Good day, and welcome to the Rollins Inc. Third Quarter 2019 Earnings Conference Call. Today's conference is being recorded. At this time, all participants are in a listen only mode. Later, we will be conducting a question and answer session and instructions will be given at that time.
I would now like to introduce your host for today's call, Marilyn Meek. Ms. 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 1, 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 1 hour after the call and run for 1 week. The replay can be accessed by dialing 1-eight eighty eight 203-eleven twelve with the passcode 2,950,556.
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 and presenting are Gary Rollins, Rollins' Vice Chairman and Chief Executive Officer John Wilson, Rollins' President and Chief Operating Officer and Eddie Northam, 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, Marilyn. Thank you and good morning. We appreciate all of you joining us for our Q3 2019 conference call. Eddie will read our forward looking statement and disclaimer and then we'll begin.
Our earnings release discusses our business outlook and contains certain forward looking statements. These particular forward looking statements and all other statements that have been made on this call, excluding historical facts, are subject to a number of risks and uncertainties, and actual risks may differ materially from any statement we make today. Please refer to today's press release and our SEC filings, including the Risk Factors section of our Form 10 ks for the year ended December 31, 2018 for more information and the risk factors that could cause actual results to differ.
Thank you, Eddie. Well, 1st and foremost, we're pleased with our Q3 execution and results across all of our business service lines. The warm weather finally appeared thankfully, although later than normal. As a result, we experienced a strong delayed demand for our pest control services. Following a less than satisfactory second quarter, we worked diligently to ensure that we right sized our headcount and reduced expenses that weren't essential for the quarter.
We're proud that our team responded effectively. It's also noteworthy that many of our investments in programs continue to generate improved levels of employee retention. This is worthy that many of our investments and programs continue to generate improved levels of employee retention. This is an important step to improving customer service in the field and administration. In addition, earlier this month, we completed the transition of our fully funded U.
S. Pension plan to an insurance company. This will provide our company with several accomplishments. We will be eliminating the annual pension contribution, insurance fees, administrative costs, pension management and other related costs to the plan. There will be ongoing cash savings.
Our employees since freezing of the plan in 2,006 have enjoyed significant enhancements to their benefits, most recently to their 401 plan. Eddie will provide more detail on the pension discontinuation in his remarks. Record revenues for the quarter $7,700,000 in the Q3 of last year. Diluted net income of $44,100,000 or $0.13 per share was impacted by the non cash pension settlement cost that compares to 66,600,000 dollars or $0.20 in 2018. Revenues for the 1st 9 months rose 9.6% to 1,500,000,000 compared to 1,377,000,000 for the same period last year.
Net income was approximately $152,600,000 or $0.47 per diluted share compared to $180,700,000 with earnings per diluted share of $0.56 for the 1st 9 months of last year. Eddie will review the non GAAP results shortly as they're very meaningful. We experienced strong growth in all of our business lines in with residential up 17.6%, commercial pest control rose 9.2% and termite and ancillary services grew 15.4%. We believe our 3rd quarter results reflect both the resiliency of our company and our team's ability to respond to operational challenges. Before turning the call over to John, just a quick update on Clark.
John and I visited again with the team in California this quarter and the more time we spend with Clark and their employees, the more excited we are about having them as a member to our family of brands. We're making great strides with our integration as they are now live on our fleet system, fully transitioned into our 401 program and improving their telecom systems. Now I'd like to turn the call over to John. John?
Thank you, Gary. With the warmer weather experienced during the Q3, mosquitoes among other pests were much more active. Even as the population is becoming more aware of the health threat of mosquitoes, there's still much to be done in this area. Eastern equine encephalitis, West Nile, Zika and other diseases caused by mosquito bites are becoming our greater health threat. We continue to work with various agencies and organizations in an effort to educate the public about these mosquito risks.
In order to meet this public threat, we have worked persistently over the years to add mosquito services in all branch locations. This year we have grown that service line by more than 30% and this has helped greatly to propel us to our 6.4% overall organic growth rate for the quarter. Additionally, we know that coupling these and other service offerings together for our customers clearly lengthens our relationship with that customer, increasing the revenue received. Now I'd like to share with you some exciting news regarding one of our brands. Northwest Exterminating, last week at the National Pest Management Association meetings, Northwest received the National Pest Management Association Gives Award.
The NPMA Gives Award recognizes member companies that have demonstrated leadership through dedication and contribution to their community. Rollins has increasingly encouraged our brands to give back to their communities and Northwest has certainly led the way in this effort. We are proud of this recognition and want to congratulate our team at Northwest. In 2,006, Northwest introduced their Green Pest Control Program, which is a rather unique service offering targeting common household pests, ants, spiders, roaches, mice, centipedes, millipedes and more, using only high quality non toxic products derived from botanicals such as flowers, plants and natural elements from the earth, as well as an IPM or integrated pest Management approach utilizing exclusion techniques to keep pests out in the 1st place. Over time, this program is expanded to include a Green Elite offering as well as other green services such as termite, mosquito and lawn care.
Northwest's green programs are continuing to grow with an increasing desire among homeowners for non chemical treatment and pest control. Overall, these programs are greatly contributing to Northwest's impressive growth rate as this brand has produced the highest growth of any Rollins brands during the quarter. Gary previously noted our strong employee retention and I am pleased to be able to say that we have continued our improvement in that important metric in the Q3 of this year. We talk about retention a lot in our businesses as we can't stress enough that for a service provider the importance to ensuring that our employees remain happy and motivated in their jobs is paramount. A happy employee translates to a happy customer.
We have largely focused our field team efforts in 3 ways to gain this improvement. 1st, we conduct exit surveys to focus on why people leave, as well as concerted employee engagement assessment efforts to ensure our teams feels they have a voice in making things better. And last is the effort to improve the onboarding and orientation experience our people undergo. We know if we can just get them past the 1st year or so, the likelihood to stay goes up exponentially. Our team members are the face of our brands and we will continue to invest in training programs, technology and provide opportunities for advancement to ensure they remain with us.
Finally for me, just a quick update on routing and scheduling.
For the Q3, we
again had improvements in driving and route efficiency as we clocked 571,000 less miles driven. This improved efficiency comes on the heels of a 1,400,000 mile reduction in Q3 last year, and we have now had 19 consecutive months of mileage reductions. Now let me turn the
call over to Eddie. Thanks, John. Mother Nature returned with full strength in the Q3 and our operations, support staff and sales groups were up for the challenge. Record revenues enabled strong improvements in our financial metrics across the board. Even with the ongoing business expenses, headwinds of employee benefits, foreign currency exchange and Clark integration items, we made tremendous improvements in all of our financial metrics for the quarter and are positioned well to end the year on a very strong note.
For the quarter, all of our service lines showed exceptional growth and keys to the quarter included finalization of the Rollins pension risk transfer, expansion of our Glimpse communication to our residential customer base and a return to margin growth year over year. Before we proceed with the review of our financial results, I hope that you've had a chance to review our press release from October 3rd related to our pension risk transfer. If not, it is posted on our website to view. Our overfunded status grew from our original estimate of 104% to nearly 111%. As noted in the press release, we will be using these cash proceeds to fund our company 401 match over the next several quarters and pay other plan related expenses.
Once these steps are completed, we will anticipate bringing $6,000,000 to $8,000,000 in cash back to the company for additional deployment. The accounting adjustment was also significantly lower than our original estimate, mainly driven by lower interest rates. This accounting pension adjustment flowed through our P and L in Q3 and was approximately $50,000,000 before tax. As you know, this is a one time non cash occurrence. As Gary said, I will be discussing our GAAP metrics and then spending time on our non GAAP financial metrics that exclude the pension adjustment.
For the quarter, we are only calling out the pension adjustment for our non GAAP results. But a few other items to keep in mind with regards to our net income for the quarter related to our Clark acquisition are depreciation of $1,400,000 for the quarter for buildings and vehicles added, amortization of intangibles up $2,900,000 for customer contracts, interest expense was $2,800,000 related to the borrowing of Clark, Professional services up $800,000 as Clark uses a large number of subcontractors and this is a higher percentage of revenue than in our other Rollins brands. These categories equate to 7,900,000 and as they subside or are lapped, we'll continue to improve our year over year margin expansion moving forward. As we look through our numbers, I will give you GAAP numbers that include our pension accounting adjustment and then transition to our non GAAP numbers that reflect our true operating results, again, only with the pension loss eliminated. So with the pension, looking at the numbers, the 3rd quarter revenue was $556,500,000 That was an increase of 14.1 percent over the prior year's 3rd quarter revenue of 487 $700,000 Again, with the pension adjustment included, income before income taxes was $46,100,000 or 48.7 percent below 2018.
Net income was $44,100,000 down 33.9% compared to 2018. Our GAAP earnings per share were $0.13 per diluted share. Without the pension adjustment, our non GAAP income before income tax rose 6.8 percent to 96,000,000 dollars compared to $89,900,000 in 2018. We had a slightly higher tax rate this quarter at 26.4 percent, but feel that our full year rate will be in the low 20s with our Q3 pension entry. Our net income rose 6% to $70,600,000 and EPS were $0.22 per diluted share, up from $0.20 per diluted share in the Q3 of 2018, a 10% increase.
As I have mentioned calls, our best financial measure at this time is EBITDA, which was $120,600,000 compared to $106,700,000 in 20 18, a 13% increase. We have only had one other quarter outside of the quarter with the Tax Cuts and Jobs Act that eclipsed this growth since 2014. With detention revenue for the 9 months ended September 30, 2019 was $1,509,000,000 an increase of 9.6 percent over the prior year's Q3 revenue of 1,377,000,000 dollars Income before income taxes decreased 20.9 percent to $189,200,000 from $239,300,000 in 20 18. Net income fell 15.6 percent to $152,600,000 and earnings per share were $0.47 down 14.5 percent from the 2018 number of $0.55 EBITDA was $252,100,000 down 12.9% compared to 2018. Without the pension adjustment, income before income tax decreased a 10th of a percent to $239,000,000 from $239,300,000 in 20.18.
Net income fell 8 0.8 percent to $179,200,000 and earnings per share were $0.55 flat to the previous year. EBITDA was $302,000,000 up 4.3% compared to 2018. Our technology roadmap continues to pay healthy dividends with regards to operational efficiency improvements and an improved customer experience. John mentioned the improvements in miles driven for the quarter as we continue to see improvements year over year since the inception of our routing and scheduling initiatives, which started in 2016. These reductions increase the technicians' capacity.
As of September, we have added over 70% of our Orkin residential routes to Glympse. Each customer on these routes is receiving multiple proactive text or email notifications from the technician beginning days in advance and culminating when they are on their way to the customer. This technology is the best in the industry and our early results show improved customer retention for each of our mature branches that are providing this enhanced customer communication. We anticipate these results to continue to improve our customer retention and margin for quarters years to come, much like we have seen from our routing and scheduling results. Let's take a look through the Rollins revenue by service line for the Q3.
As discussed earlier, our total revenue increase was 14.1% and included 7.7% from Clark and other acquisitions and the remaining 6.4% was from pricing and organic growth. This is the strongest organic growth rate in a quarter since 2013. In total, residential pest control, which made up 45% of our revenue, was up 17.6%. Commercial Pest Control which made up 37% of our revenue was up 9.2% and termite and ancillary services which made up approximately 17% of our revenue was up 15.4%. Again, total revenue less acquisitions was up 6.4%.
From that, residential was up 8%, commercial increased 3.5% and termite and ancillary grew 7.9%. This was the largest commercial increase in over a year. Revenue strength this quarter is a combination of the late season that did not materialize in Q1 or Q2, execution by our operations and a great job by our sales force. One of Gary's famous quotes is, the season always comes. At some point, it does get warm and the pests do come out and the season does start.
In most years, that strength is seen in May June and impacts Q2. As you know, that did not occur this year, but our year to date revenue growth ex currency and M and A is moving in a direction to be in line or higher than the past 3 years. The key is that demand does not evaporate. When it gets warm, the bugs come out. This year, that did not happen until July, but it did in a really big way.
In total, gross margin improved to 51.7 percent from 51.6% prior year's quarter. The quarter experienced increases in several categories such as service salaries, sales salaries, personnel related and professional services, all related to the acquisition of Clark. These increases were offset by reductions in administrative salaries due to improved efficiency and reduction in materials and supplies. The additional Clark items that I just mentioned impacted the margin by almost a full percentage point. Depreciation and amortization expense for the quarter increased $4,800,000 to $21,700,000 an increase of 28.6%.
Depreciation increased $1,700,000 due to acquisitions and equipment purchases as mentioned earlier, while amortization of intangible assets increased $3,100,000 due to the amortization of customer contracts from several acquisitions. Sales, general and administrative expenses for the 3rd quarter increased $22,100,000 or 15.2 percent to $167,200,000 or 30 percent of revenues, up 0.3 percentage point from 145,100,000 or 29.7 percent of revenues for the Q3 of 2018. The increase in the percent of revenues is primarily due to acquisitions as well as increased sales competition, compensation, enhanced 401 plan expense, maintenance and IT contract expense. As for our cash position for the period ended September 30, 2019, we spent $431,200,000 on acquisitions compared to $71,800,000 for the same period last year, which of course included Clark. We paid $103,100,000 on dividends and had $18,700,000 of CapEx which was up 4.8% from 2018 primarily from planned IT upgrades such as our BOSS Canada rollout and building improvements.
We ended the period with $104,400,000 in cash, of which 71,000,000 dollars is held by our foreign subsidiaries. Yesterday, the Board of Directors declared a regular cash dividend of 10.5 dollars per share that will be paid on December 10, 2019 to stockholders of record at the close of business November 11, 2019. In addition, the Board declared a special dividend of $0.05 also payable when the regular dividend is paid. For the regular cash dividend, this is a 12.5% increase over the prior year. This marks the 17th consecutive year the Board has increased our dividend by a minimum of 12% and the 7th year in a row the Board has declared a special dividend.
Gary, I'll turn the call back over to you.
Thank you, Eddie. We're happy to take your questions at this time.
Thank you, Our first question will come from Tim Mulrooney with William Blair.
Good morning.
Good morning. Good morning.
Yes, I want to focus on I know it's a smaller piece of your business, only 17% in the quarter, but wanted to ask you a couple of questions about your termite business this morning. Almost 8% organic growth, which is particularly impressive, I think, given that last year that's on top of a 6.5% growth. So I mean your termite business is growing really well and kind of above what we've seen in some of your competitors. I was wondering if you could comment on that business and perhaps why you're seeing such strong performance there?
Yes, Tim, I would say a couple of different things. We've had good termite growth. I think if you look back probably over the last 9 or 10 quarters, maybe even a little bit further back than that, we've had good consistent termite growth. You're right, this quarter enhanced a little bit more. A little bit of that would be pent up demand.
But we've talked about on previous calls that we have our internal credit department that enables us to really be able to help as a closing tool for that. So it's a great quality service from a termite perspective. And we also have that ability for our customers to be able to use our internal credit department for some time in some cases a larger dollar expense that they would have for that type of a service. So operations continue to put a good quality product out there and I think the sales folks continue to use our sales tools extremely well to be able to close those sales.
Okay. That's helpful. Thank you, Eddie. And then as my follow-up, one of your competitors recently began talking about some increased claims expense that they're experiencing because of more aggressive behavior from the Formosan termite and this was in a specific region, but I'm just curious if you guys are also seeing higher claims activity, some thought maybe if one company was seeing it, maybe other companies would be seeing it too. I'm wondering if you're seeing increased pressure from higher claims activity as well.
Thank you.
Yes. Tim, I don't know the specifics of the other that you're talking about and we can read some of the same things that you read publicly. I'll say from a perspective for termite, our termite claims are actually down year over year. Our dollars our litigated dollars are down and our claims dollars are down year over year. I think the thing that we have in place that really has enabled us to continue to reduce this over many years is we have a very strong dedicated termite services group, technical services group that enable us to make sure that we have a good quality product that's out there.
We have a QA group that will look on the backside to make sure that a good quality service is being done. And they'll also help to manage any claims related issues or concerns that might be out there to be able to help to minimize that in any way possible. We also take a look carefully at the contracts that we offer that are available and out there kind of based on type of termite in the different areas of the country to make sure that we feel like that it's the right risk to be able to take in the different areas.
Yes. And I would add to that, that this termite dedicated termite quality assurance team that Eddie mentioned, they are independent from our branch operations. So they go into every one of our branches on a regular basis to actually go out and inspect the work that they do and make sure that we are delivering what we promised. And so that's been a huge linchpin in terms of us reducing our termite damage claims, both from a dollar perspective, paid perspective and a number perspective over the last, say, 20 years.
Thank you. Our next question comes from Jamie Clement with Buckingham Research Group.
Hey, gentlemen, good morning.
Good morning.
Good morning. John, I don't know if you want to
take this or Gary, but just obviously M and A activity in your industry is what I think is probably an unprecedented level right now. And it seems like a lot of smaller businesses are being bought by some of the bigger folks. It seems you all are interested in some quality smaller businesses as well. Can you talk a little bit about the challenges purchasing and integrating small businesses with respect to retention both at the technician level as well as the customer level?
Yes, Jamie, no doubt the market is frothy from that perspective in terms of the opportunity to buy these companies. And with the multiples being paid, certainly many of the smaller companies are out there and actively shopping and trying to sell their companies as well. We certainly go after the small ones. Just like we do the bigger ones. They can provide a tremendous opportunity to tuck into a location and really improve the density, the route density of that branch and that business.
And so that's usually the approach we'll take with those. But from an employee perspective, we take the same approach as we do from with the bigger ones, because as I like to say to our team, in our business, when you buy a company, you don't buy a lot of hard assets. All you get are employees and customers and neither has to stay. And so if we don't treat the employee well and onboard them well and integrate them well, then that customer won't be there at the end of the day either. And so that's really our approach, whether it's big or small.
Okay. I appreciate that. Thank you.
Thank you. Our next question comes from Seth Weber with RBC Capital Markets.
Hey, good morning, everybody. I'm just wondering if you could give us some more color, the 3.5% growth in commercial, you noted that was the best in more than a year. Is there anything you'd call out there, any kind of special initiatives, anything you've been targeting there? Can you talk about what you're seeing on the pricing front as well? That's my first question.
Thank you.
Yes, I would say that the pricing is still very rational in the industry. We know that there are other players that if you look back 3 years, 5 years, 7 years that may not have been in the market, we're still seeing very rational pricing that is out there in most cases that are available. We've really concentrated on areas where we know that there's less price sensitivity. So we've really shifted our focus probably over the last 18 months from a new customer perspective really And we're continuing to move away from those and And we're continuing to move away from those and continue to concentrate in areas where there's less price sensitivity and they care more about the quality and they're willing to pay for the quality of the service. So we're seeing some more retention from that because of the quality of service that we're able to attain.
And I think that's helping us to be able to continue to incrementally improve and in this case have a pretty, pretty healthy jump as far as the commercial is concerned. Yes, it looks great.
Yes, one thing I might add, we also implemented a new pay plan for our commercial sales people that much more greatly incentivize them to pursue recurring revenue. We kind of got hooked on that bed bug revenue for a period of time. And while that's great to get, it's not recurring. And as you guys know, we really prefer that recurring revenue to build. And so we've sort of changed our focus and incenting our people to pursue these other higher quality customers that are recurring in nature as Eddie described.
John, I'd like to add
to that. We have developed a software that we call Insight. So we have the ability to show commercial customer the layout of their facility and what we intend to do in those areas typically bait stations and service emphasis on the high pest pressure areas and we think that this is going to help distinguish what we can offer the customer so far we don't have it in everywhere, but where we do have it, we're showing good results.
And are you finding that customers are willing to pay the contract size is bigger with that insight By using insight, can you get higher contract values and things like that or can you just expand on that a little bit?
I think ultimately we will. I mean it distinguishes us and then we're able to identify where we've had a rodent activity. So this isn't just a sales tool, but it's also a means to have continuous communication with the customer. This is especially important when you get into big commercial situations and you know you might have 50 base stations in some of these larger warehouses and manufacturing operations. So So I think one of the benefits will be not only from the sales point of view, but retention point of view because we're just reaffirming the fact that we are doing these service stops, if you will, or checking the base stations and it gives a customer a feel that this is not just a sale, this is an ongoing communications tool.
Our next question comes from Brian Butler with Stifel.
Good morning. Thank you for taking my questions.
Good morning.
Just the first one on kind of the growth trends you're seeing. Can you give a little more color, I guess, on the organic trends? Maybe help us if we pull out some of the seasonality across Q2 to Q3, what kind of organic trends are you seeing? Is this pace changed recently to improving? That would be very helpful.
I think it'd be extremely difficult to break it out exactly. We've talked about pent up demand. Gary talks regularly about looking at a full year as far as revenue growth because there is going to be fluctuation that's going to occur between the different quarters. Of course, this year was tremendously different than anything that we've seen in previous years. And I think Gary probably would say the same thing in his time period.
Completely different. But there was significant pent up demand. But I would also say that we had great marketing initiatives and our operations executed extremely well to be able to have a higher retention rate from a customer perspective, which I think will help us from an organic revenue perspective as we're moving forward in time. So I think the combination of those things helped with the record that we saw this quarter. And I think you're going to help us as we're moving forward.
The technology that we put in place with Glympse and John talked about our routing and scheduling is making it a better job for our technician and it's making it a better customer experience from our customers' perspective and all those things are incrementally improving that customer retention piece, which ultimately will help us as we're continuing to grow our revenues. Okay.
And then my follow-up question just on the margins, just looking at the EBITDA margin, it looks like EBITDA margins ex the pension were still down around 20 basis points. Can you give a little bit of color on kind of very strong revenue growth, but some of that operating leverage seems to have been lost somewhere. And then how to think about operating leverage going forward from here?
Well, I talked about that a little bit in my comments when I because the only thing we called out in the adjusted was the pension adjustment. However, we do know that we have some one time events having to do with the Clark integration such as our D and A, our interests, professional expenses, as well as our 401 increases. All of those contributed probably to a difference of a percentage point as far as the overall margin was concerned. So I think if you go through and you if you want to look at it from that perspective, you go through and kind of strip those things out, I think you'll see a nice improvement year over year for the quarter. And we believe that as those areas subside and or we lap those areas, we're going to continue to see that margin moving in a positive direction as we have for many quarters, many years before this.
Thank you. Turn it back over to management for closing remarks.
Well, thank you all for joining us. We appreciate your interest. I hope you sense it. We're optimistic about our company's opportunities going forward. We have a lot of investments that we think will start to pay off in a greater form.
It's kind of hard to put it all together and come up with a cumulation of these investments and where they take us, but we see movement with all of them, positive movement with all of them. And we got some tremendous companies and brands. We're very proud of what we've done and we've got very proud of the transition that these companies have gone through and have experienced. So we look forward to giving you our update with our Q4 call. Thanks again.