Jul 23, 2014
Executives
Marilynn Meek – IR Gary Rollins – Vice Chairman and CEO Harry Cynkus – SVP, CFO and Treasurer
Analysts
Jamie Clement – Sidoti Sean Egan – KeyBanc Capital Markets Dan Dolev – Jefferies
Operator
Good morning and welcome to the Rollins Incorporated Second Quarter Earnings Conference Call. Please note, today’s conference is being recorded.
At this time, all participants are in a listen-only mode. Later we will be conducting a question-and-answer session and instructions will be given at that time.
(Operator Instructions) I would now like to introduce your host for today’s call, Marilynn Meek. Ms.Meek, you may begin.
Marilynn Meek
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 212-837-3746 and we will send you a 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 1-888-203-1112 with the passcode 9319923. Additionally, the call is being webcast at www.viavid.com and a replay will be available for 90 days.
On the line with me today is Gary Rollins, Vice Chairman and Chief Executive Officer; and Harry Cynkus, Senior Vice President, Chief Financial Officer and Treasurer. Management will make some opening remarks and then we’ll open up the line for your questions.
Gary, would you like to begin?
Gary Rollins
Yes. Thank you, Marilynn and good morning.
We appreciate all of you joining us on our second quarter 2014 conference call. Harry will read our forward-looking statement and the disclaimer and then we’ll begin.
Harry Cynkus
Our earnings release discusses our business outlook and contains certain forward-looking statements. These particular forward-looking statements and all other statements that have been made in this call, excluding historical facts are subject to a number of risks and uncertainties, and actual risks may differ materially from any statement we make today.
Please refer to today’s press release and our SEC filings, including the Risk Factors section of our Form 10-K for the year-ended December 31, 2013 for more information and the risk factors that could cause actual results to differ.
Gary Rollins
Thank you, Harry. We had another good quarter with revenue growing 5.3% to $369.4 million, compared to $315.8 million in the second quarter last year.
Net income increased 13.5% to $40.9 million with EPS of $0.28 per diluted share, compared to $36 million and $0.25 per diluted share for the second quarter of 2013. Revenues for the first six months rose 5% to $682.8 million, compared to $650.5 million for the same period of last year.
Net income grew 12.6% to $66.6 million or $0.46 per diluted share compared to net income of $59.2 million or $0.40 per diluted share for the same period, an increase of 15%. While we would like to hit higher revenue growth for the quarter, we’re pleased with a 45% follow through of profit before taxes from each dollar of revenue increased in the quarter and for the first half of this year.
We continue to see strong growth in our commercial pest control business with revenues up 8.1%, residential pest control sequential growth due to softer than expected customer demand came in at 3.9%. Our termite service line was up 4.2% which was helped by our Australian acquisition but there is no slowing down in our bed bug business which grew 18% over last year with revenues of over $14 million for the quarter.
We are continuing to see solid growth in residential demand which now represents almost 40% of this business, although commercial continues to grow as well. Year-to-date revenue six months for bed bugs is approximately $26 million.
As we continue to invest in initiatives to further grow our business it’s important that we keep our marketing expenditures in balance with seasonal demand. The challenge is to maintain a good lead acquisition cost in the pay search channels while continuing to refine our ability to identify and attract the most desired consumer base.
In this regard it’s encouraging that we’re growing our business organically as more consumers visit our website and are selecting our brands. We continue to build out the content of this valuable piece of real estate.
A little over a year ago we launched our Orkin’s pest control down to a science team as our national marketing campaign where we highlighted the Orkin man and his vast knowledge of pest. In addition to our television and radio advertising we have put great emphasis on supporting the campaign via our website at orkin.com.
This quarter we re-launched this site. It now has both a new look and provides a greater distinction between Orkin’s residential and commercial service offerings versus all the other competition.
There are key components on orkin.com that both educate consumers and demonstrate Orkin’s leading ability to handle all types of pest and control related problems. We continue to improve our site which now includes a new and improved pest library, customer expectation videos, and highlights of Orkin’s award winning training.
Our new pest library is more robust with actual pest photos into more illustrations and pest videos covering numerous topics including dangerous pest in your home, when to request a termite inspection and so forth. In mid April we launched three new customer expectation videos that show what customers can expect when their Orkin man or woman shows up to perform pest control services.
These have proven to be highly popular with our prospective customers. These residential and commercial videos highlight our ongoing progression of three critical practices that are conducted to give our customers the peace of mind that comes with year around pest protection, we call it A.I.M.
This acronym describes these activities that our technicians follow. First, our technicians assess the situation in a customer’s home or property to determine what the problems are.
Next, is to implement specific science driven solutions based on their findings. And finally, to monitor future pest activity and resolves to make sure our actions are working.
Our new website also accomplishes a better mobile experience and will be adjusting its content based on what device you’re viewing via tablets, Smartphone, or desktop PC. These new site improvements are contributing to improve lead conversion while supporting our overall national marketing campaign, and are good example of not being satisfied with the status quo.
We’ve also expanded our advertising reach this year to include value added opportunities. Recent research shows that our marketing folks at certain sports have a better chance of reaching our target audience.
So if you see an Orkin’s logo during a NHL play-off, PGA tournament or Major League Baseball game, your eyes weren’t playing tricks on you. This advertising is generating solely at the networks discretion, so you never know exactly when or where the advertisements will be shown.
But look for them to pop-up when you’re captivated by your favorite sport team. Result [ph] also looking at improving our ability to get to a different audience via YouTube, and this year we have created three different campaigns with a goal of gaining views and engagement and driving consumers to our website.
The viewership has been as good as we expected and while it’s still in the early stages in this newer channel, too quick for us to celebrate but overtime we look forward to affordable lead conversion as this new audience routinely comes to the site. This is another example of our quest to be better through innovative marketing approaches that helps distinguish ourselves from the smaller competition who don’t have the resources or expertise to pursue these opportunities.
Let me comment a little further on that point. As stated often, we are continuing to aggressively pursue strategic and complementary acquisitions.
In conversation with many smaller and medium sized companies vested, they are sharing if their world has changed so much that they either don’t have the knowledge, energy or resources to invest in building their brand via the new digital and social media world. Being the industry’s largest gives us many advantages in this regard, and we believe that this also will create a window of opportunity acquisition lies with these companies.
As mentioned previously, we established our own in-house analytics team last fall. And their data mining and number crunching is well underway.
We plan to test some of our findings in the fourth quarter with the expectation of developing marketing strategies that will help spur next year’s growth. As we began the year, we anticipated some slowdown with HomeTeam’s installs based on the new home construction outlook for 2014.
We’re pleased however that HomeTeam’s installs are up modestly and we’re seeing strong improvement in their profitability, which is up more than 40%. This is in part of result of the activation of our Tubes in the Wall Systems by new customers coupled with a restructuring of HomeTeam’s field operations.
Installs were up 3.7% in the quarter and 5.5% for the first half of the year. To bring up-to-date [ph] on our CRM branch administrative operating system as I mentioned in late January, we were doing testing in a number of different business environments.
However, we had two final hurdles that needed to be addressed before operations would give the go ahead to roll the system out to branches beyond the pilots. Number one of these obstacles was completing our daily, weekly, and monthly performance reports which will now be near a real-time updating data hourly and accessible to the branch managers PC, iPad or phone.
We’re pleased to report that that went live June 16. The other requirement was its functionality of the commercial handheld iPhone App had to be working properly.
That has been completed as well with over 150 users now with bait station scanning ability. We’re ready to start implementing our new system with a first tranche of non-pilot branches to roll out in August, September and October.
To give you an idea of the magnitude of the branch operating system development, since we originally deployed the software and testing in pilot branches in January 2013, we have made over 1200 additions, changes and deletions. It is probably not accurate to refer to the system as service week much longer because we’ve done so much customization.
In fact, we’ll be having an internal naming contest shortly to name our proprietary CRM system. By year end we expect to have the 50 branches online in addition to the 29 that we currently have, or almost 80 branches.
The full roll out of the system for Orkin will take 18 months with a bulk of branches occurring in 2015. Our other brands will follow afterwards.
As we’ve said in the past, once fully implemented we believe that this system will be a real game changer for our company. This quarter we are pleased to have three South American franchises to our roaster during the quarter.
All three will offer commercial and residential pest control and termite services. The first two companies are located in Brazil, and the third franchise is located in Paraguay.
All three will be carrying the mantle of the great Orkin brands. In closing, I’d like to reiterate our commitment to being the best pest control company in the world providing residential and commercial customers with extraordinary pest control service.
We’re focused on our initiatives to achieve this goal and remain enthusiastic about the numerous opportunities we have, both domestically and internationally. With that said, I’ll turn the call over to Harry who will walk you through the financials.
Harry Cynkus
Thank you, Gary. Good morning, and thank you for joining us on the call.
It’s good to have a normal conference call, no snowstorm, no burns [ph], just good numbers. For those here last quarter and are curious, my daughter delivered a healthy baby girl minutes following last quarter’s call, mother and Willa Rose are doing fine.
Second quarter revenues were $369.4 million, representing 5.3% revenue growth. We had growth across all service lines but not the sequential quarter-to-quarter growth that we prefer to see this time of the year, more about that in a minute.
However, as Gary pointed out, we did a good job in converting that incremental revenue to profit and cash. Net income increased 13.5% to $40.9 million or $0.28 per diluted share, compared to $36 million or $0.25 per diluted share for the same last year.
For the first six months of 2014 revenues rose 5% to $682.7 million, compared to $650.5 million last year. Net income for the first six months of 2014 was $66.6 million or $0.46 per diluted share, compared to the same period last year representing a 15% increase in diluted earnings per share year-to-date.
Net cash provided by operating activities is strong this year, increasing 23% to nearly $90 million. We ended the quarter with $101.5 million cash in the bank, and no debt.
Fundamentally our business remains solid. For the first time since 2008 we saw some softness in leads, partly because of the late spring and some uncertainty in consumer demand as the retail industry confirms.
As we move up to income band, intentionally with our rates, we attract less in the lower income category which you often don’t retain long enough to recover your acquisition and start-up costs. The results of this strategy can be seen in both of our continuing closure improvement, as well as better price realization.
Long-term, we should also see higher retention as well. The analytics work we are doing in this area should pay big dividends in the future.
Despite decrease in leads we saw increase in sales. Overall, we continue to see improved customer satisfaction and retention which are the key indicators of long-term health of our business.
Clearly, we are maintaining our positive momentum within the important drivers of our business. As Gary has said before, we are pleased, just never satisfied.
Last quarter we ran our annual price increase test which showed little change in the elasticity. Price increase eligibility is determined based on the tenure of the customer, variance in the customer’s price for the current rate card and contract terms.
In June, Orkin and some of our other brands implemented their traditional annual price increase program for eligible residential and commercial customers. HomeTeam’s price increase program rolled out July 1.
As Orkin’s was rolled out partially in the quarter, the impact on revenue for the quarter was minimal, probably in the four times to five times of a percent range, and will more favorably impact us in the third quarter. We are currently anticipating approximately $17 million to $19 million over the next 12 months from this pricing action.
Canada revenue was up better than 7% from the quarter before impact of currency. The weakness in the Canadian dollar continues to negatively impact our overall revenue improvement, reducing it approximately 1.5% this quarter.
So acquisitions more than offset it contributing better than 1.5% to our revenue. Let’s talk about the service lines that make up our business.
Our commercial pest control is the largest provider in North America, and our fastest growing service line representing nearly 41% of our revenue. Excluding fumigation commercial pest control grew 8.1% this quarter, 7.3% after taking into account fumigation which was up 5%.
Retention was excellent with some of the best numbers I ever recall. We are very pleased with this performance.
When I talk about our commercial business in the past I sometimes distinguish with and without fumigation. For those new to the company, the reason being – while the fumigation business is a small part of our overall business, less than 2.5%, and makes up less than 7% of our commercial pest control business, the revenue can fluctuate greatly from quarter-to-quarter.
Food manufacturing and processing fumigations are not often scheduled to occur at the same time from year-to-year. This fluctuation in the business can distort the quarter-to-quarter comparisons.
With joint portfolio [ph] in the third quarter and on a Friday it was an ideal weekend to schedule large plant fumigations, and as a result, we saw a number of customers delaying work until that particular weekend. From a fumigation portion of our commercial business clouds the view of our commercial business I’ll mention it, and when it doesn’t I won’t.
Our residential pest control business, the original cornerstone of our company represent approximately 40% of our business this quarter. This quarter we saw a 3.9% growth equal to the first quarter.
This service line is far more dependent on leads as the potential customer usually waits until they have a pest sighting, they pick up the phone or go to the computer and contact us. While we add it to our customer base sequentially, as well as over the second quarter last year, the softness in demand here certainly hurt us from being able to grow as expected.
Despite the late spring, retention was flat to last year while customer satisfaction improved. The last service line, termite, which represents 19% of our business in the quarter bounced back from last quarter’s growth rate to more respectable sounding 4.2%.
Excluding our Australian acquisition, termite grew 1.6% versus a decrease of 1.1% in the first quarter. This year we didn’t have a good swarm season, but fortunately termite is the smallest part of our business.
Remember only half of that 19% is new completions, with the balance being very profitable, recurring revenue from renewal payments. We strategically placed greater emphasis on pest control services back in 1998 due to the higher claim risk and lower growth potential in termite, and to concentrate on growing our commercial business.
For those waiting anxiously to learn about our bed bug business, it was up over 18% to $14.4 million for the quarter, with residential and commercial growing close to the same rate. Bed bugs provide a great opportunity for us to introduce our other services into accounts that have not considered regular pest control.
[Indiscernible] if I didn’t talk further about HomeTeam which has profit-wise outperformed even our lofty expectations so far this year. Install growth has moderated with 22,400 new installs made in the quarter, up 3.7% for the quarter and 5.5% year-to-date.
As a result of incremental margins from new customers, significantly better pricing on their termite pre-treat work, good expense control and cost taken out of their overhead structure, HomeTeam improved their profit contributions to the company better than 40% this quarter and year-to-date. Gross margin for the quarter increased 30 basis points to 50.6% for the second quarter versus 50.3% in the prior year due to primarily favorable termite and casualty claim experience, and good cost controls across most spending categories which more than offset a decrease in overall productivity as the company’s events [ph] of what turned out to be a very, very late spring.
Depreciation and amortization expense for the quarter increased 800,000, an increase of 8.6% increasing one-tenth of a percent to 2.9% of revenue. Depreciation increased $100,000 to $3.8 million and amortization of intangibles increased $700,000 to $6.9 million.
The increase in intangible amortization relates to the acquisitions made over the course of the last 12 months. For the full year amortization of intangibles typically from the value assigned to customer contracts gained in an acquisition will represent a significant after-tax non-cash charge of $0.12 this year.
Sales, general and administrative expenses for the second quarter increased $1 million or nine-tenths of a percent to 29.9% of revenues which is favorable from 31.2% for the second quarter last year. The decrease in margin percent is due to reductions made in administrative salaries, reflecting realignment of some of our operations, and cost containment programs initiated at the corporate offices late last year, along with reductions in bad debt expense.
Last year addition expenses were incurred which did not reoccur to our professional services related to our commercial pricing project, and last year’s incremental spend for the new advertising campaign. Tax rate for the quarter came in at 37.8% for the quarter, no breaks this quarter and no corporate tax reform on the horizon.
Yesterday the company declared it’s regularly quarterly cash dividend of $0.105 per shares, earlier this month we announced that the company repurchased a 192,583,000 shares. In total, 4.7 million additional shares may be purchased under the shares repurchase program.
We continue to operate from a solid foundation. We have confidence in our fundaments, the company is performing well, the balance sheet is strong.
As always, our first priority for our remarkable cash generation capabilities remains investing in what we know best, pest control and only pest control. We look forward to announcing our next acquisition shortly.
With the year half over, we are well positioned for a great 2014. I look forward to talking to you next quarter.
Let me express our continuing appreciation to all the Rollins associates whose hard work is behind our outstanding results. We likewise are most appreciative of our customers who make everything we do possible.
Thank you for your time and interest. And with that, I now turn the call back over to Gary.
Gary Rollins
Thank you, Harry. We’re now ready to open the call for any questions that you might have.
Operator
(Operator Instructions) We’ll take our first question from Jamie Clement with Sidoti.
Jamie Clement – Sidoti
Gary, Harry, good morning.
Gary Rollins
Good morning.
Harry Cynkus
Good morning.
Jamie Clement – Sidoti
Gary, I have to ask you a question, this is the highest revenue operating income, net income, and EPS quarter you all have ever reported, I sensed however, a slight bit of disappointment in your voice on a couple of things. And – that’s a little unusual, I’m listening to these calls for a while…
Gary Rollins
I need to practice more, that’s the case.
Jamie Clement – Sidoti
Yes, and I was just wondering if it sounds like the lead generation situation was obviously – mother nature obviously has an impact on that and obviously, the marketing strategy.
Gary Rollins
Mostly you get up for our season and just kind of – like retail, the Christmas season, and we were disappointed that the demand was not more robust, our branch marketing with suppliers and competitors confirmed that this was a real phenomenon, it wasn’t a result of our advertising not working. And we have a couple of ways, if we check our advertising, one is kind of what I call the generic search on the web, how many people search for roaches or ants or termites, and so we kind of compare this year versus last year.
And we have other ways that we look at – testing as far as I have mentioned, our suppliers, and our competitors. So – we’re satisfied that this wasn’t a Rollins thing, this was an industry situation.
But as Harry said, we did a great job converting, I think that speaks loudly to the programs that we’ve initiated in the past couple of years and we were fortunate that it all came together and the results from our earnings point of view were very good.
Jamie Clement – Sidoti
Yes, absolutely. And that’s why I asked the question because on the surface – and obviously, the months of April and May were not particularly warm by recent historical standards, so I just wanted to make sure I wasn’t missing something here.
And obviously, I know you are your own harshest critics.
Gary Rollins
Yes. I need to work harder because I was – and the Board was pleased.
So my bosses are pleased, they are generally Harry and I are pleased but…
Jamie Clement – Sidoti
Okay, alright, very good. Thank you very much for your time.
Gary Rollins
Okay.
Harry Cynkus
Thank you, Jamie.
Operator
And we’ll take our next question from Sean Egan with KeyBanc Capital Markets.
Sean Egan – KeyBanc Capital Markets
Hey, good morning gentlemen.
Gary Rollins
Good morning.
Harry Cynkus
Good morning.
Sean Egan – KeyBanc Capital Markets
I just had a quick question on your affix to shift your customer mix to a higher income demographic. Can you please help us explain any potential impacts that might have on the P&L, possibly a higher margin through higher average ticket realized, are there any offsets to that such as fewer customers?
Can you just kind of walk us through any of those potential impacts?
Gary Rollins
Yes, certainly. Everyone gets their fair share of some of these leads.
We priced – we’re proud of our pricing. And so – if you mismatch premium pricing with customers who aren’t willing to pay the price, we see it often in retention, and the customers might only take two or three services and be gone in three or four months as opposed to a year.
Your customer acquisition costs, you’re not going to recover the additional cost and time put in until the initial services. It just makes for a unprofitable customer for you.
So what we want to do is, make sure we are appealing to the customers who value the service will stay longer. If you’re successful with the strategy and we certainly saw it in the first quarter because while our leads were down our total sales were up.
And what you do is, you spend more time on the phone with customers who will be appealing to you and appreciate your service, so you’ll get higher closure percent and better price realization. In both of those we saw, our leads were down, our total sales were up, so the strategy is working.
I think we’ll see in six months to a year we should see better retention because we will be bringing less of the customers who turnover more rapidly through the – into the mix. It’s just – you have a limited amount of marketing dollars and we are through the data analytics that work that we’re doing, we’re getting a lot smarter in spending the money in the right channels, appealing to the right customers.
So we’re kind of happy that that has worked out.
Harry Cynkus
Let me just add one thing to that. Most of our pest control technicians, further pay is based on productivity.
And when you give them a better mix of customers at higher rates, basically they get a raise and when you have customers churning, it’s very disruptive as far as you’re arriving in a scheduling. So, as you stabilize the customers you’ve got a better priced customer, everybody wins.
And I think to Gary’s point about retention, I mean, I think he would expect the retention to improve, and I think that’s basically what we saw this past quarter.
Sean Egan – KeyBanc Capital Markets
Great, thank you. And then just one more, is there any update that you can give us on how Australia is going.
Is it ramping better than expected in line? Any color on that would be appreciated.
Gary Rollins
We’re obviously – Australia, it’s a long-term play for us. We’ve done – we’ve closed now on two acquisitions in Australia.
The first one out of the cage is performing below our expectations, some of the contracts are in the hopper [ph] haven’t come on board as fast as we had hoped or projected. So, that’s been a little disappointing but we’ve got a great team there, great prospects, and we’re really excited about them long-term.
The second acquisition we closed on Statewide has come out of the gates as game busters, I think their revenues are running 13%, 15% of the big ran this time a year ago. So we’re excited with the team we’re building down there, we’re continuing to evaluate other opportunities.
And we think Australia be a great market long-term.
Sean Egan – KeyBanc Capital Markets
Great, thanks a lot. That’s all for me.
Operator
Thank you. (Operator Instructions).
We’ll take our next question from Dan Dolev with Jefferies.
Dan Dolev – Jefferies
Hey Harry and Gary, good morning.
Gary Rollins
Good morning, Dan.
Dan Dolev – Jefferies
Thanks for taking my question. There has been some changes recently in the market, what are you seeing, let’s say in the last three months in terms of the competitive landscape, especially vis-à-vis your largest competitor, both on the commercial and residential side.
Harry Cynkus
I don’t know if we really are seeing any particular difference in the marketplace. I think in ServiceMaster, Terminix, Rentokil, with their brands, Stereotek [ph], Ecolab; we’ve been competing head-to-head with them for a number of years and really I don’t – our sales team hasn’t reported anything particularly different.
I think the one thing we’ve seen maybe a little different – I think that maybe a little more competition on the acquisition side, some of the prices that are being paid for some of the deals, I scratched my head and questioned how they are modeling to get reasonable returns on the investment but I sorted that. Harry, you’ve got any more to talk?
Gary Rollins
Well, the only thing I would comment is – I think ServiceMaster and Terminix is reorganization certainly. We had to create a little bit of distraction and we didn’t have that but as Harry said we certainly benchmark and we do research but we’re really not seeing any phenomenon out there in the marketplace that somebody has got a silver bullet or has come up with something really unique that’s going to change our market share.
Dan Dolev – Jefferies
Got it, that’s very helpful. And then one last question, Harry, you mentioned that you’re looking something like – we’re looking for to the next acquisition soon, is there something eminent or was that more of an aspirational comment?
Harry Cynkus
They are always aspirational until signature is on the paper.
Gary Rollins
Yes, they have a place for people that speculate or the deal they call it jail.
Dan Dolev – Jefferies
Oh, we don’t want to be there. Alright, thank you very much.
Gary Rollins
Thank you.
Operator
(Operator Instructions) At this time there are no further questions. I would like to turn the conference back over to our speakers for any additional or closing remarks.
Gary Rollins
Well, we’d like to thank you for joining us today. We’re certainly flattered by your interest and support and we look forward to the next quarter.
And we’ll be working hard to improve our business. So, thank you again.
Operator
And as a reminder, the replay for this call, which will begin two hours after this call concludes will run for one week. The replay can be heard by dialing 1-888-203-1112 with the passcode of 9319923.
Again, that phone number is 1-888-203-1112 and the passcode is 9319923. This will conclude today’s conference.
We appreciate your participation.