Oct 29, 2014
Executives
Marilynn Meek – IR Harry Cynkus – SVP, CFO and Treasurer Gary Rollins – Vice Chairman and CEO
Analysts
Jamie Clement – Macquarie Dan Dolev – Jefferies
Operator
Good day and welcome to the Rollins Incorporated Third Quarter 2014 Earnings Conference Call. Today’s conference is being recorded.
At this time, I’d like to turn the conference over to Marilynn Meek. Please go ahead.
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 212-827-3746 and we will send you a copy and make sure that 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 5152310. 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 for our third 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 on 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, indicating 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’re very pleased to have reported our strongest quarter for the year with revenues growing 6.3% to $384.9 million compared to $362.2 million in last year’s third quarter.
Our net income increased 13.6% to $41.1 million with EPS of $0.28 compared to $36.2 million or $0.25 per diluted share for the third quarter of 2013. Revenues for the first nine months rose 5.4% to $1.067 million.
Net income grew 13% to $107.7 million or $0.74 per share compared to net income of $95.4 million or $0.65 per diluted share for the same period last year. We’re also pleased to have achieved a 35% flow through of profit before taxes from each dollar of revenue increased in the quarter.
This was off a little bit from the 41% flow through year-to-date, but with greater growth comes more related upfront cost. We saw a good growth in our commercial pest control business with revenues up 7%.
Residential pest control was up 4.9%. While our termite service line was up 8.2% which for the quarter includes contributions from our recent acquisitions – Allpest, Statewide and PermaTreat.
With this being our last call in 2014 and our year is about over, I thought I’d take a moment and bring you up-to-date on the feel of the new initiatives we’re working that will contributing in 2015. As you may recall approximately a year ago, we established our own in-house analytics team to help us gain greater insight in the customer preferences and to enable us to better formulate our marketing plans and priorities.
We felt that this capability was needed to take our company to the next level. Through this group’s efforts, we now have a better understanding of our customer base, their behaviors as well as a greater understanding of our specific business segments.
Going forward, we will have more and better data, so more of our decisions can be based on facts versus supposition. As you would expect, this will be an ongoing effort and as we do further testing, substantiating our findings to develop and implement our 2015 marketing initiatives and plans.
Historically, one of the strengths of our company has been our marketing efforts. As a result of this new research, our marketing team will be raising the bar next year to drive more business to our brands.
We believe that this more sophisticated approach to our marketing will be more cost effective and enable us to meet our goal of stronger single digit revenue growth with double digit profit improvement. The digital world just keeps expanding.
Not only are there more devices emerging, but there seems to be a growing trend among TV viewers to cut the proverbial cord either entirely or partially. This was highlighted in the last couple of weeks with HBO announcing their intent to beginning screening content in 2015 which was followed by some more announcement from network giant, CBS.
As you may recall our company embraced digital early on and it was currently becoming an even more significant medium to connect with today’s consumers. We believe that there are growing opportunities to various digital touch points including streaming unique video and display.
We will be expanding our presence and spend in this area in the New Year. At the same time, we will continue to leverage our knowledge and conventional blogcast media channels to efficiently drive awareness and reference to the Orkin brand among current users and future prospects.
Our PR folks will also be raising the bar on plans to more economically build consideration for our brands in the media both nationally and locally in the large communities where we do business. This will be complemented to our use of social media including hosted blogs and live Twitters.
At the same time, we will reinforce our scientific pest control team and brand positioning through our valuable partnerships which includes our work with the CDC and our affiliation with over 20 leading zoos and aquariums throughout the United States. And let’s not overlook the old work in Insect Zoo at the Smithsonian.
If you’re in the Washington area, you might want to drop by and see their tarantulas. We value our customers highly and want their experience with us to be rewarding from the first consideration of our services to purchase and our service delivery.
We will continue to drive communications with customers through various touch points including personal emails and a e-newsletter that is currently distributed to many of our customers. These touch points will help us build and maintain customer loyalty which is critical to all important customer retention.
Speaking of retention, our analytics team that I mentioned earlier has also identified many drivers to help improve customer retention which we will be market testing in the New Year. Rollins is a naturally recognized leader in employee training as attested by our having been named one of the top training companies in America over the past 12 years.
We’re also a leader in using technology to advance our training efforts. Our new commercial sales training curriculum is one example of how the Rollins learning center is making our training better by partnering more consistently with our field.
I know it sounds like a no brainer, but today we’re soliciting more feedback from our frontline employees. Our training employees specialists are working closer with teams or division representatives from a variety of positions to identify what aspects with existing training were effective and what needs to be improved.
As an example, teams have tailored our customers sales training to better complement our newly introduced technology of proprietary iPad BizSuite application. Our dedication to succession planning across all divisions and levels at Rollins continues to serve us well as we identify our management talent needed to meet our long-term growth objectives.
As an example, recently, we realigned our regions within the Atlantic and Southeast divisions improve our span of control and to achieve other operational efficiencies. We’re able to accomplish this in part by drawing from our bench strength of talent identified through our annual employee ranking and performance tracking software.
As a result, Pat Chrzanowski was promoted Vice President of our newly established Northeast Division. Pat joined Orkin’s Atlantic Division in 2007 and has worked his way up to our company through his successful accomplishments and numerously field assignments.
At the same time, Freeman Elliott who has led the Atlantic Division since 2010 was recognized to oversee the important Southeast Division which now includes North Carolina and Tennessee. We’re enthusiastic about both of these assignments and have high expectations for accelerating our growth and management improvements for both of these divisions under Pat and Freeman’s leadership.
We’re continuing to advance our investments to improve risk management for our company and our employee’s welfare. To that end, we recently brought on a new Director of Safety and Health, Christopher Moss [ph] who will be responsible for developing, implementing and expanding Rollins’ safety and health programs.
Chris has already started work on what he calls humanizing safety and has been out in the field interacting with employees across the country gaining their insights. It is our intent for safety to come naturally to everyone with a daily goal that everyone does their job safely.
Before handing the call over to Harry, I just wanted to provide an update on a couple of subjects that you may have been wondering about. First of all, HomeTeam, there have been several conflicting and confusing dichotomies in recent weeks concerning the status of the home construction industry.
September 17th news release noted that builder confidence in the market for newly built single family homes rose for a fourth consecutive month to a level of 59 on the National Association of Home Builders, Wells Fargo Housing Market Index. But this index brings at the highest level since November 2005, any number above 50 is considered to indicate that more builders view condition is good than poor.
But some 24 hours later, the U.S. Commerce Department reported construction starts on new U.S.
homes tumbled over 14% in August, pulling back after a surge in July, signaling some shakiness in the housing market recovery. So confidence is up and further government start is down.
Acquisition is that we can’t change the reports but we can improve our execution and operating margins. And that’s what we’re working on.
We have great confidence in HomeTeam, its people and their ongoing contributions to our company’s overall growth as the housing market further stabilizes. For the third quarter, we experienced a modest 4.3% growth in installs in line with our expectations and anticipate this type of growth in October.
We’re pleased that leading builders also have a great confidence in partnering with HomeTeam. As an example, for the fourth consecutive year, HomeTeam earned the nationally acclaimed Partners of Choice Award given by David Weekley Homes for outstanding supplier performance.
HomeTeam is the only pest management company to ever receive this well-respective industry award and one of eight companies from approximately 200 suppliers to earn an A in service quality. Bill Justus from David Weekley said it best, earning an award is difficult and what HomeTeam has accomplished winning for four consecutive years is a truly outstanding achievement.
Most of you are aware of our acquisition of PermaTreat which was finalize on August 1st. However, I wanted to take this opportunity to welcome this fine team to our business family.
They’re a great cost refit for us and helps extend our presence in Northern Virginia. Second, just a quick update on where we are with our CRM branch at administrative operating system.
We began the rollout of our first charge of non-pilot branches in August and remain on target with this year’s plan. What was most encouraging about the first non-beta conversion was how smoothly it went.
Nothing ever goes perfect, but the number of whoopses [ph] were small and very manageable. Three branches are certainly not a scientific representative sample, but like I said, it was very encouraging.
A lot of time and effort has gone into these first plants conversions. And I’d like to thank our team who made it possible while minimizing the pain at the branches.
We’re proceeding with a net rollout converting an additional 13 branches. In closing, we are pleased with the progress that we’re continuing to make in advancing our initiatives to be the best service company in the world.
For us, this is a journey, not a destination. We are privileged to have a team of employees who are creative, innovative and enthusiastically seizing the opportunities available to our company both today and for the future.
I’ll now turn the call over to Harry who will walk you through our financials. Harry?
Harry Cynkus
Thanks, Garry. Good morning and thank you for joining us on the call.
What is it about October? Last year, the financial headlines were all about the aftermath of the U.S.
Government shutdown, the next looming death sealing breach and what the potential Fed tapering will do to business. This October, it’s all about global growth scares, slowdown in tech, cheap foreign imports, et cetera, et cetera.
A lot of headlines. There’s something reassuring about being a pest control company.
These type of events just don’t impact our business. Pest control is a recession resistant, but not recession dependent business representing a non-discretionary purchase for commercial in most consumers.
But that’s not to say we don’t ever have to work hard to produce our results. As we experienced last quarter, we saw continued softness in leads through July.
August saw the fourth year-over-year improvement, slight, but a gain nonetheless. Then came September.
I always said that spring will come and things will pick up. I just didn’t expect to see it in September, neither did Gary.
It’s hard to put an explanation of what has proven to be the best September sales month on record by far. Good weather, but not phenomenal, no particularly good economic signals, if anything the newspapers had negative headlines most of the month, no change in our marketing strategy, but the phones rang off the hook.
And our sales associates executed. I’m happy to report that it looks like the positive trend is continuing into October.
Last quarter, I said the last time I saw significant slowdown in leads was in 2008 and it appeared that consumers deferred making that pest control call for help for a year. This time, it appears they only deferred it until the fall.
Third quarter revenues were $384.9 million, representing 6.3% revenue growth. We saw a continued sequential growth across all of our brands.
Net income increased 13.6% to $41.1 million or $0.28 per diluted share, compared to $36.2 million or $0.25 per diluted share for the same period in 2014. Year-to-date revenue is $1.067 million, a 5.4% increase.
While net income has increased 13% to $102.8 million. EBITDA totals $205.1 million while EPS has increased 14% to $0.74 per diluted share.
We see good momentum with lead growth returning and no significant negative changes in the other fundamentals that support our business – closure, pricing, customer and employee retention, all working together to achieve that we have for the first nine months as well as for the remainder of the year. Let’s get deeper into the results.
This quarter we have seen 6.3% revenue growth among all brands and all service lines. We saw a good growth in our commercial pest control business with revenues up 7%.
Residential pest control was up 4.9% while our termite service line was up 8.2% favorably impacted by our acquisitions. Allpest, Statewide and PermaTreat acquisitions accounted for approximately 2% of our overall growth.
Our Canadian operations represents better than 7% of our company revenues, had good organic growth. However, the weakening currency impacted our growth this quarter costing us four tenths of 1%.
Let’s look at the service lines that make up our business starting with residential pest control. Residential sales are driven by inbound activity, phone calls and web leads.
The strong finish in September made it the strongest quarter of the year for residential increasing 4.9%, 4.3% excluding acquisitions. This service line represents 42% of our revenues this quarter.
Commercial pest control which makes up 41% of our business was up 7%, 4.6% excluding acquisitions. With the commercial business, you receive less than one tenth as many commercial leads as you do residential.
So for them, it’s all about being creative, knocking on doors and making proposals. The impact of the currency exchange was reflected almost exclusively in our commercial business as most of Canada’s business is commercial.
Domestically, commercial is up 5.4%. Lastly, our termite business which makes up 16% of our business this quarter enjoyed growth of 8.2% in the third quarter which is strong.
The acquisitions played a big part of it. But even excluding them, 3.7% growth for this service was our best quarter so far this year.
Last year, we talked about our proprietary sales to HomeSuite, an iPad application in the hands of our sales inspectors. This tool has been successful in helping improve closure as well as enabling us to sell additional auxiliary products.
Lastly, when it comes to revenue, we can’t leave out our favorite, bed bugs. While they don’t make the headlines they used to, it continues to be our fastest growing business line having achieved its first $20 million quarter since we began tracking this business in 2009 when we did $24 million in revenue for the entire year.
For the quarter, bed bug revenue grew 17.8% to $20.5 million. Interestingly, if you’d look at our bed bug business alone, it would rank among the top 12 pest control companies in the United States.
Needless to say, we’re proud that we have been able to successfully build this business and provide our customers with the most needed service. Year-to-date, revenues for bed bugs are approximately $46.5 million and will easily exceed $60 million this year.
Gross margin increased to 50.9% for the third quarter versus 50% in the prior year. This is due to primarily favorable termite and casualty claim development, improvement in service salaries.
We’re seeing productivity improvement for the first time this year as well as good cost management across most spending categories. Depreciation and amortization expense for the quarter increased $1.4 million totaling $11.4 million.
Depreciation is almost $4.2 million and amortization of intangibles was $7.2 million. We expense all cost as incurred in organically growing our business.
However, we are required today of the customer contracts and other intangibles required in acquisitions. And as a result, as of September 30th, we have $150 million in customer contracts and other intangible assets on our balance sheet.
Amortization of these costs will remain a significant non-cash charge to the P&L for some time. This year, it will represent a $0.12 charge to earnings.
While we’re on the subject of non-cash charges running through a P&L, we have nearly $8 million year-to-date in stock based compensation which will represent $0.04 charge to earnings as well this year. Capital expenditures are running $22.7 million year-to-date which is unusually high for us from a historical perspective, but further testament confirming that although we are not a capital intensive business, we will invest when the opportunity justifies it.
The primary driver in the higher than normal capital spend rate was the decision to do a very robust PC refresh ahead of our branch operating system rollout. Sales, general, administrative expenses increased $5.7 million or 5% to 30.8% of revenues decreasing from 31.2% for the third quarter ended 9-30.
The decreases in cost as percent of revenues were the result of us being able to make reductions in administrative salaries reflecting realignment at some of our operations and cost containment programs initiated to corporate office late last year. Last year, additional expenses were incurred which did not reoccur for advertising related to our new rollouts.
As a result of gearing up for and beginning of the implementation of our branch automation project, we incurred an additional $600,000 in SG&A costs over last year’s run rate. The provision for income tax has returned this quarter to its normalized run rate, 37.6%.
Our balance sheet remains very strong. We ended the quarter with $114 million in cash with no debt.
We continue to work hard to find opportunities to put back cash to work in what we know best, pest control and only pest control. We have been able to accelerate our acquisitions this year both abroad, Australia and Canada as well as domestically.
The deal pipeline is as strong as I’ve seen it in a number of years. But I’m constantly reminded, bad acquisitions at a good price are still bad acquisitions and good acquisitions at a bad are in a good use of our hard earned capital.
We continue to remain disciplined. But acquisitions don’t deter us from returning capital to our shareholders both through dividends our share repurchase program.
With $114 million in cash and no debt, we certainly have the flexibility to pursue acquisitions, continue to increase our dividends as well as buy back stock. During the quarter, we were active with our share buyback program.
Early this month, we announced that the company had repurchased nearly 780,000 shares under the share repurchase program and just over 1 million shares have been repurchased year-to-date. In total, 3.952 million additional shares may be purchased under previously approved programs by the board of directors.
The program does not have an expiration date. Yesterday, the board declared a regular quarterly dividend on its common stock of $10.5 per share payable December 10th to shareholders at record at the close of business in November 10.
The board will reexamine the quarterly dividend as it normally does in the regularly scheduled January meeting. This past year marked the 12th year which the increase of our annual dividend by a minimum of 12% each year.
We continue to generate more cash than we can wisely redeploy in the business and through stock buybacks. As a result for the third consecutive year, the board declared a special year-end dividend this year payable December 10th to shareholders of record at the close of business November 10th of $0.10.
Where did the year go? Hard to believe, 2014 will be drawing to a close.
We haven’t come close to exhausting the opportunities we have to grow and improve our business. I look forward to talking to you next quarter in sharing our fourth quarter and record year results.
Lastly, let me express our appreciation for a job well done to all of the Rollins associates whose hard work and dedication are behind these outstanding results. With that, I’ll turn the call back over to Gary.
Gary Rollins
Thank you, Harry. Harry and I will be happy to address any questions that you all might have.
Operator
(Operator instructions) And we’ll take our first question from Jamie Clement with Macquarie.
Jamie Clement – Macquarie
Harry, Gary, good morning.
Gary Rollins
Good morning, Jamie.
Harry Cynkus
Good morning.
Jamie Clement – Macquarie
All right, two questions for me. First of all, Harry, obviously CapEx is trending a little higher than normal.
But given the branch system rollouts, should higher still going into next year or is this a level you’d expect to kind of stay out or even declined over the next 18 months or so?
Harry Cynkus
No, I would expect it to decline back to more historical trends in the $17 million to $20 million range for the year. Like I said, we did a very robust rollout to improve the branch operating computers which normally we do staggered over a number years.
But the capacity and strength of what we needed in the branches with the rollout coming just required a unusual deceleration of that. So no, there’s no big CapEx surprises next year.
Jamie Clement – Macquarie
Okay, very good. And Gary, if I could turn to you.
You mentioned some of the data and the news on housing starts and the housing market in general. Correct me if I’m wrong, but you all are not making a lot of money on the actual installation of the Taexx tubes in the wall.
I mean in all cases, this is really about recurring revenue from a family that moves into a house. The way I’ve always sort of looked at this is the business, the new leads that you’re generating from HomeTeam, the decision to build this homes was made many, many years ago.
So I mean is that the right interpretation in your opinion, in other words, not to get too worked up about short-term stories and data and that kind of thing?
Gary Rollins
Well, of course we’re using our data in other areas or all areas. But you hit it on the head as far as the cost related to installs versus the benefit to get me really turn the system on.
It’s almost like the razors and razorblade phenomena that you’ve got to put the system in in order to benefit from it, but once you got it installed, we have a customer that has better retention that conventional pest control because the home owner has made an investment, in their mind as far the system, it’s something that they own. And it’s just a lot more sticky in this residential pest control account than there is the conventional account.
Harry Cynkus
And it also provides a – it’s kind of interesting, I think it’s even than the razor and razorblades because five years from now the 83,000, 84,000 plus homes that we installed systems in this year, many of those homes we also did pre-treat termite work. And that pre-treat termite work comes with a five year warranty, guarantee.
So five years from now, we know the homeowner, we know what the exact date that their warranty expires, we’ve been servicing probably 70% of these homes doing their pest control. So who better than to renew their termite work with than HomeTeam?
So it’s an interesting phenomena that when housing turns down, you have this five year backlog of customers that will need termite work. So if you look at this past recession, during the housing downturn 2008 through 2011, we were going back to customers so we installed or did pre-treat termite work 2002 to 2006 selling room [ph] termite work.
And the HomeTeam grooved through the recession because of the backlog of termite customers needing additional work.
Jamie Clement – Macquarie
Guys, thank you very much as always for your time.
Gary Rollins
Thank you, Jamie.
Operator
(Operator instructions) At this time, we’ll take our next question from Dan Dolev with Jefferies. Caller, your line is open.
Please check your mute button. Again, your line is open.
Please check your mute button. (Operator instructions) And we’ll pause a moment to allow everyone an opportunity to signal.
Gary Rollins
We’re on a technical problem with Dan.
Operator
And we’ll take our question from Dan Dolev with Jefferies.
Dan Dolev – Jefferies
Do you hear me now?
Harry Cynkus
Yes.
Gary Rollins
Yes.
Dan Dolev – Jefferies
Sorry about that. Quick question for the mid-sector, the nice installation revenue on the residential side and termite.
How much of those is really [indiscernible] external market including any sort of execution that Rollins [indiscernible]?
Gary Rollins
Well, I’d love to believe it all has to do with execution of Rollins and marketing.
Harry Cynkus
Excellent management, Gary.
Gary Rollins
Excellent management. But I don’t have any data to – well, I can say I don’t have any data to support it or suggest otherwise.
We know whether it was good in September or was good last year in September, was it better, did that drive it some, we really think some of this as I suggested was people earlier of the year who delayed making decision and gave up waiting. You know I sense just in benchmarking and attending the national industry events as this has somewhat lacked luster.
On termite season, they didn’t have swarm. Typically, that’s enjoyed in most areas.
I think we’re getting a benefit from our HomeSuite application. We’re in a better position to communicate to the home owner to the kind of work that we do and why do we do we do it and specifically how that relates to their home.
So I’d like to get the benefit of anything that’s new, it just takes it a while to get it into your culture and into your routine. So I believe that’s been very helpful for us.
And the industry, I mean the season just really felt crazily, I mean as far as the end of the quarter is concerned. But that was more so in pest control than it was in termite.
Dan Dolev – Jefferies
Got it. That makes sense.
And then quickly one follow up on Home. Can you give that number, I think last time, you mentioned positive earnings about 40%.
Is there an equivalent number for HomeTeam in quote this time?
Gary Rollins
Yes. I don’t have it handy.
But the fact that I don’t recall it says it probably was in line with prior – with what they’ve done all year. Yes, I’m trying to find it here quickly.
Yes, it was in line with prior quarters in terms of their improved contribution to the company.
Dan Dolev – Jefferies
So it’s contributing – it’s margin accretive for the company at this time?
Gary Rollins
I’m sorry. You broke up a little there.
Dan Dolev – Jefferies
It’s margin accretive for the company at this time?
Gary Rollins
Are you talking about HomeTeam?
Dan Dolev – Jefferies
The HomeTeam business.
Gary Rollins
Yes.
Dan Dolev – Jefferies
Got it.
Gary Rollins
Yes, they continued to improve their margins.
Dan Dolev – Jefferies
Okay. That’s helpful.
Thanks, Gary. I appreciate it.
Operator
(Operator instruction) And I’ll pause another moment to allow everyone an opportunity to signal. And it appears we have no further questions in queue at this time.
I’d like to turn the conference back over to our speakers for any additional or closing remarks at this time.
Gary Rollins
Thank you. Well, it’s been an exciting year for the company with again with a lot of enthusiasm and energy.
And I think that’s just built through the year as the year progressed. And we really started to see a return on the investments that we had from a technology point of view which was very encouraging.
And we really look forward to frankly to the New Year. I know this one’s not over yet, but we’re really very much involved in the plans for 2015.
And I look forward as does Harry in speaking with you next time. So thanks for your attendance.
Operator
Thank you for joining today’s conference. A replay will be available today, October 29th at 12 o’clock Central, 1 o’clock Eastern and will run through November 5th.
You may access the replay by dialing the 1-888-203-1112 and reference passcode 5152310. Again, you may access the replay by dialing the number 1-888-203-1112 and reference passcode 5152310.
This concludes today’s conference and we thank you for your participation.