Rollins, Inc. (ROL) Q2 2012 Earnings Report, Transcript and Summary

Ladies and gentlemen, thank you for standing by, and welcome to the Rollins Inc. Second Quarter 2012 Earnings Conference Call. [Operator Instructions] Following the presentation the conference will be open for your questions. [Operator instructions] Today’s conference is being recorded July 25, 2012. I would now like to turn the conference over to Marilyn Meek. Please go ahead.

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 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 runs for one week. The replay can be accessed by dialing 1800-406-7325 with the pass code 4551562. Additionally, the call is being web cast at www.viavid.com and a replay will be available for 90 days. On the line with me today are Gary Rollins, President 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?

Yes, thank you, Marilyn and good morning. We appreciate all of you joining us for our second quarter 2012 conference call. Harry will read our forward-looking statement and disclaimer and then we will begin.

Our earnings release discussed as our business outlook can contain certain forward-looking statement. 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 risk may differ materially from any statements we make today. Please refer to today's press release and our SEC filings, including the risk factor section of our Form 10-K for the year ended December 31, 2011 for more information and the risk factors that could cause actual results to differ.

Thank you, Harry. I am pleased to report that following a very strong first quarter we posted solid performance in our second quarter. Revenue for the quarter rose 4.5% to $334.9 million, and net income rose 6.5% to $33.1 million. Taking a closer look at our business, commercial pest control rose 3.2%, residential rose 7.8% and termite was up 1.2% in this quarter. As you may recall, due to the unseasonably warm weather in the first quarter we experienced early swarm activity this year with our termite revenue increasing a very strong 10.5% than over the prior year. Overall, we were pleased with our results for the quarter and the first half of the year. Our bed bug business also continues to grow. Companywide total bed bug service was up over 40% from the prior year, commercial was up over 20% for the quarter, which represents approximately two thirds of our overall bed bug growth. However, residential revenues have been increasing significantly in recent quarters. For the quarter residential grew over 90%. Clearly bed bugs continue to be an expanding pest problem, and frankly we don’t see anything at this time that would deter the increasing bed bug infestation. Summer is also the season when other bothersome and potentially dangerous pests threaten our family and pets, which include mosquitoes, fleas and ticks. At the beginning of May, Orkin reported enquiries concerning fleas and ticks at more than double nationally compared to the same time last year. Further demand for our mosquito service remained strong, having increased over 20% over the same quarter last year. At the same time, Lyme ticks and Lyme disease continue to be an ongoing problem, particularly in the Northeast. You may recall that last year the Centre for Disease Control, CDC, asked Orkin to be the exclusive pest control provider for its Lyme and Tick-borne Disease Prevention Study. At that time, Orkin worked with the CDC and state health departments in providing one time tick treatments to more than 1500 participants in specific areas of New York, Connecticut and Maryland. The 2011 disease analysis is being wrapped up and the CDC expects to release their findings later this year. In February of this year, the CDC again reached out to Orkin asking us to provide tick treatments for a second year to more than a 1000 properties. By the way we are compensated for these treatments. Their study is designed to evaluate the relationship between preventative tick control and incidence of diagnosed Lyme disease. Results from the earlier study show that preventative tick treatments do decrease tick populations. As we have mentioned in the past, collaboration with organizations like CDC and leading universities such as The University of Kentucky, known for their bed bug research, keep us in the forefront, while maintaining a high level of knowledge concerning these two important and highly publicized insect pests. Over the past year, we have talked from time to time about our emphasis on continuous improvement of our commercial and residential customer service, and the initiatives we have put into place to achieve this objective. We are pleased with our progress in this regard and we firmly believe that in business you are either going forward or backwards. There can be no comfort with a status quo. This commitment to excellent service can be validated in part by lengthy customer relationships. Let me share a couple of examples of customers that illustrate the quality and dependability of our service delivery, and our pledge to achieve long-term customer relationships. Long before any of us were born over 100 years ago, Vas Brothers general merchandize had been a working customer. Our relationship with this store located in Nashville, North Carolina, began in 1910. The store was actually established five years earlier, but either because Mr. Vas didn’t need pest control service, or more likely because Orkin service wasn’t available in Nashville at that time, we didn’t come onboard until later. Now three generations afterwards, Vas family members are still running the business, and our association with them is still going strong. The same emphasis on customer retention and excellent customer service of lasting affiliations holds true for our residential pest business as well. Let us go back to 1957. That was the year when Dwight Eisenhower was President, the average price of a home was $2300, gasoline was $0.24 a gallon, and McDonald’s had fewer than 40 restaurants. That same year 55 years ago, 5.5 decades, Maurice Grief of Rockwood, Tennessee, chose Orkin Pest Control to protect his family’s home, and has been a customer ever since. Needless to say over the years these two customers have seen more than one service technician. However, Mr. Grief insists that our service has always met his expectation. He summed it up best when asked why he kept doing business with Orkin all these years, he said it is simple. No bugs. I have had bugs from time to time, but you always take care of them. These are the type of customers and relationships that we strive for everyday. In April, we combined our technical services and training departments into one group led by Greg Baumann, a 25-year pest control expert and leader. A combination of these two units will enable us to better provide more coordinated and improved support services to all of our brands. One of the reasons that we have been able to provide best-in-class service to our customers is the investments that we make in training. One of these investments to enhance our training and delivery capabilities is our movement from satellite-based training distribution system to a web-based system. Today all of our brands using either a desktop or laptop computer can receive our sales, service and administrative training via the Web. Additionally our domestic and international franchises will be able to receive and participate in our training and broadcast as well. By the way this is the first opportunity in this regard for our foreign franchisees. Speaking of international franchises, we added three franchises in the second quarter. In April, we established a franchise in Mexico City, one of the largest cities in the world. Orkin Mexico City will offer both residential and commercial pest control, however focusing mainly on hotels, office buildings, food processing facilities, restaurants, hospitals and apartments. In May, we established an international franchise in Hainan Island in the People's Republic of China, our second franchise in China. Hainan Island is recognized for its tropical rain forest and beautiful beaches making it a very popular holiday destination. Orkin Hainan Island will offer commercial pest control focusing mainly on the vast hospitality sector located there. Also in May, we expanded our presence in the Caribbean with the establishment of a franchise in Turks and Caicos, which will offer commercial pest control also focusing mainly on the hospitality sector located there as well. We are pleased with what we have accomplished in the first-half of this year, but we aren’t slowing down. We will continue to serve and listen to our customers, and take care of their pest needs, while protecting their health and property. Likewise, we will continue to train and listen to our employees to ensure we provide them a great place to work, and provide the support needed to excel in their jobs. With that said, I will turn the call over to Harry, who will provide detailed information on our financial performance. Harry?

Thank you Gary. Good morning and thank you for joining us on the call. Second quarter each year has long been considered our most important with the arrival of spring. As you all know, this year in most of the US spring sprung sooner, say that fast three times. The good news was that we added pest control customers early in the year, enabling us to benefit due to the recurring nature of this revenue. A strength of our company is its strong recurring revenue. Almost 80% of our revenue each month is scheduled for service when we open the doors on the first day of the month. At the same time, our termite business also came early with a tremendous influx in business in the first quarter. As anticipated, actually very little carried over to the second quarter. Termites live and are working year-round, but those highly visible reproductive swarmers, or flying termites, help drive the demand for this service when sited by homeowners in their living rooms, and certainly will get the customer’s heart pumping and our phones ringing off the hook. Unfortunately, this is a relatively short period and once the swarm is over, it is over, and then you have to creatively find and sell the service. Fortunately, the customers we added early, as I described in residential and commercial, only helped to build our recurring revenue for the second quarter, and as Gary has already noted termite was up 1.2% in the second quarter after experiencing 10.5% growth in the first quarter. So you can see it was only the growth in the termite that was pulled forward, and year-to-date termite is up 5.2%. For the second quarter, total revenues for the company were $334.9 million, representing 4.5% growth. Net income increased 6.7% to $33.1 million compared to $31.1 million, and diluted earnings per share increased 9.5% to $0.23 per diluted share from $0.21 in the second quarter last year. For the first six months in 2012 revenues increased 5.4% to $624.3 million compared to $592 million last year. Net income for the first six months of 2012 was $56.2 million, or $0.38 per diluted share, compared to $49.7 million, or $0.34. This represents 11.8% year-to-date increase of diluted earnings per share. The fundamentals that drive our business remains strong, leads for residential and commercial were up nicely in the quarter, though off slightly in termite. We aren’t seeing any significant changes in consumer sentiment as it relates to pest control. Closure remained solid with improved price realization. Pest control retention continues to improve. Our occasional invaders, bed bugs and mosquitoes are invading more frequently, and continue to contribute to our positive momentum. Last quarter we conducted testing as we regularly do in preparation for our annual price increase program, and the result showed little change in elasticity. As a result, Orkin implemented its traditional annual price increase program for eligible customers based on very selective criteria in the month of June. Overall, the revenue realization should be similar in scope as last year’s price increase. Its fluctuation in the second quarter this year versus last year is marginal. HomeTeam’s price increase program will go into effect in the third quarter, beginning July 1. Gross margin for the quarter improved 20 basis points to 50.4% for the second quarter as a result of the company experiencing more favorable claim development cost with regard to casualty in termite, which were partially offset by higher medical plan costs. The cost of gasoline moderated, but still averaged $0.06 per gallon more this year than prior year quarter. Depreciation and amortization expense for the quarter increased $300,000 totaling $9.6 million, remaining unchanged at 2.9% of revenue. Depreciation was $3.8 million and amortization of intangibles was $5.8 million. Capital expenditures year-to-date totaled $7.4 million, of which our ServiceSuite branch operating CRM project represents a little more than one-third of that. While I’m on the topic I will give you a quick update on the project. We now have eight branches up and running on this software. The software is working for the residential portion of the business and we are well into development for the commercial side. You may recall, we are having the largest commercial pest control company in North America, and this software needs to be robust to meet the needs of these customers. We hadn’t planned for, and do not plan to roll-out anymore branches over the summer because of our seasonal demand, plus we have plenty of programs tweaking remaining. Sales, general, administrative expenses for the quarter decreased to 31.7% of revenues. The decrease in margin percent is due to reductions in professional services, and improvement in bad debt expense. Our provision for income taxes was 37.7% versus 37.3% a year ago. We dream endlessly of the day Congress agrees to rewrite the tax code that would lower corporate rates and further stimulate business investment and the economy. As I have mentioned before, it is not the service companies in America that aren’t paying Uncle Sam their fair share of taxes. That is for sure. We continue to operate from a solid foundation. We have confidence in our fundamentals, the company is performing well, the balance sheet is strong. As always, our first priority for our outstanding cash generation capabilities remains investing in what we know best: pest control and only pest control. But at the same time, we recognize our responsibility to our shareholders. Last evening we announced as part of the company’s active management of equity capital, our board of directors authorized the purchase of up to 5 million additional shares of the company’s common stock. The company plans to repurchase shares at times and prices considered appropriate by the company. The share repurchase program is in addition to the company’s existing plan of which 298,183 shares remained available for repurchases as of July 24. With the year half over, we are pleased, just never satisfied, but are well positioned for a great 2012 and look forward to talking to you next quarter. Let me express our continued appreciation to all the Rollins associates, whose hard work is behind our outstanding results. We likewise are most appreciative of our customers, which makes us successful. Thank you for your time and interest and with that I will turn the call now back over to Gary.

Thank you Harry. We are now ready to open the call for any questions that you might have.

[Operator instructions] And our first question comes from the line of Joe Box with KeyBanc Capital Markets.

Question for you on the margin, if you were to go back over the last 10 years or so, it looks like you have typically picked up about 380 basis points of operating margin expansion in 2Q from 1Q levels, but whereas this year the margins only sequentially increased by about 340 basis points, is that delta a function of just better volume in 1Q or were there any step-up costs in 2Q, like the CRM system that would have dampened some of that sequential margin improvement?

Good question, and I think it is just more variability than anything really specific. You know, if you go and look at how we have improved margins over 10 years, it is not always the same items, we didn’t see the productivity improvements that sometimes we see this quarter, and with the large influx of leads and new business coming from the residential, it is kind of hard to -- if you want to get all those new customers started that is certainly probably -- it is probably a bigger share of both. But beyond that I don’t have anything specific.

I think I could add to that. There is just a lot of moving parts in our business. I think it is margin improvement often is more art than science. The influx of termite business typically contributes to the margin because it is profitably quick, whereas pest control it takes a couple of quarters to cover your initial cost when you start, and your commission that you pay. So that affects the margin. I think the positive thing that I could say is if you look historically, Orkin has had much better margins, and it would be in our intent to continue to work towards getting to those levels again. I think service suite, when functioning company-wide has the ability to do that because of the productivity and mileage improvement opportunities that exist with it. I think that is the real payoff for that but we’re a long way from having that implemented throughout the company.

Sure. That is helpful. Maybe just a follow-up to that, then as we are thinking about incremental operating margins, now those margins were elevated over the last couple of quarters, but this quarter it moderated to a more normal range in the mid-20%. How should we be looking at incremental margins going forward, are we potentially looking at below trend due to some of the required spending or are we thinking a normalized type of flow through?

Philosophically we are not expecting any margin -- Harry kind of turns pale when I say that, but we -- as I mentioned there is just a lot of areas whether increasing of pricing, getting half a count more a day from our pest control technicians. There are just a lot of levers that you can pull and we really believe that we can continue to move our margins, improve our margins as we go forward.

Okay. Can you talk a little bit more about overall retention rates in the quarter, and maybe specifically how the retention rates panned out for some of the newer customers that you signed up in 1Q?

You know, the retention, pest control, commercial, you know, we saw improvement over prior quarter, over prior year. You know, I don’t have immediate information on what happened to our customers we have signed up in Q1. We do know our gross contract revenue grew from Q1 to Q2. So, I feel pretty strongly that the customers that we added in Q1 you know, are here in Q2 that, you know, that we continue to work with our net promoter score. We are working to build that into the culture. We think we are definitely think it is helping us on our retention. I believe it was mid quarter. It would have been May, and we had one of our, it was the best performance to index retention that we have ever had. So things are working in the right direction. We are focused on continuously improving customer satisfaction and it is a good opportunity for us to grow the business by retaining the customers that we have. I love the examples of our 100-year-old commercial customer, and 57-year-old residential customer, and we hope to be continuing to add stories like that. I think our survey programs is really the most powerful tool that we have had on a long-time as far as improving retention, and we really learned that from HomeTeam who began surveying their customers I think as long as 10 years ago. And we saw the data that just showed how it moved retention and one of the things it does is it really gives a branch or report cards that they can look at and see how they are comparing to their peers and how they compare to the same previous survey that was done at the same time of the year, and just get a lot more believability. Sometimes it's hard to get your point across that, you know, you're not really doing as good a job as you think you're doing, but when the customer tells you that, you know, you can't deny it. So I think that that's you know, we've been able to kind of break through the clutter so to speak and really have a good tool to motivate our branches to improve the service that they have done.

Great that's helpful. Last question, then I will turn it over. I think last quarter you talked about double-digit lead increases. Now that we are looking at a more normalized weather type of environment, can you just talk to lead generation this quarter and maybe just segregate between the residential and commercial businesses?

Both residential and commercial had double digit lead increases, they weren’t big double digit, but they were both over 10% increases in leads.

Our next question comes from the line of Clint Fendley with Davenport & Company.

I wondered, good news on the developments there with the software program in getting 8 branches up and running. I'm wondering, would 2013 be too early to begin thinking about some of the leverage that we might be able to get from further implementation of the software through additional branches?

I would think so. I mean, certainly those branches as they mature, you know, certainly will be improving their margins et cetera. But at that time when you look at you know, 400 locations you know, we're not going to have a large number of branches converted at that time. So I think that, you know, when it is all done when it is all said and done and you've got branches that have been on it for 18 months and 12 months and six months, at that point you will see some I believe that you will see movement in productivity, and movement -- improvement in fleet expense, fuel, number of vehicles et cetera.

We had some -- as we talked about, the software is working real well on the residential side of the business. We do have commercial branches up and operating, with the software. We have identified, opportunities for improvement before we want to roll out further, we definitely still need to improve response time and have some greater functionality there. So to really know how much leverage we’ll have in 2013, I think we have to have the game plan for how many branches we’ll be rolling out in 2013…

And the maturity of it.

And the maturity of those branches and the big question is, how much development we get done over the next couple of months, over the summer and whether we will be ready to start staging an aggressive rollout or not. We should be able to answer that question fuller come three months from now when we have well our programmers have done.

Do you have a rough plan now for how many branches you would like to deploy the system into?

No.

Okay. You know, just to add to what Harry said, the reason you have a pilot is that you want to make sure that you really get the warts kind of removed so to speak and have it running smoothly. I've been through several of these doing my career and the worst thing you want to do is step on the gas when you don't have an A plus system and we are far from having an A plus system.

Okay, fair enough. You know, I wonder would they also with shifting gears a bit with a little bit of broader uncertainty in the economy, any update on how the pricing maybe increases, maybe you are expecting at this point or any reasons for that?

You know, we tested in the -- over the winter months, similar as we have done for each of the past four or five years, we really didn't see significant differences. So we rolled out a full price increase program June 1 throughout Orkin. July 1 from HomeTeam, the dollars that our customers saw the increased first-time June 1. So we won't know until later here in July and August as to you know, the sticking rate whether we have to rollback prices or not. We don't suspect and we're not thinking at this time that it is going to be any different than prior years based on the testing that was done. So we think it’s pretty much like it has been.

Clint, I think it might be helpful. You know, we've been doing this for years and I guess we brought Boston Consulting in, was that three years ago? Just to make sure that we were using the most sophisticated testing that you could do and there were some refinements that we made, but we test the Sunbelt branches, Florida, Southern Louisiana, South Texas that really continue to have mild weather. So when we do this, we are pretty much replicating the season if you will, and we really didn’t see a noticeable difference as far as retention is concerned, which should take different levels. We look at 6%, 4%, 0% and, you know, the zero is our control, and so, you know, we really don't feel like we are rolling the dice by any stretch of imagination and, people really consider, our customers consider our service important, and keep in mind you know, we're not talking about hundreds of dollars per account, typically we are talking about you know, $4 or $5. So, one of the advantages that we have you go to raise the prices is you know, you are just not going after a tremendously large amount of money as far as the individual residential customers.

Our next question comes from the line of James Clement with Sidoti & Company.

I was wondering if, I wanted to ask a bed bug question but not directly related to bed bugs. I mean, there are so many news stories out there that and have been for two years now. How much do you think that just the paranoia about bed bugs is actually helping the rest of your business?

Well, I think bed bugs give you an wonderful opportunity to sell your regular home pest control service. Quite often when we are out there looking for bed bugs, we find spiders in the basement or we find mouse droppings or whatever. I mean, get in the home. So we have a wonderful opportunity to take a bed bug call if you will and turn it into a regular annual pest control contract. So there is no doubt that we are getting the benefit of that, and really as we continue to work with these universities and these manufacturers, and I think we had mentioned earlier that we're experimenting with DNA testing to identify bed bugs infestations with Auburn University. So there is a potential of having ongoing inspections. If the homeowner doesn't really change their lifestyle, and I am talking about residential now, if one or more of the members of the household have a job that requires travel and staying in hotels and motels throughout the country.

And particularly the State of Ohio.

Exactly.

I'm sorry.

But New York, I mean New York is kind of scary the city and many of the major, certainly the northern major cities like Chicago and Kansas City and so forth. So there is a very likelihood that if you have a bed bug infestation certainly from a residential point of view that you could have one again. From a commercial point of view, if you are in a hotel, I mean, literally we could eliminate the bed bugs in the month of August and a guest brings bed bugs into the hotel in September. So I think that there is a lot of opportunities as far as looking at ongoing inspection service both residential and commercially and the fact that we will no doubt sell other services to the residential customer once we establish that first relationship.

Okay, that's very helpful and then the final question. You know, it seems like over the last you know, 5 to 10 years you all have experimented with different ways of marketing outdoor, summer pest control services. Where does that stand now and can you kind of, and can you give me a little bit of a history lesson in terms of you know, how we used to market for example mosquito services and how we are doing it now, and it seems like over the last couple of years you've done a better job of it.

Well, I think that we have reached out to our exist -- we do a better job today reaching out to our existing customers, and making sure that they are aware of the fact that we do, do mosquito service. I think that's been a big improvement. It's not just the pest control customers but reaching out to all of our customers, termite customers as well. I think another thing is we continue to go out each year. It’s so much like lawn care and that you know, that we continue to provide the service until the customer says I don’t want any service, and the wonderful thing about mosquitoes is our service there is it really works. So I think like anything else we got a little smarter as far as doing it. We're doing more direct mail as far as mosquito service is concerned. So I think just like any service line that has matured somewhat, we’ve just gotten a little smarter in the way we reach out to potential customers.

And our next question comes from the line of Eric Hollowaty with Stephens Inc.

Harry, could you just quickly remind or quantify for us how much incremental operating expenses you expect this year for the branch operating system implementation.

We’ve hired our first group of field trainers, and we brought them on at the end of last quarter. That’s going to add several hundred thousand dollars in the third quarter. We probably won't add any more trainers until later or late in the third quarter once we get a good feel for the rollout for the fourth quarter. So the total incremental cost that we’ll see in the P&L probably before the year is out I'd say will be less than you know, $0.005. It won't be a significant drag this year.

Great. That's very helpful, and any sense you can give us for how HomeTeam has been performing of late and maybe any commentary on the near-term outlook there.

Yes, HomeTeam has been a, you know, very good acquisition for us. We always wish we could control the timing and buy it at the bottom the housing market, but we missed by a year or two, but the HomeTeam is growing. They had in excess of 6% revenue growth in the quarter. The number of -- what's really encouraging with HomeTeam is their new system installs. I believe their installs year-to-date this year, nearly just over 30% over last year, and that's a positive because those installs will represent new customers, pest control customers next year. The downside of rapidly increasing installs is it puts pressure on their margins in the short term. We do lose money on the installs but putting in a system and the cost of putting that system in for HomeTeam is really -- we look at it as customer acquisition costs. So as long as we are getting good cooperation with the home builder that we know who they’re selling their homes to, and we are getting good penetration and activation of those systems, we are happy to take that short term loss for that long-term customer. The HomeTeam is performing well, the news you're reading about the home sales and home starts picking up and people being optimistic, we're definitely seeing it in a lot of HomeTeam’s markets.

That's great and just to refresh my memory, those customers, those installs typically convert at around 70% or so.

Correct.

Well, great. And then just one final, I'm sorry, Gary did you have a comment?

It’s kind of like a plant in the garden. You know, I mean, you got to plant it to harvest it, and you know, if you really want to improve your margins in that business don’t grow. You know, which as Harry said is certainly not the desired strategy but once you get those recurring revenue stream built, then it goes finance the installs, but you know, the new installs that you’re doing. So this lull that we’ve had where we really didn’t have the garden planted all that well, we just have to overcome that by getting your installs.

Right, make sense. And just one final one, I think it was Gary in your remarks, you talked about the bed bug business and I just want to make sure we got the numbers correct. I think you said that the business during the quarter as a whole was up around 40%, and two thirds of it was from commercial which was up 20%...

That is right.

And the other third was residential, which was up 90%.

Yes, the other piece of it is residential, which is 90%. So although the growth rate, you know, percentage wise is far greater, just the base is far smaller but this is the first time that we’ve really seen a jump like this as far as residential is concerned.

First-quarter.

Yes, so I mean to us that's a encouraging situation, and if you would expect I mean, if you're staying in these hotels and motels that are infested, you know…

You bring them home.

You bring them home. I think the press has done a good job of educating the public as to what to look for in the fact that the situation is out there, and we really were encouraged by that. I mean, it’s the smaller number than commercial, but the fact that we saw that kind of jump so far this year has been very encouraging.

We did nearly $11 million bed bug business of which $4 million is residential.

[Operator instructions] And I'm showing no further questions in the queue at this time. I would like to turn the conference back to management for any closing remarks.

Okay, as always we appreciate your interest in our company and we look forward to visiting with you again next quarter.

Ladies and gentlemen, this does conclude our conference for today. If you’d like to listen to a replay of today's conference please dial 1 (800) 406-7325 or (303) 590-3030 and enter the access code of 4551562 followed by the # sign. Thank you for your participation. You may now disconnect.