Rollins, Inc. ($ROL)

Welcome to Rollins' session. This is Tomo Sano, SemiCap Industrials analyst at JPMorgan. With me today, we have Ken Krause, EVP, Chief Financial Officer. Ken, thank you for joining us.

Yes. Well, thank you for having me.

So to set the stage, I wanted to highlight why Rollins is such a compelling story for this conference. Rollins anchored by iconic Orkin brand has delivered over 20 years of consecutive growth with a resilient recurring revenue model and industry-leading margins and making it a standout in the pest control sector. To kick things off, I think it'd be helpful to start with an introduction to Rollins. Who the company is, what you do and your stories for those who may not as familiar. So Ken, could you talk about that?

Sure. No. Great to be here. Thanks for having us, and thank you for all of your interest in Rollins and making time to attend the conference and also listen online. But Rollins is a premier services company. We've been providing services to residential homeowners as well as commercial businesses for well over 50 years. Our focus is pest control. We are focused on protecting property and protecting health of our customers. We have -- as you had mentioned, we have consistently grown for 20-plus years, 24 years, I want to say, to be precise, that we've put up growth. We've grown through the great financial crisis. We've grown through the industrial recession. When oil was volatile back in 2015, and we grew during the pandemic as well. I think it's something like 96 straight quarters that we have seen growth. So it's been -- it's certainly -- we are known as a compounder. Our focus is compounding revenue, double-digit revenue growth, double-digit earnings growth and double-digit cash flow growth. We enjoy a very capital-light business model, and we've got an incredible amount of highly engaged teammates. We employ over 20,000 teammates and they continue to execute each and every day with the Rollins way.

Thank you. And with a strong culture of operational discipline and technician training and customer focus, what have you been the most important cultural or organizational changes driving this transformation?

Yes. It's interesting. Something that I consistently talk about is modernization. Modernization of the business. I joined the company in '22, 2022. And Jerry Gahlhoff became the first nonfamily member CEO in the history of the company on January 1, 2023. And so Jerry and I are working together to really advance and implement a number of strategic programs across the business, whether it be growth programs that we're focused on our 9 shots on goal around the house and expanding our breadth of services with our customers or whether it be the focus on ancillary businesses and things like that or the margin profile, gross margin and pricing. We've talked a lot about our focus on pricing. Since I joined, we became more focused on CPI plus pricing that's enabling us to continue to get paid for the essential nature and the value of our services. And then we continue to do a lot in the back office and modernizing our back office processes and teams and -- it's interesting. It's -- you sit back and reflect on the last 3 or 4 years, stock's up roughly 80-plus percent. The dividend is up over 80%. We've continued to see great results, and we're certainly really excited about what is yet to come.

Thank you, Ken. And then if you could talk about how do you ensure that operational discipline safety and people first culture remain embedded across your multi-brand and global footprint.

Yes. It's interesting. We focus on what we call the Rollins way. Jerry had led an effort to really roll out what we call the Rollins way. And there are 3 primary aspects of the Rollins way. It's essential together, focused on how we're creating an essential team and relying on each other being remarkable -- being remarkable for our customers and for our teammates. And having a heroic impact, our technicians are having a heroic impact with our customers each and every day when they go in and take care of the issues that the customer is needing to be taken care of, it's an incredible amount of impact we're having with our customers. But -- it's interesting, you talk about safety. Safety is so important to us. When we think about there's nothing more important than getting our technicians home each and every day. They're out on the highways. And as you know, it can be dangerous. And getting them home safely is so important to us. And we've invested in safety technologies and our trucks to help enable that to mitigate exposures to accidents and other things like that.

And could you talk about your talent strategies. I was impressed. I had an opportunity to visit your one of the training center in Toronto and how do you maintain consistency and accountability across our network of 20,000 technicians become like heroic -- having a hero impact.

Yes, there's a very structured approach, and it's been something that the company has followed for a very long time. It's a consistent training program that we administer clear down through the organization, but certainly focused on the technicians. Because for us, the service to our customer and the consistency in the application is just so important. There's a science behind this business. And it's important that we share that science down through the organization, educate our technicians to ensure that they're being safe as they're also -- they're applying these services and applications at the customer level. But they're also troubleshooting and targeting the issue effectively. We get paid for providing an effective service. And so being -- making sure that it's consistent, it's effective, it's backed by science, and it's safe, is certainly areas that we continue to invest in. And the training that you saw when you were on site, is a really good example, how we're bringing people in. We continue to educate people and make sure they're current and up to speed with all of the various changes that might be occurring. We also invested in leadership development. Last year, we've talked a lot about our co-lab initiative, and that's bringing together -- it's interesting. It's really exciting because it's bringing together our brands and Orkin for the first time. For so many years, the business was very much managed like a silo. So we had our Orkin brand and then we had all these other brands, and we weren't sharing. We weren't bringing people together. We weren't investing in development across that space. It was very much focused on Orkin or it was focused on the brands. We're making great strides with our colab. And it's really exciting to see the engagement because really I think there's a super power, so to speak, when we think about how we can collaborate across the brand portfolio. We can collaborate and learning best practices to ensuring customers aren't leaving our family of brands. It might be okay to leave 1 of our brands, but what we want to do is make sure they're not leaving our family of brands. And if we can improve the collaboration across the brand portfolio, I think we can do a better job at keeping those customers and reducing churn in our business.

And let's talk about growth strategies in markets and you have about 80% recurring revenue business model and untapped market opportunity with household -- penetration is still only 15%, so what are the major drivers like for the revenue and margin growth like from here?

Sure. When I think about our business, I look at it, I was talking earlier today with some investors in one-on-ones. And the way that I look at our business is twofold. I look at the recurring ancillary one-time. So as you point out, the 75% to 80% of our business is recurring. It's under some form of service agreement that we have with our customers. 10% to 15% roughly is ancillary. And that's very much complementary to the recurring business. If you remember, our 9 shots on goal or 9 opportunities to do business with customers, that's that ancillary business. It's growing quite attractively. And then the last area is the onetime business. That's the area that's kind of slow growing. It's flattish, negative 2% to plus 2% sort of range. But for us, our focus is how do we continue to expand and increase the customer count, reduce churn around the recurring business, how do we increase the penetration rate of our ancillary business. That -- it's interesting. When you look at ancillary, 10% to 15% of our business is ancillary, but it's, for the most part, all in Orkin, it's not in the brands. And so if we can better share practices across the brands, I think it's a great growth opportunity. And the thing that sometimes you miss when you just look at the 10% of the businesses, that it's only probably 2% to 3% of our customers. So we've got 95% to 97% of our customer base that's not using the ancillary services today. And if we can continue to expand that, that represents a very attractive growth opportunity for us on the ancillary area of the business.

Again, if you could talk about the market competitive dynamics. You are one of the market leaders in -- I think it is more fragmented market [ areas]. And how should we think about the market landscape from your perspective?

Well, it's an attractive market. As you had pointed out earlier, you had talked about a 15-or-so percent penetration rate in residential households. So market is big, but I really do believe the market has opportunities to continue to expand as that penetration rate comes up and increases, you're going to see more and more people using pest control. And we have seen that over the last 10, 15, 20 years. And I think that will continue. There's -- it's interesting when you look at the space, there's roughly 30-plus thousand competitors in our space. That gives us an incredible pipeline for acquisitions. We have consistently acquired businesses. That's how we've built our portfolio. Even going back to Orkin. Orkin was a leveraged buyout back in 1963. That's a while ago, and that was before my time, so to speak here. But when we look at the last 10 to 15 years, we have certainly made investments in brands and acquiring. And right now, our focus is adding 2% to 3% of revenue growth from acquisitions each and every year. Now last 2 to 3 years, we've added 3 -- 1 year, it might be 3% to 4%. Another year, it might be 2% to 3%. But that 2% to 3% is very realistic, and we continue to see great opportunities to do that. That's what helps us get that double-digit revenue growth on a recurring basis.

And could you talk about the cross-sell opportunities based on our recurring services and especially termite and ancillary offerings.

Sure. It's interesting, so what I was alluding to earlier is that we have an incredible opportunity on the cross-sell. Two things I always talk about is, on average, every customer is using less than 2 services. And we've got 8, 9, 10 plus services that we could provide to customers. We have customers that are using pest control but aren't using termite control. So we can come in and bring them into the fold and add the termite control. We have customers that are doing termite, but they're not using pest control, again, another opportunity. And then you look down through the broad array of services, mosquito. It's one of our fastest growing -- it's continued to be one of our fastest-growing service offerings. We're seeing more and more adoption of those services and using -- and people using these services. Ticks, Lyme's disease, we've all heard about that horrible disease. And by treating your lawn and reducing ticks in the lawn, you reduce the likelihood of contracting Lyme's disease. And so continuing to expand that service, you look at a home, you've got insulation. We're seeing great growth in insulation. We're not an insulation business. But what we do is we go in and we remediate. If a pest gets into -- a rodent gets into the addict, they'll destroy the insulation. We'll go in, we'll replace that insulation. We'll put new insulation in. We'll also put work -- do work around exclusion. Keeping the pest out of the home is a really big important area for us. So we'll do exclusion work. We will encapsulate crawl spaces. That's an area that is just prone for insects or prone for rodents and other pest. And if we can do a better job at encapsulating that area, certainly will reduce the likelihood of a pest problem in your home, and we're seeing good service offerings there. But the reason I say all that is because we've got so many different growth opportunities, it's just not a pest control, but it's not just a termite control, but it's all these various services that we go to market with. That's why we have consistently grown at 7% to 8% organically. We take care of the customer. We provide effective solutions, and we develop these relationships that stay with us for years. And those are the reasons why we've enjoyed such a such a consistent run from a growth perspective.

Thank you, Ken. If you could touch on the typical technicians, they and sales marketing strategies when it comes to knocking the door on the customer versus more digitalization kind of platform strategies you have.

Well, it's interesting. What you're pointing out there is how effective the business model is and really what makes it so special? It was one thing when we had the Orkin brand and Orkin is incredibly attractive and a great brand. But when we were able to acquire Northwest or Clark or HomeTeam or Fox or Saela more recently, what it does is it gives us a number of things. But 1 thing that is really important is it gives us new access to the customer. We're not overly dependent upon digital per se. We've got billboards. We've got cross-sell. We've got homebuilder relationships. We got door knocking. 3, 4 years ago, door knocking, a lot of people looked at door knocking, and they just didn't feel it was an attractive business model. Quite frankly, those have been 2 exceptional acquisitions for us. Fox in '23 and then Saela last year, two incredibly attractive, accretive to growth, a couple of our most -- our fastest-growing businesses, very attractive margin profile, highest price point in the service offering and churn is not -- it's not diluting our overall growth rate. And so building the portfolio with a broad array of access points to the customer is what we've done, but we also have a broad array of services and diversified geographies that we're in. So when we think about these acquisitions going forward, we continue to vet these acquisitions through a number of lenses. Those 3 lenses are certainly important to us.

And then if you could talk about how do you see the balance evolving between residential, commercial and termite, ancillary segments and also if you could touch on the margin profile as well, like for overall portfolio perspective?

Yes, sure. I stated earlier, we're talking about recurring ancillary and one time. And that's 1 way of slicing the business and looking -- and analyzing the business. The other way of analyzing the business, as you had indicated, is through service offerings, residential, commercial and termite and ancillary. Residential, incredibly large market, incredibly fragmented market, pretty low barriers to entry, but that's okay. That allows us to continue to see new companies come into the mix and create a really strong pipeline for acquisition. But it's a really attractive market. I mean, 100-plus million homes in the U.S. and only 15% or so using pest control, huge opportunity, huge upside, great, great growth area around home services. Commercial business and commercial pest control, it's probably one of the most attractive areas. It's highly valued by the customer. There's -- they'll certainly pay for the value that they are being provided. You're protecting a customer's brand. When you go in, you want to make sure that you're engaging with a brand like Orkin who has a very strong brand and a reputation for providing exceptional service to ensure that we continue to protect those brands. The last thing our customers want to see are pest during entering their business when customers are there. That will destroy the brand immediately, social media will blow up, and it's a really horrible situation for our customers. So engaging with us, they pay for that value. They realize that value and they're willing to pay for that value. And they oftentimes stay with us for 8, 9, 10 years. And the churn -- so the churn is less than 10%. And so we have -- it's a really attractive business. That's why that business oftentimes is growing 8% or 9% or 10%, whereas residential might be growing more like a 4%, 5% or 6%. It's because the churn is not as great in the commercial side as it is on the residential side. It's not unattractive in the residential side. It's -- it's just a different business. Diversity of which -- and diversification on the ZIP codes creates challenges from time to time from a churn perspective. But the commercial certainly is probably the most attractive. And then you've got termite and ancillary. And that's a sticky business, too. When you come in and you engage with us to do termite, you'll see it's a highly recurring business model. You got to continue to treat those areas and treat those issues. You've got to have a strong quality control program in place. We have that and we help protect our homeowners. The largest investment oftentimes is their home. And so our customers' largest investment is their home. And so we help protect that with the termite business and the termite control. And then the ancillary, I talked about earlier, it's all these different services we're providing and huge opportunity because the penetration rate and the customer base is relatively small. And so it provides us a lot of optimism as we think about the future.

Ken. And if you could talk about in Q4, you had weather disruptions for onetime factors for onetime business. How did you manage that kind of circumstances in Q4 as well as when it comes to 2026, we probably have another weather disruptions might be. So how actually would you tackle with those kind of conditions as the Rollins?

When we look at this, we look at it through a number of views. And when we think about the fourth quarter, again, going back, our recurring revenue, our focus is recurring revenue, our focus is ancillary revenue. The onetime is good business to have, but it's just that, it's one time. And sometimes it can be expensive to acquire when you think about that side of the business. But for us, when we look at Q4, the recurring business continued to be very strong. It actually -- recurring growth was slightly higher in Q4 than it was in Q3. Ancillary was down a little bit just because we couldn't get trucks out on the road, the lot of snowfall, a lot of icing conditions in November and then again in December. And when you have those situations occurring in the second or third month of the quarter, it can be challenging because you don't have time to make up for it. If it occurs earlier in the quarter, like it did in Q1, you oftentimes have time to make up for that. And so -- but we didn't have time. And as soon as it started to get better in December, it got worse again. And so we didn't have time to make up for it. And so the ancillary was a little bit weaker in Q4. And then the onetime business went from growing 3% to 4% to be down to low single digits. And so that was probably -- that was the largest swing in the business in Q4. As we think about Q1 unfolding in 2026, we still, for the year, are committed to that 7% to 8% organic growth. That's our internal plan. That's what we're reflecting in our internal plans, and that's how we continue to talk externally in terms of our expectations. Q1 is probably going to be a little bit more challenged relative to the rest of the year. We've talked about that. That's not new. The one thing that I would say is January was tough. We had a lot of closures of branches. February got better. The growth rate in February was better than the growth rate in January and March. March is the make-or-break month. we really view March favorably. We think it's going to be a good month. We're not done. We're only about halfway through the month right now. But March is the start of a busy season. And it's the time where you start to see the calls pick up. You start to see improvement. Generally, you're seeing a 5% to 10% sequential improvement between February and March in terms of growth because these markets are coming online, it's interesting being in pest control, I noticed mosquitoes now. And it's funny in Atlanta, Georgia, I walked out over the weekend, and I couldn't help but see mosquitoes. And so you're seeing it. It was 75, 80 degrees last week in Atlanta, Georgia. And so you're seeing that start to occur. You're starting to see the calls come in to the call center, people are becoming more aware. And so we're hopeful that March will be a good month. Again, that will really dictate the strength of the quarter, but what I would say is January was challenged, February got better, and we're hopeful that March will continue to show that trend going forward.

And Ken, if you could talk about the pricing strategy, since you joined the firm, it's now CPI plus pricing strategies. And when we initiated Rollins, we talk about the AI, it's difficult to replace the -- all the pest control industries. And how you actually you embrace the AI data-driven pricing models? And if you talk about the pricing strategy since you joined the firm.

That's a great question. Pricing is so important. Some businesses are at CPI, some are below CPI and some like ours is above CPI. And so when I came into the business and started to understand it more completely. What I identified was this is an essential service. You have to have it. If you live in certain parts of the country, you just have to have pest control in order to have a quality of life that we all deserve. You also have to have it to protect your assets in your home. Termite control in -- when I lived in Pittsburgh, Pennsylvania, didn't really need termite control. but I needed it to close on my new home in Atlanta, Georgia. And so really important for me and for homeowners that is having that service. So I'm telling you all that to tell you that this is an essential service one. And the other aspect that when you think about pricing is, how sensitive are folks to it? Like how big of a ticket price is this? Is this a large percentage of a homeowner or a business's budget and no, it's not. It's a very small price to pay for an incredibly valuable service. So as a result, that's why we talk about our business through a CPI plus lens. So if CPI is at 2% to 3% like it is today, we should be getting 3% to 4% pricing. We're not in the business of surcharges or we're in the business for providing an effective price that will help us manage through the ups and downs of any economic cycle. And the nice thing about our business, and I'm kind of going into a different area here now, but when I look at the business and I think about inflationary pressures in the business, a lot of times people today are talking about fuel costs. We don't really have inflationary pressures from fuel costs. And the reason we don't have those pressures is because it's a very small part of our cost structure. I want to say 1% of sales is spent in fuel. So a really small portion of the cost structure associated with that. So it's interesting when you think about all of the various cost structure components, the only area where we have a dependency upon is in our people. Over 50% of sales is reinvested in people. It's a people business. And the way we pay our people helps our people not just depend upon a base salary, but it's a heavy incentive compensation structure. So when we grow, they grow. When we win, they win. When we become more profitable, they see it in their paychecks. And so it's a really -- it's quite frankly, a beautiful model. We're able to share with our teammates in our success. That helps us manage through inflation. When I joined CPI was mid- to high single digits. People were giving merit increases in a lot of businesses at 6%, 7%, 8%, we were giving a 3% to 4% merit increase at that point. And I thought to myself, how are we doing that, but not losing people? Well, we were doing it because there was not an overdependence upon that base comp and being able to incentivize our folks and as we grew at 8%, 9%, 10%, they were growing at similar rates. It was -- it allowed us to manage through the inflationary cycle very effectively and not overly to rely upon price increases or surcharges or things like that, it's a business model that's built for the long term and that pay structure certainly helps us do that.

Very helpful. And if you could talk about international business opportunities, how you see the differences between the U.S., North America versus international, like the in terms of the end markets, competitive landscape and how you see opportunities in there?

I oversee the international business. It's a great business. That is -- in our business, that's Canada, the United Kingdom, Singapore and Australia. Great business. We built it through acquisition. But I'll tell you that the focus of our investments are in the U.S., U.S. and Canada. Those 2 markets make up a bulk of our business, there are 2 of the most attractive businesses. The market is enormous. It's very sizable. There's -- it's just a -- it's a great geography to be in. As we think about international, we're continuing to evaluate that business and the footprint that we have across the international landscape. There's opportunities to grow there. But for us, our focus is the U.S. and Canada. And that's where you're going to see a bulk of the M&A dollars spent in the foreseeable future. That's where you're going to see the bulk of the growth coming through. That's our priority market.

And capital allocation, M&A with strong balance sheet, free cash flow, how do you prioritize between organic investment, bolt-on M&A, share repurchases and dividends?

Yes. It's interesting. So Brady Knudsen is here with me too, today, and he's our Treasurer. And so Brady came in and really did an exceptional job last year, taking us public in the investment-grade bond market. And when I joined company 3 or 4 years ago, we didn't have any debt. We had -- we were cash positive. Over the last 3 to 4 years, I think what we've done is a really good job at executing a balanced capital allocation strategy and opening up new opportunities to enable access to new sources of capital, sources of capital that we deserve, investment grade. Only 8% of companies at our size are investment grade, but we're 1 of that 8%. One of those companies will make up that 8%. And so for the last 3 to 4 years, we've been talking about balance. And for us, it starts with -- we have an exceptional cash flow profile. We're growing cash flow mid-teens. I think last year, adjusted free cash flow was up 20%, doing an exceptional job there. So when I look at it, first and foremost, it's about growth. How do we continue to bring new brands and new teammates into the business and make those acquisitions. And we've spent upwards of $1 billion of capital the last 3 or 4 years on acquisitions. Fox and Saela, a big part of that, but there's also a lot of other brands and teammates that we brought into the business. The second area is dividends. When we look at dividends, we -- when I joined the company, they were paying a special dividend. There wasn't this consistent approach to dividends that we see today. So over the last 3 or 4 years, I've worked to increase the dividend by upwards of 80% to 85%. And that dividend stream today represents roughly 50% of cash flow. We have an incredible amount of opportunity to continue to service that dividend. And our focus is to increase that dividend as cash flow increases. And so we're going to continue to do that. We've also executed on share repurchase the last 2 to 3 years. When I joined -- it was interesting when I joined the company, we had a family that owned over 50% of the business of the outstanding stock. And we were trading -- I want to say we were probably trading $50 million or $60 million of stock a day. And they entered a point in their ownership timeline and a life cycle that they needed to diversify. They needed to execute state planning. There was a number of things, I think they were trying to accomplish. And they were selling through blocks and 144s. And you know as well as I do, when you have an owner at that level, selling through that sort of mechanism, it creates a headwind to the share price. And so what I did after the first 3 or 4 months, we've started to work with that owner and that shareholder to put together a shelf program to register their entire position and to do a major secondary. And so we did our first major secondary in September of '23. The stock was $34 a share. It was down 8% to 10% roughly on the announcement. We bought back $300 million, so 20% of the deal at that point, and we executed that. Volume stepped up slightly. We brought on some new sell-side analysts It was a success. I would call it almost like an IPO for the business. It just was -- it just helped us get out and tell our story. Two years later, well, the family locked up for a full year in that time -- at that time and weren't in the market until this past November. And so this past November, we did our second secondary. There was there was really very little, if any, discount on the stock when we did that secondary. We did a -- we bought back 20% of the deal again. We spent $200 million and we're excited about that. And by doing those things, by participating, but also doing this sell-down and executing that, it allowed us to bring new investors into the stock. It's -- our volume is now approaching $150 million to $200 million a day, up from roughly $50 million a few years ago. And so we're seeing really good success, but it just took the structure. It took time and we were able to execute on that. But saying all that to say that we will use the balance sheet to buy our stock back. We see an attractive opportunities, and we will execute on that, especially during secondary offerings.

Last two questions. Other aspects of Rollins business, recurring revenue models, declination training, digital transformation, M&A pipework, you believe underappreciated by investors at this moment. And you have Investor Day coming up and anything that we are excited about, like for that?

Yes, there are so many different things, and we're excited about the Investor Day. I want to say that's May 14 that we're having that at the New York Stock Exchange. And so we're excited about the opportunity to get the team in front of the investment community. Again, we had one 2 years ago. But hey, there's opportunities on growth, organic growth, great opportunities, good pricing cross-sell opportunity, M&A, exceptional of M&A opportunities for us as we think about the future, back-office modernization. The tax rate has improved over the last couple of years. We're seeing great improvements there and trying to do more around that. We've seen 100 basis points of improvement in the effective tax rate. That's meaningful when you look at our earnings profile. And then there's continued opportunities around cash flow. So it's -- there's so many different things, I think, to be excited about and we're looking forward to the Investor Day where we can highlight some of those things.

Thank you. very looking forward to it. So it's time. I'm going to wrap it up. So thank you very much, Ken, and thank you, everyone, for joining today.

Well, thank you.