Rollins, Inc. 2016 Form 10-K Summary
Business Context and Reporting Period
Rollins, Inc. is an international pest and termite control services company serving residential and commercial customers through brands including Orkin, HomeTeam Pest Defense, Western Pest Services, Critter Control, Rollins Australia and Safeguard Pest Control. The company reports one segment: pest and termite control. This filing covers the fiscal year ended December 31, 2016; the filing is an annual report rather than a standalone fourth-quarter filing.
Rollins completed 34 acquisitions in 2016, including the June 2016 acquisition of U.K.-based Safeguard Pest Control. The company operated in 47 countries and had 120 Orkin franchises at year-end, including 70 international franchises.
Financial Performance and Position
| Metric | 2016 | 2015 | Change |
|---|---|---|---|
| Revenue | $1.573 billion | $1.485 billion | 5.9% |
| Income before taxes | $260.6 million | $243.2 million | 7.2% |
| Net income | $167.4 million | $152.1 million | 10.0% |
| Diluted EPS | $0.77 | $0.70 | 10.0% |
| Gross margin | 50.9% | 50.4% | Up 0.5 percentage points |
| Net profit margin | 10.6% | 10.2% | Up 0.4 percentage points |
| Operating cash flow | $226.5 million | $196.4 million | 15.4% |
| Capital expenditures | $33.1 million | $39.5 million | Down 16.2% |
| Cash and equivalents | $142.8 million | $134.6 million | Up $8.2 million |
| Total assets | $916.5 million | $848.7 million | 8.0% |
| Stockholders’ equity | $568.5 million | $524.0 million | 8.5% |
Residential pest control revenue increased 7.3%, commercial pest control revenue increased 4.4%, and termite revenue increased 6.3%. Approximately 80% of pest control revenue was recurring. Foreign operations represented approximately 7% of revenue, and unfavorable foreign exchange rates negatively affected Canadian and Australian results.
Cost of services increased 4.9%, while sales, general and administrative expense increased 5.8% but remained 31.2% of revenue. Depreciation and amortization increased 14.3%, primarily because of depreciation of the BOSS customer relationship management system and amortization from acquisitions. The effective tax rate declined to 35.8% from 37.4%, aided by a one-time tax event and increased foreign tax credits.
Cash Flow, Debt and Liquidity
- Operating cash flow was $226.5 million, compared with $196.4 million in 2015.
- Investing cash outflows were $76.8 million, including $46.3 million for acquisitions and $33.1 million of capital expenditures.
- Financing cash outflows were $136.4 million, including $109.0 million of dividends and $31.1 million of common-stock purchases, partially offset by $3.7 million of excess tax benefits.
- The company had no borrowings outstanding under its $175.0 million unsecured revolving credit facility at December 31, 2016. The facility matures October 31, 2019, subject to extension options.
- Approximately $35.0 million of letters of credit were outstanding, primarily supporting workers’ compensation and casualty insurance arrangements.
- Management stated that cash, expected operating cash flow and available borrowings should be sufficient for operations, obligations and expansion for the foreseeable future.
- Management expects 2017 capital expenditures of approximately $25.0 million to $28.0 million and is considering approximately $5.5 million of pension contributions.
Material Changes Versus the Prior Comparable Period
- Revenue growth accelerated to 5.9% in 2016 from 5.2% in 2015, while net income growth was 10.0% versus 10.5% in 2015.
- Gross margin improved by 0.5 percentage points, reflecting routing and scheduling efficiencies from the BOSS system, lower healthcare claims, and lower insurance and claims costs, partly offset by professional fees related to BOSS implementation.
- Acquisition spending increased to $46.3 million from $33.5 million, and 34 acquisitions were completed versus 12 in 2015.
- Cash dividends increased to $0.50 per share from $0.42 per share, including a $0.10 special year-end dividend. The board subsequently approved a 15% increase in the regular quarterly dividend to $0.115 per share beginning in March 2017.
- Open-market share repurchases increased to 0.8 million shares costing $22.7 million, compared with 19 thousand shares costing $0.4 million in 2015. Approximately 5.1 million shares remained authorized for repurchase.
- Customer contracts, net, increased to $117.5 million from $92.8 million, primarily reflecting acquisitions. Goodwill increased to $255.7 million from $249.9 million.
- The pension deficit declined to $2.9 million from $9.7 million, although the pension discount rate declined to 4.45% from 4.70%.
Guidance, Outlook, Risks and Unusual Items
Management emphasized continued organic growth, selective acquisitions, international expansion, franchise development and continued benefits from the BOSS system. No formal revenue or earnings guidance was provided. The company established 23 new Orkin international franchises during 2016, including 12 in China.
- Key risks include intense competition, discretionary spending sensitivity among residential customers, economic weakness among commercial customers, adverse weather and seasonality, labor shortages and wage inflation, acquisition integration, cybersecurity and payment-card risks, and environmental and pesticide regulation.
- The company is subject to ordinary-course litigation and environmental matters. Two HomeTeam-related antitrust lawsuits remained pending; the company could not estimate any potential loss, although management did not believe the matters would materially affect overall financial position, results or liquidity.
- Unfavorable litigation outcomes could nevertheless produce a material charge in an individual quarter or year.
- A one-time $9.1 million tax event related to dissolving Kinro Investment Inc. increased SG&A and was offset by a credit in income tax expense.
- The company self-insures certain general liability, workers’ compensation and vehicle risks, and estimates for insurance and termite claims are subject to actuarial and management judgment.
- The defined benefit pension plans were underfunded at year-end. Plan assets included $42.1 million of Rollins common stock.
- The company adopted deferred-tax balance-sheet classification changes retrospectively in 2016 with no impact on reported results. It expected to adopt the new revenue standard in fiscal 2018 and was evaluating the impact.
- Management and affiliates controlled approximately 57% of outstanding shares and the company elected the NYSE controlled-company exemption, limiting certain governance requirements and the influence of minority shareholders.
Investor Verification Items
- Verify the sustainability of recurring revenue growth and the extent to which 2016 growth depended on acquisitions, pricing and foreign-exchange effects.
- Assess whether BOSS-related efficiency gains and the 50.9% gross margin are sustainable after implementation costs normalize.
- Review acquisition returns, customer-contract amortization, goodwill and potential impairment exposure as acquisition activity continues.
- Monitor cash deployment among dividends, repurchases, acquisitions, capital expenditures and potential pension contributions.
- Review the $175.0 million credit facility, approximately $35.0 million of letters of credit, insurance reserves and contractual obligations totaling $137.7 million.
- Evaluate pending HomeTeam antitrust litigation, termite claims, self-insurance reserves and environmental contingencies.
- Consider foreign-exchange exposure, international cash balances of approximately $54.4 million, and the company’s plan not to repatriate foreign cash.
- Confirm the effect of the planned revenue-recognition, lease and share-based-payment accounting standards on future financial statements.