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Rollins Inc. (NYSE:ROL)

Q3 2010 Earnings Call

October 27, 2010 10:00 am ET

Executives

Marilyn Meek - IR

Gary Rollins - President, CEO & COO

Harry Cynkus - Treasurer, SVP & CFO

Analysts

Clinton Fendley - Davenport and Company

Jamie Clement

Operator

Good day ladies and gentlemen and thank you for standing by. Welcome to the Rollins Inc.Q3 2010 conference call. During today’s presentation all parties will be in a listen only mode. Following the presentation the conference will be open for question. (Operator Instructions) this conference is being recorded today, and the date is 27 October 2010.

I would now like to turn the conference over to Marilyn Meek from the Financial Relations Board, please go ahead.

Marilyn Meek

Thank you. By now you should have all received a copy of the press release however if any one 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 run for one week. The replay can be accessed by dialing 1800-406-7325 with the pass code 4372650. 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 are Gary Rollins, President and Chief Executive Officer and Harry Cynkus, Senior Vice President, Chief Financial Officer and Treasurer.

The management will make some opening remarks and then we will open up the line to your questions. Gary would you like to begin.

Gary Rollins

Yes thank you Marilyn. Good morning and thanks all of you for joining us on our third quarter 2010 conference call. Harry will read our forward-looking statements and disclaimer and then we will begin.

Harry Cynkus

Thanks, Gary. Our earnings release discusses our business outlook and contains certain forward-looking statements. These particular forward-looking statements and all other statements that have been made on this call excluding historical facts are subject to a number of risks and uncertainties and actual results may differ materially from any statements we make today.

Please refer to today’s press release and our SEC filings, including the risk factor section on Form 10-K for the year ended December 31, 2009 for more information on the risk factors that could cause actual results to differ.

Gary Rollins

Thank you, Harry. We are very pleased with the record results for both the quarter and the first nine months of this year. With revenues increasing 6.4% over the last year’s third quarter and 5.2% up year-to-date. On August 1 we completed the acquisition of Waltham Service, a leading New England pest control company that was established in 1893 even before Orkin started.

Excluding the contributions that Waltham made to our results residential pest control posted an impressive 5.5% increase in revenues and the highest growth rate we’ve seen in residential revenue since the third quarter of 2006. Commercial revenues increased 6%, aided by strong growth in fumigations while termite increased approximately 1% over last year’s third quarter. These strong revenue results contributed to a 12.2% increase in net income.

As we discussed on our second quarter call, our focus this year has been on increasing new sales yield. Simply yield is the end product after we get a lead to sell the lead and perform the start of the account. Our team along with (ECG) worked together to develop five simple ways for our employees to better engage customers to improve customer yield and customer retention.

We want to make it easier for the customers to work with us and our results have been positive. Given the publicity that bed bug have received I will be remiss if I failed to recognize their impact on our quarter. I have always looked with pride at the growth rate of our mosquito service which is increasing at better than 20% annually, but our bed bug business is leaving the mosquitoes in the dust.

Needless to say bed bug demand continues to grow and represents over 4 million in revenue in this quarter alone, up over 75% from the same quarter last year. While we don’t have any clear cut evidence as to what further impact this high level of ventures and publicity will have on our residential pest control revenue, we have no doubt that the bed bug invasion has made consumers more conscious of other pest problems. Specifically as it relates to the health and property causing them to have greater concerns about their living environment. Such housing concern of this nature is always good for our business. We know our training efforts are a significant contributor to the success of the company. This area is also one of the reasons that we have continued in named the Training Magazine’s Top 125 list of organizations that excel in human capital development. Most of our award winning training is generated from the Rollins Learning Center in Atlanta and we are proud to say that all of the Rollins pest control brands are benefiting to some degree from this excellent stores of knowledge and education.

Let me share some of our recent training initiatives. In the third quarter we conducted four certificated field trainer courses, certainly we invest routine rate in the train to trainer as it gives us more training leverage. We now have a total of 357 certificated field trainers, 63 of our employees signed up for mastering the art of front line customer service training. 552 students completed the introductory technical training and 225 students completed new higher sales training.

Our Rollins University sales training team conducted a four day college of a new commercial and termite sales management training program which defines the standards and best practices used to generate greater commercials and termite sales. And media services satellite broadcast along with video on demand also play a central role in our training. Media services just recently completed five initial residential and commercial training classes, three initial termite classes, three account manager training classes and three termite sales technical training classes. Additionally, they also conducted several technical training sessions that were certified by state regulatory agencies. When our training is accepted by regulatory authorities and CEUs or continuing education units, it’s very beneficial to us.

And for the most recent quarter there were 18,467 launches of online resources and enrollment of our web-based training curriculum. I can go and on and on about our training but I think you can see that we take training very seriously at our company and it is paying off at Rollins Training using a sometime spending, its in all the time spending. At this point I’d like to take a minute to personally address a recent change in management that may be on some of your minds as many of you are aware in early September the companies board of directors announced that my son Glenn would be leading the company.

While I cannot elaborate on his departure since they has legal ramification and it would also would not be appropriate since it’s their family matter. Although this situation was a personal disappointment I want to be clear that this an unfortunate family matter not a business disagreement. I also wanted to assure you that Glen’s departure will not and have not affected the operations of our company nor our plans for the future.

Keep in mind, I have never been out of the Rollins working picture and I won’t be in the near future. Furthermore, it’s important to understand that we have a very strong management team that builds corporate and divisional levels. During the past couple of years in particularly we have strengthened and expanded our leadership teams through numerous internal promotion and at the same time added several top level executives through acquisitions.

In December of last year, you might recall we have promoted John Wilson as highly successful division president he joined Orkin in 1996 to the newly created position of President of Orkin USA. John served the company in a number of catastrophes and was responsible for significant improvement in both of the operating divisions that he managed before being promoted.

In January Greg Clendenin, who has over 30 years of industry experience and was instrumental in building a leading Florida Pest Control company joined Orkin and replaced John as the President of the Southeast division. We in fact have nine Rollins and Orkin division Presidents who collectively have over 205 years of industry and management experience, most of it gained at our company. There is not a service company that I am aware of with greater depth of highly capable leaders.

Over the past 11 years, the strategic acquisitions that we made have provided us with outstanding leadership. In fact we typically target companies with strong management teams that are committing to stay and continue to operate their businesses. This has not only help make us the acquire of choice but also has strengthened our company. Equal to management teams and Rollins family of brands brings expertise and improvement track records that continue to help and build our business.

As I mentioned earlier we were pleased to have Waltham Services join our family of pest control brands and they are already contributing to our results having posted 3.5 million in revenues for the partial quarter. We are referring future acquisitions through the balance of the year which could provide an additional 10 to $20 million in revenue carrying over into the New Year.

Let me bring you up-to-date on our service routing initiatives. After backing away from our previous routing and scheduling project last December, we identified a vendor with a relatively new and robust routing software package. We initiated the proof of value pilot in two test branches earlier this year. While initial results were promising, the economics more care as you show an acceptable ROI. In part the cost of the expense of having to have a separate system rollout.

Frankly this is why you do pilots and test and we carefully the results from these tests. Our primary branch operating system which we refer to as Focus is several years old. While it served us well we realized during our routing and schedule test that we have a greater need to concentrate our IT efforts toward a new common Rollins branch operating system. One in which all brands can benefit from enhanced features and processes. We believe that this initiative will provide a very high return on investment.

As we have acquired a number of brands over the last several years, we have had the opportunity to observe up close some newer more advanced branch operating software packages. Currently, Orkin is in the very late stage of piloting one of these packages used by several of our brands in many of our Orkin franchisees. This would take the place of Focus. This initiative could provide an updated universal Rollins branch operating system that would allow us to leverage the data captured by all operations which in turn will enable us to better service us our customers and provide greater support to our technicians, sales people, administrators and mangers, while improving operating efficiencies.

This software also provides a routing and scheduling platform. So we ultimately will be pursuing this benefit as well and with one system rollout. Sometimes I envy Orkin’s founder Otto Orkin as we begin to have the challenge of identifying and adopting new computer technology. We just personally worked on sales, service and collections.

I will turn now to something that we’ve been very successful with our Bed Bugs ad campaign. Since first airing in 2006, it continues to be extremely popular. TV awareness is up to 90% for these commercials. We will continue to build upon our equity in Bed Bugs and we can all look forward to the introduction of some new characters and story line in our spring 2011 campaign.

At the same time we continue to optimize our internet strategy which continues to provide us with a high percentage of leads. We plan to roll out new internet strategies in the New Year. By the way if you haven’t visited our Orkin website recently, we invite you to do so. You will observe over 400 positive customer testimonials by branch locations, which are really creating interest and increasing traffic. Rotation page viewers were up 54% over year-to-year and we also now have a Spanish version of the site.

But before I turn the call over to Harry it’s the time of year, when we start working on our annual reports and I want to congratulate our annual report team for winning a silver award from the League of American Communications Professionals. This is quite an impressive honor given that there were 4,000 entries from more than 20 countries worldwide. I’ve told our people however that this recognition just raises our bar towards the 2010 product.

The first nine months of this year have been most gratifying for all of us, but as I have said in the past we have a culture of never being satisfied and always believing there’s room for improvement. I am confident, we will continue to build and improve our business to the benefit of all our constituents, employees, customers and shareholders.

Let me now turn the call over to Harry who will provide you with more about our financial results.

Harry Cynkus

Thank you, Gary. Good morning, appreciate you all joining us on the call. In the third quarter, we accelerated the solid growth from the first half of the year positioning us well for the remainder of this year and a great stepping stone for next year. Today, we reported revenue of 305.1 million, our first $300 million quarter. This represented 6.4% revenue growth, net income increased 12.2% to 25.5 million or $0.26 per diluted share compared to 22.7 million or $0.23 per diluted share for the same period in 2009.

The fundamentals that drive our revenue, liens, pricing, closure and retention remains strong and continues so into the fourth quarter albeit it’s still early in the quarter. Clearly, our positive momentum strengthened. Let’s look deeper into the result. Certainly, revenue was aided somewhat by the acquisition of Waltham Services as their results were included for two of three months in the quarter. Excluding Waltham, it still remains our strongest organic growth in some time with revenue growth of 5.1%. The stronger Canadian dollar made little impact listing revenues just (Inaudible). Revenues on a comparable basis to last year excluding Waltham and Canada, we grew 4.9%, a nice improvement over last quarter’s comparable growth of 4.2. While fed funds had generated a lot of interest in our company off late, I think it’s important to remind investors of the underlining strength in our business is the reoccurring nature of most of our services. In fact, nearly 80% of our revenue is recurring. Our best quarters, spring and summer are now behind us. We always hoped for a late winner but what is most important to us at this point is our gross contract advantage or GCR which describes so much recurring business we are carrying into Q4. This year, it will be in access of 5%, over 300 basis points better than where we were going into the fourth quarter last year.

Let’s talk some revenue specifics. First, residential pest control which continues to represent above 40% of our business, wholesale impressed at 5.5% increase in revenues, the highest growth rate we’ve seen in the residential sector since the third quarter of 2006. This is noteworthy since back in 2006, we currently employed a door-to-door sales program that if the time represented 10% of our sales.

Today it’s used very selectively and represent less than 3% making this quarter’s revenue gain all the more impressive. Pest control is a great recessionary system business where the residential or commercial for that matter people and business don’t like bugs and their concern over health and property is paramount. As we’ve noted our brands enjoyed low price elastic giving us opportunity to continue to fine tune our price realization programs and at the same time retention continues to improve. Commercial pest control continues to be a steady performance in a starling business environment it represents 43% of our revenue. Last quarter our commercial sales team mission was to knock on a few more doors and for the quarter our commercial pest control business excluding Waltham Group 6%. We saw a strong improvement in commercial retention as well. As for termite it represents less than 19% of our annual revenue. Termite results were mixed, we saw some strong results in some parts of the country with weak results elsewhere this portion of our business is more dependent on new sales with approximately half the revenue recurring coming from renewal and monitoring.

Gross margin for the quarter improved 30 basis points to 48.9% for the third quarter versus 48.6% in the prior year due to improvements in productivity from both services and administrative salaries and reduced professional fee. Those improvement were partially offset by higher fuel and material supply cost that’s related to the fumigation business which had a strong quarter.

As I said last quarter, given the amount of new customers we put on we are certainly surprised to experience of decreasing the service wages as a percent of revenue. The impact of Waltham with its higher cost of service was marginal; maybe 5 basis points. Depreciation and amortization expenses decreased slightly $245,000 if amortization of intangible specifically customer contract from our 1999 acquisition of PCL Canada are now fully amortized however this pick up was partially offset from the additional $300,000 increase and depreciation and amortization from Waltham Services and acquisition that closed August 1. The recording of intangible from the acquisition we now add a 145 million of value assigned to customer contracts and other intangible assets on our balance sheet as of September 30. Amortization of intangibles will continue to represent a significant non-cash charge to the P&L for sometime. Based upon our fully diluted shares outstanding would be non-cash after tax charge of $0.13 per share.

Sales, general and administrative expense increased 5.7 million to the 32.4% of revenues decreasing from 32.5% of revenue. We saw a dollar increase in sales, administrative staffing and commissions related to the growth of the business along with higher consulting costs however revenue grew at a faster rate and that’s the decline in SG&A as a percent of revenue.

Our provision for income tax is 37.7% versus 38% a year ago. We continue to build to our solid foundations. The economics of the business only continues to improve. Our balance sheet remains strong with total assets exceeding $600 million. We continue to generate significant free cash flow in excess of 85 million year-to-date, which has allowed us to take advantage of growth opportunities such as the acquisition of Waltham Pest Services as well as possible other trends and actions anticipated for this quarter that Gary has already alluded to.

For those investors who have been lamenting not buying the stock earlier when it under $20, our Board has addressed your concerns. In case you missed the announcement, our Board justly approved to three for two stock split. The split will be affected by issuing one additional share of common stock for every two shares that common stocks held. The additional shares will be distributed on December 10, 2010 to holders of record at the close of business on November 10.

In addition the company declared its regularly quarterly cash dividend of $0.09 per share. This cash dividend will be paid down to three split shares. The Board of Directors will reevaluate the amount of their regular quarterly dividend as it has historically done at the January Board meeting. Hard to believe 2010 will be drawn to a close before we know it. It’s been an excellent year for our company and we are looking forward to 2011 with great enthusiasm. As Gary always says, there is much to be done.

We are focusing on improving and expanding on the initiatives we have put in place and look to identify and capitalize on new opportunities to grow and improve our business. I look forward to talking to you next quarter and share our fourth quarter and record year result. Let me once again express our appreciation to all the Rollins associates who hard work and dedication are behind these outstanding results. We also think our customers, suppliers and shareholders for their continued support. With that, I will now the call back over to Gary.

Gary Rollins

Thank you Harry. We’re now ready to open the call for any questions which you might have.

Question-and-Answer Session

Operator

We will now begin the question and answer session. (Operator Instructions) our first question comes from the line of Clinton Fendley with Davenport and Company. Please go ahead.

Clinton Fendley - Davenport and Company

Wondered if we could get a little bit more color just on the 5.5% growth that we saw in residential and any trends geographically or any pricing and end volume commentary?

Gary Rollins

Well, we had overall improvement and all of our business units had good revenue increases, which always makes you feel good. Demand was up which is always important for us both on the internet and convectional telephone leads. We continue to make progress as far as our pricing is concerned. We completed a successful price increase campaign for existing pest control customers. So I think we have just a lot of things coming together in the quarter that contributed a little here, a little there and we didn’t see any unique thing occurring as far as any geography or any one particular business unit.

Clinton Fendley - Davenport and Company

And a lot of these pricing changes were made back in the late spring timeframe. So I guess it’s safe to say that that’s definitely stock at this point then.

Gary Rollins

Yeah, all the price increases went into effect at the end of the, by the end of second quarter. HomeTeam price increases effective July 1, if we took the total impact of the price increase this year versus last year, this year is actually a little lower than last year, not significantly. So the quarters are pretty comparable in terms of the dollar from the price increase this year versus last year.

Harry Cynkus

The great thing in that current price increase is the gift that keeps on giving. So we did, you know it rolls into this quarter, it will roll into next quarter and so forth. So we’ve done a lot of research, a lot of work on our pricing and we watch it very carefully.

Clinton Fendley - Davenport and Company

Any reason why your door-to-door sales approach is being used a lot less in the current environment?

Gary Rollins

We were really concerned that these customers were not as sticky as conventionally acquired customers. The prices continue to go up, finding people to do this. We hired college students who would work showing independent organization and they become fewer and fewer so the rates kept climbing. And we just kind of sit down and up to a pencil and just decided although it was painful to stop, it just wasn’t the best thing for our business and as Harry stated we use it sparingly, if we have our unique market that we really think that we can turn up the growth significantly. And we can make this economics work for us and we will selectively do it. Its also with the door-to-door program that’s more of an impulsive buying decision and certainly in this environment people are less inclined to make that impromptu decision. So we are bad and the economics of it that’s very eluded to at a high cost of sale, the retention is not as good as you know I think it’s because of the impulsive nature of the buy that we dialed at that significantly.

Clinton Fendley - Davenport and Company

And switching gears for just a moment, what is the time line for the rollout of the replacement for the Focus system? And just any thoughts here as to the CapEx requirements for the new system?

Gary Rollins

Well I think the rollouts going to take as close two years I mean if everything because those enhancement is having you know they were having to do now although this is a very robust product, we just have some new launches in the way we manage our business and run our business. So we can’t really take the product right off the shelf and have it to fill all of our requirements.

Harry Cynkus

And we don’t have a clear rollout schedule, we are doing a pilot, we are converting the one branch here in the fourth quarter and as a result we need to evaluate those results, do additional changes if any needs to be made, incorporate it, we should really then determine what the roll-out would look like. CapEx, again until we have a roll-out schedule plan, I really can’t give you any color on the impact next year but its not anything out of the ordinary as CapEx runs pretty consistently between 10 and $20 million a year. We hit the highs of 20 million when we do something like this. This year we are at the low end. So if there is anything outside of that range once we looked at to get a better picture, the roll-out will give you more color at that time.

Unidentified Analyst

So Orion in total, if I’m not mistaken, was about, what, $15 million? So would this be more or less than that?

Harry Cynkus

No. I was far or less to 15 million.

Gary Rollins

I think that may have been the intent when we got fairly finished. But over a couple of years it’d certainly be in that neighborhood to 15 and 20 million that could cost to some of that CapEx, some of the internal cost trading.

Harry Cynkus

One other things that we have kind of mastered to some extent is this web-based training which as opposed to sending a bunch of people out and physically being on hand at locations to put on this systems. We’ve had good success with some of our smaller projects by doing our training over the web, more people can become familiar with the routines and ask questions and so forth. So one of the benefits I would think here is your is comparing to Orion that next system roll out should be more economical because their training will not be so hard.

Gary Rollins

That just one of the things that we’re pointing right now but we’re really early to this process and we’ll give you more color when we really understand the full impact at this point. We’re planning to absorb the cost in our normal operating cost and if it falls outside of that, we’ll let you know.

Operator

(Operator Instructions) Our next question comes from the line of Jamie Clement. Please go ahead.

Jamie Clement

Just a follow-up question on the software system from Clint’s questions. What exactly, from like an efficiency standpoint, are you looking to achieve? I’m not talking numbers, but just sort of like from a process. I think you mentioned you had some of your different brands were using different systems. What are the top two or three sort of cool things you hope to achieve with the system?

Gary Rollins

I will be sharing data more carefully now, measuring our advertising and marketing results, having common definitions as far as the way you count customers and the way count retention. And you can imagine each of these systems have a little twist or return. So I think we would be adapting common definitions to measure and account for the data and performance of the business. We are certainly complying with GAAP and Sarbanes and all of that but it is frustrating when you try to find out exactly how many lease do we have in the whole company and in the end you just find it’s not everybody who counts the lead are saying what. So I think the data side and the marketing as it relates to marketing will be a pretty powerful addition. And it’s just a lot cheaper to maintain one operating software. You don’t have to have a group of IT, three four who are familiar with four different systems. So I think there are just inefficiencies. We’ve not identified all of them but I think the other good thing is this isn’t the focus and I think these non Orkin brands looks towards a universal software system with a little bit more enthusiasm is opposed to trying to adopt Orkin’s system. That’s been one of the positive things Harry gave us and all of our different brands are enthusiastic about getting on this.

Operator

And there are no further questions, please proceed.

Gary Rollins

Well, thank you all for joining us today we look forward to the balance of the year and we will continue to work hard to grow and improve our business and we look forward to sharing year end results with you.

Operator

Ladies and gentlemen this concludes the Rollin Inc. Q3 2010 conference call. If you’d like to listen to the replay of today’s conference please dial 303-590-3030 or 800-406-7325 with the access code 4372650. ACT would like to thank you for your participation you may now disconnect.

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