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

Okay. All right. Good morning, everyone. So welcome to the Piper Sandler Growth Frontiers Conference. So my name is Peter Keith, senior research analyst covering consumer broadlines and hardlines. So I'm very pleased to have Rollins with us today. This is, to be honest, one of the fireside chats I've been looking forward to the most with the conference. We just picked up coverage of Rollins back in, I guess, it was early July. And we think it's a great consumer services company that warrants a lot more attention. And so we're going to dig into the story today, and it's obviously their first time at our Nashville conference. So welcome, Rollins team. With me on stage is Ken Krause, the CFO; and then my longtime friend, Lyndsey Burton is the VP of Investor Relations. Many of you may know her from the Home Depot days. So welcome to our Growth Frontiers conference.

Great to be here. Thanks for having us.

So let's just -- since it's your first time here, let's just ask and open ended question to Ken. Maybe just give us a quick overview of the overall business model and the services you guys are offering.

Certainly. Yes, very diversified service offering across commercial B2C as well as our B2B as well as B2C with the residential homeowner. We compete and we play in a $20 billion global market all focused on pest control, pure-play pest control company with some additional services around the house like insulation work, encapsulation work, exclusion work. We like to say that we have 9 shots on goal with the homeowner to do business. And we've been operating through economic cycles. We've seen growth through just about every economic cycle, whether it be the great financial crisis back in 2008, 2009, the industrial slowdown in 2015 or more recently with COVID, we've continued to execute and successfully grow our business, continuing to see really good demand, very resilient business, an essential service with a significant amount of pricing opportunity.

Okay. Great. So the business has been -- Rollins has been around for a long time and been very successful over the long term. I guess one of the things that gets me excited about the outlook is this company modernization effort. I joke with my team is -- after a time, I've learned how to say modernization without sounds like it's a tricky word. But Ken, let's just maybe talk to you first, and then I want to move over to Lyndsey. You started in 2022. Your CEO and partner, Jerry basically started at the beginning of 2023. Just take it to like the origination of the modernization philosophy and then some of the key elements that you guys are implementing?

Certainly. So I joined the company '22 as CFO. I was a CFO at MSA Safety for about 7 years prior to that. We followed a very similar modernization journey where we went from more of a closely held, slow to change sort of company to a much more dynamic company. And so when I saw the opportunity come across, I first looked at the market. We -- I certainly can't fix a market. But what I joined was an incredibly strong market with an opportunity to tweak things and become more modern, more transparent and access a number of different things that would enable us to reach our full potential as a business. And so in '22 I joined, Jerry became CEO in '23. He was the first nonfamily member CEO, he followed in the footsteps of Gary Rollins and Randall Rollins. And as you know, Jerry Gahlhoff, his last name is not Rollins. So he's the first nonfamily member CEO. But I saw an opportunity to join an incredibly strong business, but an opportunity to make a big impact to modernize a number of things in the back office as well as in the capital markets. And so over the last 3 years, what my focus has been and our focus as a team has been really modernizing a lot of our external-facing areas as well as our talent. When we go through the number of things we've done, we've increased the dividend by 70% over that period of time. We've priced in a special dividend, and we've grown that. Cash flow continues to compound at 15-plus percent and it gives us the opportunity to do -- to provide investors with that reliable source of capital returns through the dividend. We then changed our auditor. We then put a revolver in place, a multibank revolver. We then did a shelf offering and sold the family down to under 50% control, did about $1.5 billion offering. I used about $250 million to buy back stock as part of that offering at $34 a share. And today, we're roughly $57. We entered the bond market earlier this year. We became an investment-grade issuer with our inaugural bond offering in February of this year. And we've changed the talent footprint. Of course, Lyndsey is here with me, phenomenal resource on the IR side. Will Harkins, is our new Chief Accounting Officer, I have a treasurer, Brady Knudsen and Andrew Light is our Tax Director. And all those folks are new, and we were actually reflecting yesterday, 3 or 4 years ago, none of us really knew each other. And it's really exciting to be a part of this team and working with these really talented people to make an impact. And so now as we think about the modernization journey and entering the next phase, it's really about internal process improvement. When we look at the business, there's tremendous opportunities to do more around centralization and improving our back-office support functions. We already have an incredible return on capital. We're very acquisitive, and we see a really healthy margin profile. But we really do think this modernization journey should help us, help enable even more growth, but also improvements in margin and cash flow performance as we think about the future and the centralization efforts we're doing around the back office.

Okay. And Lyndsey, maybe share your perspective from an Investor Relations effort. Your thinking around transparency and just making the stock more investable and easier to invest in?

Yes. I mean I think -- the fact that exist in this company is probably evidence of the modernization journey. I mean we historically were not as involved in terms of showing up at different conferences and engaging more broadly with the Wall Street community. So that's been a change. We've picked up a lot of great new coverage, sell-side analysts and have held kind of an Investor Day and started to give some sort of guardrails in terms of how we think things should look from a financial perspective. We're not going to be a quarterly guider. We'll never be a business that tries to get things down to the basis points, but just making sure that everybody is operating from the same set of facts from a directional perspective has been important to me, important to Ken and Jerry and the rest of the management team. And so that has been a focus of mine over the last 2 years since I joined.

Okay. Great. Yes. And the disclosures and the transparency seems to get better almost every quarter in a way. There's more and more information that we can dissect and look at. So thank you for that. One part, I think is intriguing is your new approach to pricing. And maybe, Ken, you want to dig into that. That seems to be something that you've changed in a way that can enhance growth and even the margin profile?

Certainly, when you look at the business and you evaluate the pricing opportunities, a couple of things come to mind. One, this is very much an essential service. It's about protecting property. It's about protecting health and our consumers value it. We don't see a large amount of do-it-yourself for efforts in this space. People want to pay somebody to take care of this -- the pest and provide an environment that's conducive with their lifestyle. And so when you look at it, it's very essential. It's also in a really small ticket item, purchase item for our consumer. An annual pest control contract might be $500 or $600. It might range higher than that depending on the location you're in, and the pest you're treating, but generally, $500, $600. So when we look at it, small purchase item for our consumers, highly valued purchase item, very resilient. It's not something you can do once and forget about it. You've got to repeatedly treat the issue. And so when you look at this, what we've evaluated is the pricing opportunity and elasticity and the pricing, evaluating it through how our consumers value the service. When we think about a couple of that with the inflationary environment, over the last couple of years, you've seen CPI inflect higher. And so what I've tried to do is, I've tried to position the business to get a CPI plus pricing realization. When we look at this business, this is highly valued, it's incredibly small purchase item for our consumers. And so we should be getting pricing that's above the rate of consumer price inflation in the economy. So the last couple of years, we've been passing along 3% to 4% price increase. Very durable with very little impact from a customer churn perspective. And so we're continuing to focus on getting pricing that's in excess of CPI. So if CPI regresses back to a more 2% to -- a more historical trend of 2% to 3%, we really do believe that 3% to 4% is still a realistic goal for us as we think about the future. And that's helped our growth. If you go back the last 15 or 20 years prior to 2020, what you saw was growth that was maybe a 4% to 5% sort of growth profile. But more recently, what we've seen is 7% to 8% organic growth. Some of that is just execution in Commercial and some of those other opportunities around the Home, but a part of it also is the pricing realization that we're getting in the business. And we're continuing to focus on that. We actually just met earlier this week to start to evaluate the pricing environment for next year. And we'll share more of that as we go throughout the latter half of this year, but we feel pretty good about our ability to get pricing that's above the rate of inflation in the economy.

Okay. Great. And I guess it's not -- if I understand correctly, it's not just national pricing moving up. It's more strategic varied by region, by type of service.

Yes, it's clear on the ZIP+4 level. And so we're looking at it based upon the consumer and where they reside in the overall economy. So we might set an overall target of 3% to 4%. Some areas might be getting 5% or 6% or 7%, others might be getting 1%, 2% or 3% depending on the environment that -- where they reside. And so we continue to take a much -- we take a broad view, but we also take a local view when we execute the pricing clear down to the branch level.

Okay. Great. And so Lyndsey, you talked about just providing some growth framework, let's talk about top line, that sort of top line annual growth target and then some of the building blocks to get there, which would include some M&A as well.

Yes. I think we kind of look and have targeted for the last few years and talked about kind of from an organic growth perspective, being in that neighborhood of 7% to 8%. That is where we've been. It's been pretty consistent. And we feel like in the near term here, that's the appropriate range for organic. And then in any given year, from an M&A perspective, what we've kind of anchored people to is to think of getting an additional 2% to 3% of growth from M&A. It's a very fragmented market. There are -- we have a very robust pipeline with a number of different opportunities of varying sizes and probably stages of potentially transacting. But the right way to think about that would be kind of 2% to 3% of growth coming through the M&A line. This year, we've talked about that being a little higher. We did a transaction in April. Saela, which was a great business, very complementary to our portfolio, provided us kind of a nice, what we call second but bite at the Apple brand in certain pockets of the country, Pacific Northwest through Colorado Midwest. So that was a great transaction for us. So we've said kind of 3% to 4% is probably what we would be in the range for this year from M&A. But on the calendar turns, kind of the right way in general to think in the out of years is kind of a 2% to 3% range.

Okay. And so to both you, maybe let's just stick on Saela and think about it as the elements of Saela that you like that ultimately caused you to buy the company. I think [ we were ] talking to Jerry, you've been familiar with them for a long time. So what did you like about it? How is the integration going so far? And how should we think about the accretion angle on your overall business?

It's interesting. When you look at Saela and I was remiss -- I'd be remiss if I didn't mention it, but earlier when we talked about modernization, I think the Fox acquisition from 2 years ago and then the Saela acquisition more recently is reflective of -- also reflective of some of the modernization efforts we're taking, where we're looking at the business more broadly. Prior to the Fox acquisition, a lot of folks looked at door knocking and really kind of -- they looked at it through a skeptical lens. It really wasn't of the same level as maybe some of the other businesses. There was a lot of concern about churn of customers and really how long does customers stay with you? Is it really valuable? Is it too expensive? And so what we did is we did a study across the industry, and we identified that this is an incredibly large and fast-growing sector of pest control. And so we entered that market with the Fox acquisition from 2 years ago, and that business is doing exceptionally well. It's got gross margins that are accretive to our overall margin profile because you've got dense routes. It's also got a tremendous growth trajectory from an organic perspective. That caused us to have more confidence in our ability to do Saela. So we did Saela in April of this year, and we're off to a really fast start with that business. We said on our call in Q2 that it was growing double digit organically. We also talked about the fact that even on a GAAP basis, we saw neutral to slight accretion in the first quarter of owning it. That's really hard to do when you're financing these things, it's 4% or 5% today and you have deal amortization at its highest -- the largest amount of deal amortization coming through in that first quarter. But it was -- it did exceptional. In fact, the margin we're approaching 30% from an EBITDA margin perspective. So really good business. And it's interesting. When you look at these businesses, I oftentimes refer to the contrast between a sales company and a service company. So if you're buying these businesses and you're focused on sales and these businesses are just out selling pest control services, that's not the type of business that we're interested. We're interested in businesses like Saela and Fox that are really providing service to the customer because we've learned is if you provide the service, you earn the right to keep the customer for a long period of time. And so we bought those businesses, very strong focus on service. And there are also a strong focus on geographic diversification. And so when you think about the FOX brand, the Fox Pest Control brand, what you see there is Northeast exposure, Midwest exposure. What you saw with Saela was more of the Pacific Northwest, more of the Mountain West, a little bit of the Midwest, but it was very complementary to the Fox portfolio. So when we look at these acquisitions, we're looking at geographic diversification. We're also looking at how they're accessing the channel. Our brand strategy really is enabled by the multifaceted approach to accessing customers. We're not reliant solely on digital or door-to-door or cross-sell, but we really have a really nice diversified way in which we access customers through different channels and different geographies.

So maybe let's just stick on the Pacific Northwest because you guys have the Orkin brand, that's your biggest national brand that most people are familiar with. So you were in the Pacific Northwest with Orkin. So just talk about you bring in Saela, and it's a multi-branded approach. You talked about multiple bites at the apple, explain how that works because one would think that now you bought something that could cannibalize your own business, but perhaps that's not the case.

It's not. It very much isn't. I mean, in fact, we've learned that through the Northwest acquisition from 2017. That's our Southeast brand. We bought that business based in Atlanta, Georgia, and we've grown that business from roughly $50 million to approaching $200 million over the last 7 years by buying a platform and bolting-on. And what we've learned is the Northwest brand is going to market completely different than the Orkin brand. And so they're very complementary. They might look like they cannibalize each other, but they're very complementary in the manner in which they access the market, access customers and certainly, at times, there's customers that prefer to do business with the smaller neighborhood, so smaller community-oriented brand as opposed to a large national brand. So they like to do business with somebody that they're more relatable to. They might see in the local grocery store. They might see in the community and they want to support their local community. And so it gives us that opportunity to provide that customer with that additional choice and -- that they're looking for when they're acquiring pest control. And what we have is we have brands like Clark in California with Orkin. We've got now brands like Saela in the North West -- Pacific Northwest with Orkin. We've got the Northwest pest control in the Southeast, which is kind of hard to explain at times and understand, but it was founded in Northwestern Georgia. And so that's where the name came from. But Northwest complementary to Orkin and then HomeTeam, which is all across kind of the Sunbelt region and very complementary also to Orkin as well as some of our other brands. It's a very orchestrated effort with going to market. There's rules of the game but we see a real benefit in having that multi-brand strategy and our customers prefer to -- are showing how they prefer that as well.

Okay. And pests have been around for a long time. It seems like there's more and more. So just talk about how you think about the -- if there's an industry CAGR, it seems like there could be a couple of different drivers to the overall industry and maybe how those drivers are trending?

Certainly. Yes. I mean when you look at the market, you look at our organic growth at 7% to 8%, that's certainly not all market growth. But there's pricing that I talked about earlier. There is market growth. There's a little bit of share gain. Overall, we're seeing this market growing at roughly 2% to 3% over the long term. But there's opportunities to see that inflect even higher. And a couple of those things that are really impacting that are generally the warming of the environment. Pests continue to evolve. You see different pests every year. Just a few years ago, I was back in my hometown of Pittsburgh, Pennsylvania and we saw lanternflies, I've never saw lanternfly in my life. And quite frankly, they even know what it was. But imagine seeing that at your home, you're calling the pest control service. They come out and do the treatment, but then it also opens up opportunities to do other treatments for the homeowner. Just a lot of migration to the South, warming environment, pest evolution -- and then also just the penetration rate in the residential homeowner. We estimate that roughly only 15% of homeowners use pest control, and we see an opportunity for that inflect -- to inflect higher as we think about the future, in turn, drive a higher underlying market growth in this really attractive industry.

Also think about just the dynamics of kind of the do-it-for-me, the rise of do-it-for-me consumer, right? And it speaks to the world that I came from. But if you think about baby boomers, who own the majority of the houses today, when they stepped into homeownership, they didn't have a phone to say, how do I solve my ant problem. they just went and solved it themselves. Obviously, they've kind of -- as professional pest control has become more mainstream, more awareness around it, you see that adoption rate continuing to grow. And as Ken mentioned, it's still relatively underpenetrated if you look at other kind of similar essential kind of service-based businesses. So and then you have millennials stepping into homeownership who have a natural desire, particularly with something that doesn't have -- I was talk about, pest control doesn't really have a therapeutic [indiscernible] element to it. Nobody -- maybe Jerry Gahl, our CEO, is jazzed about spending a Saturday administering past control in it's home, but there's not a whole lot of people that, that's something that they kind of find as a hobby or some sort of way to relax. But -- so I do think that dynamic also is playing to the industry's favor as well.

Okay. That's a good perspective. This -- in the interest of time, let's just hit on a couple financial questions to wrap it up. So you guys do have a very attractive margin profile. What you speak to is an incremental EBITDA margin of 25% to 30%. I think over time, you see that going to 30% to 35%. Maybe talk about what are the margin levers that you see to pull in the coming years to get it that higher?

Certainly, there's a number of things. When you look at this business and you unpack that 25% to 30% incremental margin, you have to start first at the gross level. At the gross level, our incremental gross margin is roughly 55% to 60%. So if you take the midpoint of that range at 57% or 58%, what you see is an opportunity to drive even more incremental margin. So when you start at the gross margin, 57%, 58%, then you look at SG&A. And right now, we report roughly 30% of sales as SG&A. Roughly 90% of that is more variable oriented, 10% is fixed. So if you look at that, you unpack that, roughly 27% of SG&A or sales is spent in SG&A from a variable cost model. So 57% minus 27% gets you to that 30% sort of target of incremental margin for us. We hit that number, we will hit that number unless we're making significant investments in our sales programs or we see volatility in claims. Generally, setting those aside, we will provide, and we will perform at that 25% to 30% range. What we see as an opportunity through some of the modernization where we're implementing back-office consolidation, shared services, centralizing certain things, pulling it back in that would enable us to continue to inflect the incremental margin higher as we think about the future.

Okay. Great. And then maybe just to round out the last question, Lyndsey, I will give it to you. We'll just talk about that growth framework, this long-term compounding. When you look at the top line growth, if you think about the margin expansion, build us up to the annual EPS growth that you guys are targeting?

Yes. I mean, very simply, at the end of the day, I think if we can grow all-in revenue, and you talked about this all the time, it's a measure of your ultimate success. If you can grow that double digits, grow EPS higher than that in compound cash flow in the 15% to 20% range. That's the algorithm that we feel that we can drive and it's pretty attractive. So...

Yes. I mean I spent a lot of time talking about incremental margins, but we're really a growth company. When we think about this business, we're a growth company. So what we like to provide our investors with is that steady double-digit rate of growth, which is 2/3 or 3/4 organic and 1/3 to 1/4 M&A, see tremendous opportunities to continue to provide that M&A growth and then turn that growth into double-digit earnings growth. We enjoy a very favorable cash flow position. We have negative working capital. And so as a result, we look at the cash flow conversion, we're seeing 120-plus percent conversion of income into cash flow. That enables us to grow cash flow and compound it at 15% to 20% like we've been doing for a long time. So that's the algorithm. And that's kind of how I view the business and judge the success -- financial success of the organization.

Okay. That's great. Well, we'll wrap it up there. But thanks for spending some time with us today and keep up the great work.

Thank you. Great to be here. Thank you.

Thank you.