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

All right. Thank you, everyone, for being here, and thank you, Ken Krause, CFO of Rollins. It's a tremendous honor to have him here. Rollins is a tremendous company. And you may have seen in the news last week, they did a $1.5 billion equity offering. We were delighted to be an active booker around that. And for those who don't know, and I'll let Ken explain more, but Rollins is the #1 player of essential consumer pest services serving residential and commercial customers. The company has a 55-year track record and which has delivered really highly consistent results, demonstrated by 20 years of consecutive growth and 20% TSR over that same time period. And today, the company is about $18 billion of market cap and about $3 million of revenue.

And with that, Ken, what makes this business so consistent, so resilient over time?

That's a great question, Derek, good morning and great to be here. Thanks for having me. You mentioned -- you used one word to describe our business. And I think that word is essential. The business is essential, whether it be for our commercial customers, whether it be for our residential customers or whether it be in our termite business. We're an essential service, and our focus is helping protect people's brands, people's property as well as people's health. And I think it continues to be a really exciting industry to participate in. We've seen robust levels of growth over the last 20-plus years. There's 3 words I would use to describe the business, and maybe we'll dive into them each and every one of them, and first and foremost, consistency; second is, we're looking at a lot of different things to implement modernization and really continue to improve the business, so continuous improvements is the second area; and then opportunity. And when I think about the future, I'm excited because there's tremendous opportunity in our industry to continue to pursue growth, but also to focus on improving our business and our margin profile.

No, that's great. And you touched on the market. Can you just expand a little bit around the outlook for the market? It's been very consistent, but it feels like there's drivers that will continue to sustain that.

Certainly. It's a growing market. It's many size, it is $20-plus billion in terms of a global market with 20,000-plus competitors. And so with those competitors comes M&A opportunities. When I think about the market and the growth profile of the market, secular trends are certainly prominent in this business. When I think about weather, when I think about people moving into southern locations like Florida and Tennessee and Texas and California, so you continue to see really strong secular growth associated with both of those. And then last but certainly not least, pests continue to evolve. You continue to see new pests. I think many are seeing lanternflies this year, who would have thought we would have been dealing with lanternflies last year or prior to that. And so -- or ticks. Ticks continue to be a really common issue in the Northeast and Mid-Atlantic. And so we continue to deal with that. So weather, population trends as well as the evolution around pests continue to be really prominent in the industry and providing a lot of secular growth opportunities for us.

You mentioned a lot of competitors. What makes Rollins and the scale that it has kind of advantaged relative to the long tail?

Certainly, our position in the industry is second to none. We're well known with our Orkin brand. We've had the Orkin brand for, as you mentioned, 55-plus years. And it's been a prominent brand for us. But what we also have in our business is what we call and Jerry Gahlhoff, our CEO, will oftentimes refer to it as second bite-of-the-apple opportunities. And so we've got a nice combination of this large national work in very powerful brand complemented with regional brands like Northwest or Clark or HomeTeam, who, quite frankly, I struggle with finding a business model as good as HomeTeam. And so when you look at HomeTeam, another great opportunity, another great brand for us. So we've got all those brands, combined with the Orkin brand which gives us a really strong position in a very competitive market and a great market. The market continues to be a really great market to compete in.

When you think about some of the components of the cost structure here, how does inflation, how does fuel impact the business?

Certainly. The one thing that I start with when I talk about inflation or I think about the cost structure of the business, is the question that might be top of mind with you is how much elasticity is there in pricing. And so when I look at this business, we continue to enjoy a really strong position from a pricing perspective. This year, we announced the 4% price increase. Last year, we were around 4%. We continue to be focused on passing along price that's consistent with the value proposition. That value proposition goes back to that essential service that I spoke about before that essential service and it's a really small purchase for many of our customers. So as a result, the pricing opportunities are very prominent in the business. And so that pricing is really helpful when we think about inflationary cycles. There's 3 -- 2 or 3 major buckets of costs that we have in our business. First and foremost, it's very much a people business. So about 50% of every dollar we generate is spent in people. And so -- but what we've done with our people for the -- which is really attractive, especially on the technician side, is migrate from a fixed salary or a fixed compensation to something that has a little bit more variability in it. So our tech benefit from price increases, our tech benefit from cross-sell opportunity, our tech benefit as our business grows. So it's not just a wage that our techs are getting, but they're also benefiting as we grow our business. That really helps us when we think about an inflationary cycle. When I joined the company a year ago, I remember joining and we're talking about a 3% to 4% merit budget, and I was scratching my head thinking how do we get away with a 3% to 4% merit budget when I hear about others raising wages 7%, 8%. Well, the way that we are able to successfully navigate that is by incentive compensation. So we're able to incentivize our workforce. And when we do better, they do better. And so it's a really nice win-win. When I look at materials and supplies, second broad bucket of costs, we continue to leverage that as well as the fleet cost. When I think about fleet, there's 2 components -- 2 or 3 components to the fleet cost. One is gasoline. And so gasoline continues to moderate. And the price of oil continues to moderate around $80 or $90 a barrel. We continue to be -- see healthy leverage on the gas in our fuel cost. The second area that comes to mind when I think about fleet is resale of used vehicles. That's one headwind we're certainly feeling this year. A year ago, in the third quarter, we saw really strong returns because used car prices were very elevated. And so we benefited from that a year ago. We're not seeing that benefit this year. But the price increase that we're seeing is certainly helping us leverage. In second quarter, we generated 53% gross margins, and we saw leverage on the gross margin line. So we're able to show and pass along price, which helps us navigate inflation or cost changes in our cost structure.

That's great. Talk a little bit about the mix of the business. I think it's roughly 50-50 between residential and commercial. Is that -- does that continue to be the plan moving forward? How do you see the trends in each?

It's interesting. It's not quite 50-50, but it's sort of bit prominent. There's a larger degree of residential business. And whether you think about resi in your traditional sense or in the termite business, that's all residential for the most part. So you've got a higher degree of business that's touching the resi customer than you do the commercial customer. With that said, we certainly are excited about opportunities on both ends of the spectrum. I think the resi business continues to perform. We continue to see nice performance there, strong demand, a lot of secular growth. And then the commercial business is often very much sticky. So the churn in the commercial business sometimes can be better than the churn in the resi market. And so for that reason and a number of other reasons, that commercial business continues to be a really exciting opportunity. So I guess to sum it up, we're eager to go after, grow, acquire, invest in both of those markets. The profitability profile is tremendous in both of those markets and the growth profile is also exciting. So we're open to both ends of this business.

And then along those lines, predominantly a North America business, but how do you think about international, your existing presence and plans for the future?

And so when I look at the strategy at Rollins and the growth strategy, you think about the organic growth, you think about the inorganic growth, and you think about the expansion around international opportunities. What I would say is we are opportunistic when we think about international growth. We don't have to go after and pursue growth in Europe or in new regions, we've got more than enough growth that we can enjoy in the U.S. market, and we continue to enjoy. But we also are looking at areas like the U.K., Singapore, Australia, Canada and other regions where we can continue to make investments. But what I'm -- I guess the point is, don't expect us to make a student body shift right or left into a new international market. We just don't have to. The market is that good in the U.S. So we continue to double down and invest in the U.S. market while remaining opportunistic for some of those international markets.

Great. If we could touch on margin for a moment, do you have a -- from your tenure at MSA, a track record of delivering strong margin expansion, how do you see the opportunity at Rollins?

I'm hopeful we can see some success at Rollins as well. When I think about the Rollins business, we already enjoy such a strong margin profile. Over the last 14 or 15 years, we've seen margins expand by 750 basis points. So that's exciting. And it just reflects the strength of the business over a long period of time. But when I look at the business through a fresh set of eyes, I can't help but see the SG&A cost. And when we look at SG&A, our SG&A costs run around 30% or 31% of sales. You remember me talking about gross margin at 53%. So you can see a large bucket of cost that are residing in that SG&A. I don't think you're going to see -- at MSA, we took margins up about 800 basis points under my tenure, and SG&A came down pretty nicely. You're probably not going to see the same lift in this business. But I do think there's a couple of hundred basis points over the next several years that we can continue to go after. And in fact, this quarter here in August, we executed our first restructuring program in over 20 years. And so we enjoy a really strong business. We haven't had, thankfully, had to do a lot of restructuring. But I think the focus here is continuous improvement. And so we started to execute some restructuring programs here in August to really change the back office. The thing I think to focus on -- where the focus is, is on your finance, your IT, your HR, your legal, those types of costs. The last thing I'd want to do is go out and disrupt the customer. We have such a strong position with our customers, and it quite frankly, is working. But what I think we can do a better job is being a better back office, a better supporter of our brands. How do we implement shared services, for example, in the back office that will make us a better acquirer when we think about the future. So that's really the focus. There's back office, there's SG&A costs that are in the back office more than G&A, quite frankly, that are in the back office, just to be a better parent company for many of our brands.

Got it. As you think about capital allocation, you touched on M&A, the company has a long history of acquiring businesses, should folks expect kind of that to continue or elevate? Or how do you think about the M&A strategy moving forward?

Yes, we're going to continue to be acquisitive. No doubt about it.

Are those bigger deals?

There's -- it's interesting. There are bigger deals, but we don't have to go after and pursue those bigger deals. I think if you think about the future, if we're able to be successful with changing the back office, being a better shared service, I think we'd be better positioned to do larger deals in the future, but we don't have to. I mean if I look at the last 20 years or so, 7%, 8% total growth, roughly 2/3 is organic, 1/3 is M&A. That's a really nice formula. And I'd like to be able to continue to execute on that formula. Our cash flow profile, our balance sheet profile, our business and the foundation that's been laid in this business positions us very well to continue to go after and make those acquisitions. This year, we're spending $350 million to $400 million in acquisitions. We bought Fox. Great acquisition, great to have those folks as part of the team, and it's performing very well.

Yes. Speaking of Fox, talk a little bit about how it interacts with some of your other service offerings, the ability to drive synergy and cross-selling?

Yes. The one that comes to mind with the Fox acquisition, we closed it in April -- early April. And it's been a huge success thus far. We think there's a great opportunity to partner with the Fox business, with the HomeTeam business, for example. So if you don't know, HomeTeam, HomeTeam is essentially a tube-in-the-wall sort of business. So when a builder builds a new home, they'll install tubes in the walls of the home that we can go in and hook in the ports on the exterior of the house to service the house with pest control. So essentially, you have an entrenched customer base. What happens over the period of several years is people move. And so over 5 or 7 years, people might move from their home. When they move, those tubes are still in the walls and sometimes the new homeowner doesn't even realize that those tubes are in the walls. So if we can deploy resources from our Fox acquisition to go after, there's legacy, those old -- people call them dead tubes, that generates -- that represents a pretty meaningful growth opportunity. So we're focused on bringing those together to really drive that growth profile that we think is out there.

On the balance sheet. As part of the equity deal, you guys bought back $300 million and used the balance sheet to do so. How do you think about it moving forward?

Yes. It's -- we're positioned, first and foremost, we're positioned very well on the balance sheet. Even after that deal with the buyback, we still have less than 1 turn of leverage. And so we continue to be positioned well. I mean, for me, it's all about balance. And so when I think about this year, so for 1 year in as CFO at Rollins, when I think about deploying capital, last November, we essentially went in and I said we were paying special dividends. And I said, well, why don't we bake in the special dividend into the regular dividend and grow from there. And so we did that, and we grew our dividend 30%. Over the last 20 years, we've grown the dividend by 19% on average. And so it's been a really good way of sharing capital with our investors. But if I look at the last year, we've done that, then we just executed a share buyback of around $300 million. And then we've made, as I said earlier, $350 million to $400 million of acquisitions. So if I look at the capital allocation strategy and I then look at the balance across it, we've deployed roughly $900 million to $1 billion of capital over the last year, $400 million or so is acquisitions, $300 million is share repurchase and $250 million to $300 million is in the form of a dividend. And so I think if we can continue to have that kind of balance, I think that's where we want to reside.

And so we mentioned the exceptional TSR of this business, really a top decile performer of around 20%. How should we expect that to move forward? What's the overall formula to keep that going?

I'd love to be able to be sitting here in 10 years and say, hey, we've had another 10-year run of 20% or 25%. It's just you can't control your stock price. But what you can control is your business and the controllables. And so how do you go after each and every day and focus on growing the business, investing in the business, buying the right companies, partnering with the right companies and the brands, taking care of our people. If we can do that, we can continue to grow this business. Then if we can continue to take a continuous improvement focus and look at the business through a lens of continuous improvement, I think we can continue to see improvements in margin. So if we drive growth, if we improve our margins, if we continue to accrete cash flow and improve our cash flow and generate meaningful growth in cash flow, I think we'll continue to see nice performance. I wish I could sit here and guarantee that performance. I just can't do that. But what I can say is our focus is growth, continuous improvement and driving cash flow -- an improvement in growth cash flow.

No, that's great. What else can we -- what else should the audience know about Rollins?

I think the key here is, as I started the conversation, we talked about consistency, we talked about modernization and opportunity. And so I think the focus here continues to be, even with Jerry and I really knew in the seat -- Jerry's been CEO for just under a year, and I've been CFO for just over a year. I think the focus here is to continue to be consistent and continue to drive the growth profile. No need to make a student body shift right or left, but how do we continue to just focus on modernizing, bringing new folks into the business. If you look at what we've done with investing in our people, we've continued to bring new people into the fold, new Chief Technology Officer, a new Head of FP&A, Chief Accounting Officer is relatively new. And I can go through a number of different people. So we continue to focus on hiring the best and the brightest and complementing our already strong employee base with those new people, and that's driving more opportunities to continue to improve the business. So it's really through those lenses that I think Jerry and I continue to guide the business.

And then obviously, the deal last week with the monetization from the family, how should -- with a nice 365-day lockup, how should folks think about potential monetizations in the future?

When I joined the company a year ago, I joined in September. In August, there were a number of 144 sales. And then in December, there was a big block trade. And so when I sat back and looked at it through a new CFO's lens, I thought we should think about how we can put something together to work more closely with our largest shareholder. And so what we did is, first, I put a big revolver in, in January that would position us to do this buyback that we just did and also continue to grow the business. But also then in June, we put together the shelf facility that essentially registered the entire family position that enabled the secondary offering to occur last week. And so we were able to be successful with that. When we put the balance sheet to work, something that was important to me was a lockup. The last thing I wanted to do is put the balance sheet to work and see future stock -- a supply of stock hitting the market after I put $300 million to work. So we were able to work with the family and enter into -- with the underwriters, enter into a 365-day lockup. I can't speak on behalf of our largest shareholder, but I do think that this was an important transaction for them. It provided liquidity. It provided them an opportunity to continue to do the estate planning that they need to do as a family. I have no idea what their intent is as you get a year in a day or 2 years in a day. I think the focus for all of us is to grow the business, improve our market, improve our position in our markets. And if we do that, I think we're going to be positioned very well for the future.

That's great. That's all I have for me. Anything else to leave the audience with?

No, I just appreciate your interest and great to be here representing Rollins at the Morgan Stanley Conference. Thank you.

Great. Thanks, again.