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Rollins, Inc. (NYSE:ROL)

Q2 2010 Earnings Conference Call

July 28, 2010 10:00 AM ET

Executives

Marilyn Meek – Financial Relations Board

Gary W. Rollins – CEO, President & COO

Harry J. Cynkus – CFO & Treasurer

Analysts

Clinton Fendley – Davenport

James Clement – Sidoti & Company

Operator

Good morning, ladies and gentlemen. Thank you for standing by. Welcome to the Rollins Inc. Q2 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 questions. (Operator instructions) This conference is being recorded today, Wednesday, July 28, 2010.

I would now like to turn the conference over to Marilyn Meek. Please go ahead, ma’am.

Marilyn Meek

Thank you. By now you should have all received a copy of the press release. However, if anyone is missing a copy and would like to receive one, please contact our office at 212-827-3746. We will send you a 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 1800-406-7325 with the pass code of 4329321. Additionally, the call is being webcast over at www.viavid.com and a replay will be available for 90 days.

On the line with me today are Gary Rollins, President and Chief Executive Officer; and Harry Cynkus, Senior Vice President, Chief Financial Officer and Treasurer. Management will make some opening remarks and then we’ll open up the line to your questions.

Gary, would you like to begin?

Gary W. Rollins

Yes, thank you, Marilyn. Good morning and thanks to all of you for joining us on our second quarter 2010 conference call. Harry will read our forward-looking statement and disclaimer and then we’ll begin.

Harry J. 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 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 statements we make today.

Please refer to today’s press release and our SEC filings, including the risk factor section on our 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 W. Rollins

Thank you, Harry. We’re very pleased to report that all business lines contributed positively to the second quarter financial results where revenues for the quarter rose 5% and net income was up 8.7%. This marks the 17th consecutive quarter of earnings improvement. We continue to experience solid performance in residential pest control revenue which were up 4.7%, the highest increase that we’ve seen in this service since the fourth quarter of 2006. This is particularly gratifying coming off of last year’s second quarter on residential pest control was down 1.8%. Commercial pest control reported an increase in revenues of 5.4% while our termite business grew 4.2%. Additionally, we’re seeing a strong growth in our ancillary services.

Our mosquito season is now in full force and at the end of January, we saw an almost 20% increase in this business over last year. And as discussed last quarter, we continue to see a lot of that bug activity with a lot of press coverage. As net bugs remain a major concern the country, this business is rapidly growing as well. We believe that our positive financial performance is an indication that our strategy to steal shamelessly throughout all of our brands is paying off. The sharing of best practices concerning price increases, new customer pricing and new customer acquisition is benefiting all concerned. In the end, however, it all comes down to the many positive contributions our employees make every day. We take pride in our strong emphasis on recruiting high-quality individuals when needed and more importantly, pride in retaining our base of excellent employees. At the same time, we foster an environment in which all of our employees have the opportunity for career advancement.

We were therefore pleased to announce earlier this month that Steve Levitt (ph) rejoined Orkin in 1994 has been promoted to assistant to the President of Orkin, USA. That was recently, Steve was a Senior Region Manager for Orkin in the Pacific division responsible for four regions in the West Coast customer care center. Steve is relocating through Atlanta and will be focusing on among other things, maximizing Orkin’s residential pest control growth. We’re also pleased to have Bob Cipriano (ph) and Greg Thalman (ph) join our home office support organization. Bob brings over 25 years of human resource expertise to Rollins, came through his senior level positions at Kimberly Clark and General Electric. He joins Rollins as Assistant Vice President of Human Resources and will oversee five division human resource areas for Orkin. In a people business like ours, this is a big responsibility.

We’re very proud to have Greg Baughman (ph) join our company as Director of Technical Services, including 18 years at the National Pest Management Association. He has worked in the pest control industry for almost 30 years. Greg will provide technical support and service guidance to Orkin branches nationwide. As I mentioned, Rollins is a people company and we are rightfully so proud of these three and all of our team. As many of you are aware, strategic acquisitions are an important aspect of our business plan. And over the last ten years, we have acquired five significant pest control companies that today represents over a third of our business. At that end, at mid-month, we announced that we have signed a definitive agreement to acquire Waltham Services, Inc. (ph), established in 1893. By the way, it was hard to find the business older than Orkin but we did. Waltham is New England’s oldest and finest pest control company. We’re extremely pleased that they will be joining our family of brands. Their outstanding management team and talented associates will greatly enhance our service network in the important Northeast market.

Waltham isn’t new to our company, having had a strong benchmarking relationship with our Western Pest Services business for over 40 years. Ranked the 33rd largest company in the industry, they have annual revenues exceeding $17 million. Following the acquisition, Waltham will operate independently to preserve its successful brand, local customers and employees. Internationally, we continue to expand our presence globally as well and an Orkin franchise will begin to offer pest control services in Turkey. Turkey marks the 16th foreign country in which Orkin operates. This franchise will primarily provide commercial pest control services.

In June, the owners of the franchise completed their initial training at our learning center here in Atlanta. From time to time, we talk about the importance of our long established relationships with our various vendor partners. However, I’m not sure if we’ve mentioned Portrait software previously. Located in the U.K., they are a provider of customer interaction optimization software which is call-center related. We began a relationship with them in 1999 when we began using their software in Orkin’s national call center.

During the second quarter this year, we expanded our relationship with Portrait to include all six of Orkin’s call centers. This implementation will be concluded later this year. We believe this upgrade in expansion will allow us to better identify and measure agent performance and service offerings across our entire call center network. Our goal is to facilitate high quality and personalized dialogues and provide exceptional customer experiences at every interaction throughout their country.

During the quarter, we also announced the partnership with NSF International, an independent third party health care organization. We’re working together to assist new processing and warehouse facilities by helping them refine their pest control programs to excel in food safety audits via an internet site. This idea was born when our quality control people formed our food processing and food warehousing contacts to find out how they stayed ahead of food safety audits.

Some of the responses we got backward that they relied on a calendar and in some cases, just their memory. We thought both of these were concerned. We saw an opportunity to develop for them a better way to manage their pest control responsibilities and surpass food safety audit requirements. And we’re doing that with a web tool that counts down the days until the users’ next food safety audit and since reminders and tips on the important dates via email. Well, these are just two examples of how we continue to invest proactively to improve our business and help to ensure our residential and our commercial customers receive the highest quality pest control service. The first six months of 2010 has been a busy and rewarding time for Rollins. We’re enthusiastic about the balance of the year and intent to stay focus on growing and improving our business. I’ll now turn the call over to Harry. He will provide you with the details of our financial results.

Harry J. Cynkus

Thank you, Gary. Good morning, appreciate your all joining us on the call. The second quarter was one of solid growth positioning us well now halfway through the year. Today we reported revenue of $298.8 million representing 5% revenue growth. Net income increased 8.7% to $27.7 million or $0.28 per diluted share compared to $25.5 million or $0.26 per diluted share for the same period in 2009.

Last quarter, we reported that the trends we have seen over the last six months as to the strong fundamentals to drive our revenues lead pricing and retention was a trend and not an aberration. I’m happy to report today that this trend is strong and continuing. Clearly, we have positive momentum. Let’s look deeper into the results. This quarter, as we enjoyed our strongest organic growth in some time with revenue growth of 5%. With foreign operations, primarily Canada, accounted for nearly 8% of our revenue. It’s important at times to look at the impact of foreign currency exchange. We continue to benefit from the stronger Canadian dollar though the impact has less meaning. If we look just at our domestic revenue, revenue was up 4.2% versus 3.1% last quarter.

Let’s talk about our residential pest control service which represents almost 40% of our business where our momentum continues to build. A lot is written in the press release about weakening consumer confidence and demand. However, you couldn’t tell that looking at our business was really an element of surprise, which really isn’t surprising as we have stated and demonstrated for some time. Pest control is just not a consumer discretionary purchase. As Gary says, rats and roaches don’t read the Wall Street Journal.

A greater quarter with strong fundamentals leads pricing retention. Retention is a great parameter into our customers’ frame of mind and our keeps improving. Residential pest control grew 4.7% in the quarter, its best quarter for organic growth going back as Gary said to the fourth quarter of 2006. As we’ve talked about on the call last quarter, we started with a great April. Then May flow but June came back strong. It all added up to a strong double-digit increase in leaves for the quarter and is continuing so far into this quarter. As much as we’d like to take credit for all of this, you have to give mother nature some credit as well.

We aren’t asking for any breaks in the current high weather, though, but we do sympathize and support those bookings for some array. Nothing some like good heat with some rain mixed in. It really brings on those assets, the nation’s number one insect pest. We have continued to work in our price realization programs and are experiencing better pricing.

Last year, Orkin’s residential price increase program which instituted in two phases, the primary increase in May and a second much smaller group of customers in July. In order to balance this year’s increased program, we delayed one month implementing the program in June. While it’s favorably impacted the quarter less than $1 million, it only impacted one month in the quarter unlike two months last year in the second quarter. Home Taylor (ph) rolled out their price increase in July as they have traditionally. The customers (ph) continues to improve as well with just over 10% fewer customers canceling this year. Commercial pest control, our fastest growing line business, this quarter continues to be a steady performer in a stagnant business environment. It represented over 40% of our revenues and for the quarter grew 5.4%. 3.3% in the U.S. giving its domestic leadership for time to residential. Sales saw a small decline in the quarter compared to the previous quarter. Our leaves were up somewhat.

The commercial business typically comes from knocking on doors and we need to knock on more doors next quarter. We had similar improvement in commercial retention that we experienced in residential. As we did last year, the commercial price increase rolled out June 1 to those customers who do not have a price increase condition built into their contract with something less than half of our customers. We expect to see a greater gain this year which should offset the smaller gain we expect to see from the residential action. That net will be consistent with last year’s price increase program adding between one in a quarter and 1.5% to Rollins’ total revenue over the next six months.

As for termite, it represents less than 20% of our annual revenue. We are pleased to say we continue to see revenue growth, 4.2%. In addition to termite protection, our termite sales and sales from ancillary services including moisture control and installation which contributed to the revenue growth. Home Team’s (ph) pre-treat business is also a contributor as there has been housing search begin to climb from a year ago. Gross margin for the quarter improved 10 basis points to 50.3% for the second quarter versus 50.2% in the prior year. Slight improvements in productivity, favorable insurance and claim cost as well as gains from the sales vehicles, more than offset an increase in the cost of fuel and personnel-related costs both helped in employment value.

Given the amount of new business we put on, we were pleasantly surprised to still experience the decrease in the service wages as a percentage of revenue. Depreciation and amortization expense for the quarter decreased slightly totaling $9 million. Depreciation was $4 million in amortization was at $5 million. Amortization of intangibles declined $400,000 from this quarter a year ago as customer’s contracts primarily from our October 1999 acquisition of TCL Canada are now fully amortized. We have almost $138 million of value assigned to customer contracts and other intangible asset on our balance sheet as of June 30th. Amortization of intangibles will continue to represent a significant non-cash charge to the P&L for some time.

Based on our fully diluted shares outstanding, it’ll be a none-cash after tax charge of approximately $0.13 for this year before adding the impact of the upcoming acquisition of Waltham Pest Services. Sales, general and administrative expenses for the second quarter increased $5 million or 5.4% to 32.4% of revenues, increasing from 32.3% for the second quarter last year. Almost half of the dollar increase was due to sales, administrative staffing increases to handle the growth in the business while the increase as a percentage of revenue was driven by higher personnel-related cost both helped in employment taxes consulting in an acquisition-related cost and we can’t forget fuel. In fact, fuel’s impact on cost of services provided in SG&A in the quarter was $2 million, $3.8 million year-to-date.

Provision for income taxes was 37.6% versus 38.6% a year ago. We continue to operate from a solid foundation. We have great confidence in our fundamental. The company is stable. The balance sheet is strong. We generate significant free cash flow which gives us the ability to take advantage of growth opportunities such as the one presented to us with the acquisition of Waltham Pest Services, New England’s oldest and finest pest control company. We will be closing on the transaction tomorrow effective August 1. Waltham, with its leading position in the marketplace, is profitable and generates good cash flow. I can’t tell you how accretive it may be until we complete the valuation of its customer contracts and other intangibles. What I can tell, it certainly will be accretive from EBITDA perspective.

We will continue to look for outstanding pest control acquisition candidates to invest in. We have ample following capacity, willing banks and hope to be able to consummate the visual acquisitions before the year is out. For the year half over, we’re well-positioned for a great 2010 and look forward to talking to you next quarter. Thank you for your time and interest. Let me also express our appreciation to all of the relevant associates whose hard work is behind our standing result as well as thank our customers and suppliers for their continued support. With that, I’d now turn the call back over to you, Gary.

Gary W. Rollins

Thank you, Harry. Well, we’re now ready to open the call for any questions that you might have.

Question-and-Answer Session

Operator

Thank you, sir. We will now begin the question and answer session. (Operator Instructions) And our first question comes from the line Clint Fendley with Davenport. Please go ahead.

Clinton Fendley – Davenport

I’d like to talk, first about the termite segment. As the revenue growth that you guys have had there is far better than what we saw during, even the 2006, 2007 time period. I know you’ve never been a big participant in the home inspection market. Can you tell us maybe what’s happening to some of the smaller regional competitors that were big players in that market? Just trying to understand the acceleration here that we’ve seen in the growth in that segment.

Gary W. Rollins

Well, I think one of reasons is we’re growing and some aren’t is because of our investment and adding additional sales people where we have strong demand. I think we’re doing a better job analyzing where we need – the people engaged, we have worked on our sales training which, I think, has kind of fallen a little bit by the wayside in the past. So we really refreshed our training.

We refreshed our training of sales managers and trainers so I think we’re doing a better job closing our leads, handling those leads by ensuring that we have the right staffing, where we have high demand. And we’re just focusing on the business better than we’ve had in the past.

Clinton Fendley – Davenport

If we were to see the housing market turn up at some point, I mean, have you learned anything from home team with regard to the pre-treat market? I mean, should we look at the segment differently if we were to begin to see strength within new home construction?

Gary W. Rollins

I think that we’ve concluded that Home Team needs to be our new home marketing organization. Orkins kind of years ago have been in the pre-treat business and really did not do it particularly well. It’s a very competitive feel and you really have to spend a lot of time cultivating relationships with builders. And Home Team just does that tremendously. I think one of the great things that Home Team have going for them right now is they’re able to sell some of the better builders that would not buy from them before the cross of the relationship that they had with Syntax (ph).

So they’re pretty much encouraged. They feel like they see the housing starts improving. Now much of that is because they’ve got new customers coming on the line like total brothers and full team (ph) but one of the wonderful things of that Home Team is they really don’t spend a lot of time relaying some of the bad statistics that you read about home sales out there. They just try to find more creative ways to get additional sales.

Clinton Fendley – Davenport

Right. Thank you, that’s helpful and switching gears, Gary, I wondered if you could update us on the DCG study? I mean, any early conclusions from the work that they are doing?

Gary W. Rollins

Oh, the year we’ve retentioned (ph), we continue to work hard on that. I think that we’ve gathered some great statistics about what percentage of customers or new sales we start depending on how quickly we get there and there’s definitely correlation. You know, quite often, our branch is busy and it’s human nature sometimes as well. We don’t really need to do anything tomorrow. We can always do it on Friday but our statistics indicate that that’s just a terrible conclusion and we have done a better job educating our branch users to how important it is to get that account started quickly. Steve led its role frankly and I touched on him a little bit earlier.

We took one of our very best people from the field, our operators and this is his area. And he is carefully monitoring how we are closing leads in our call center which is really the beginning of the yield process, how few times we hand off that lead. We also know that every time we had a lead off to another party, that our closure goes down and as I touched on a minute ago, we also know that when you don’t start to sell the same day, or when the customer wants you to, has requested it that you really lose a lot of potential sales. So I think it’s a lot of things that we’ve done in the past. We just kind of got a magnifying glass-typed focus on this particular part of our business and we’re seeing improvements.

Clinton Fendley – Davenport

Okay, great. And then the last question. This morning on NPR, there was a report on the bed bug epidemic in New York and I guess the city has gone as far as creating a bed bug dog focus on the problem. Are you seeing any notable pickup in bed bug calls?

Gary W. Rollins

Our bed bug business is picking up and we’re pretty pleased we have a kind of an inner company multi-brand task force that’s working on refining our bed bug protocols. I mean, I think we’ve been a little bit uncomfortable that we were doing this a lot of different ways and as I mentioned, before, I think we’ve gotten good about stealing shamelessly from ourselves so we’ve got our team together and we are refining our treating protocol. We are refining our pricing and our guarantees. I mean, this selling is continuing to pick up momentum, depressed loves. The subject I read earlier in New York, that they were contemplating legislation where landlords had to advise new tenants as to whether the property had had bed bug problems in the past which is a wonderful thing for our cost control operator. So we are – we’re very much aware that this really has high potential for us.

Gary W. Rollins

You’re welcome.

Operator

Thank you. And our next question comes from the line of Jamie Clement of Sidoti & Company. Please go ahead.

James Clement – Sidoti & Company

This was actually not going to be first question but since Clint brought it up, I’ll follow up with it directly. Obviously, I’m located in New York and you can actually – there are many charitable organizations, high profile, one of would have heard of, that now will not take matters because of this. And from some of the stuff that I read was that really the treatment protocols, thus far have really not been all that successful, like how or do you feel like there’s – first of all, (a) is that an accurate statement and (b), you alluded to this a little bit but do you feel you have the right remediation techniques?

Gary W. Rollins

Well, we think that we’re getting there so to speak. I use the analogy, there’s more than one way to Chattanooga. There’s not a single, at this point, there’s not a single best way to eliminate bed bugs. We think that one of the best ways is with heat. We have been using heat on the West Coast probably for 18 months now with good results. I have some drawbacks. One of the drawbacks is if you overdo it, you can get the elimination of the furniture and some things with the wallpaper and so forth. So it’s not a silver bullet. But we think that it really has a lot potential.

You’re right about the mattress steel. I mean, if you’ve got a severe bed bug infestation in a hotel, we would strongly recommend that they change the mattress. It’s just because of eliminating one of the big sources of hard-to-reach (ph) we’re using and don’t laugh but we’re using dogs in Canada. Dogs in the Midwest, dogs in the Northeast – very effective, the same capabilities that they have of locating drugs on airline passengers, et cetera. They have the same ability when trained to locate bed bugs.

One of the big challenges with bed bugs and I know this sounds a little bit far-fetched but the industry is even considering into some way that they can use DNA because you can go into a hotel and just do a wonderful job eliminating bed bugs. And within a month, they can have bed bugs again. And then, you got a customer that’s kind of unhappy that says, “Hey, why didn’t you kill all my bed bugs?” And you start debating of how did these new bed bugs or old bed bugs that didn’t die. It’s pretty complicated thing because they’re not going to stop their business. I mean, they’re not going to, when they have inquiries from foreign countries, they’re not going to restrict the company from checking in and quite often, that’s where the bed bugs come from to begin with.

James Clement – Sidoti & Company:

Sure. And I mean, it sounds to me like we might be actually on the brink of some municipality legislation on all of this stuff when people finally figure out what the story is. I don’t know, that’s my impression and obviously maybe I’ve in ground zero so to speak in the bed bug world.

Gary W. Rollins

I don’t think you’re far off because I have read in the paper about Abercrombie closing their store in New York and because of having a bed bug problem. So this is not a causal situation like carpet beetles or something.

James Clement – Sidoti & Company

Sure, sure. Can you just give us a little bit, Gary, you all – last year and towards the end of ‘08, you never made excuses on the residential side of the business? You never referenced the related recession. Obviously your residential growth numbers were not what they have been. Now they’re looking great.

I know you spent a lot of time, a lot of effort, and a lot of money on refining your lead generation techniques, refine where your marketing dollar is spent, all that sort of thing, do you think that getting a little bit of a lift from the fact that we kind of maybe today isn’t as bad as it was a year ago or do you really think it’s more that a lot of those initiatives that started three, four, five years ago, the investment you made in the call, dependent on the sales or was it there all kind of coming together also or a little more?

Gary W. Rollins

Well, I hope this isn’t a conceited answer and I guess the most truthful answer is there’s no way to know precisely. But typically, when you spend a lot of energy and you invest a lot in a particular area and really work hard on it, you can move it and we think that we’ve had a lot to do in moving it with our marketing decisions. We’ve had a lot to do in moving it with our attention to our call centers. I mean, we used our moving closure percentages in our call center on these leads and then you start moving or reducing the cancellations after the sale is made.

And I touched on starting the customer quickly. Those are all pressure points that add up and we think we’ve really worked on that. We think, Harry touched on it – don’t ever underestimate mother nature. And mother nature has really been good for us generally. And she does make a difference. I wouldn’t say the autonomy – my sense of all the things that I just mentioned, the economy would have the least to do with the success that we had.

James Clement – Sidoti & Company

And I think I’d agree with that. I don’t know what industry data you look at but in terms of, I mean, you mentioned mother nature but mother nature, should that spend (ph) the rest of your industry, too? And I haven’t seen a number of working at residential pest control and there are a bunch of different numbers out there. But I have not seen a growth number getting higher than a number that has a two in front of it, three in your industry and what was it this quarter, $4.7 for you guys?

Gary W. Rollins

Right.

James Clement – Sidoti & Company

So that’s impressive work.

Gary W. Rollins

There are some things that we can do that they can’t do and that’s the benefit of the scale that we have, certainly Terminex (ph) can do the things that we do because of their network but when you look at advertising leverage and call center management, many of these people don’t have a call center.

Operator

Thank you. (Operator Instructions).

Gary W. Rollins

Okay, well no more questions. In closing, thank you for joining us today. We appreciate your interest. And as I mentioned, we’re looking forward to the balance of the year and we’ll continue to work hard to grow and improve our business during that time. So we look forward to joining you next quarter. Thank you.

Operator

Thank you. Ladies and gentlemen, this concludes the Rollins Q2 2010 conference call. If you would like to listen to a replay of today’s conference, as a reminder, the phone numbers are 303-590-3000 or 1800-406-7325 followed by a passcode of 4329321. ACT would like to thank you for your participation. You may now disconnect.

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