singles and it's very sizable and it's very fragmented. So I'm inheriting incredible valuable business. And working with Jerry, we're trying to identify the areas where we can modernize, make additional investments and make this business incrementally better. We don't have to transform it. It's already a great business. But how do we make it better each and every day? And that's something I've interacted with Gary Rollins, not too long ago. And the thing that he said was, it's really about how do you just get a little bit better each and every day. We've done incredibly well with this business. And as I said, I've inherited a lot of value, but it's how do you -- how do you continue to make the changes to bring it up to speed and to really leverage all of the strengths you already have? And so that's kind of what I'm focused on. No big surprises from a downside perspective. I mean, what you see is what you get with this company, quite frankly. It's a pretty straightforward business model. And that's what makes it even more special. It's such a straightforward business model. The cash generation is so strong. You're not evaluating like global supply chains like you are in other businesses. You're not -- you don't have to make huge CapEx investments. They're very small, very manageable investments you're making with an incredible amount of reward on the backend. And so yes, it's a great business. Great to be here and look forward to more opportunities going forward.

Great. Yes, definitely, good to have a predictable growth company with little to no generative AI risk. But if there's any other closing comments, please be my guest.

Thanks for having me. Great to be here again and look forward to reporting back in future quarters.

Thanks for coming.

Thank you.