Apr 23, 2008
Executives
Gary Rollins - President and Chief Executive Officer Harry Cynkus - Chief Financial Officer and Treasurer Leslie Loyet - Financial Relations Board
Analysts
Jim Famalette - Sidoti & Company Clint Fendley - Davenport [Sam Lau] - [Asset Value Investors]
Operator
Good morning, ladies and gentlemen. Thank you so much for standing by and welcome to the Rollins’ first quarter conference 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). As a reminder, this conference is being recorded today, Wednesday, the 23rd of April, 2008.
I will now turn the conference over to Ms. Leslie Loyet of the Financial Relations Board.
Please go ahead.
Leslie Loyet - Financial Relations Board
Thank you. By now you should have all received a copy of the press release.
However, if anyone is missing a copy and would like to receive one, please contact our office at 212-827-3777. We will send you the release and make sure you are on the company’s distribution list.
There will be a replay of the call which will begin one hour after the call and run for one week. The replay can be accessed by dialing 1-800-405-2236 with the pass code 11112420.
Additionally, the call is being webcast over www.viavid.com and a replay will be available for 90 days. On the line with us today are Gary Rollins, President and Chief Executive Officer; and Harry Cynkus, Chief Financial Officer and Treasurer.
Management will make some opening remarks and then we’ll open up the lines for questions. Gary, would you like to begin?
Gary Rollins - President and Chief Executive Officer
Yes, thank you Leslie. Good morning and thank you all for joining our first quarter 2008 conference call.
Harry will read our forward-looking statements and disclaimer and then we will begin.
Harry Cynkus – Chief Financial Officer and Treasurer
Thanks, Gary. Our earnings release discusses our business outlook and contains certain forward-looking statements.
These particular forward-looking statements and all other statements that may be 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 today’s press release and our SEC filings, including the risk factor section on Form 10-K for the year ended December 31, 2007, for more information on the risk factors that could cause actual results to differ.
Gary Rollins - President and Chief Executive Officer
Thank you, Harry. We were pleased to report a 4.4% increase in revenues for the first quarter.
Total pest control sales were up approximately 10% led by a strong commercial pest control sales result. We saw strong commercial performance particularly in our national accounts, which was up over a100% from the same quarter last year with more than $7 million in sales.
As I mentioned on our last call, this quarter we started service on three national accounts that were sold earlier with approximately 3,500 locations in the US, which contributed. There was not a high volume of new residential pest control or termite control sales due to the small amount of pest activity this quarter.
We are pleased to have completed the acquisitions of HomeTeam Pest Defense, a Centex subsidiary. It could be said that this is an acquisition that took a long time to come to fruition.
We first contacted them almost 10 years ago and have routinely been in touch throughout the period. We last contacted them about five months ago they were more receptive.
As one Centex’s executive said we really like pest control but right now we need to focus completely on our home building business. HomeTeam’s fiscal year ended March 31, and recorded revenues of approximately $134 million.
The revenue and customer base when combined with ours will considerably broaden our market share. HomeTeam was attractive to us for a number of reasons beginning with the fact that they provide a strategic opportunity to handle a market channel that we’ve not previously pursued, new home construction and the new home owner.
I know people can be a little nervous these days when they think of home construction but home building is not going to stop. It slows down from time to time but it doesn’t stop.
Keep in mind that more than half of HomeTeam’s business has nothing to do with new home construction. For that unique proprietary KX tubes in the wall system we have gained a number of competitive advantages.
For us this market segment has significant barriers to enter. Next HomeTeam has already earned great builder acceptance with relationships with 18 of the nation's 20 largest builders and the business has a lower cost of service delivery for ongoing pest services and they enjoy in most markets high route density.
The service is less invasive as the customer does not need to be home for treatment. Home owners value of the company’s innovative tubes in the wall pest control delivery system which they look upon as a purchased asset.
Customer convenience and the high level of quality service provided by HomeTeam have translated into very high customer satisfaction ratings and excellent customer retention some of the highest in the industry. They have a very nice installed customer base servicing approximately 380,000 customers from 48 locations in 13 states.
Additionally, they have a tremendous potential of thousands of homes with the homeowner has not activated this system. We believe that efficiently solutioning these customers can provide a wonderful opportunity.
In the past, we have distinguished ourselves acquisition wise with key management remaining and helping us improve the business, HomeTeam is no exception. The company’s 11 members of top management have all chosen to remain with the company and we are delighted to have them and they are approximately 1,500 co-workers as part of the Rollins team.
As we have -- our other acquisitions HomeTeam will retain their planned identity and operate as a separate Rollins’ entity. We appreciate the job the Centex did as a great pair in business developer.
They provided credibility with other homeowners and created a very powerful business model. We think we can improve what they started by taking the concept to new markets a substantially less capital and cost and which previously needed.
And will be able to help them purchase materials and supplies more favorably by using our buying power. Working together we think that we will discover many other fastest energies as HomeTeam integrates into our organization.
The people who have wondered from time to time whether were willing to leverage our balance sheet, this acquisition should clarify that. We bought $90 million to finance the acquisition of HomeTeam, however, that doesn’t mean they were not willing to look at other additional acquisitions that did.
We are not out of the market. We have a $175 million credit line with a $75 million of OD in future.
So, at the right acquisitions come along we are more than willing to tackle it as well. And if any pest control operators are listening today and perhaps are worried about the possibility of capital gains taxes going up, give us a call.
Turning our attention to some other events of the past quarter we continue to expand our international presence with the establishment of three franchises. One in the City of Jeddah in the Kingdom of Saudi Arabia, a second franchise for the country of Qatar and a third in the Kingdom of Bahrain.
We now have four franchises in the Middle East and a total of ten international franchises worldwide. Our work in franchises in -- franchise in the United Arab Emirates was recently awarded a three-year $29 million US contract to provide pest control services to commercial and residential customers to Al Ain City, which is located about 45 minutes from Dubai.
Our franchisee has experience with similar large government tenders through their landscaping business. Orkin will provide pest control know how training and collaboration.
On March 14, we launched our new 2008 TV advertising campaign developed by new advertising agency, Richards with focuses on the idea that bugs will do anything to get into your home. And the Orkin man is there to keep pests in their place.
Two versions of the commercial are running our metro TV on ABC, CBS, NBC and FOX as well as network cable and syndication. It’s still a little early to know the impact from a lead generation perspective, but the early feedback has been positive.
Our company has always been proactive in building our brand by providing pest information to the public through our many alliances. In this ongoing effort, we recently established a new educational website through our partnership with a consumer education counsel on termites or CECT.
This site will help homeowners learn how to protect their homes from termites, the website termites101.org is designed to enable homeowners to understand and have a better partner with a termite provider to identify, prevent, treat and control termites. Visitors can also access practical tips on how to deter termites as well as download a consumer brochure with key information from the site.
Homeowners can e-mail questions to a termite expert and submit comments to the sites termite talk block as well. CECT is made up of a group leading scientific and academic exports on termites in the United States, including university experts from including university experts from Purdue, Texas A&M University, University of Georgia and Virginia Tech.
Another initiative that we are pleased to be part of is Orkin’s campaign to Fight the Bite by encouraging consumers to wage war on this disease-carrying mosquito. This is the program that engages both our employees as well as customers.
On an international basis Rollins and it affiliates are pledged to donate a minimum of $100,000 to the United Nation's 'Nothing But Nets Campaign,' a global, grassroots effort dedicated to savings lives by preventing Malaria in Africa. Nothing But Nets will use these funds to purchase and distribute at least 10,000 long-lasting, insecticide-treated mosquito bed nets in the areas of greatest need in Africa.
We will raise this money through a company NetDrive and a customer donation effort through contributions solicited through nets.orkin.com. I am sure one question on everybody’s mind is concerning the economy and how it might be affecting Rollins and Orkin.
We have often said that our business is recession resistant. The demand might slow somewhat but Rollins and Orkin haven’t been greatly impacted in past recessions.
A commercial segment has been performing extremely well, and we haven’t seen any pressure in that area. Keep it in mind that businesses must have pest control so we don’t expect to see any fall off in this area.
On the residential side past experience has shown that weather has more impact on demand than the economy. Historically, if demand softens, we have to hunt orders for new business and with over a 100 years of experience we know how to do that.
We look forward to reporting our second quarter results, but first that will include HomeTeam are pretty exited about our business prospects, our new acquisition and the plans that we have in place to carry us through the balance of the year. I will now turn the call over to Harry.
Harry Cynkus – Chief Financial Officer and Treasurer
Thank you, Gary. Today we reported first quarter revenues of 4.4%, we owe another round of thanks to our commercial sales team.
Revenues totaled $210.1 million compared to $201.2 million for the first quarter last year that income for the quarter is $13.8 million as compared to $12.8 million last year, an 8.2% improvement while our diluted earnings per shares this quarter is $0.14, 7.7% improvement over the split adjusted $0.13 reported last year in the first quarter. There is a lot of publicity turning the economy these days but as Gary said it has not impacted our commercial business.
Our commercial pest control, which has been a key repeated focus of ours, now represents 46% of our business. Excluding commercial fumigators, our commercial revenues grew 10.2%.
Our fumigation business was off 4.3% in the quarter, first by the weak dollar and as a result a decrease in food imports, which require fumigation. As a result in total commercial pest control were 9.3% with the continued maturation of our sales force, our average monthly sales where commercial account managers continued to increase and with their dedication to providing the best in class pest control service, our customer retention continues to improve.
We showed significant improvement in this quarter. Our residential pest control service representing almost 35% of the business grew 1.6%.
Fortunately, the long winter is now behind us and the spring albeit in some place is now on us. Three weeks doesn’t make a quarter, so with revival spring plus our other move and with our new ads running the phones are ringing once again.
It's early that we are seeing a very strong improvement in leads. I wish I could say all our service lines grew, the termite decreased slightly with 1.5%.
Termite control represents less than 18% of the business in the first quarter this year. This month, today again we are showing a healthy lead increase and are looking forward to a normal termite season.
As reported our gross margins improved by 60 basis points, this represented an improvement in gross margins of 47.5% versus 46.9% last year. The increase in margins is primarily due to continued improvements in the cost of risks related to our termite work.
Claims for the quarter was 30% less than a year ago and totaled $1.3 million. The expense claim experienced couple with favorable resolution of some termite litigation resulted in $1.5 million reduction in our insurance of claim costs.
Unfortunately with our higher cost to fuel, fleet cost increased $1.8 million in the quarter. Sales, general, administrative expenses during the first quarter ended March 31, increased 3.7 million by 5.5% to 33.7% of revenues from 33.3 for the first quarter last year.
Expenses increased greater than revenue due to nearly $1 million in expenses related to the acquisition of the HomeTeam. The company continues to generate superior cash flows.
Cash and cash equivalents at quarter-end stood at 71.3 million with practically no debt. It was nice cash in hand when we did that was a HomeTeam acquisition we found a great opportunity that put that money to work and earn far better returns for our shareholders.
So, what has been a most difficult credit market for many, we were able to quickly reach agreement with our banks on very favorable terms with our strong balance sheet and the businesses stable, recurring revenue stream and resulting cash flow, our banks were more than willing to put together a $175 million credit facility but what we feel is that the attractive borrowing costs, LIBOR plus 50 basis points to help finance the acquisition of HomeTeam. Thinking of HomeTeam, let me give you some further detail on their business.
The HomeTeam business in many regards is not unlike the traditional pest control company. It has a very strong recurring revenue base.
Over 50% of their revenue comes from traditional sources with the balance developed through the new homebuilder channel. In total, approximately 70% of their revenue is pest control, primarily residential, with maybe 5% being commercial.
Of the total pest control business, 40% is conventional pest control service, very similar to Orkin’s business, though their primary service offering is quarterly, while Orkin's is every other month. The other 60% of the pest control business is from customers who have had the KX systems in the pest defense system.
Traditional to my work, i.e., renewals, completions, big voluntary et cetera, accounts are about another 20% of their revenue. The balance of the revenue last year 10% came from builders representing the installation of tubes and termite-free treatment.
We do not feel the current new housing marketing conditions prevent the opportunity to grow this business. There are many opportunities outside their current model.
For example, we have the opportunity to offer additional services to their existing customer base i.e. mosquito control.
In addition, we can expand their business into new market at substantially less cost they may can previously, as we already have an established national network of service locations. While our expectations that the HomeTeam business should grow mid single digits over the next 12 months but they appear slow based on their last few years result.
It is respectable to the current market condition. We firmly believe that pest control business owned and co-managed by the world’s best pest control company are far more than a pest control owned and managed by homebuilder even our first five’s one such as Centex.
There are many opportunities for improving their margins, but no the least will be our materials supplied buying power. To minimize any disruption in the transition to get the HomeTeam employees enthusiastically onboard and focus on the upcoming season, Glen Rollins, President of Orkin and Bob Wanzer, President for HomeTeam along with our Top HR people from both Rollins and HomeTeam are wrapping up a four-week Rollin tour having visited all 13 states in which HomeTeam operates and personally meeting with all HomeTeam employees.
From a profitability standpoint, HomeTeam had an EBIDTA of approximately $9 million over the trailing 12 months. But most acquisitions in the pest control business, there were little tangible assets acquired.
In fact, goodwill will total approximately $145 million and exceed the $137 million in the cash purchase consideration. This occurs as the liabilities assume exceed tangible assets.
As a result of the goodwill valuation, approximately $84 million will be assigned to identify intangible assets with definite lives ranging from 8 to 20 year. As a result, we will record a non-cash charge of almost $8 million a year in amortization.
This coupled with interest expense on the debt we incurred will minimize any accretion to EPS in the first year. In closing, we have an abundance of opportunities not only with the HomeTeam with our existing business as well.
We look forward to reporting our results as the year continues. And, I will now turn the call back over to Gary
Gary Rollins - President and Chief Executive Officer
Thank you, Harry. We are now ready to open the call for any questions that you might have.
Operator
Thank you. (Operator Instructions).
And, our first question from the line of Jim Famalette with Sidoti & Company. Please go ahead.
Jim Famalette
Hi, Gary. Harry, good morning.
Gary Rollins
Good morning.
Harry Cynkus
Good morning
Jim Famalette
Gary, one thing about --about HomeTeam their business model that I’m a little unclear about in and I really you know as a part of a large organization so this, limited historical numbers out there for us, but, did this HomeTeam technician actually have to be onsite when the tubes are essentially built into a home or they just sell the tubes themselves?
Gary Rollins
No, they actually install the tubes.
Jim Famalette
Okay. Okay, so, I’m looking at just their EBITDA margin based on the last 12 months, looks like it’s cut it was been half of what Rollins is, when times are challenging in a home building market as they are now, is there infrastructure in place at HomeTeam that the company just got it has to absorb until time is get better and I guess it’s kind of a follow up question so there will be two parts would be, where margins better in say 2005 and early 2006 in this business and would you expect that when conditions improve I mean is there a fair amount of margin upside in this business?
Gary Rollins
We have to answer a lot of questions.
Jim Famalette
I’m sorry, I apologize. You don’t worry, I’m going with this.
Gary Rollins
If there are, as margin now opportunities, you know, we think that we have knowledge, that we can share, that we’ve gained and wrapped the pest control business, these are good people, they are good operators, but, we think that we can bring some things that to the party to help, show them some things that they may not be aware of-- to get back into the kind of the margin movement and how things were two years ago versus you know this past year. Their margins have continued to improve.
This business till some extent is kind of like to burglar alarm business or the cable television business. When you are adding a lot of homes, it’s really more costly than when you are not adding a lot of homes.
Jim Famalette
Okay.
Gary Rollins
You have the benefit of the recurring revenue base which you don’t have the installation recruitment et cetera. So, to some extent as a kind of good news bad news, the bad news is that the housing industries are, but the good news is that the housing industry is all -- because you don’t have this phenomenal investment that you are extending to install these units in these new homes.
So, we really think that as Harry mentioned that there is a lot of areas that we can improve the margins and one of the factors that I have mentioned a little earlier is half of the business is just the conventional pest control. And I guess a reasonable question would be, why is that so and that’s so is because they acquired pest control companies that have a base of operation when they went into these various cities.
So, they have a large number of customers that they don’t have anything to do with the tubes.
Jim Famalette
Okay. And presumably you know they operate in, I believe you said what was 13 states?
Gary Rollins
That’s right.
Jim Famalette
And you operate a lot more than that. So, that would also be an opportunity I would assume?
Gary Rollins
Well I think so and they really have to do it the hard way and I think Centex really made a major investment in this business by acquiring a large number of pest control operators and really dealing with the losses in the first years but there is many markets that we could go into that you know Orkin already in there you know we’ve got a facility now because we changed our marketing model through our call offices et cetera. We have space in a lot of our facility.
So, it may not require that they have to -- the first year go out and let a new facility. So, I think that there is a lot of synergies in that regard.
Jim Famalette
Okay.
Harry Cynkus
Gary Rollins
Okay, we don’t have all the answers, we don’t even know what are the questions are? We are going to learn, we have no real interest to turn this business upside down, these are great people they have done a terrific job, Bob Wanzar is a super operator and you know, we should try this like we did with Western and we are likely to do with PCL.
We are going to try to be helpful. I think our experience rather are in contacts with them, they are very open to ideas and suggestions, they have never really market it much to multiple unit apartments you know, this might be a great opportunity with some softness and single family homes to do some work as far as these apartments are concerned, so we think that there is a lot of great opportunities.
Jim Famalette
Okay. And Harry just last follow up question, I don’t know if I got the exact number, but your non-cash intangible amortization charge for the first quarter was wide and either millions are in per share basis.
Harry Cynkus
For Rollins in the Q1 it was 3.3 million.
Jim Famalette
Okay.
Harry Cynkus
The annual run rate when you combine what HomeTeam would be close to 8 million and Rollins had a little over 13; will be nearly $42 million in non-cash charges.
Jim Famalette
Okay. Very good.
Harry Cynkus
Thank you very much.
Gary Rollins
Thank you, James.
Operator
(Operator Instruction). Our next question is from the line of Clint Fendley with Davenport.
Please go ahead.
Clint Fendley
Hi, gentlemen. This is Jerry for Clint this morning.
Just a question on the SG&A, obviously it was impacted this quarter by the acquisition, I don’t know how she think about further impacts going forward turn the acquisition and in addition it looks like HomeTeam had the significantly higher issues and higher amount of SG&A expense as only with the time frame. Your thoughts in that time frame and cutting that down to be more loyal in the Rollins core business?
Gary Rollins
Well as -- as we mentioned they have a different sales model in terms of Q1 in SG&A, we incurred around $1 million in cost related to that acquisition, this is you know the counts for lawyer’s environmental, consultants and what not, they are still a little to come in Q2, we tried to capture much what we do in Q1, the price there’ll be some additional transaction cost in Q2, but I suspect it should be less than $400,000. In terms of there SG&A, organic and with the different sales model and that’s one thing, you know, we will look at in brain storm with them.
You know, and I really don’t have at this point have any forward-looking estimate and what we can do in that area and we will share more with you when we learn what opportunities that might be there.
Harry Cynkus
I think we do have some upside though in that to the extent that - in the last few years, we made major investments in our commercial sales organization and any time you build sales organization you got a pretty significant cost burden until these people with successful and be productive, so we do have some opportunities as I mentioned our sales force, you know, is selling higher average sales per salesman and they are maturing and so, you know, we do have some potential as far as the sales that are - the sales margin, expense margin related to our commercial sales organization.
Clint Fendley
Hi, that’s helpful, thank you and just one another question on fuel within a huge factor, I guess this quarter is out what are your thoughts going forward, it is a past re-provisions or is there any kind of controls in place as you priced this share and that is going down any time?
Gary Rollins
y
Gary Rollins
One of the good things I guess about our company is that our people as you know when we kind of come up with an adverse situation, we try to find a way to offset it and there will be a lot more motivation to proper routing, there will be a lot more attention given to parking the vehicles where we have facilities that allow parking the vehicles. As Harry mentioned, we will be looking at after our use of the vehicles, you know, we have a kind of wake-up call like gas selling for $3.50 and I guess $4 on the west coast, it just makes me start looking at areas that you can help offset that kind of an increase.
Clint Fendley
Alright, thank you very much gentlemen.
Gary Rollins
Thank you.
Operator
Alright, thank you. Our next question is from the line [Sam Lau] with [Asset Value Investors].
Please go ahead.
Samuel Wayne
Hello. It's Sam Lau.
Thank you for taking the call or question. I wanted to ask you, I guess couple of just nuts and bolts type thing and then I also wanted to ask about the just if you could elaborate on why your claims that I guess experience is lower in the first quarter and a little more detail and after that I want to ask you, the amortization of intangibles from HomeTeam acquisition, are those deductible for taxes, income taxes as well?
And then the actual share count on March 31st toward the end of the quarter?
Gary Rollins
Okay. The write off for tax purposes is actually even greater than it is in the books, the full amount allocated for goodwill would be written off over 15 years for tax purpose.
We do have a book tax difference there.
Samuel Wayne
What’s the amount in your one then for example?
Gary Rollins
For book or for tax?
Samuel Wayne
For tax?
Gary Rollins
For tax, I guess that I don’t have a calculator, but the final goodwill is $145 million and you get it over 15 years, it’s about $9.6 million in tax deduction on per month basis.
Samuel Wayne
Gary Rollins
Yeah, I don’t believe you -- you get any bonus or salary, it’s a pretty…
Samuel Wayne
Okay.
Gary Rollins
I will verify my tax form, I’m pretty sure it’s 115.
Samuel Wayne
Alright.
Gary Rollins
Share count on the press release...
Samuel Wayne
Okay, on your press release you gave the average equivalent shares outstanding?
Gary Rollins
Okay. It should be right around that $103 million on the --
Samuel Wayne
I was hoping for.
Gary Rollins
103 million shares.
Samuel Wayne
I will look for more exact count, but the best we think wait for this. Thank you.
Gary Rollins
Yeah, I don’t have it in front.
Samuel Wayne
Okay.
Harry Cynkus
I can address, you know, your question about termite claims, you know simply we are, I guess reaping the benefits of the investments that we have made over the last several years as early as the late 90’s where we changed the treating requirements, changed from either sides that we used, changed our claims processing procedures where we really get an early reporting of the current potential termite claims much like you will do on workmen’s comp claim. So, we have really reengineered our termite business and fortunately we are starting to see and just like I guess anything that involves a large face with a tail which has taken several years to which has really started seeing the benefits of these changes that we have made back in the late 90s.
Samuel Wayne
Okay. Alright, thank you.
Gary Rollins
Thank you.
Operator
There are no further questions at this time. Mr.
Rollins, please continue with any closing comments.
Gary Rollins
Okay. Well, we appreciate your attendance and in your interest in our company and we look forward to meeting with you again next quarter where we can share results.
Thank you.
Operator
Thank you. Ladies and gentlemen, this does conclude the Rollins first quarter conference call.
If you would like to listen to a replay of today’s conference in its entirety, you can do by dialing 1-800-405-2236 or 303-590-3000, enter the access code 11112420. Those numbers again, 1-800-405-2236 or 303-590-3000 and put the access code 11112420.
We would like to thank you very much for your participation, you may now disconnect. Have a very pleasant rest of your day.