Rollins, Inc. (NYSE:ROL) Q4 2023 Earnings Call Transcript

Rollins, Inc. (NYSE:ROL) Q4 2023 Earnings Call Transcript February 15, 2024

Rollins, Inc. isn’t one of the 30 most popular stocks among hedge funds at the end of the third quarter (see the details here).

Operator: Good day, ladies and gentlemen. Thank you for standing by. Welcome to Rollins, Inc. Fourth Quarter and Full-Year 2023 Earnings Call. During today’s presentation, all parties will be in a listen-only mode. Following the presentation, the conference will be open for questions. [Operator Instructions]. This conference is being recorded today, Thursday, February 15, 2024. I’d now like to hand the call over to Lyndsey Burton, Vice President of Investor Relations. Please go ahead.

Lyndsey Burton: Thank you, and good morning, everyone. In addition to the earnings release that we issued yesterday, the company has also prepared a supporting slide presentation. The earnings release and presentation are available on our website at www.rollins.com. We have included certain non-GAAP financial measures as part of our discussion this morning. The non-GAAP reconciliations are available in the appendix of today’s presentation as well as in our earnings release. The company’s earnings release discusses the business outlook and contains certain forward-looking statements. These particular forward-looking statements and all other statements that have been made on this call, excluding historical facts are subject to a number of risks and uncertainties and actual results may differ materially from any statement we make today.

Please refer to yesterday’s press release and the company’s SEC filings, including the Risk Factors section of our Form 10-K for the year ended December 31, 2023, which will be filed later today. On the line with me today and speaking are Jerry Gahlhoff, President and Chief Executive Officer; and Ken Krause, Executive Vice President, Chief Financial Officer and Treasurer. Management will make some opening remarks, and then we’ll open the line for your questions. Jerry, would you like to begin?

Jerry Gahlhoff: Thank you, Lyndsey. Good morning, everyone. Fiscal 2023 was an outstanding year for Rollins as we achieved a milestone of $3.1 billion in revenue. Demand from our customers remained strong throughout the year across all major service offerings. While full-year revenue increased 14% versus last year, we grew earnings per share by over 18% and adjusted earnings per share by 20%, reflecting consistent execution of our operating strategies and a commitment to continuous improvement in our business. We finished the year with a strong fourth quarter and observed sustained strength in the pest control markets we serve. We also continue to drive share gains in our markets by leveraging a multi-brand, multichannel approach at scale to differentiate ourselves competitively.

Digital marketing, cross-selling, service bundling and door-to-door sales methods help us reach new customers and enhance engagement with existing customers to support organic growth. We have also strategically allocated resources to the commercial side of our business to capitalize on opportunities within key verticals. Most notably, we have grown our sales force and invested in training and tools to enable their success. Our service quality is high, and our offerings are customized, which helps new sales professionals gain confidence and become successful quickly. Additionally, we are leveraging the scale of our Orkin brand across North America to effectively serve commercial customers coast-to-coast in both the U.S. and Canada. While we’re still early with respect to our efforts in this area, we see good results as demonstrated by approximately 11% commercial revenue growth for the year.

Investments to drive organic growth are complemented by strategic M&A. And in 2023, we welcomed 24 new businesses into our company through acquisition. This includes the addition of Fox Pest Control, which was the second largest acquisition in our company’s history. Our synergistic approach to integration has gone well with the Fox team exceeding the financial targets we outlined last April. Additionally, during the fourth quarter, we divested certain non-core businesses, most notably our lawn care business, which includes insect, fertilization, and weed control for turf grafts. We recognized a pretax gain on sales of that transaction of approximately $15 million. The decision to divest this asset aligns with our strategy to focus on profitable growth in core pest control operations.

Operationally, we remain committed to developing exceptional talent and investing in our teams. The hiring environment improved in 2023 as we put a lot of energy into onboarding the right people in both support functions as well as the customer-facing side of our business. Effective sales and service staffing levels help us capitalize on continued demand and deliver solid results for the year. 2023 was also an important year with respect to continuous improvement and safety was a key area of focus for us. During the year, we implemented an app that monitors driving behaviors once our vehicle is in motion. The app protects unsafe driving maneuvers associated with acceleration, breaking and speed, then converts data collected into a driver safety score.

I’m pleased to report that by year-end, our average driver safety score for drivers that we monitor increased over 30% from the beginning of the year, but we aren’t stopping there. Improving the safety culture isn’t something that is done overnight. But we are proud of the progress we have made and have set ambitious goals for ourselves to encourage safe behaviors throughout our organization. We believe these efforts will improve our ability to serve customers, help mitigate potentially negative financial impacts on our business and most importantly, ensure our people return home safe every day. Our continuous improvement efforts also set our own initiatives to modernize our back office and support functions. This is a work in progress, but we took some important steps to upgrade talent and systems during the year.

These efforts are aimed at further enabling our growth priorities and increasing productivity as we work to become a better, more effective provider of shared services for our brands. In closing, our performance in 2023 demonstrates the strength of our business model and the engagement level of our team. Our family of pest control brands are driving profitable growth and we are focused on continuous improvement throughout the business. We remain committed to providing our customers with the best customer experience and investing meaningfully in our team to drive growth both organically, as well as through disciplined acquisitions. We’re pleased with where our business stands today and the momentum we carry into 2024. And I want to thank each of our 19,000 plus associates around the world for their efforts and contribution to our success in 2023.

I’ll now turn the call over to Ken.

Kenneth Krause: Thank you, Jerry, and good morning, everyone. Our results for the quarter and the year reflect continued strong execution by the team. Let me begin with a few highlights for 2023. First, we delivered robust revenue growth of 14% for the year with double-digit growth across each of our service offerings. It was encouraging to see organic growth of 8% for the year, while acquisitions continue to be a meaningful part of our growth profile, accounting for approximately 6% of our total revenue growth. Second, we made good progress on profitability improvement in 2023. Full-year gross margins were healthy as we were positive on the price cost equation and saw improvement across several key cost categories. Adjusted operating margin finished the year at 19.7%, improving 140 basis points driven by leverage across the P&L.

This translated into GAAP EPS of $0.89 per share, up over 18% for the year and adjusted earnings per share of $0.90, up 20% for the year. On an as-reported basis, we generated incremental margins of almost 30% for the year and on an adjusted basis, incremental margins were almost 28% for the year. And last but not least, we delivered operating cash flow of $528 million and free cash flow of $495 million, both up over 13% versus last year. Our strong cash flow performance enabled us to execute a balanced capital allocation strategy, deploying nearly $1 billion of capital in 2023 with a focus on investing for growth, while returning cash to shareholders through a growing dividend and share repurchases. Turning to our fourth quarter performance.

The team delivered a strong quarter with revenue up 14% to $754 million. Currencies had a negligible impact on quarterly revenue growth. We saw a good balance of growth between organic and inorganic activities as organic revenue was up over 7% with acquisitions accounting for the other 7% of growth. Jerry mentioned that we divested certain non-core businesses in the quarter, most notably our lawn care business. The purchase price for the transaction was $18 million. We received $15 million in proceeds during 2023 and recorded a pretax gain of $15 million on the sale. This business doesn’t provide the growth or profitability profile of our core pest control business. Going forward, we don’t anticipate any significant divestitures associated with portfolio rationalization in the foreseeable future.

In the fourth quarter, Residential revenues increased approximately 18%, Commercial Pest Controls rose nearly 11%, and Termite and Ancillary was up over 13%. Organic growth was healthy across the portfolio with growth of nearly 5% in Residential, approximately 9% in Commercial, and over 11% in Termite and Ancillary. We normally see a step down in revenue as well as growth in Q4 along with Q1 due to seasonality. Comparing Q4 this year to last year, we saw an acceleration in organic growth across all service lines. Gross margin improved 40 basis points to 50.9% in the quarter. While Fox was accretive to gross margins for the quarter by about 30 basis points, we saw 10 basis points of improvement in organic margins as leverage from people costs and fleet offset pressure from materials and supplies and higher insurance-related costs.

Gross profit also steps down in Q4 and Q1, primarily due to lower volume levels associated with the seasonality of our business I previously discussed. With that said, I’m pleased with the fourth quarter performance as we saw improvement year-over-year and recorded our highest Q4 gross margin level in the last several decades. Quarterly SG&A costs as a percentage of revenue increased by 10 basis points versus last year. Excluding the earnout adjustment for the Fox acquisition, SG&A costs as a percentage of revenue decreased by 10 basis points in the quarter. We saw nice leverage on people costs, which offset increased advertising and selling expense associated with the growth initiatives that Jerry discussed previously. Fourth quarter GAAP operating income was $139 million, up 16% year-over-year.

Adjusted operating income was $144 million, up over 20% versus the prior year on 14% total revenue growth. Quarterly EBITDA was $181 million, up 24% versus last year, and EBITDA margin was a healthy 24%, up 190 basis points versus last year. Fourth quarter adjusted EBITDA was $167 million, up 14% and representing a 22.1% margin, flat versus last year. While we saw nice leverage with respect to both gross profit and SG&A, adjusted EBITDA margins were negatively impacted by about 40 basis points in the quarter due to lower non-operational gains on property and vehicle sales that were included in other income when compared to the fourth quarter of last year. This impacted incremental EBITDA margins in the quarter as well. The effective tax rate was 25.8% for both the quarter and the full-year period.

And for 2024, we’re expecting an effective rate — tax rate of approximately 26%. Quarterly GAAP net income was approximately $109 million or $0.22 per share, an increase of nearly 30% from $0.17 per share in the same period a year ago. For the fourth quarter, we had non-GAAP pretax adjustments associated with the Fox acquisition-related items that I mentioned earlier, totaling approximately $5 million of pretax expense in the quarter. We also recognized the $15 million pretax benefit associated with a gain on the sale of our non-core business. Taking into account these adjustments, adjusted net income for the quarter was $101 million or $0.21 per share, increasing over 23% from the same period a year ago. Turning to cash flow and the balance sheet.

Operating cash flow increased 24% in the quarter to $153 million. We generated $142 million of free cash flow on $109 million of GAAP earnings, a 22% increase versus last year. Cash flow conversion, the percent of income that was converted into operating cash flow was well above 100% for the quarter. Debt remains low and debt-to-EBITDA is well below 1x on a gross and net level. We continued to fund our dividend in the quarter. Going back to the fourth quarter of 2022, we have increased our dividend 45% and we remain committed to funding our growing dividend as cash flow improves. As we look to 2024, we remain encouraged by the strength of our markets and the execution by our team. We are focused on delivering another year of robust growth and healthy incremental margins, further complemented by a strategic and disciplined approach to M&A.

From a pricing perspective, we remain focused on effectively pricing the value of our services to remain positive on the price cost equation. And we have begun to raise prices for 2024 in the first quarter at a rate that is consistent with 2023 levels. We also continue to be active in managing our rate cards. Our focus remains on driving consistent growth, delivering healthy incremental margins and compounding cash flow that will enable a balanced capital allocation strategy focused on investing in growth initiatives in our core market. Before I turn the call back to Jerry, I wanted to announce that we will be holding an investor and analyst conference on the morning of May 17th in New York City, where we will share more about our strategic priorities and how we are positioning ourselves for continued success in the future.

We’re looking forward to sharing more details in the coming weeks and months. But for now, please hold the date. With that, I’ll turn the call back over to Jerry.

Jerry Gahlhoff: Thank you, Ken. We’re happy to take any questions at this time.

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Q&A Session

Operator: Thank you. We’ll now be conducting a question-and-answer session. [Operator Instructions]. Our first question is from Tim Mulrooney with William Blair. Please proceed with your question.

Tim Mulrooney: Jerry, Ken, good morning.

Jerry Gahlhoff: Good morning.

Kenneth Krause: Good morning.

Tim Mulrooney: A couple of questions here. On the resi organic growth, Ken, as you highlight, it decelerated from 7% to 5% from the third to the fourth quarter. But you’re right. As I look at results historically, I do see a slight deceleration seasonally from the third quarter to the fourth quarter, typically. So could you just talk about what those seasonal factors are? Like onetime revenue or whatever else. And if that’s the case, could you also talk about how your recurring — your residential recurring revenue stream looked like in the fourth quarter?

Kenneth Krause: Certainly, Tim, I’ll start, and then turn it over to Jerry for additional comments as well. But when we look at the business, the business, as you so well indicate has a high degree of recurring revenue. And so as a result, there is a consistent base to the revenue that we enjoy and we benefit from. The one thing that does have an impact on our business from time-to-time is what we call onetime type of service. And when we look at the quarter in the fourth quarter, we did see a decel and the deceleration in the rate of growth in those areas of our business. That’s probably the largest area of impact on the revenue growth in the quarter. We were really encouraged, quite frankly with the level of growth that we continue to see from the recurring business.

It was a healthy level of growth for us, despite being stacked up against last October, you may recall was more beneficial because hurricane season was pretty tough in September. And so some of that business pushed into the fourth quarter of last year. There’s always puts and takes, of course, in this business with weather. But we continue to be pretty encouraged with respect to our growth, especially in the resi sector.

Jerry Gahlhoff: And I would add, Ken, as I think about residential pest control, your — every other month in your quarterly service frequency offerings of your recurring base, that’s your bread and butter. That is the healthiest indicator of what’s going on in our business as we are growing our business, increasing our volumes and are we ending the year from a positive standpoint and customer — in net customers — net new customers to start the year, we certainly did that. And that quarterly and EOM pest control is your bread and butter and the onetime is that gravy on top. And sometimes you don’t always get that gravy and that’s what’s really caused the slowdown in addition to the divestiture of the lawn care, that was about another $1 million on the residential side that also impacted that number in the quarter as well, Tim.

Tim Mulrooney: Got it. Okay. So there was a little less gravy in the fourth quarter, which implies that your recurring revenue in that business is above your stated organic growth in the fourth quarter. Am I correct on that?

Jerry Gahlhoff: Yes. Absolutely. Our recurring quarterly every other month service definitely outpaced our organic overall number.

Tim Mulrooney: Got it. The other one for me, and thank you for that, is on digital [indiscernible]. You mentioned last quarter that digital marketing [indiscernible] were, I think the language was flat to down slightly. Correct me if I’m wrong about that. But I was just curious if that trend carried through the fourth quarter or if it moves up or down at all?

Jerry Gahlhoff: Yes. So as we look at the digital queries we saw in the fourth quarter, the digital queries, we saw modest increases in the quarter versus the prior year. But we did — so it did result in some healthy increases in lead starts and sales both from a digital as well as just overall in our business. We did see a lift there. It was certainly better than flat. It wasn’t stellar performance, but it was an improvement year-over-year. So we believe we continue to benefit from a diversified approach that we’re not overly reliant on all the digital space. And that’s a key part of the formula in our organic growth.

Kenneth Krause: Yes. It’s interesting, Jerry, just adding on to that. When we look at the business in the fourth quarter and as well as throughout the year, what really proves the point that we’re continuing to see good cross-sell, and we always talk about additional ways we access the customer. And one area is the cross-sell and the Termite and Ancillary business is really representative of that. We continue to see really robust levels of demand on the Ancillary side of our business, which is driven a lot by that cross-sell activity that the team continued to execute upon.

Tim Mulrooney: Got it. Thank you, Jerry and Ken. When my kids turn 16, I might try to hit you off from one of those driver monitoring systems.

Jerry Gahlhoff: It’s a good idea. You should probably get on it yourself, too.

Tim Mulrooney: Thank you.

Jerry Gahlhoff: Thank you.

Operator: Our next question is from Jason Haas with Bank of America. Please proceed with your question.

Jason Haas: Hey, good morning. And thanks for taking my questions. I’m curious if you could remind us what level of price increase you had put in last year. And I know it’s early in the year, but I’m curious if you’re seeing any more sensitivity from customers to the price increase you’re putting in this year versus last?

Kenneth Krause: So as we had talked about previously, Jason, we had passed along a 3% to 4% price increase in the prior year. We followed that on again this year with a similar price increase here in the first quarter, ahead of our heavier pest market season, which starts here later in the first quarter. So we’re pretty — in terms of what we’re seeing on the customer side, we monitor that. We assess that, we look at churn, we look at cancellations, we look at rollbacks. We look at a number of different metrics. And we feel like the level that we’re passing along is at a very healthy level and is representative of the value of our services.

Jason Haas: Got it. That’s great to hear. And then as a follow-up question, I’m curious if you could just talk about competitive dynamics in the industry. I’m curious how your growth rates in 4Q compared to the industry? If you feel like you’re still gaining share? And just if you see any opportunities for the share gains in the year ahead?

Jerry Gahlhoff: I mean we continue to have a highly fragmented market in this industry. It remains very competitive. I wouldn’t necessarily characterize any significant shifts or changes in that competitiveness, it’s always been that way. And while there are some ebbs and flows in here and there, we just keep doing what we do, focusing on our business and trying to win at what we do so.

Kenneth Krause: When we look at our growth, Jason, in the quarter at organic growth, which was north of 7%, and we think about how that fares relative to how we’ve discussed the business and also how we outperformed. We’re pretty happy with the level of growth that we’re seeing come through the business. And we also continue to have a high degree of optimism and we’re encouraged about the future growth that we continue to see in this business. So we really look at how we’re performing relative to our expectations, and we continue to perform at a level that we’re pretty pleased with.

Jason Haas: Got it. That’s great. Thank you.

Operator: Our next question is from George Tong with Goldman Sachs. Please proceed with your question.

George Tong: Hi, thanks. Good morning. Following up on the Residential business. Can you talk about what recurring revenue growth trends were? How did it perform relative to your earlier quarters? And what you see as the key drivers of growth acceleration going forward?

Kenneth Krause: Certainly, George. When we look at the growth rates and we look at their recurring revenue growth relative to prior quarters, the business continues to perform pretty well. It continues to hold in there. I mean Q4 always sees a step down and just generally the growth year-over-year. But it’s above what we saw a year ago, and it continues to be at a healthy level. So there’s nothing that’s indicating that there’s a significant decel in the growth rates or a different or a change in profile and the growth rates that we’re seeing coming through our business.

George Tong: Got it. And you talked about earlier, making good progress with bundling, cross-selling in door-to-door sales. Can you talk a little bit about your priorities for 2024 with respect to these areas and how you expect that to drive volume performance?

Kenneth Krause: Certainly, when you step back and you look at the business, George, we look at it across a number of different priorities. We — and when we think about our expectations going forward, we talked earlier about our pricing. We’re focused certainly on getting the value of our services through strategic pricing management. And we again raised prices and we’ll continue to raise prices and manage our rate cards effectively. So that’s one side of the equation. And so that rate — that growth rate associated with pricing is at this point expected to be in line with what we saw a year ago at 3% to 4%. And then secondly, when we look at growth profile across the business, we remain encouraged by our position in our market.

We continue to have confidence in our ability to deliver a healthy level of growth going forward that’s in line with what we’ve seen here in the last couple of years. We’ve all enjoyed the benefit and you’ve seen the benefit of our growth rate accelerating post-COVID. We continue to operate at a pretty healthy level of growth in our business from an organic perspective. And then, of course, we saw a really robust uptick in growth associated with M&A in the last year. When we look at the initiatives across the business, the cross-sell is certainly really important, going after those customers that may have one service, but trying to add additional services like mosquito and ticks and other services like that. Continuing the focusing on the Termite and Ancillary business is very important.

And then last but certainly not least, is the Commercial side. Jerry spoke about the Commercial business in detail, we talked about it in the third quarter as well. We continue to place this portion of focus on the Commercial business and driving growth there. So all of those initiatives are coming together to give us optimism as we think about our growth rates going forward.

Jerry Gahlhoff: George, I’ll add. This is Jerry. When we think about one of the ways I just love our business model is the diversity that we get from our brand strategy. Each of our brands has various different ways to acquire customers, whether it be, say, Northwest and Home team that rely heavily on the homebuilding market or Fox doing door-to-door. And now, for example, we have Home team doing door-to-door and expanding that offering in their business by things they learn from the Fox team. These are all things that we can deploy across and due to the diversity of our brands and what each one brings to the table that we think continues to help us with this solid growth profile for the future.

George Tong: Very helpful. Thank you.

Jerry Gahlhoff: Thank you, George.

Operator: Thank you. Our next question is from Michael Hoffman with Stifel. Please proceed with your question.

Michael Hoffman: So the challenge is to how creative can I be to ask four questions in two. Good morning, everybody.

Kenneth Krause: Good morning.

Michael Hoffman: So things that would help the model, Ken, are specifics that I think you can share like the three to four and 1Q pricing. What is the dollar amount of the M&A rollover from ’23, so everybody just gets that right? And how do you think about the cadence of it in the calendar year, so we just don’t get that wrong?