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Rollins Inc. (NYSE:ROL)

Q2 2008 Earnings Call

July 23, 2008 10:00 am ET

Executives

Gary Rollins - President and Chief Executive Officer

Harry Cynkus - Chief Financial Officer and Treasurer

Scott Amann - Financial Relations Board

Analysts

Clint Fendley - Davenport

Jamie Famalette - Sidoti & Company

John Christensen - Kayne Anderson Rudnick Investment

Mike - Kenwood Capital Management

(Robert Mitchell)

Operator

Good morning, ladies and gentlemen. Thank you so much for standing by and welcome to the Rollins’ Second Quarter 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). As a reminder, this conference is being recorded today, Wednesday, the 23rd of July, 2008.

I will now turn the conference over to Mr. Scott Amann of the Financial Relations Board. Please go ahead.

Scott Amann– Financial Relations Board

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 are on the company’s distribution list.

There will be a replay of the call which will begin one hour after the call and run for one week. The replay can be accessed by dialing 1800-405-2236 with the pass code 11116485. Additionally, the call is being webcast over 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, Chief Financial Officer and Treasurer. Management will make some opening remarks and then we’ll open up the lines up to your questions.

Gary, would you like to begin?

Gary Rollins - President and Chief Executive Officer

Yes, thank you Scott. Good morning and thank you all for joining our second quarter 2008 conference call. Harry will read our forward-looking statements and disclaimer and then we will begin.

Harry Cynkus – Chief Financial Officer and Treasurer

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 statement we make today.

Please refer to today’s press release and our SEC filings, including the risk factor section on Form 10-K for the year ended December 31, 2007, for more information on the risk factors that could cause actual results to differ.

Gary Rollins - President and Chief Executive Officer

Thank you, Harry. We were pleased to report a 18.7% increase in revenues for our second quarter. As reflected in the press release a large percentage of this improvement resulted from a recent acquisition of HomeTeam Pest Defense. Excluding HomeTeam a 4.7% growth was an up tick from the second quarter and was contributed by both our commercial and residential Pest control business lines. During the quarter we also experienced an increase in new residential pest control weeds which continues to confirm that the demand for our service is stable and in fact this quarter increasing. This leads to a question on many peoples mind these days and that is the economic downturn effecting new business. This is an understandable question since we all see the current economic environment having in affect on most businesses across the country.

Unfortunately we aren’t experiencing this handicapped today. Historically, as I have stated in the past our business is prudent to be recession reassessment. We are moving through for completely immune to that economic environments, demand may slow somewhat but historically we have continued to make progress both revenue and profit vise in the downturns.

We believe that there is several contributing factors in this phenomenon. Three are in total. First we are stay to focus on our core competencies residential and commercial pest controls. We are not diversify thereby awarding exposures to businesses that don’t have the same virtues as pest control. Additionally, over the years we worked hard to become a leader in FDO, so we have more influence on our faith than many other companies do. Actually, we have significant over 80% of our revenue is recurring revenue, which means that each month starts with that big advantage. Externally we have founded a good times and bad our customer have a high regard for what we do by protecting our health and property. The commercial customers must have pest control service and homeowners need to protect their home against termites. The number three fop here in the US today is the insects, so these customers could keeping insects out of their home as a high quality. This four factors are all reality that make our prospects customers and business more stable than always during economic downturn.

Back to the quarter, excluding the impact of HomeTeam our margins improved this past quarter. At the same time we continually look to improve our customer service and customer satisfaction, however, we have a much service as one such example, it is grown in popularity, especially with working families and our pest control retention has improved as well. At the same and we have advanced our marketing technology to ensure individuals and businesses seeking pest control can find these easily on the internet.

Our national working customer service center was contributing to our revenue improvements in this area as well. These significant initiatives along with other steps that have led the higher customer retention into more new customers.

Our commitment to improve our business doesn’t stop. We never lose site that there is always in which we can make advancements. We had new most opportunities to further improve our business for the benefits our customers, employees and company. As an example the escalating gas expenses has been met with numerous initiatives to reduce miles travel. Provide more GPS over the slide. Purchase feel better as well as other steps to reduce the impact that this cost has had on our business.

Let me talk for a moment now about HomeTeam Pest Defense. This acquisition was a really positive step for our company. I spoke about this one on our first quarter conference call, but now we’ve got three months under our belt and we are extremely pleased with this acquisition. We believe that both for the short term as well as long term HomeTeam will be regarded as a vital aspect at Rollins. When we begin our discussions with HomeTeam, we felt that they were an exceptional company. Following our due diligence we were even more convinced that they were perfect fit and this has quickly been affirmed. In that HomeTeam’s first 90 days with us they are well ahead of our plans for them having been accretive in the second quarter. HomeTeam provides a solid and growing revenue base consisting of both its new construction, new home owner that they excludes in the old customers and their conventional Pest Control Customers. I think there has been some confusion over HomeTeam's mix which is important to clear off.

First more than 90% of HomeTeam’s business is Pest Control. Servicing residential customers with conventional pest control and termite treatment just like work it does, along with their tubes in the wall pest defense system. Less than 10% of their revenue comes from sales to homebuilders for installing new systems for future residential customers.

Second, HomeTeam has extremely high customer retention rates one of the highest in the industry, coupled with very high customer satisfaction ratings. Third, even as Home construction has slowed their numerous homeowners that have yet to activate those systems and we expect the benefit from this untapped bracelet in the future. One other situation I would like to address is that the tubes in the wall are not 1.5 inch or even 11/4 inch PVC tubes like some people have envision. But they are 8 inch or less. It’s actually very thin plastic tubings smaller and thickness cholesterol actually now like fats together. This small size is more conducive to my new pesticide delivery, plus provides more session instillations.

HomeTeam success is largely the result of an exceptional management in CEO team. As previously mentioned that was an important to consideration for us when acquiring this business. But Rollins is all about people, our most important asset. We are very proud what Bob Wanzer and his team have accomplished in such a short time and where they can do lot of tube. We believe that we can help them further leverage their business and improve their profitability. When we acquired HomeTeam their margins were 7% on a trailing 12 month basis. But we believe that we can double those margins in the next four years. In fact, we have already seen the margin improvement, using our Buying power, risk management practices and other efficiencies such as fleet management well all be making an impact.

Turning the other areas, I am happy to report that our new national advertising campaign is being well received then having a positive affect on our lead generation. I hope you have all seen a big bulge commercial and I feel, I feel it as we do that they are memorable. If you haven't seen one you can go to our website www.orkin.com and watch the Orkin man working hard to protect owners, homeowners from a six foot cockroach control mind.

During the second quarter we reports just 260,700 source of the company stock under our share repurchase program, taking the advantage of the current stock market environment. We also reduce our debt under our credit line by $36 million which is attribute to the cash generating power of Rollins.

I would like now the turn the call over to Harry, he will discuss our financial results in greater detail.

Harry Cynkus – Chief Financial Officer and Treasurer

Thank you, Gary. I am also proud to report the second quarter results. But first reflecting our most recent acquisition HomeTeam. I think the results speak volumes about the resiliency of the business even now this year’s more difficult economic condition. We’ve had what I feel is a great quarter. We produced record revenue, record profit, and generated a lot of cash allowing us to payback 36 million of the 90 million we drew down at the beginning of the quarter to finance the HomeTeam acquisition. We are also buying back $4.2 million of our stock.

Let's get into details. Revenues for the second quarter grew 18.7%, revenues totaled 284.5 million compared to 239.6 million for the second quarter last year. Net income for the quarter is 22.7 million as compared to 21.2 million last year, a 7.1% improvement. While diluted earnings per share this quarter is $0.23 and 9.5% improvement over this full adjusted $0.21 reported last year in the second quarter.

Earnings before interest, taxes, depreciation and amortization EBITDA was 46.4 million increasing 12.3% over the second quarter last year. EBITDA grew faster than net income due to s1.9 million of amortization of intangibles relating to HomeTeam acquisition recorded for the first time this quarter.

A most recent significant acquisition HomeTeam Pest Defense contributed revenues of 33.7 million. Excluding the impact of HomeTeam revenues increase 4.7% in the quarter and 4.5% year-to-date. There continues to be a lot of talk of economic concern, but it has not significantly impacted our business. Our commercial pest control now represents 39% of our business and continues to lead the track phase wise.

Excluding the contribution HomeTeam our commercial revenues grew 9% and 9.4% if you look at excluding through negations. New sales for the quarter were over 10% better in the same quarter last year and this business is that only what new business you sell or what you retain and our commercial customer retention improved slightly, approximately 1.5 of point over last year's record. A testimony to our best-in-class service to our customers. This also conforms that we are not losing any significant number of commercial account due to the economy. Our residential pest control now represents a little more than 39% in the business and grew 2% before HomeTeam's contribution, up from the first quarters growth of 1.6%, and with our HomeTeam 30.4% in the second quarter compared with the prior year quarter. We saw an increase in release during the quarter which resulted in improved sale.

Lastly, let's talk about our termite service revenue which now represents just under 21% of our business and grew 17.2% as a result of the acquisition of the HomeTeam. In fact excluding HomeTeam's contribution our previously existing Termite business growth was a little up then flat. Even the pest control industry trends concerning the Termite business I think it held up surprisingly well overall. Termite work as a much larger dollar purchase, but if one has termites most people wont considered a discretionary purchase.

As HomeTeam has a higher cost of services before the quarter our gross margin declined by 60 basis points from 49.3 last year to 48.7 this quarter. Margins excluding the impact of HomeTeam actually improved 40 basis points due to greater service technician productivity and a decrease in pension cost which was partially offset by $1.4 million increase in fleet cost, primarily the higher cost of fuel.

Deprecation and amortization expanses to the second quarter totaled $8.7 million with amortization of intangibles at 5.3 million and depreciation of 3.4 billion. Amortization increased 1.9 million in the quarter, an increase of 56% due to the almost $90 million were signed to customer contract and other intangible assets as part of the HomeTeam acquisition. Amortization of intangibles primarily customer contract valued at the time of the acquisition represents a significant non-cash charge to the P&L. Under GAAP we write-off the value of signing the customer contract acquired in acquisition over their economic life where we fully expense all cost that are acquiring new customer internally.

In 2008, total amortization of intangible expenses will be approximately $19.3 million, based upon our fully diluted share outstanding it represents a non-cash after tax charge of $0.12 the GAAP EPS this year.

Sales, general and administrative expenses for the second quarter ended June 30, increased 15.2 million or 19.9%, a 32.3% revenue from 32% for the second quarter ended June 30, 2007. $10 million of the dollar increase was due to the addition of HomeTeam expenses excluding the impact of HomeTeam as a percent of revenues increased 60 basis point due to higher sales salaries, additional $600,000 of lead expense, and additional $900,000 in non-recurring expenses related to the acquisition of HomeTeam.

On last quarters call, we recorded concerning the contribution we expected from HomeTeam. As we were concerned about minimizing any of this and giving the HomeTeam Associates onboard focus on the business. While I am happy to report that we have successfully on boarded the HomeTeam, disruption has been minimal, and they have exceeded our expectations in all respects, operationally and financially. HomeTeam is a great psychotically as well. They are working hard and enthusiastically take advantage of the million of programs we can offer them to improve and expand their business. At the same time our ownership has opened doors of opportunity for the HomeTeam not previously available. A number of builders who previously had not used the KX systems and the pest defense system because of the of the form of Centex being a competitor. They are now willing to top and are begging to work with HomeTeam.

Most notably (Inaudible) known as America’s builder, a largest homebuilder in the United States has added HomeTeam to their improved tender list. We still firmly believe that the pest control business owned and managed by the worlds Pest control company and it form more than a pest control company owned and managed by a homebuilder even at world class one. We are working diligently to take advantage of the many opportunities who are improving their margins, but the trialing 12 months further acquisition that have reported EBITDA of approximately $9 million representing a margin of 6.7%. Based on the progress they made on their own over the course of the last year and now have been converted us to payroll and benefit programs, replacing their insurance programs with our, taking advantage to our purchasing cars, we have already seen greater than a 200 basis point improvement in their EBITDA margins. We believe that it continuous to be awful opportunity to more than double over the next four year bringing them into line with our other business. But bottom line the question everyone is interested in, whether it would be accretive? The answer is yes. Even though the large write-off of intangibles and interest expense on the pest to fund the acquisition we expect this to be accretive on a GAAP basis in its first year.

We always continuous to be financially solid, we generated $45 million in free cash flow, cash provided from operations less capital expenditures year-to-date, and this represents 9.1% of revenue. A strong cash flow allowed us to payback 36 million or the one-third of the $90 million barrels in April to purchasing. In addition 8.2 million has been expended under the company share buyback program.

We continue to have an abundant of opportunity not only with the HomeTeam and with our existing businesses. I look forward to reporting our results as the year continues, but I will turn the call back to Gary.

Gary Rollins - President and Chief Executive Officer

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

Question-and-Answer Session

Operator

Thank you ladies and gentlemen. At this time, we will begin our question-and-answer session. (Operator Instructions). And Clint Fendley with Davenport, please go ahead.

Clint Fendley

Thank you. Good morning gentlemen. Nice quarter, and with a very difficult environment out there.

Gary Rollins

Thank you.

Clint Fendley

A couple of modeling question to off to start. I mean obviously, some nice pay down on your debt, what's that outlook there between now and the reminder of the year and how will you sort of balance that against the opportunity for sale or purchases here in the near term?

Harry Cynkus

Well, I think you should look historically at cash generation by quarter; third quarter tends to be a strong quarter. I think last year cash from operations was, let us say 30 something million dollars FX probably 4, 5 million. So our first priority will be to pay down debt, but we will continue to look at opportunities in the market place. We bought stock in Q2 and I think what was our average price was close to 15.5. So I think there will be some opportunities possibly in this quarter to continue to buying back stock. We have about half a million shares currently authorized.

Clint Fendley

Okay, thanks. That’s helpful Harry. And then on the termite accrual do you have the adjustment that was made to the provision and then also the settlements during the quarter?

Harry Cynkus

We will have that in the -- I don’t have that handy. Claims though we had very positive results for the quarter as to all 3% over 31%. Total claims for the first six months of this year was only $2.6 million. So after a 30 plus percent reduction and the claims last year were running against some you know, our low numbers and we have improved it to further 30% flat. So we had a small minor net expense in the quarter.

Clint Fendley

Okay. And on the -- you can -- some really nice developments on the margin that HomeTeam obviously, some very good long-term expectations there for that acquisition. I mean any thoughts maybe even on the near term and how you might be able to get a new potential low lying fruit maybe in the next two quarters or through the remainder of the year for that unit?

Harry Cynkus

Well, again they are only at the front end and starting to take advantage of our purchasing power. It’s going to take some time for the inventory to work its way through the oil prices you know, what they certainly pricing their inventory levels. We are working with them obviously, you know, that takes longer to work its way through. We are looking at the insurance, we need to track and see what their experience is. They are aggressively looking at how to grow their businesses in this economy they have. They are doing their sales mix in an additional city, they had not been in before trying to establish, frequently established a presence in the new markets. So they are looking at -- they are in the process of -- we are also looking at some of the other programs we have. It's like taking that from a 1000, not from a 1000, like its more (Inaudible) right now, they have a lot of opportunities, but they have a great management team and they are focused on growing the business. They have got the goals, they are talking to a number of builders who previously chose not to do business with them and like I said we are happy that (CI Holton) has made them approved their vendor and we hope to see some of the units in CI Holton down the road here.

Clint Fendley

Okay, thanks Harry. And then a final question, I have had a couple of question asking about any kind of update on the software routing and where you guys stand on that?

Gary Rollins

Well, we continue to work on it. I guess we have got a better appreciation of the complexity of our service scenario unlike EPS and some of the other seers and some of the other people that we benchmark with, there is quite a few variables that they were still working on. We have got multiple frequencies, we have got call backs, we have got customers changing their service date; we have got new starts to add encapsulations to the lead. So it will be the most complicated service routing system that’s been developed, but each of our testing environments and we have had those along the way where we bring our field people in. They are most enthusiastic and are pleased and the fact they are getting kind of anxious about let's turn it on in the branches, but based on previous experience with IT initiatives, we are going to be very cautious about it. So we continue to be encouraged and look forward to it.

Clint Fendley

Okay. Thanks Gary. That’s helpful. Thank you guys.

Gary Rollins

Thank you.

Operator

Alright, thank you. Our next question is from the line of Jamie Famalette with Sidoti & Company. Please go ahead.

Jamie Famalette

Hey good morning gentlemen.

Gary Rollins

Good morning.

Jamie Famalette

Can you talk a little bit about employee retention in this environment I think typically when the general economy gets a little tight usually that that becomes positive offset to you? I mean, have you noticed the trend there yet?

Gary Rollins

I don’t think we have noticed any trend per se, but I think you hit it right on the head and that when things get tough, there is more good people available, people put a higher priority on retaining their job. And historically I think we have been able to kind of move it up a lot so to speak that we have less openings, we have a better labor dual firm and I think as a result of an economic downturn that we get some new comers as far as just the overall quality of our people.

Jamie Famalette

Just a question about HomeTeam Gary. Is there any difference between how HomeTeam has historically marketed to homeowners that had the tubes in their homes but had not activated the system with the service contract? Was there a net that HomeTeam the salesmen were going to that kind of homeowner, or is this what you guys are going to do in that. And can you talk a little bit about that strategy and kind of how you expect that to play out?

Gary Rollins

The HomeTeam's marketing model was that their salesmen would what we kind of call blitz an area that as a large number of units were installed in a project then they would really go out and meet the homeowners and make sure that they understood what opportunities they had and how the service -- ongoing service would work et cetera. In addition to that, they did telemarketing where they called the customers and certainly there is not a any restrictions when you are talking about someone that’s really owns an asset. So it's not really soliciting a customer that has no interest in what you are doing. I think if anything we were very impressed with what they did and how they did it. I think that some of the things that we can help with is we have some knowledge about direct mail, which I think we can share with them and we have I think knowledge of doing call center work on a larger scale, utilizing some more sophisticated technology and practice it. So I think that’s -- I think I would say if there were two areas that we might be able to help them a little bit would be in the direct mail side and in the telemarketing side where they go back again, of course, a lot of times when that customer moves in. They have just got a lot of things. You know the guy is still hanging pictures and loads in the boxes and so forth. So it's not unusual to be able to add a significant amount of customers, add through -- the dust kind of settles and they have more time to think above the options which they have. So I think that they do a good job, I think they may be able to help a little bit with the technology and some of the thing that we’ve learned.

Jamie Famalette

And Gary just to sum up kind of what I am here and this is also based on your prepared remarks, I think that one of the concerns perhaps over the last couple of months here is that that there was some code un code great analyst with respect to on payment, what it sounds to me is you bought a pretty good company, you are very enthusiastic with what you have bought and really its not so much integration but just using your superior pest control company resources to help them out, I mean is that an accurate investment?

Gary Rollins

It's better than I could. I think we’ve learned something from mistakes in watching other people and that is the people are almost precious asset. And so their attitudes and how they feel like they are being treated and respected is really the consideration and we really kind of adopt it as a last period and we would like to lead them, we don’t want to push them, and the wonderful thing about this HomeTeam group is that they are just a very open minded and they really want to be excellent, and then they are pretty close to it right now, but – so, I mean, I think their attitudes have been terrific and when you have a group that’s got a great attitude about it, it just makes all the difference in the world and I would have to give Glenn and Bob a lot of credit, they travelled around the country that first almost when the ink was drawing on the purchase agreement and for the weeks this could employees face-to-face discuss, their anxieties and revenues to establish a great understanding from the beginning..

Jamie Famalette

Okay, Gary, Harry thank you very much for your time.

Company Representative

Thank you.

Operator

Thank you and your question from the line of (Math) (Inaudible) Central Asset Management. Go ahead.

Unidentified Analyst

Good morning guys.

Gary Rollins

Very good morning.

Unidentified Analyst

Couple of clarifying questions about HomeTeam of my own understanding, their business is there is tubes on the way, but are there any traditional pest control?

Gary Rollins

40% of the business is the tubes, 50% of their business is traditional. But if you really want to further expand a definition of you know, I mean, traditional to some extent is once our customers turns on the service I mean, it is very comparable to traditional cost control, I mean, certainly you have those sophistication of the technology that makes the service call easier, but they service the outside of the home, they would go inside if required. So when you make that transition and that new home owners turns the service on I mean, it replicates traditional pest control I guess the only y difference would be is they have the advantage of some pretty unique technology.

Unidentified Analyst

And what is the cost for I may not give exact numbers, but for home owners, its on new home owner I have got the system in my house, is it, what does the cost look like to you that was..?

Gary Rollins

It’s really comparable to what you are looking in every other month services. So you know, one of the neat things is that this company has maintained solid pricing which is always kind of ops to go in and you require another company what you would like to think that your prices in your margin aren’t going to be dilutive, but one of the wonderful things that they have the density, because when you sell these homeowner I mean, the technician can carry a lot bigger route, the technical service is less than a conventional call, but literally you can end to these 1000 division, and I can go from house to house down the street, and so, that’s a wonderful advantage, it just don’t have a windshield time.

Unidentified Analyst

Well great. And it’s for the top buyer, and you really pay anything extra for this system or its just kind of having your home?

Gary Rollins

The homebuilder is – will have to pay for the systems being installed, and the way that programs works HomeTeam will sell the builder or the development it’s not a future you are going to put it phase two because the people who are in phase one who don’t have it would it be necessarily happy with builder. So they will sign up and get a commitment from the builder for the entire development and that’s the home that’s build this fiscal. When the house is frame and it is to the electrical state typically they go in and install the tubes at that time.

Harry Cynkus

I think to kind of expand on that a little bit, the customers feel like they bought this. So I mean its, when you use the term pork I mean, I think if you look out it as an asset and I think that as a result of that I mean, that contributes to the retention cycle. So its unique thing we were in the long business for many years and it’s very similar to the way the customer felt about their long system that there was a part of the home when they acquired it. So you really get a strong growth legends as far as customers is concerned.

Unidentified Analyst

That’s a good point. Just lastly you mentioned that there is some opportunities with customers that have it, but have not yet signed up for the service. Can you give us some sort of order of magnitude, appetitive relative to the number of customer there are and something like that, just idea? You know there is potential growth just from sign of folks that have the system already?

Harry Cynkus

I think it’s really to soon to tell, we have add up for three months I mean, we love what we see, but its difficult that how many of those will get, but they have and I think we talked about this before it appears about 50% of half of the systems they’ve installed during the lifetime of the company, but half of that today are activated.

Gary Rollins

But I think this is one to go back to an earlier question that that if we can come up with a more efficient way to telemarket and to use direct mail then I think we have some opportunities, but frankly after three months we haven't been able to get back cranked up. So that’s really, once we do that, once we really kind of turn them on so to speak to power dialers and things like that and experiment with direct mail. I think we’ve got a great opportunity to improve the delay of these sales it would not made on made on initial contacts.

Unidentified Analyst

Okay thanks guys I appreciate that.

Gary Rollins

Thank you.

Harry Cynkus

Thank you.

Operator

Thank you. (Operators Instruction). Our next question from the line of (Robert Mitchell) with (Inaudible) Capital, please go ahead.

Robert Mitchell

Good morning guys. I wonder if you can talk a little bit more about the script in your commercial business if there is any particular initiatives or programs you are rolling out and if there is any verticals within that commercial business where you guys are really saying some traction?

Gary Rollins

One of the big think if we look for to is that our customer CRM technology and bio (multiple speakers) if we required a I guess a pretty powerful software product from (Endox) I guess about a year ago. One of the features of that has is the ability to have far more affordable salesforce.com site application, and there is really kind of means maybe alignment lying inches, you have a computer system that unable you to keep up with a calls that your salesman are making record specific information about those calls, it has follow up systems that has the ability really to monitor salesman activities from the remote sites. So the sales manager can at the end of the day really can review the data and see what his sales force did so he can plan his time and his activities accordingly. We are really on the cost of rolling that out, we have worked on it now I guess for the past 6 to 8 months. We got a lot of field input because we were using salesforce.com on the West Coast and we were using what’s the name of (multiple speaker).

We have another product that we use in Canada. So we really kind of get the best breed so to t speak features, and then and took this core software product and we’re going be able to expand that, and as I said salesforce.com is a great product, its rule over Q1 frankly for large structure, but its very expensive. So we’ve got a five more affordable systems that’s integrated and the focus which is very important focus is our preparatory branch lead and services and so, we think we’re got a come out with a superior lead management and sales management situation. The other advantage we got there is our salesman on the tooling, I mean, the people that we trained a year ago are yield better and certainly two years or two years better. So we know that as they get older and more experienced their sales go up, our turnover goes down. The average sale that they make goes up which typically improves our margins you know, they are able to sell bigger and more sophisticated customers like hospitals and nursing homes and include processing facilities and so forth. So we see a lot of good things, we also know that with the confidence of our success of some of these areas and we are – we will be growing the sales force, we will be growing into newer markets. So we will have more people on the street with tools.

Robert Mitchell

What is the, sales people in the commercial side you have right now?

Harry Cynkus

Two sales people.

Gary Rollins

We can give you better figure, we’ve kind of got two groups out there, we’ve got the vertical salesman that are working in these metro markets Los Angeles, Chicago, Philadelphia, Atlanta, New Orleans et cetera, but we also have a group of commercial salesman that are in these outline market like (Telsa), (Homaho) t cetera who work for the branch manager, so I think that’s kind of mumbling a little bit here about the number.

Robert Mitchell

Okay, great. Thanks very much.

Gary Rollins

Thank you. Okay Harry says the number is 327.

Robert Mitchell

Thank you.

Operator

(Operator Instructions.). (Inaudible). Please go ahead.

Unidentified Analyst

I am wondering just from the traditional side of the business excluding HomeTeam you guys talked about how margins improved some and I wanted just if you could provide a little more color on how much might have been from top line either pricing or better mix versus any kind of efficiencies I want stop that it might have had some challenges with the fuel prices et cetera?

Harry Cynkus

I think the, we’ve strictly productivity improvement. In anticipation in getting prepared for the roll out of our circling initiatives we have done in the last I guess six months now a lot of work with that software in and the optimization trying to optimize before we rollout a line, and we saw that in the productivity on the specific side, we also mentioned what we got a pension expanse this year letting about a $0.5 million per quarter less than last year. Thos two things more than offset the 9 million; I think a million a 9 an increase for fuel cost in CSP. So we will be happy that the productivity is working for us.

One other things that is kind of constant with us is productivity. We get so many benefits that if we can get the work with fewer people because again typically if you reduce -- if you have a technician that is not required, you also benefit on the vehicle, you benefit on the fuel cost, you benefit on the accidents you know, which is, it has a lot of good things that takes place. One of the limitations to [Mac 1] is that it's not a constant application. In other words, you can reroute your customers and organize your routes, but it doesn’t have an ongoing maintenance capability. It doesn’t deal with the adds and the deletes and the changes and so forth. And that’s the big benefit of a line that it is a real time active routing and scheduling system. So every time once you get them organized, every time that any change took place, the system just automatically adjust for that particular change.

Unidentified Analyst

Okay. Thank you.

Gary Rollins

Thank you.

Operator

All right, thank you. Our next question is from the line of John Christensen with Kayne Anderson Rudnick Investment. Please go ahead.

John Christensen

A longer term kind of question. Over the past eight or nine years, your operating margins have gone from about 2% to about 12% on the back of lower warranty cost and moving from monthly service to every other month service. These things are sort of playing themselves out now. I think they are pretty much fully played out. And so then the question comes what are your -- how much further do you have an margin opportunity and what will be the sources of that?

Harry Cynkus

Well, let me start. First, I don’t think our opportunity to improve margins has played out. I think for a long time we have said that we expect that our margin step to 15% pretax. We don’t see any reason why we can't continue to strive for that. Some comes down to this management. When we look across the field of our 400 branches, we have substantial number of branches performing well above that level and a lot of that comes down to continued focus on improving management, which will translate into better blocking and tackling at the field level. So some of the initiatives, margin improvement will continue to come from opportunity to grow the business, additional revenue, tighter routes, productivity initiatives we have underway, we continue to reduce our cost of risk. And sometimes it's a small thing and surprisingly we have started a program last year it is quite seem inaccurate, but looking at people's shoes that they wear, the safety shoes. What we learned was that people weren't wearing the shoes that we had been providing them because they weren't waterproof and they wear them in the morning walk across some of yard, the shoe would get wet all day. So we spent some time investigating that better safety shoes that were waterproofed as well as good looking that people would want to wear and as slipping this year are down significantly. It will save us probably several hundred -- well over several hundred thousand dollars reduced workers' comp claims. So the 2 million customers we have a lot of transactions and if this take small improvements per transaction to translate into a lot of dollar improvement. Anything you want to add?

Gary Rollins

Yeah, I would add this. I think that we work both ends of the spectrum. We look for triples and homeowners and we also look for the singles. The big opportunities that we have certainly is service frequency as new materials come out, we certainly have a consideration on quarterly service versus every other month service and certainly we have got to satisfy ourselves that we can maintain the level of service satisfaction that’s required because even though it's appealing to think about reducing the number of service cost and not adjusting your income, the first thing you got to be doing is delivering a good level of service, we know when the northern markets is certainly a lot more profitable and presentable than it is in the higher pest markets.

So to catch a long-term opportunity that we have a line for the reason that we have discussed today and in the past also has the opportunity to be triple for us. But we don’t ever take away from the singles and because we do have so many locations and we really get a lot of data on revenue for add net employee revenue from span of control or service manager's revenue per vehicle we are constantly looking at our operations. We have a program called 75th Percentile where we are honestly trying to move lower producing branches to the 75th Percentile with the idea being that you don’t have to be the very best in your region or you don’t have to be the best in your division. You just need to get upto the 75th Percentile. So I really think we look at both ends of spectrum, some of them are longer term as you mentioned and will be more difficult to achieve and will take a lot effort and a lot of tasking. And then others is like improving the efficiency of the vehicles or things that you know, you can starting doing and or doing on a month to month basis.

John Christensen

I think, I hear you say that your warrantee cost were 2.6 million or that even get forward period?

Harry Cynkus

Average for the first six months of the year.

John Christensen

Okay. And four years after you acquired Western Exterminator, you are still keeping that brand strengthening. I am surprised, because it makes me wonder if the Orkin brand isn't that much more powerful than Westerns and what the strength of the Orkin Brand is if you are not converting your acquisitions to that brand?

Gary Rollins

Well first of all the Orkin brand you know, we have 70% brand awareness. I think that thing is not included in your equation is that Western started in New Jersey and then at Delaware, Delmarva kind of an insulator you know, probably 50 years before working was ever up there. So you know, they are feeling if they really had a brand that was significant enough for us to consider a different strategy then we have had in other places. We continue to look at that, we look at the leads that we are getting in Orkin markets where we have both an Orkin branch and a Western branch. We have merged some of the Western operations in Georgia and did that initially within the first year. Georgia and Florida where the brand really they were new in that area, the brand really didn’t do much. And it also give us on kind of the situation like the product business is determined is you can sell a lot more cigarettes, if you have two different brands. Now saying all of that we constantly look at it and we are prepared to make a decision to you know, to take a different strategy when we are satisfied that if we were given up market shares as a result of the Western brand.

Harry Cynkus

And the other thing too is 60% of Western is commercial business where the -- but that 40% that’s not. Western is offering different service frequency in offering. They have a whole perception plan which they sell, they package differently than what the Orkin have really month or quarterly services. So having different services in the market place under different brand name you know, we think has made sense and continues to make sense.

John Christensen

If you do not merge the brands, does that mean you cannot -- you to create the wealth and gain wealth denisty?

Garry Rollins

No. Certainly it would be our expectation to move Western two Orin and really the -- this is the next generation of -- the next generation of management, branch management systems focused. We have been very much involved the Western people in the development of these products and programs. So you know, we will get the -- we have them on our fleet system. We have them on our accounts receivable policy. We have them on a payroll. We have them on a account payable. So we have made some fairly significant integration.

Harry Cynkus

We’ve also moved business between branches, I mean we adjust the optimization between the company.

John Christensen

Okay. I guess my question is if you have a neighborhood that has a Orkin customer and a Western customer, so you have to send two trucks out there?

Harry Cynkus

Currently we do send two trucks, the whole model relates to the fixation that has been serviced.

John Christensen

And so there is no anticipation of trying to get one truck and improve the wealth density?

Gary Rollins

Yeah I think that’s the ultimate objective, but as I mentioned before I think we’ve learned if the people side of it in getting these companies that we acquire on board with a e programs that we have and the practices we have really are primary consideration. And you know, when we buy this smaller businesses and immediately they are converted over to Orkin a100%. We have no short term plans to change HomeTeams brand to Orkin and I think you know when we look at it Western makes a profit plans they have very ambitious plans I hope the Western people are listening. But we have the ambitious plans for them and they need those plans. So I think its working but I don’t discount the fact that there is a lot of efficiencies to be gain when you have that one technician in the same neighborhood.

John Christensen

Thank you for your help.

Gary Rollins

Thank you.

Operator

Thank you, and you have question from Mike (Chris O’ Donnelly) Kenwood Capital Management. Please go ahead.

Mike

Good morning gentlemen.

Harry Cynkus

Good morning.

Mike

Couple of questions I think there is 385,000 HomeTeam account is that correct?

Harry Cynkus

Yes.

Mike

And did I hear correctly that half of the installed tube out there at HomeTeam since inception installed 770,000, that’s the tubes out there?

Harry Cynkus

In that neighborhood.

Mike

Okay.

Harry Cynkus

Actually the 385,000 I think is total customers that includes traditional, and I wanted to say the two numbers actually I think there is about 200,000 current tube in the wall customers and 400,000 that installed over the last.

Mike

Got it, okay. And Gary a question for you like you – this a great quarter, you’ve built a great company and your family has been patient over lot of years and you know you’ve done a great job paying down this debt here just after you know three to four months and no doubt you and your team and you family have seen cycles in the stock market and you have seen you know springs where there is not a lot of buck to and your have seen clearly time where the stock market doesn’t believe and what you are building over the years. And I am just curious what your thought might be on an efficient, more efficient perhaps capital structure I mean, the stocks up to date 10% but its still down 26% just in the last eight months. And you know its not like your cash flow is down 26%,, its not like there is 26% fewer buck, its not like you guys have become 74% smatter to used to be. And I am just wondering if there is a point where you know, and you got you feel like “hey we just spent $90 million forward 90 million to buy HomeTeam. You know what if we buying upon a $90 million but low interest rates there to buy the business we know best, which is stock and you know strength the CapEx several percent, I am just curious what your thoughts might be on that?

Gary Rollins

We certainly look at that I don’t know we have to figure what yesterday about how much stock we borrow over the last five years and you remember what that?.

Company Representative

That was very big size number.

Gary Rollins

And then we can, we can get back to you with that piece, I mean, we continue to do it, we think about those things from time to time you know you thing about going private, you think about you know making them a bigger stock purchase play, but I guess if the what we come back to is we know we feel like we know what we are doing and the approach that we have taken if you look at what stock turnover of a longer horizon certainly you know it’s a lot more substantial in what you have just indicated. You know we think we have a lot of options and I guess the good think like a lot of companies that are looking to try to pull a rabbit out of the hat, you know, we know that we can move the business force just by working on maybe a less sexy approach whether our approach are just adding customers, improving margins, reducing cost et cetera, but, we don’t just count anything.

Mike

Okay thank you again congratulation on the quarter.

Gary Rollins

Thank you.

Operator

Here we do we have followup from (Inaudible). Please go ahead.

Unidentified Analyst

Hey, just last question, I think actually the number between 2005-2007 year your brought back about it was about $90 million for the stock. Gary the follow up question that is, do you sense on acquisition environment perspective, people talk about baby boomer demographics and all those kinds of things, I mean, do you think that the next five years, could yield some fruits on an acquisition perspective basis and your conversation with other people in the industry?

Gary Rollins

We absolutely do. You know, the great thing I guess that’s got all good news, bad news, the good news is when things are tough and people get on sure about the future and see things if concern them would perhaps an administration change with the upcoming election. You know they start to reevaluate whether its time to catch and move on, and as I have mentioned in some of the calls before I think its been our strategy for the last five years certainly, more aggressively to be the first call. And then last acquisition that we made I mean, HomeTeam had no other seaters that they where really seriously contemplating Western we where the first call within, and the only call that they made, and I think we’ve really positioned ourselves well, you can make these people sale I mean, as much as I would like to, but I may thing a track record, I think when they see how we have acclimated these companies and deal with them with respect and the freedom that they’ve had, it also speaks volumes because you know some of the people what we competed against in the past as far as acquisitions are concern do not have the same regard in track record that we do.

Unidentified Analyst

Okay thank you very much for the time.

Harry Cynkus

Thank you.

Gary Rollins

Thank you.

Operator

Thank you. There are no further question at this time, please continue with any closing comments.

Gary Rollins

Okay, well thank you. As always we appreciate you interest and we look forward to our next visit. Thank you.

Operator

Alright thank you. Ladies and gentlemen, this does conclude the Rollins Second quarter conference call. If you would like to listen to a replay of today’s conference in its entirety, you can do so by dialing 1800-405-2236 or 303-590-3000, and put the access code 11116485. Those numbers again, 1800-405-2236 or 303-590-3000 and put the access code 11116485. We would like to thank you very much for your participation, you may now disconnect. Have a very pleasant rest of your day.

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Source: Rollins Inc. Q2 2008 Earnings Call Transcript
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