Rollins Inc (ROL) 2007 Q4 法說會逐字稿

Ladies and gentlemen, good morning. Welcome to the Rollins fourth-quarter conference call. (OPERATOR INSTRUCTIONS). This conference is being recorded today, January 23, 2008. I would now like to turn the conference over to Susan Garland. Please go ahead ma'am.

Thank you. By now you should have all received a copy of the press release. However, if anyone is missing a copy and would like to receive one, please contact our office at 212-827-3777. We will send you the release and make sure you're on the Company's distribution list. There will be a replay of the call which will begin one hour after the call and run for one week. The replay can be accessed by dialing 1-800-405-2236, passcode 11106089. Additionally, the call is being Webcast over www.viavid.com, and a replay will be available for 90 days.

On the line with us today are Gary Rollins, President and Chief Executive Officer, and Harry Cynkus, Chief Financial Officer and Treasurer. Management will make some opening remarks and then we'll open up the line for questions. Gary, would you like to begin?

Yes. Thank you, Susan. Good morning and thank you all for joining our fourth-quarter and year-end 2007 conference call. Harry will read our forward-looking statement disclaimer, and then we'll begin.

Thank you, Gary. Our earnings release discusses our business outlook and contains certain forward-looking statements. These particular forward-looking statements and all other statements that may be made on this call, excluding historical facts, are subject to a number of risks and uncertainties, and actual results may differ materially from any statement we make today. Please refer to today's press release and our SEC filings, including the risk factors section on Form 10-K for the year ended December 31, 2006, for more information on the risk factors that could cause actual results to differ.

We are pleased with our fourth-quarter results and record performance for the full year. As stated in our news release, this was the 10th consecutive year of improved financial results, and we remain optimistic about our future. Revenues for the quarter increased 5.5%, and 4.2% for the full year. This growth was a result of the momentum of our sales and marketing programs.

Our commercial pest control segment had a particularly strong year, with our commercial sales team delivering our best overall results and the best year-over-year improvement in the history of the Company. For the fourth quarter, commercial pest control sales were up 25%, and up almost 14% for the full year. National account sales were equally impressive with a 45% increase over last year and up 16% for the year.

It should be noted that a good portion of the sales that were made in the fourth quarter are just now beginning to produce revenue in the first quarter of '08. As an example, we have almost 3500 new individual store locations for three national accounts that are now scheduled to start service in February. I would like to voice my appreciation and acknowledgment to the members of our commercial sales team for such a terrific year, and we're looking forward to an even '08.

Our specific industry concentration and excellent service performance are enabling us to increase new contract prices. In 2007 we increased our average new commercial sales price by over 15%. Our average contract for our commercial customers has increased almost 23% over the past two years. The maturation of our commercial and national account sales force, bolstered by greater experience and savvy, have likewise generated improvement in our average sales per employee. As you can see, we're pretty pleased with this business segment.

Let me now turn to our other two service offerings, residential pest control and termite control. As many of you are aware, these units earlier were negatively impacted by the drought conditions in most of the country during the first half of '07. We were fortunate, however, that our investment in Web marketing helped offset our fall-off in conventional advertising leads. I will comment more on this in a few minutes. We overcame this handicap and saw an increase in demand in both residential and termite services late in the season that carried through until the end of the year.

Another point concerning our termite business is there was significant reduction in termite claims and related expenses this past year. The number of paid claims for the year was down over $5 million, and we ended this year with 26% fewer open claims than last year. To put our claims in perspective, you need to keep in mind that less than one half of 1% of our customers filed a claim in '07. And those that did, close to 100% have been resolved to their complete satisfaction. Fewer claims, happier customers.

The revenue growth we enjoyed in all three lines of our business just mentioned was attributable in part to our national Orkin Customer Service Center, or OCSC. We established this in '06. Their role in part is to receive and sell the majority of our residential pest control [leases], and help us acquire and forward to our branches the termite control [lease]. We expect OCSC to contribute even greater to our growth this year as we improve in both of these areas. We are also pleased to have significant improvements in customer retention in commercial pest control and termite control. Residential pest control was flat.

Now let me expand on my earlier Internet marketing comment. During '07 we continued to build upon the investment that we made in this area the previous year. This strategy is allowing us to use our size and national branch network to a competitive advantage. We expect our number of prospects for both residential and commercial Web leads to increase even further in the new year. Most importantly, we are continuing to learn how to better attract these prospects and convert an even higher percentage of those Web leads into new customers.

To help us achieve these objectives, we engaged a new search agency last month, 360i, to help us make it easier for customers to access Orkin. At the same time, we engaged a new Yellow Page agency, YPM, to assist in improving our marketing in this area, and to help us find new customers at a lower cost per customer.

Last year we determined that we needed to improve how we advertise and promote the Orkin brand in conventional media -- radio, TV, cable, etcetera -- and subsequently hired The Richards Group of Dallas, Texas as our agency of record. We felt we needed to do a better job in communicating with our prospects, and to be more effective in reaching our target audience. We have been working with them for the past few months and are very excited about our new partner and the work that they're doing with our advertising, which, incidentally, will begin airing prior to our next conference call.

We're continuing to make progress on our routing and scheduling management system, or [Orion], as we've named it. We expect to go live at several of our branches early in the second half of this year, and we plan to have a completed and field-tested system before the year is out. Due to our size, it may take as much as two years for a complete Orion rollout. As stated on our last call in preparation for Orion's implementation, we are currently utilizing MapPoint software, an offshoot of our GPS system, to begin the first phase of route organization. Part of this initiative involves refining and standardizing our customer data, which likewise will be a precursor to our Orion conversion.

We continued to invest in our greatest asset, our people. Last year's training became available to all employees in the US and some parts of Canada via our Orkin TV satellite network. We also launched what we call our Lifetime Learning Initiative, aimed at helping all of our field employees grow and develop throughout their careers. A top priority this year is to identify specific performance-based training opportunities to help employees develop to their highest potential. We were recognized this month for the sixth year in a row by Training Magazine as one of the top 125 companies that excel in human capital development.

Following on from our women's leadership conference last fall, we have formed a women's resource group to further develop initiatives to both recruit more women to Rollins and Orkin, and to advance the careers of those presently at the Company.

We're always proud of the individuals in our company who receive industry recognition. During '07, among those distinguished were Paul Hardy Sr., technical director, who won the prestigious President's Award from the National Pest Management Association. [William Grays] of Orkin's Indianapolis branch was named Termite Technician of the Year by Pest Control Technology Magazine. And our public relations team won the Silver Anvil Award from the Public Relations Society of America for its work in publicizing the recent increase in bedbug infestations throughout the US.

Overall we're very proud of our accomplishments this past year, but remain challenged to improve. The more we accomplish, the more motivated our team is to stretch ourselves to improve our company for the benefit of our customers, employees and shareholders. I've mentioned a few objectives and plans we have for this year, and will be discussing these and others with you over the next quarters. I hope you can sense that we're extremely excited about our company's opportunities in 2008.

I'll now turn the call over to Harry.

Thank you, Gary. Today we reported that fourth-quarter revenue grew 5.5%, and thanks primarily to our commercial sales team, this represents our best quarter for growth this year. Revenues totaled $216 million compared to 204.7 million for the fourth quarter last year. Net income for the quarter was 11.9 million, as compared to 10.5 million last year, a 13.2% improvement, while diluted earnings per share this quarter is $0.12, a 20% improvement over the $0.10 reported last year in the fourth quarter. For the full year, revenues rose 4.2% to 894.9 million, net income rose 12% to 64.7 million, and diluted earnings per share increased 14.3%. All EPS calculations are adjusted to reflect the 3-for-2 stock split that was effected in this quarter.

I'm particularly pleased to expand our discussion on this quarter's revenue growth and the positive growth in all of our business lines. It's been difficult to miss all the talk of economic concerns in the headlines these days, but we have not seen much of an impact on our business to date. As Gary has previously stated, rats, roaches and termites don't read the Wall Street Journal. Seriously, we are fortunate that pest control historically has been recession-resistant.

Let's start with our commercial pest control, which has been a key strategic focus of ours. This year it represents 44% of our business, though representing almost 46% in the fourth quarter. Excluding commercial fumigations, our commercial revenue grew 10.3%. Let me repeat that. Our commercial revenue, excluding fumigations, which is somewhat lumpy, grew 10.3%. That just sounds and feels so good. And including fumigation, grew 9.8%.

For some time we have stated that we felt our commercial pest control offering has the opportunity to not only outpace residential pest control's growth rate, but approach 10% growth. And this quarter's results certainly validates that statement. With the continued maturation of our sales force, our average monthly sales for our commercial account managers continued to increase. Fueled by a strong pipeline of sales proposals, we look forward to continuing positive momentum from our commercial pest control business.

Our residential pest control service, which now represents almost 37% of the business, grew 3.4%. Our termite service line also grew. Normally I wouldn't be bragging about eking out a small 0.3% gain in the quarter; however, we believe that industry-wide, termite business growth may have been significantly negative for the year.

For the quarter, our gross margins improved by 70 basis points. This represented an improvement in gross margin to 45.7% versus 45% last year. Although some progress was made in several areas, the most significant increase in margin is primarily due to continued improvements in the cost of risk. Total insurance, litigation and claim expense improved 70 margin points. These reductions were due to the success of the Company's loss control programs for both casualty and termite claims, which more than offset an increase in the litigation cost in the quarter.

In addition, we experienced improvements in service productivity, reflecting the preliminary route optimization that is underway in anticipation of Orion, our permanent routing and scheduling solution. This improvement was offset by greater fleet costs, reflecting the higher cost of fuel in the quarter. Keep in mind that major improvements in service productivity will ultimately result in lower fleet expense.

Sales, general and administrative expenses for the fourth quarter ended December 31st increased 5.4 million, or 7.8%, to 34.6% of revenues from 33.8 for the fourth quarter last year. Salary expense increased as expected due to the expansion of our staffing in our national call center, along with some higher technology costs related to resulting technology initiatives in this area.

On the favorable side, the Company experienced reductions in both bad debt expense and summer sales program costs. Tax rate for the full year was 38.3% versus 39.3 last year, due to increase in our tax-exempt interest income, and we were able to favorably resolve some state tax issues.

The Company continued to generate superior cash flows. Our cash position and balance sheet remain very strong. Cash and cash equivalents this quarter stand at 71.3 million, with practically no debt. We've completed the funding of our pension plan with this quarter's $5 million contribution. Our plan as of 12/31 is now fully funded based on actuarial assumptions. I'm sure a lot of companies would like to be able to make that claim.

Our net cash provided by operating activities for the year totaled 89 million, increasing 3.8 million over last year. We continued to return money and value to our shareholders through our dividend as well as our ongoing stock buyback program. Through these two programs, we returned over $62 million to our shareholders this year.

Speaking of dividends, the Board of Directors in yesterday's meeting increased the quarterly dividend 25% to $0.625 per share. This marks now the sixth consecutive year the dividend has been increased a minimum of 20%. As to stock buybacks, we purchased 2,373,000 shares in 2007 under our previously approved plan, and have authorized an additional 1 million shares to purchase.

Remember, our cash generation will be greater than earnings, as nearly half of our depreciation and amortization, or 13.4 million for the year, represents write-offs of intangibles, primarily customer contracts valued at time of acquisition. This represents a significant non-cash charge to the P&L. Based upon our fully-diluted shares outstanding, it represents a non-cash after-tax charge of $0.08 to GAAP EPS this year and next.

Last week we had our 2008 region manager meeting, and I don't remember a prior meeting with as much enthusiasm as voiced this year by our management team. We look forward to reporting another year of steady and consistent sales and earnings growth as we convert that enthusiasm to execution of our growth and operational strategies.

I will now turn the call back over to Gary.

Thank you, Larry. We're now ready to open the call for any questions that you might have.

(OPERATOR INSTRUCTIONS). Clint Fendley, Davenport.

Congratulations on the quarter. Harry, a couple of questions here. First off, given the adjustments in the tax rate for the fourth quarter, how should we think about that rate looking forward into '08 here?

I would expect for the first three quarters of next year to probably see a rate right around 39%, maybe a little less. And then as we -- the [states] are always a wild-card in that as we go through and true that up, and this year we had some favorable results. But I don't think -- I wouldn't count on the 38.3 being sustainable. But Gary is always (multiple speakers)

I'm glad you asked that question, by the way. It's one that I ask Harry about every month.

We continue to work on it, but I'm hoping for tax relief from next year's Congress.

And on the pension change from the liability to the asset here, was there any impact on the P&L from that?

No. All of that runs through other comprehensive income and retained earnings.

Harry, on the termite claims, do you have the actual number for the quarter?

I don't have that handy. I'll have to get back on that.

That's fine. Gary, any thoughts on why we've seen kind of the negative growth across the industry here? What could be driving that?

I think the biggest thing is the weather. I hate to give you a weather report, but probably 40 or 50% of the country had, really, drought conditions or severe shortages of rainfall. And I think that one of the learnings there is we always knew that moisture was important, as was evening temperatures. And I think this year was very educational because we really saw exactly how important it was. We can almost track our conventional leads by the relative rainfall variance throughout the country.

Thank you. That's helpful. Harry, I guess, on the cash, we saw the balance come down just a little bit sequentially. Any thoughts on what kind of drove that flex?

This quarter there was substantial share repurchase in the fourth quarter; I think it was 566,000 shares at an average price that was over $19. So, a lot out of that money was returned to shareholders through the share buyback program.

Final question. Just any thoughts -- obviously, a lot of momentum it looks like here on the commercial side as we head into Q1. Just any preliminary thoughts on the quarter?

We're optimistic. We certainly don't do earnings projections, forecasts, but we're optimistic. We think, for the reasons that I mentioned, that we've got a lot of revenue that was generated in the fourth quarter, which is typically unusual historically -- a lot of the sales, rather, will convert to revenue in the first quarter of this year. So, we hope we're not foolish. We're certainly not oblivious to the economic uproar, but we think that we can control our destiny. We're certainly in a lot better position than most companies that are really vulnerable to borrowing money and a lot of the factors that take place.

Furthermore, we have never been a company that had a large weighting towards new construction or new homeowners. And I guess that's the good news/bad news. We probably over the years should have done a better job with that, but the good news right now is that's not going to really impact us like it will contractors and a lot of other pest control companies that have really concentrated on new construction.

Do you think that that could potentially open up some opportunities for you on the M&A side with some of the regional players here that do have more exposure to the real estate market?

I'm hopeful that -- kind of a down year and the prospect of -- for some -- for some competitors -- maybe not an encouraging prospect for '08, that there will be some motivation as far as selling businesses. You never know, but I think that if people have succession plans, estate plans, and kind of a look at the prospect and maybe having two disappointing years in a row, that this may give them the motivation to decide that they need to sell their business.

Thank you.

Jamie Clement, Sidoti & Co.

Gary, do you -- I don't know if this number is something that you all disclose, but I know you just mentioned three large accounts, 3500 new locations hitting the commercial business in February. Can you give us a rough sense of kind of what the breakdown is in your commercial business between national accounts versus independent local businesses?

I'd have to give some thought to that. The total commercial business is in the neighborhood of the year just under, I think, 400 million. Our national account business is 30 to 35 million. So, national account business is less than 10% of our commercial business.

But I would also -- and this would be the follow-up question -- it seems like you all are extremely pleased with the national account sales team. So I was trying to get a rough sense of is that the area of the commercial business that you think the really super-strong growth would be the most sustainable over time?

The biggest investment that we made was in what I would call kind of local commercial (multiple speakers) regional commercial. We may have added one or two salesmen in our national account business. I think the biggest thing you're seeing in national account is, really, the service improvements, and frankly, some of the deterioration in service among some of the competition, because pest problems for national accounts are really a big deal. They just cringe over having a headline or the newscast or something that talks about a pest problem in some of their locations. So, I think it's the maturation of our national account sales force. I think it's the fact that some of our competitors have stumbled. Now, the good thing about this business that I commented on; it was all at higher prices than the competitor's had it for. So that makes you feel good. I really have no interest to go in and cut the guy's deal and get this based on price.

The way you guys can accomplish that, is that -- is your feeling on that just a higher quality of service?

I think exactly. I think as I mentioned, the consequences of bad service or a cheap deal is just getting so significant. And I think when you call on these people, you can tell very quickly in the visit that they're very concerned about keeping their company out of the paper, and really concerned in getting good quality, more so -- I've been in the business 40 years; I've never really seen the level of concern about not having pests to the extent that it exists today.

Changing gears just a little bit, earlier this year you started talking about it a little bit on the calls, and talked about it again here, but Internet leads. How untapped a resource is that for you? Roughly what percent of your residential business, the new business, is now being originated from the Internet? Would you have a rough guess on that?

Yes. I'm trying to -- I don't have anything here in front of me. A little over half our business came through our national call center, but that includes calls and Internet. Internet continues to grow double digits.

(multiple speakers)

I would say in a 20 to 30% range. We can get back with you and get maybe more --

That's okay. But it sounds to me like that's (multiple speakers)

(multiple speakers) thing is, of course, when you're just starting, the increases are pretty dramatic (multiple speakers) percent point of view. And the wonderful thing this year was that you heard about a perfect storm; I guess this was a perfect situation, because the conventional advertising was just, which typically is influenced by the weather, the pest -- our advertising and our pest pressure, if you would. But, we just had the Web thing coming on with some of the investments and the changes that we made with our Web site, the changes we made at our call center. I think I've mentioned before one of the tricky things is that people source with the Web, but they don't want to really conduct business on the Web. Now you have to figure out how do you convert a Web lead to a phone lead. So we think we've -- I guess we don't know what we don't know, but we think we're smarter than we were two years ago.

But it also sounds -- and correct me if I'm wrong -- it sounds like this is -- you've sort of just kind of scratched the surface here, and you expect your (multiple speakers)

We can just see a greater part of our advertising budget going in this regard. Of course, one of the reasons that we increased our staffing at OCSC was to make sure that we handle these leads on a timely basis. A pest control lead is not something that you can put on a shelf and work on when you get around to it. When people really get motivated because of a pest sighting, or just total frustration because they haven't been able to fix it themselves, they want to do something and take care of it. So you really have to be responsive when you get these leads.

Thanks very much for your time.

[Patrick Stowe], Priority Capital.

Just a little clarification. Did you say that the claims expense was down 5 million for the year?

For the full year.

Do you feel like that's a pace that can continue? I guess you said the number of clients was down something like 25% at the end of the year, the number of open claims.

I certainly won't sit here today and say we're going to drop -- we could drop another $5 million in the next 12 months. I think the rate is sustainable. The number of claims in the backlog is down. The number of serious cases, I think, continues to be addressed. What we have seen historically in the termite claims, it seems to go in steps. For a number of years it was 23 million for a couple of years, and they dropped down to the $17 million range; [we were in] $17 million for about three years, if you look at history dollars spent. This year it took another decrease. And some of it is the older customers that we had that were treated with different chemicals in the past become less of our total customer base.

One of the things, if I can expand on Harry's comments, I don't think we'll be taking this big a bite out of the apple each year. But I do think that what we're seeing is really what we've done in the past. We've put our claims on an early reporting deal like we do workers' comp claims, where they have to be called into Atlanta as soon as they're received. There's a penalty to the branch if that doesn't happen. So, we don't really have claims lingering out in these branches. And I think that was one of the problems that we had in the past was that they just were not receiving the kind of attention that they needed to receive. I think that my expectation is it will continue to decrease, but I don't think it will do so in $5 million [clips].

So, I guess, am I thinking about it correctly? If last year it was about a $17.5 million charge, this year it was something like 12.5?

That's correct.

At some point I guess you would expect -- there will always be some base level of claims; you wouldn't expect that to go to zero over the next 10 years.

[It'll] never go to zero. If you look back at the history of the Company, the lowest it was ever, it was $3 million. But the trends are positive, we have proactive processes in place, and we think we'll continue a favorable trend.

That's helpful. I appreciate the color. I know over the last couple of years you guys have invested in your IT systems, specifically in routing software. Can you give us an update on where you are there, and if that's helping to address the expense structure positively?

Routing and scheduling will ultimately let us be more productive and efficient. The routing and scheduling initiative has been underway probably longer than we care to talk about it. But we're in the final stages here. We've introduced it, and we brought in a number of key managers, branch managers, region managers, and demoed the system and the capabilities. I think at the last region manager meeting last week we had four of the region managers who were -- had that desire to be early adopters get up and build enthusiasm and share their experience as to what they see. So, we can't wait to get it out of the lab and get it live. It's going through a couple more shakedowns. We have -- the number of severity one issues is down to the point, I think -- we're working on the final performance tweaking to make sure that when we interface with a customer, we don't keep them on hold an extended period of time. So we've got a couple more weeks here of testing. We're running live data. We'll be -- as we mentioned, we'll -- end of the second quarter, beginning of the third quarter, we'll be live in some branches, and begin a full-scale implementation before the year is out. It could take us two years to get to the 400 locations.

I think one of the things that is really noteworthy is this isn't like changing an accounts receivable system, or an inventory system, or whatever. I mean, these are customers that are happy. They're staying with us longer. We successfully service them every month when we're supposed to. So we really have to be very cautious with this conversion and with this testing. That's why, I guess, I would suspect that our testing cycle will be twice as long as another system, or another type application, because we just want to be sure that we don't end up suffering as a result of this conversion.

I certainly understand the importance of it. And speaking from a customer's point of view, I appreciate the benefits of it. I just wanted to make sure I was thinking right about kind of a timeline of returns on that investment. It sounds like [we'll] be live at the middle of this year, and then cycling into next year, it's still a little bit out in front of us.

We're still -- we haven't -- we're disappointed that we don't have it in the field. Time is money. We're disappointed that we continue to have to spend, and we don't have it working for us. But we really haven't lost our enthusiasm as to the positive impact it can have on our business and our bottom line.

Part of what we're doing, we talked about using MapPoint to do some route optimization in front of the rollout. And we're seeing productivity improvements come from that. And part of this -- it's really a precursor, and it's part of the change environment, getting people used to doing things different, cleaning up the data, getting used to the thought of optimization and whatnot. But we're starting -- we saw some productivity improvements in the fourth quarter here with some of the prep work that we're going into. It's kind of exciting to see. We're seeing -- and it's not just in service productivity; we'll see it in less miles driven, less windshield time, in allowances, in accidents. This will affect so many different areas of the business. We're still excited about it, but we still have a lot of other opportunities in the business to improve it.

I appreciate the color. One last one if I can. Did I hear you right that your average pricing on new commercial contracts was up 15% in the quarter?

Yes, that's correct. That doesn't reflect necessarily a price increase; it has (multiple speakers). It's new contracts, and it more has to do, I think, with the complexity of the customers and the mix of the customer, that we're selling more upstream, selling more services than we had in the past. And I think part of that is having a professional sales force man it, being managed and directed. And I think part of it's an outgrowth of what we've done in part of our last couple years commercial steering project. One of the things we did is we developed [a] standard scope of services, so that when our salespeople did go into an environment they weren't necessarily familiar with -- okay, if I'm going to be in this type of company, here's at a minimum the service I should provide, and it helps them price it properly. And also, I think, it ultimately results in better retention and customer service, because we're doing the service necessary to provide them a good environment.

Just on the commercial side, you gave a +10.3% number. Is that organic growth for the fourth quarter?

Yes.

Is there any way to break that out between kind of new customer wins versus, I guess, increased revenue with existing customers?

No. We really don't slice and dice it that finely.

The last question I have is I guess you gave a (multiple speakers) sorry about that. I appreciate the time. You gave a +25% number for the commercial business.

I believe that was the increase in sales from the national -- was that the national sales?

I was just trying to reconcile that with the 10% organic (multiple speakers)

Sales and revenue are two different things. We track sales -- that revenue is going to come in over the course of 12 months. So -- and your revenue is your month-to-month or month-to-prior quarter change.

Okay.

And when we talk sales (multiple speakers)

Sales is more kind of a backlog number, I guess?

Yes. You would sell a contract, let's say, for $1000 --

Let's say $12,000. But you would just get $1000 a month for the next --

12 months.

-- next 12 months.

I understand. So that will (multiple speakers)

(multiple speakers) quarter, if we sold it in the last quarter and we started in the first quarter, then you would just get three months of the sale.

The 25% was comparing sales booked in this quarter versus the same quarter (multiple speakers)

I understand. I appreciate the time, and I wish you the best of luck.

Thanks for your interest.

(OPERATOR INSTRUCTIONS). We have no further questions at this time. I'd like to turn the line back over to management for closing remarks.

Thank you. I'd like to thank all of you for joining us in today's call and your interest in Rollins, and we look forward to you participating on our next call. Have a good day.

Ladies and gentlemen, this concludes the Rollins fourth-quarter conference call. If you would like to listen to a replay of today's conference, please dial 303-590-3000, or 1-800-405-2236, passcode 11106089. You may now disconnect.