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Edited Transcript of ROL earnings conference call or presentation 24-Jul-19 2:00pm GMT

Q2 2019 Rollins Inc Earnings Call

Atlanta Jul 26, 2019 (Thomson StreetEvents) -- Edited Transcript of Rollins Inc earnings conference call or presentation Wednesday, July 24, 2019 at 2:00:00pm GMT

TEXT version of Transcript

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Corporate Participants

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* Gary W. Rollins

Rollins, Inc. - Vice Chairman & CEO

* John F. Wilson

Rollins, Inc. - President, COO & Director

* Paul Edward Northen

Rollins, Inc. - Senior VP, CFO & Treasurer

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Conference Call Participants

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* Dan Dolev

Nomura Securities Co. Ltd., Research Division - Executive Director of Business Services

* James Martin Clement

The Buckingham Research Group Incorporated - Analyst

* Michael Edward Hoffman

Stifel, Nicolaus & Company, Incorporated, Research Division - MD & Group Head of Diversified Industrials Research

* Timothy Michael Mulrooney

William Blair & Company L.L.C., Research Division - Analyst

* Marilynn Meek

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Presentation

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Operator [1]

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Good day and welcome to the Rollins, Inc. Second Quarter 2019 Earnings Conference Call. Today's conference is being recorded. (Operator Instructions) I would now like to introduce your host for today's call, Marilynn Meek. Ms. Meek, you may begin.

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Marilynn Meek, [2]

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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, 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 (888) 203-1112, with the passcode 9599376.

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 Northen, Senior Vice President, Chief Financial Officer and Treasurer. Management will make some opening remarks, and then we'll open the line for your questions. Gary, would you like to begin?

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Gary W. Rollins, Rollins, Inc. - Vice Chairman & CEO [3]

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Yes, Marilynn. Thank you and good morning. We appreciate all of you joining us for our second quarter 2019 conference call. Eddie will read our forward-looking statement and disclaimer and then we'll begin.

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Paul Edward Northen, Rollins, Inc. - Senior VP, CFO & Treasurer [4]

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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 the 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-K for the year ended December 31, 2018, for more information and the risk factors that could cause actual results to differ.

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Gary W. Rollins, Rollins, Inc. - Vice Chairman & CEO [5]

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Thank you, Eddie. As you would expect, we're disappointed with our performance for the quarter. We, like most other pest control companies, have both strong and weaker growth periods with some seasonal timing uncertainty. Unfortunately, our situation is not like retail where everyone knows when Christmas comes. Historically, we had handled these weaker periods by adjusting our cost or head count after the season to the more appropriate levels.

This year was unique because of the fact that the season was very late. Thankfully, July looks strong, so we have a makeup opportunity. The second quarter revenues rose 9.1% to $524.2 million compared to revenues of $480.5 million in the second quarter of last year.

Net income declined 3.3% to $63.4 million or $0.20 per diluted share compared to $65 million or $0.20 per diluted share for the same period last year.

When adjusted for the onetime Clark acquisition expense and the foreign currency exchange, it would be $0.21 per share. Eddie will provide greater detail on this and other financial results in a few minutes.

Revenues for the first 6 months rose 7.2% to $953.2 million compared to $889.2 million for the same period last year. Net income decreased 5.6% to approximately $107.7 million or $0.33 per diluted share compared to $114.1 million with earnings per diluted share of $0.35 for the first 6 months of last year.

We have a number of initiatives that will enhance Rollins' future growth and margin improvement. I'd like to talk more specifically about these business improvements and how they will impact Rollins. As we approach becoming a multibillion-dollar company, the timing is right to make strategic investments that will prepare us for the future. Some of these business investments and innovations are, if you recall, we improved our 401(k) and broadened stock grants at 2018 year-end. We estimate that there's an additional expense of $6 million for 2019 but we believe that there is not a better use of our resources. As a people business, our ability to recruit and retain excellent employees is paramount.

This investment has helped generate a strong improvement in employee retention for our first 2 quarters.

Next, we've increased and expanded our investment in customer routing and scheduling. This technology directly benefits our employees and customers. We now guide our technician to the customer's address with a service day that's planned from start to finish. The technicians have better organized days and our customers receive better communication and appointment reliability.

Our most recent technical innovation in this area is the adoption of Glympse, a software that enables us to communicate with the customer via text or e-mail as to their upcoming service date and time of service. Our customers now even have the ability to see where the technician is when en route to their account. As a result of these tools, we have created a better relationship with our customers and a better job for our technicians.

The customer is better served and has the capability to change their service date and time as their circumstances dictate. This investment has also contributed to our employees and customers retention improvements and reduction of miles driven.

As you recall from our earlier calls that we are transitioning our pension to an insurance provider. When complete, this will create a significant administrative expense savings. Eddie will discuss this in more details about this initiative in a few minutes.

As I mentioned, we've made and are making these improvements and innovations to better prepare for the company's future and to help mitigate some of the challenges we experience due to the seasonality of our business. Expanding our recurring revenue accomplishes this. As you would expect, there's been a significant amount of expenditures and effort that are associated with these initiatives that have and will have a positive effect on the company.

I would add that our company's track record has shown that we don't have a spend-yourself-rich culture at Rollins and we expect a favorable return on our new and improved programs. With the Clark acquisition complete, we will continue to evaluate other acquisition prospects as adding great companies and brands will remain one of our primary objectives.

John will now update you on the Clark acquisition and our other plans.

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John F. Wilson, Rollins, Inc. - President, COO & Director [6]

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Thank you, Gary. We believe our track record with our acquired companies speaks to the success we've had an integrating and growing acquisitions made over the past 19 years, all of which have contributed in many ways to our profitable growth. Historically, the larger acquisitions require a bit longer to integrate, as you might expect, and that will apply to Clark as well.

Once fully incorporated though, the long-term benefits of these acquisitions provide excellent top and bottom line growth expansion of our company and the ability to provide customers with additional pest-control-related services. These acquired companies benefit from our internet experience, greater purchasing power and transferable technology. Clark is on track with our business plan and we expect them to be a highly successful addition to our family of brands.

Gary and I are heading out there next week where we will meet with their team and check in on their progress. We are excited about Clark as the majority of their branches are in northern California and their addition dramatically strengthens our company's presence in this area.

As you may recall, we ended 2018 with the best employee retention we've experienced in our recent history, and the first 2 quarters of 2019 continued on that trajectory.

Further, as you would expect, employee retention directly correlates with customer retention. Improving and enhancing the benefit package for our team members obviously helps retain our people. However, investments in technology and process helps greatly here too as we have slightly -- I'm sorry, as we have simply improved team member job satisfaction with these various tools. A service technician's relationship with their customers is extremely important to ensuring customer loyalty and expanding our customer base. As Gary has shared, our customer routing and scheduling capabilities are a large contributor to improvement in this area as it enables technicians to expand their service time. This enables them to better fulfill their customers' needs and, in some cases, add additional customers to their route. For our field personnel, this technology provides additional benefits in the form of reducing the amount of time spent behind the wheel.

For the second quarter, we again had nice improvements in driving efficiency as measured by miles per stop. Average miles driven per stop in our Orkin fleet were down 4% year-over-year, and we have had 17 consecutive months of miles per stop reductions.

One last item related to technology. We gained full implementation of our human resource information system during the first half of the year. And this system, when fully utilized, solves a number of pain points for our field employees. We expect to see continued benefits through 2019 and beyond from these various technology initiatives mentioned.

On another note, this time of year, we get a lot of questions about how our mosquito business is doing. Although, a relatively small part of our overall business at this point, this service line continues to grow and is in part, driven by increased concern and public awareness around disease-borne issues, including Zika, West Nile and other diseases. Year-over-year, our mosquito service has grown over 35% and we expect continued growth in the future as we gain greater cross-sell penetration of our large pest control customer base. Now let me turn the call over to Eddie to discuss our financials.

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Paul Edward Northen, Rollins, Inc. - Senior VP, CFO & Treasurer [7]

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Thank you, John. I began our Q1 call discussing the strength of April only to have May and June demand look significantly different. We come to you again sharing what we know at this point with some pent-up demand from previous quarters coming through so far in July.

Our second quarter results can be defined by looking at the past, the present and the future. Each of these time periods has a significant piece of the results that we're reporting to you today and we'll continue to build on results for quarters and years to come.

For the quarter, all of our service lines showed growth and keys to the quarter included: significant negative currency exchange through a stronger U.S. dollar and our growing international business; continued year-to-date improvements in both employee and customer retention; and uneven pest demand that carry -- that Gary mentioned in the opening. To be more specific, the past events of our investment and enhanced benefits for our employees will impact this quarter by about $1.9 million, $1.5 million for the 401(k) and $400,000 for the special restricted stock and about $1.75 million for the remaining quarters of 2019 as we add Clark to our 401(k) plan.

While divesting of the special stock grants was a onetime event this year, the 401(k) will be impacted moving forward by employees joining or leaving the plan or increasing or reducing their contribution as we move forward. John just spoke about the lasting outcome that this investment has made on our employee retention, which is a key driver to our long-term success. Again, as a reminder, these items impact both CSP and SG&A, which I will discuss in more detail in a moment.

In addition to the items that Gary and John mentioned a few minutes ago, our present and future is, and will be, significantly impacted by our acquisition of Clark. We're on pace with our integration and have already made positive changes related to vehicles, procurement and benefits plans. Clark will go live on our fleet systems the 2nd week of August, which will be a step to getting their fleet operating margins more in line with Rollins' levels.

Based on past acquisitions, we have the opportunity to improve the fleet margins over 20%. Our Rollins support staff have visited with Clark in Lodi, California and we are learning so much. From my recent visit, I had a chance to listen to customer calls, and I was truly impressed with their call center function, the interaction with the customers and its efficiency. When I visited the Stockton branch, I gained a deeper understanding of how they run their operations at such an impressively high level.

Since that time, several Clark employees have visited Atlanta to learn more about Rollins and how they can support our integration efforts.

In addition to the reduced fleet expense, other items that will impact the P&L in Q3 and Q4 related to Clark are: depreciation will be up $1.9 million per quarter for buildings and vehicles added. We have received a draft of evaluation of Clark, and including Clark as well as the other 40-plus acquisitions that we've made over the last 18 months, amortization has increased $8.8 million.

We are in a position to share more details related to the purchase interest expense now that we have worked through some of the specifics. For Q2, we have $1.9 million of interest for the partial quarter of borrowing. For Q3, we estimate $2.7 million as we have already started paying down the loans and have added an interest rate swap to fix a portion of the loan at a rate of roughly 45 bps below LIBOR. We will continue to pay down the loans and estimate a reduction of interest expense to $2.5 million for Q4.

Again, we've already started to pay off the outstanding loans and our plans are to be debt-free by early 2022.

Finally, professional services were up $1.9 million for Q2, significantly higher than originally anticipated at the time of our Q1 call due to an in-depth regulatory review, and the need for economic experts to support our case for acquisition as well as expertise related to the real estate transactions. There will be an additional $400,000 of expense related to this in Q3 and we anticipate nothing in Q4.

For those of you that had a chance to review the release of our 8-K related to the Clark audited 2018 financials, I wanted to share some additional details.

From the bottom line results that were shared, there are approximately $11 million which will be excluded as we move forward in time: $5.7 million of that is for rents that are no longer paid since we now own the properties; an additional $2.4 million on elimination of vehicles and transportation; and then other expenses in addition. These expenses were normal private company expenses and there was agreement to make these changes prior to the finalizing of the acquisition.

There will be several margin points of gains from these changes that will be added to additional changes that we add from our integration of the business, previously mentioned.

One additional item where the Clark deal will have benefits will be in our free cash flow. Including the acquisition and the benefits of Clark, we will have approximately $40 million increase in free cash flow for 2019. Even with lower-than-average net income in Q1 and Q2, this increase is in line with the previous few years.

For 2019, as we've shared on prior calls, the earnings per share will be flat but we believe the deal will be accretive by $0.005 for the full year 2020.

Looking at the numbers, the second quarter revenues of $524 million was an increase of 9.1% over the prior year's second quarter revenue of $480.5 million. There was an accounting change that increased our franchise revenue recognition last year by approximately $1.5 million that did not occur in 2019.

Income before income taxes improved from Q1 but decreased 3.6% to $87 million from $90.2 million in 2018. Favorable expense adjustments were made but demand still lagged in several areas during the quarter. This impacted all of our subsequent financial metrics as well. Net income fell 1.9% to $64.3 million; earnings per share was $0.20 per diluted share, in line with $0.20 per diluted share in the first quarter of 2018; EBITDA was $109 million, up 2.2% over Q2 2018. EBITDA is the best measure for the near term with the addition of Clark.

Revenue for the 6 months ended June 30, 2019, showed -- was $953 million, an increase of 7.2% over the prior year's second quarter revenues of $889.2 million.

Income before income taxes decreased 4.3% to $143 million from $149.4 million in 2018. Net income fell 4.9% to $108.5 million, and earnings per share was $0.33, down 5.7% from the 2018 number of $0.35. EBITDA was $181.5 million, down 0.7 of 1% compared to 2018.

I detailed out some of the past and the present, now let's turn our discussion to the future. As first mentioned several quarters ago, we are in the final stages of transitioning our fully funded pension plan off of our books. There's so many positive impacts from this step, which include: managing the volatility of the assets, the elimination of that; the elimination of the annual $5 million payment to fund the plan; and the elimination of the daily administrative management of the plan.

In addition, since our plan is approximately 104% funded, which equates to roughly $6 million, these assets will be deployed in other areas of our business that will be discussed on our Q3 earnings call.

Most of the financial impact from the pension transition will occur in Q3. First, we will have a significant noncash charge of approximately $76 million pretax, which will be pension expense in Q3, which will equate to approximately $0.20 per share after taxes. This $76 million expense is the accounting treatment of the accumulated sum of unrealized losses associated with our plan. Net of tax, the loss will be approximately $64 million. The tax treatment is consistent with the method other companies would apply. The tax effect from the transition of the pension plan will be a reduction in the effective tax rate for the third quarter and for the year.

Let's take a look through the Rollins' revenue by service line for the second quarter.

As discussed earlier, our total revenue increase of 9.1% included 5.5% from Clark and other acquisitions and the remaining 3.6% was from pricing and organic growth.

In total, residential pest control, which made up 43% of our revenue, was up 11.1%; commercial pest control, which made up 37% of our revenue, was up 7.7%; and termite and ancillary services, which made up approximately 20% of our revenue, was up 9.2%. Again, total revenue less acquisitions was up 3.6%. And from that, residential was up 4.6%; commercial increased 2.8%; and termite and ancillary grew 4.6%.

In total, gross margin was down slightly to 51.7% from 52% prior year's quarter. The quarter experienced increases in most expenses due to acquisitions as well as in administrative salaries due to amortization of the employees special restricted share grants from the prior year and increased salaries. Service salaries, materials and supplies and fleet increased with production for the period. Taking out these onetime items, gross margin would have been 51.8%.

Depreciation and amortization expense for the quarter increased $3.8 million to $20.1 million, an increase of 12.9%. Depreciation increased $1.5 million due to acquisitions and equipment purchases, as mentioned earlier, while amortization of intangible assets increased $2.2 million due to the amortization of customer contracts from several acquisitions.

Sales, general and administrative expenses for the second quarter increased $18.5 million or 12.9% to $161.9 million or 30.9% of revenues, up 1.1 percentage point from $143.4 million or 29.8% of revenues for the second quarter of 2019.

The increase in the percent of revenues, as I discussed, is primarily due to acquisitions and the amortization of restricted shares from the 2018 special grant distribution and increases in the 401(k) expense. Taking out these onetime items, SG&A would've been 30.3%.

As for our cash position for the period ended June 30, 2019, we spent $414.8 million on acquisitions compared to $54.6 million the same period last year. We paid $68.7 million on dividends and had $13.4 million of CapEx, which was up 5.7% from 2018 primarily from planned IT upgrades, such as our BOSS Canada rollout and building improvements.

We ended the period with $98.5 million in cash, of which $67.8 million is held by our foreign subsidiaries. Yesterday, the Board of Directors declared a regular cash dividend of $0.105 per share that will be paid on September 10, 2019, to stockholders of record at the close of business August 9, 2019.

The cash dividend 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%. Gary, I'll turn the call back over to you.

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Gary W. Rollins, Rollins, Inc. - Vice Chairman & CEO [8]

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Thank you, Eddie. We're happy to take your questions at this time.

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Questions and Answers

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Operator [1]

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(Operator Instructions) We'll now take our first question from Michael Hoffman with Stifel.

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Michael Edward Hoffman, Stifel, Nicolaus & Company, Incorporated, Research Division - MD & Group Head of Diversified Industrials Research [2]

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I have a big macro question that would -- is about the pest control market, broadly. Do you believe that you're beginning to see a secular decline in the overall underlying growth rate -- organic growth rate? And then it will be part of a cycle? We've had an improvement tied to an improving -- economic cycle, cycle is starting to slow. Is the overall market growing slower?

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Paul Edward Northen, Rollins, Inc. - Senior VP, CFO & Treasurer [3]

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Yes. Michael, this is Eddie. I don't know that we have any insights that would change what we believe will continue to be a growth market as we move forward in time. I think current weather patterns have moved things on one side and the other. Over the previous few years, current weather patterns warmer during the warmer seasons, and I think we've seen growth occur during those times. I think that you actually highlighted some of the weather patterns that we've seen over the first part of this year in certain areas, at least in the U.S., and I think we've seen adjustments with that. So I don't know that we know anything or see anything secular in nature or different in nature other than what we've seen.

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Michael Edward Hoffman, Stifel, Nicolaus & Company, Incorporated, Research Division - MD & Group Head of Diversified Industrials Research [4]

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Okay. When...

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John F. Wilson, Rollins, Inc. - President, COO & Director [5]

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And management we have is what we now have -- what, 400 branches in North America? So we really do see from coast to coast. And certainly, as Eddie said that weather has a lot to do with how the season starts. And we're just not seeing an overall decrease as far as demand is concerned.

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Michael Edward Hoffman, Stifel, Nicolaus & Company, Incorporated, Research Division - MD & Group Head of Diversified Industrials Research [6]

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Okay. That's helpful. And then switching gears to Clark and I'll come back into the queue. I just wanted to be clear on the comment you shared with us, Eddie. So there's -- in the 8-K, there's -- I'm rounding, there is approximately $9 million of reported income by Clark. And you're suggesting that you have $11 million that you can add back to that because of -- underlying it with vehicles and -- forgetting the other item you pulled out here as I'm looking through my notes. Vehicles and rents were $8 million of that but that there is $11 million. So I'm looking at a $20 million as a starting number. Is that the right way to think about it on the way you'd run the business before any other adjustments?

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Paul Edward Northen, Rollins, Inc. - Senior VP, CFO & Treasurer [7]

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I think that's a fair way of thinking about it. Yes.

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Operator [8]

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We'll now take our next question from Dan Dolev with Nomura.

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Dan Dolev, Nomura Securities Co. Ltd., Research Division - Executive Director of Business Services [9]

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I was a little bit surprised on the commercial side that I think the comp was a little bit easier. If I'm not wrong, you did about 2.8% organic growth in that subsegment. That's quite a bit lower than -- if I look historically, you're averaging 4%, 3%. Is there anything we should be concerned about regarding competitive pressure from your larger competitor that's being more aggressive on that side? I can't help -- is that -- is the weather impacting commercial like it impacts residential?

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Paul Edward Northen, Rollins, Inc. - Senior VP, CFO & Treasurer [10]

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Yes. So Dan, I'll start with say looking at a year ago, we grew 4.2%. That's a pretty hefty number on the commercial side. And I would say that one of the things that we saw in the quarter was fumigation that was just from some individual jobs and customers that just didn't come through. And fumigation is a piece of what we do on the commercial side. It's not tariff-related. It's not anything else like that. It's actual jobs that didn't come through that we had historically seen. So it wasn't competitive in nature at all. And when we went through and looked at what those impacts were over that time period, it was rounding to 1% for us on the commercial side. So we've made adjustments where we can in the operations with that. But that's something that, historically, we've not seen kind of move like that. So no competitive concerns at this point. A little bit of a higher comp from a year ago and the fumigation a piece.

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Dan Dolev, Nomura Securities Co. Ltd., Research Division - Executive Director of Business Services [11]

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Got it. And just a separate question. We've done some survey work here that showed that obviously the customer satisfaction is very good and people that like the Orkin service really like the customer satisfaction. But on the other hand, it felt like pricing matters more than what I had expected. Is -- this industry has been known for almost infinite price elasticity. Have you noticed any changes? Have you seen any pushback from customers on the price increases?

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Paul Edward Northen, Rollins, Inc. - Senior VP, CFO & Treasurer [12]

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Yes. Thanks for that. We've not seen issues with that. I think as you know, we've talked about, our marketing group is very robust in their testing. So that we want to know and understand what sort of temperature we'll have when it comes to rolling out our price in individual markets and individual areas because we do not want to lose customer for price because the lifetime value of the customer is the most important thing to us. So I think we feel comfortable with the testing that's going on. I don't know of any material pushback that we've had. Our pricing is relatively in line with what we've seen in previous years. And again, as we mentioned on the call, our customer retention numbers continue to improve. So I don't think that we're seeing issues or concerns or problems at this point in time in that area.

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Gary W. Rollins, Rollins, Inc. - Vice Chairman & CEO [13]

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Eddie, if I could. We're very fortunate in our call center that we have -- that we can verify really if there's any pricing issues with our closure. So we kind of have a laboratory, if you will, that you have the same people kind of handling these calls from Northeast and the Midwest and so forth and so on. And so we're able to track closure literally by region and division.

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Operator [14]

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We'll now take a question from Jamie Clement with Buckingham.

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James Martin Clement, The Buckingham Research Group Incorporated - Analyst [15]

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I was just curious if I can get your thoughts. I think this was -- this has been an unusual year in the sense that, from our perspective, the industry has faced some unusual weather in both the first and the second quarters. And what I was curious about was, if in local markets, some of your competitors and everybody was finding it hard to generate leads in the first quarter, do they tend to spend more time to generate leads in the second quarter? Did you notice any of that? And how do you all strategically respond? Do you try to match them? Or do you just kind of stick with the blueprint?

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Paul Edward Northen, Rollins, Inc. - Senior VP, CFO & Treasurer [16]

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I think we -- we'll stick with the blueprint. The marketing really has to go through and figure out ways to be innovative when it comes to that acquisition cost per lead. And then it's on us to be able to make sure that we're doing what we can to close the lead from there.

I don't think we've seen anything different having to do with either the price necessarily for that in total. Now there are some channels obviously that are more expensive. But our marketing group I think, again, is doing a great job by going and finding other channels to be able to create some of those leads. And it's just a matter of is there enough demand there for the lead? And I don't think it's necessarily that we're not winning leads. I think it's just been the demand that is there and the leads not being available to us.

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James Martin Clement, The Buckingham Research Group Incorporated - Analyst [17]

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Okay. Eddie, I'm not sure I caught this, were you saying that the depreciation as a result of Clark would be up about $1.9 million sequentially from Q2 to Q3? Is that what you said?

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Paul Edward Northen, Rollins, Inc. - Senior VP, CFO & Treasurer [18]

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I don't think I said that about depreciation.

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James Martin Clement, The Buckingham Research Group Incorporated - Analyst [19]

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Okay. Basically what I was just trying to get sort of like what's the current all-in quarterly D&A number post-Clark?

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Paul Edward Northen, Rollins, Inc. - Senior VP, CFO & Treasurer [20]

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Yes. We did say it was up $1.5 million year-over-year.

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James Martin Clement, The Buckingham Research Group Incorporated - Analyst [21]

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I thought there was a different number you gave about Q3. And I didn't know if that was cumulative. I just was -- just because it's noncash, and I just wanted to make sure that there are no grievous modeling errors.

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Paul Edward Northen, Rollins, Inc. - Senior VP, CFO & Treasurer [22]

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We'll go up back and we'll look at the transcript and we'll share that with you. How about that?

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James Martin Clement, The Buckingham Research Group Incorporated - Analyst [23]

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Okay. All right. Great. And yes, and just a general comment, Gary, how the international businesses are performing?

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Gary W. Rollins, Rollins, Inc. - Vice Chairman & CEO [24]

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They are performing well. We're very pleased. We've had some challenges in Australia but we seemed to have turned the corner there. Their economy has not been robust as we have here in North America. But we're very pleased with U.K. We're very pleased with our operation in Singapore. And so I would think, all in all, we're pleased with our international performance.

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James Martin Clement, The Buckingham Research Group Incorporated - Analyst [25]

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Are more international acquisitions very much on the table?

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Gary W. Rollins, Rollins, Inc. - Vice Chairman & CEO [26]

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I think so. We continue to have candidates. And I think our track record has helped us understand what we can expect and when we can expect it. So I think we're a little bit more robust than we were before, but we're really pleased. And one of the great things is these people that have built these businesses have stayed. So we don't have to learn the culture and all of the things that a local individual is already extremely familiar with. And I think that, that's been a blessing. And we also have a position that we can refer a candidate to our other acquired companies. And that's helped us a long ways because I think we get good results or good feedback that we don't go in and try to change everything or change everybody, that we're patient, and we try to share things that we think would benefit them. But we're not taking a heavy hand. And I think that goes a long way when you're trying to acquire a company.

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Paul Edward Northen, Rollins, Inc. - Senior VP, CFO & Treasurer [27]

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Jamie, to close the loop I did mention, I just want to make sure the total depreciation versus what we called out for Clark, we did say up $1.9 million per quarter for buildings and vehicles having to do with Clark.

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James Martin Clement, The Buckingham Research Group Incorporated - Analyst [28]

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And that -- so that was second quarter year-over-year?

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Paul Edward Northen, Rollins, Inc. - Senior VP, CFO & Treasurer [29]

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That's correct.

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Operator [30]

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(Operator Instructions) We'll now move to Tim Mulrooney with William Blair.

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Timothy Michael Mulrooney, William Blair & Company L.L.C., Research Division - Analyst [31]

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Eddie, you and Gary and John, you guys have thrown a lot of numbers at us this morning. On the margins, if you could exclude Clark for a second, just stepping back here, I kind of thought margins would have been heading up higher this year with the roll-off of some of your IT expenditures, maybe a more normalized growth of recurring revenue customers. But it appears like maybe there are more headwinds here, other things to consider offsetting some of these benefits. Could you just step back for us and kind of give us the major puts and takes on margin in 2019? And how we should think about the major puts and takes overall, I guess?

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Paul Edward Northen, Rollins, Inc. - Senior VP, CFO & Treasurer [32]

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I think if you take Clark out, the benefits piece is going to be one of the larger pieces that we're going to have that will be out there. That is, as you know, it wasn't something we thought was going to be a headwind expense-wise. We thought we would be flat to the previous year but with our improved usage of the plan, of more people joining the plan, more people increasing their match in the plan, that has been an additional expense for us. But the other piece of it is going to be staffing for a season that hasn't come as normal or as expected. We don't have a dollar amount for that. We don't have a dollar amount to give you puts and takes having to do with that. But the solid numbers that we have talked about do have to do with the benefits.

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Timothy Michael Mulrooney, William Blair & Company L.L.C., Research Division - Analyst [33]

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All right. No. That's helpful. That's helpful. How do you think about margin on a go-forward or a long-term basis? Do you think this business tops out in the 20%, 21% EBITDA margin range? Or is there more room to run through stronger density and tech investments and stuff like that?

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Paul Edward Northen, Rollins, Inc. - Senior VP, CFO & Treasurer [34]

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I think, coming from a density background, and that's before Gary convinced me to make the best decision of my life, after marrying my wife, was -- but how -- was learning and understanding points of density. And every single time John and group find and acquire a mom-and-pop company, they find and acquire a regional company that we end up rolling into another existing brand or organization, we get a little bit more dense, we get a little bit more efficient, and we become better every single time that happens.

So to me, in an extremely fragmented industry like we have, I think the upside opportunities continue to be out there for years to come.

And I think when you double down on that with the technology investments that we have made and the fact on how we are executing on those technology investments at this point in time with a lot of runway to go, I still think, personally, that there's a lot of upside potential that has to go with that.

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Timothy Michael Mulrooney, William Blair & Company L.L.C., Research Division - Analyst [35]

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So a lot of runway left, no reason structurally why Rollins' EBITDA margin tops out at 20%, 21%?

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Paul Edward Northen, Rollins, Inc. - Senior VP, CFO & Treasurer [36]

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I don't believe so. I think there's more room potentially to grow as we move forward in time.

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Timothy Michael Mulrooney, William Blair & Company L.L.C., Research Division - Analyst [37]

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I just want to squeeze in one more here because it's kind of related to that. Just on the Clark acquisition. If I add back that $11 million to the reported how we calculated EBITDA of $16 million, we get more to a run rate EBITDA for Clark that's closer to 20%, already excluding that -- those $11 million onetime items or items that won't repeat. Am I doing that math right? Are you getting to a go-forward Clark EBITDA margin in the high-teens range? And where do you think you can get that to in a couple -- am I doing the math right? And how do you think about it long term?

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Gary W. Rollins, Rollins, Inc. - Vice Chairman & CEO [38]

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Yes, I think your math is right. And we started calling out some of the things that we are already moving on, having to do with improving our vehicle margin. We're going to be moving those folks over to -- the Clark folks over to some of our benefits plans, which is going to be a saving. We've already started with our procurement spend items. So we know there are going to be multiple margin points that are going to be in addition to those other items that I called out $11 million. And the good news is, like I mentioned, we've had our support staff out there, we understand what we can move on and the priority of how quickly their needs are. They've been here to work through those integration steps. And like I said, so even in 2 weeks, we're starting with the fleet. We're going to start moving the fleet piece of it. The 401(k) plan is going to be moving over in August to the Rollins 401(k) plan, which will be a saving.

So there is -- there are multiple opportunities that we believe, from a margin perspective, will help in addition to what you lined out.

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Operator [39]

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(Operator Instructions) We'll take a follow-up from Michael Hoffman with Stifel.

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Michael Edward Hoffman, Stifel, Nicolaus & Company, Incorporated, Research Division - MD & Group Head of Diversified Industrials Research [40]

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So there's 2 pieces here. One, on the -- you gave us an adjusted gross margin of 51.8%, which pulled out all the noise. So that's still down year-over-year and yet retention is better, I'm still struggling with why margins aren't improving? And then the second part, you gave us an $8 million amortization number but you didn't tell us whether that was a quarterly or how does that flow through? So when I look at D&A in total, I get $1.9 million for Clark plus what for amortization per quarter?

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Paul Edward Northen, Rollins, Inc. - Senior VP, CFO & Treasurer [41]

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Yes. I'll -- so Michael, I'll go back to the first question that you had there. And I think it's a little bit of what we responded back to Tim with. We've staffed for a season that has not come through as we've seen from a normal demand perspective. And as Gary opened up the call, we're not as -- our efficiency is as good as we normally have it, and we're making adjustments for that. It's just the abnormality of kind of the way this has fallen. We don't want to be in a position where we're not staffed accordingly for a season, have the season come, and then not be able to take care of things from a customer perspective and a long-term customer value perspective.

So we had an abnormality there, and I think that's what we're seeing as part of that margin piece. We're moving forward. We're making adjustments to that. And like I said, July has been off to a good start.

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Gary W. Rollins, Rollins, Inc. - Vice Chairman & CEO [42]

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I'd like to add to that. If we cut our vehicles and our head count a month ago, we'd really be in bad shape right now. So whether you like it now or not, you've just got to hold them. And fortunately, I guess July now is showing that, that strategy or those actions were really the right things to do. But it's very painful when you have that period that you're not getting your revenue as you're expecting but you've got that incremental expense buildup in the form of head count and vehicles. So that's really what put more pressure on the margin than any of these other things.

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Paul Edward Northen, Rollins, Inc. - Senior VP, CFO & Treasurer [43]

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And Michael, we're not going to manage to a quarter. That's the bottom line of what our company is about and it's the way the Rollins has been successful for a lot of years. And we're not going to make a short-term decision that might help on margin 1% or 2% or whatever else like that and then damage the long-term business. We're not going to do that. And that's unfortunately what we've gone through in those first 2 quarters and to Gary's point, paying off and we're seeing the demand that's coming through and we're prepared for that. Second part of your question had to do...

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Michael Edward Hoffman, Stifel, Nicolaus & Company, Incorporated, Research Division - MD & Group Head of Diversified Industrials Research [44]

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Can I just ask for clarification just so I make sure I understood everything? I get what you're making -- the statements you're making. I get the business management reasons for managing the cost the way you did. If the second half growth rate -- it's a good growth rate but it's still organic -- is lower year-over-year, by all rights the margins should expand because of the way the math of adding new customers, lower margin in the first year, better margin in the second, really good in the third, isn't that -- is that the right way to think about that, all else being equal?

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Paul Edward Northen, Rollins, Inc. - Senior VP, CFO & Treasurer [45]

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That's exactly the right way to think about it. You're exactly right with how you're thinking about it. That's what our expectations would be as we're moving through the remainder of the year.

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Michael Edward Hoffman, Stifel, Nicolaus & Company, Incorporated, Research Division - MD & Group Head of Diversified Industrials Research [46]

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Okay. And then just a clarification on the amortization number you gave us. How do I apply it in the model?

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Paul Edward Northen, Rollins, Inc. - Senior VP, CFO & Treasurer [47]

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That's going to be year-over-year increase is what that's going to be.

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Michael Edward Hoffman, Stifel, Nicolaus & Company, Incorporated, Research Division - MD & Group Head of Diversified Industrials Research [48]

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Full 12 months, so divided by 4.

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Paul Edward Northen, Rollins, Inc. - Senior VP, CFO & Treasurer [49]

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Correct. Correct. I do want to clarify one other thing, Jamie. You had asked a question earlier about the depreciation. I misstated something, so I just want to clarify that. The $1.9 million for the depreciation for Clark is going to be for Q3 and Q4. For Q2, it was $1.3 million and that's because we acquired them at the end of ...

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John F. Wilson, Rollins, Inc. - President, COO & Director [50]

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April.

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Paul Edward Northen, Rollins, Inc. - Senior VP, CFO & Treasurer [51]

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At the end of April. So it's 2 months out of the quarter. So I want to make sure that we clarify that.

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Operator [52]

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And we do have a follow-up question from Jamie Clement from Buckingham.

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James Martin Clement, The Buckingham Research Group Incorporated - Analyst [53]

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And then just 1 follow-up question. Just reading a little bit of the news about California and some of the rodenticides situation with the legislation and that kind of thing, is there a -- is that an opportunity for somebody like you, if the industry has to change protocols?

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Paul Edward Northen, Rollins, Inc. - Senior VP, CFO & Treasurer [54]

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That's a really good question, John is probably closest to that.

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John F. Wilson, Rollins, Inc. - President, COO & Director [55]

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Yes. Jamie, that's a great question. I don't know, I'm not sure anybody knows right now. I was reading an article on that just last night.

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James Martin Clement, The Buckingham Research Group Incorporated - Analyst [56]

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So was I.

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John F. Wilson, Rollins, Inc. - President, COO & Director [57]

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So we're not real sure just yet. We do -- there's -- obviously if you take away the second-generation rodenticides, the opportunity for the rodent population is to grow pretty dramatically is there. And so that creates opportunity. But it's unfortunate and we're, as an industry, wrestling with that as we speak. But I think there can be opportunity there, just may not be good for the residents of California.

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James Martin Clement, The Buckingham Research Group Incorporated - Analyst [58]

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Yes. No, I get it.

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Gary W. Rollins, Rollins, Inc. - Vice Chairman & CEO [59]

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I think it gets down to how much pressure the public is going to put on these regulators because rats are pretty onerous and just their appearance if nothing else. So it's going to be interesting to see. Because I think this is the first legitimate shootout that you have between the environmentalists that think they did the right thing but apparently, by all indications, this is just really backfiring on them. I mean this is unintended consequences and we certainly have more rodent leads than we had, I mean if there's a preponderance of the population. But it's going to be really interesting to see how this thing shakes out.

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John F. Wilson, Rollins, Inc. - President, COO & Director [60]

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Jamie, one thing too. They haven't taken these products away from use in food processing plants. So they're still going to be out there and then further to that, while you can't buy them off the shelf in a grocery store in California, you can order them on the Internet. And depending on the number that you look at, we maybe take care of 20%, 25% of the population. The rest is unvended and they're going to various Internet sources and buying those same products and they'll still be using them.

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James Martin Clement, The Buckingham Research Group Incorporated - Analyst [61]

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And probably using them less responsibly than you'd be using them.

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John F. Wilson, Rollins, Inc. - President, COO & Director [62]

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Exactly, right and that's been our big issue with the regulation. So...

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Paul Edward Northen, Rollins, Inc. - Senior VP, CFO & Treasurer [63]

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Michael, one other clarification for you having to do with the amortization, kind of similar to back to the question that Tim had having to do with the depreciation and I misstated. So the amortization for the quarter was about $2.2 million, but we only had 2 months of Clark as part of that. So the amortization, as we move forward per month, year-over-year will be slightly higher than that. So just because -- so obviously, we'll have 3 months to be in there but I just wanted to clarify that.

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Operator [64]

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And it appears there are no further questions at this time. I'd like to turn the conference back over to management for any additional or closing remarks.

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Gary W. Rollins, Rollins, Inc. - Vice Chairman & CEO [65]

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Well, thank you for joining us today. We appreciate your interest in our company, and we look forward to updating you on our progress on these numerous new programs and initiatives that we're taking and also the fact that the season this quarter certainly is starting strong. We would hope that, that will continue throughout the quarter. Thank you.

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Operator [66]

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And once again, that does conclude today's conference. And we thank you all for your participation. You may now disconnect.