Rentokil Initial plc (RTO) Earnings Call Transcript & Summary

Hello, and welcome to Rentokil conference call. [Operator Instructions] I'd now like to turn the call over to Andy Ransom, CEO. Andy, please go ahead.

Thank you very much. Good morning, ladies and gentlemen. As you will have seen this morning, we've issued a trading update following lower-than-anticipated revenue and profit performance in our North America business. We now expect the group adjusted PBTA to be around GBP 700 million for the full year, with a group adjusted operating margin for the year of around 15.5%. There were 3 main reasons for this. Firstly, whilst we saw some positive momentum in North America sales activity at the end of the second quarter, the trading performance in July and August was lower than anticipated, and we now expect North American organic revenue growth in the second half to be in the region of 1%. Secondly, our business in North America invested to deliver our planned growth through the peak summer months, with increased labor available in sales and service, increased overtime and higher materials and consumable expenses. And thirdly, since the interim, sterling has strengthened against the dollar. If rates remain at current levels to the year-end, this will result in a full year incremental headwind of around GBP 10 million. Our immediate focus is on the RIGHT WAY 2 plan to improve revenue growth through increased lead flow, better sales conversion and customer retention. We're taking decisive action to mitigate the cost overruns as we exit the peak season, managing inventory more effectively, managing technician workload and overtime, and we'll rightsize these sales resource for the volume opportunity. The rest of the group continues to perform well. I know you'll have lots of questions for me and Stuart, who's out in the United States. And so let me hand over to the operator and get straight into questions. Thank you.

[Operator Instructions] Our first question comes from Simona Sarli from Bank of America.

Andy, Stuart, just a quick follow-up on what you mentioned this morning, and that is related to your cash conversion guidance, that you are leaving unchanged that 80% to 90% and then just a small increase in leverage compared to last year. Can you please talk about the moving parts here on why you're retaining the cash conversion guidance? And also in light of the fact that you are now looking to reduce the size of your sales force and also all the other initiatives that you mentioned, if we should expect any incremental one-off costs compared to what you have guided for at the beginning of the year?

Thanks, Simona. Stuart?

Yes, yes. Up and running. Well, look, the 80% to 90% is a cash conversion rate. Clearly, it's in a reasonably broad range. And broadly speaking, we'd expect most of this adjustment to the outlook to be cash in nature. There'll be some pluses and minuses in working capital, but I wouldn't expect it to have a material impact on our cash conversion rate. 80% to 90% is still the range. We've still got the slight headwind from the historic termite damage claims, which is what brings it down from the over 90% level. But working capital well managed, and we're a pest control business. And ultimately, customers pay and we deliver service and we bear costs to the labor, vehicles, fuel and materials and consumables. So there's no particular mystery to our cash conversion characteristics. So reasonably comfortable that outlook on leverage and our cash flow burden rate will remain true. Then in terms of the one-offs on sales, routinely, we adjust the size of the sales force at the end of the season. Usually, that's through natural wastage, and usually, you're replacing colleagues who have left and getting them in training for the new season. That's true of service as well, by the way. And so there's plenty of scope in the normal rhythm of the organization to manage adjustments to the scale of your resource as you go through the off-season. Bear in mind that our colleague retention is circa 80% or so, I think. So plenty of scope within that to -- and sales retention, of course, is lower than that. So plenty of scope to manage that without materially moving our cost to achieve [indiscernible].

And as part of the question regarding cash conversion, can you elaborate a little bit more on working capital and the reversal that you're expecting in the second half of the year? Because if I remember correctly, in H1, you came in with cash conversion a little bit softer than expected, and there was an element due to debtors and also suppliers. So is there any update on that front?

Well, all I would say is it's behaving exactly as we expected it to. We did, in July, get a decent bounce back as we expected to, and so I've got no reason to adjust my outlook or mindset on working capital at this point. So I'm absolutely fine with where it stands.

[Operator Instructions] Our next question comes from Nicole Manion from UBS.

Sorry, I missed the call this morning. So sorry if this has been asked, but just one from me. You were talking, I think, this morning, about execution on the integration so far. I just wanted to kind of get a sense of how that kind of early branch integration as you sort of shift into that heavy-lifting phase, what you're seeing that may be different from expectations? And if there's anything in there that you think you need to sort of rethink around that branch strategy, particularly sort of closing some of those smaller branches, whether that's all unchanged? Just trying to get the sense of what's really differed from your expectations so far in terms of those early kind of, yes, full branch integrations.

Thanks, Nicole. Yes, and there's not a lot to tell on the integration story so far. The -- as you say, the original pilots that we did some time ago, we had -- we did them for and see what we could learn to find out where the pinch points were, and we learned a tremendous amount. So we've avoided those pinch points in the integrations we've done so far. So to be clear, what have we done so far? We've done very, very significant heavy lifting on systems integration, moving historic Terminix branches and Terminix systems onto the new platform. That's very complex, very multifaceted that has gone extremely well so far. Lots and lots of issues have popped up, but the vast majority have all been resolved very, very, very quickly. So I think in terms of the model that we've got, can we migrate Terminix branches on their IT stack, onto the new IT stack without major drama, the answer would appear to be a strong yes at the moment. We're -- next up is to do a series of what we call rebranching, and that is effectively rebranding within a branch. So that's the deliveries and the logos and the branding, and that's started recently, that's got off to a decent start. In terms of the pace and the cadence of integration, we've not made any changes to that as it stands. I have asked the business whether there are opportunities to go faster given the so far so good progress on the systems integration. So that's something that the business is looking at. Could we get through the systems migration faster because that would be wonderful to have every part of the -- every branch and every part of the business on the same system stack with the same management information and same business information. That's something we're looking at, but at the moment, we're not changing the cadence. And in terms of the branch plan, at the moment, there's no change to that. So I would say, steady as she goes in terms of what we've seen so far and certainly over the last few weeks and months. But as you know, quite a long way still to go.

Okay. So as a summary of that, I guess what you're saying there is that it's been a little bit more disruptive maybe than you expected, but there's not anything that you can pinpoint that sort of materially kind of underperformed versus the expectations that you have had at the outset?

Yes, I'm not sure I would say it's been more disruptive than expected. Integrations are always complex, and they've always got their challenges. Certainly, in the early pilots, going back a bit, we saw levels of disruption. I think we've remediated the vast majority of that. So it's just hard. There's just a lot of it. There's a lot to be got through. So I think maybe it's more about time pressure than it is about anything that isn't going to plan. So it's just a lot to get through is the way I'd describe it. We've got some questions that have been submitted, that have just been stuck under my nose. I'm happy to answer these. Or do we have any other calls on the line before I do these?

Yes, we have our next question from Simona Sarli from Bank of America.

Andy, sorry, just one last one from my side. Any update that you can give on where you stand in terms of realigning the compensation package of the salespeople. If I remember correctly, at H1, you were mentioning that you were going to run some pilot programs towards the end of the year.

Yes. Thanks, Simona. Yes, where we're up to on that is the design of the new unified comp plans, both for sales and service have been signed off. They have been signed off by the business by the operational leaders, the functional [ leaders ], the financial leaders and by me. So we have a design that we've locked and loaded. That now has to be configured in IT systems. So designing is one thing, you've got to be able to deliver it to your colleagues. We've done some soft, not piloting, but soft pre-marketing, if you like. So we've taken some focus groups of colleagues, and we've started to socialize the planned changes to comp. And I don't have a detailed feedback on that, but the anecdotal feedback I had was positive and encouraging. So next stage is to plumb those comp plans into IT systems, so they can be delivered. And then in the fourth quarter to pilot them, as you say, in actual branches, and then we'll learn a lot more over the next few weeks and months as to whether they've landed well, which obviously, we hope they will, or whether we've got to make any fine-tuning and tweaking. Any more...

Our next...

Please go ahead. Yes.

My apologies. Our next question comes from Oli Davis from Redburn.

And just a couple of questions. So in terms of the GBP 50 million cost overrun, can you just discuss the reasons why that was so much of a budget as I assume most of that would have occurred even if you achieved 3% organic growth in the second half? And then, I guess, secondly, how much confidence do you have that can be better budgeted into 2025?

Yes. Stuart, do you want to pick that up for Oli?

Yes, sure. Thanks, Oli. So yes, if I just sort of tap through the elements of that. I think the materials and consumables is the easiest to deal with. We -- 2 or 3 factors in materials and consumables. We stored, we stocked up at the beginning of the season at fairly normal levels and then -- and normal levels for the volumes that we were expecting. Those volumes didn't come through, and therefore, we're wearing a P&L debit on that volume. We've done a couple of deals with suppliers as well, which is a bit more upfront cost for the better full life outcome. So -- but we expense stuff as it gets distributed to branches and technicians. So it may be that once we inventory the year-end, then we will get a little bit back, but I wouldn't bet on that. We just think we'll expense it, we'll acknowledge the overrun. And with good luck, we'll have a little bit of carry through to 2025. On the labor side, again, it's not really a budgeting issue, but the -- in service productivity in order to maximize, albeit the disappointing growth that we've experienced, in order to maximize it, the guys have been doing a lot of weekend work, a lot of time and a half, a lot of double time, a lot of the marginal revenue is being delivered through a pretty high-cost labor model. And that's just it, and we wouldn't have budgeted to do that, but we've made the decision as we go that we still make a gross margin on that and it's worthwhile doing. So economically, it makes sense, but clearly, it gives us some cost variances. And then on the sales side, as we really described, we've taken a double whammy there. Not only have we not got the GBP 20 million or so of contribution, but -- from the guided number, but additionally, we've resourced to a higher number. And therefore, we want a degree of sales costs that we wouldn't normally expect to take -- sorry, at that level of volume. So the combination of those 3 things, as you can see, it's a pretty weighty number that's quite painful. But I don't really think it's a budgeting issue. It sort of comes back to 1 or 2 small things around the edges. But really, it's about the challenges of delivering the growth, the degree we expected. What does that mean for 2025? Well, as I said earlier on, it's early days. The disclosure requirements in the U.K. are as soon as you're aware you have a variance then you have to declare that variance. And clearly, in parallel to that, we're working through what that might mean for 2025. We expect in the normal course of business to have a resource model, which matches the revenue we expect. And broadly speaking, we've done that over many years, and we expect to return to that in 2025. Quite what that means for margins we've got to work through because one of the base assumptions that we have to bake in is volume. And clearly, with 1% organic growth if you've got price, which we have, you've got a de facto decline in volume. And so we've got to work through the implications of that volume shortfall on our route density, and therefore, our margins in 2025 and beyond. So that's a work in progress. We'll update you again in the Q3, and we'll update you again at the prelims in February because we probably won't have a full satisfactory answer in the next couple of weeks. But that's the way to think about it, Oli.

Okay. And then just one for Andy, on the pay plans. Are they consistent across the country? And I guess, when do they get rolled out to branches that aren't impacted by a consolidation?

Yes, Oli, they will be consistent across the country. There may be some variances because the state laws are different. The laws in California are different, for example, but they will be broadly the same. And the current plan is to deploy as we integrate in the branches. So the current plan is not to go big bang across the entire workforce in one go, but to roll it out on a phased basis as we do the phased integration.

Okay. So effectively done regionally, basically?

Yes, exactly. Very good. I've got 4 questions here on the screen. So maybe I'll pick these off because I don't want to lose these in the interest of time. The first one is, we may have touched on this already, Stuart, but I'll give you a second chance to go at it. How does the lower-than-anticipated U.S. performance impact the deleveraging target and the time line to reach this, please?

Yes. Thanks, Andy. As I said this morning, I think we guided to modest deleveraging in 2024. I think the impact of this adjustment gets us about level, but that's at about 2.8x, something like that. Just for clarity though, we are well within the range of our current BBB flat rating. So we do have a medium-term target to get to 2 to 2.5x. But we're really not that far off, and that will give us substantial headroom against a BBB flat and actually might -- would even probably put us into a BBB+ category. So I'm not remotely concerned about the rating. We got plenty of headroom in our facilities. What does this mean for further deleveraging? Well, that comes back to the comments I made just now about 2025. What does 2025 look like? How do we normalize the resource? How do we cope with what is clearly a lower volume base than we were planning for and what does that mean for margins in 2025? And that's a work in progress. But on our previous plans, we were expecting a pretty significant deleveraging through '25 and '26 as the operational synergies are delivered through the branch integration and as the cost to achieve fall away, actually, we throw out quite a lot of free cash at that point. Now clearly, there's a timing point there. But it almost follows naturally. So I'm -- we'll come out with the guidance in due course, but I think we're in really good shape actually. And the impact on this year is pretty marginal, if I'm honest.

Thanks, Stuart. The next question, I'll take. Can you provide any color on the competitive landscape in the United States, retention both staff and client, and any comments on your market share? What would I say? If I take colleague retention first, we've continued to see improvements in sales, service and admin colleague retention pretty much every month so far this year. I think I've seen the latest data up to date as well, and we continue to see improvements there. So given in my world view that, that's the most fundamental building block of building a quality operation is to get high colleague retention. Seeing the college retention number continuing to improve month-on-month, quarter-on-quarter is pretty important and that appears to be the case. So that's positive. How does that compare with competition? Really difficult to say. I don't have their data, and I'm sure we added it up differently in any event. Customer retention, I think, is an important point. I would say it's the second corner piece in the jigsaw puzzle for consistent, profitable organic growth. And that is you've got to get your underlying portfolio of customers in growth. Customer retention, as we measure it, and we've measured it since, I don't know, probably 60 years, is a revenue-based concept. So when measured by revenue, customer retention remains stable, similar levels to last year. So not part of the story significantly in terms of the weakness that we've called out today, but customer retention, by customer number, by the volume of customers, absolutely needs to improve. And that, I think, is the fundamental building block and rebuilding block of organic growth that we are focused on. And I mentioned at the half year, we're putting additional resources into customer retention, and I'll be going out to the states in a couple of days' time. We'll be spending a fair bit of time working on our strategic and tactical initiatives to drive up customer retention. So stable as measured by revenue, but a significant opportunity to increase that, and we have to increase that by volume to drive up the organic growth. In terms of market share, what would I say, I've just been asked this by one of the media outlets. I would say, market growth in United States, very difficult -- low level of transparency, but market growth in U.S. pest control seems to be about its normal level that 4% to 5%, give or take. Clearly, with us growing at the 1% mark, we are growing less than the market. So that, by definition, means we are losing market share, but this is not a market where we lose and then competitor A or competitor B wins. This is not -- I won't name other esteemed competitors. This is not a case of they win equals we lose, or we lose equals they win. Competitors can be doing very nicely, thank you, growing in line with the market or better than market and that may well have very little to do with how we're performing. And the reason for that is this is very much a local market. And we're operating in 600 cities and towns across the United States. And in every one of those cities and towns, we're competing against 10, a dozen, 15 local regional national competitors all competing for the same business. So it's a very competitive market. It's a very dynamic fluid market, but it's not the case of our growth below market is because one competitor or another is particularly winning at our expense. That isn't how the industry works. The next one, I'm just trying to get through all of these, and it's a philosophical question. I was wondering if you could go back to the start of the integration with Terminix, would you do things differently? Are there learnings from the differences between commercial and residential stroke termite, and maybe in terms of how you target consumers and how you generate quality leads -- and generation of quality leads? Honestly, it's difficult to say with the benefit of hindsight, what if anything, one would do differently. I'm sure there are things that mistakes will have been made in response to the earlier question, on the pilots. The reason we did extensive piloting a year or so ago is to try and work out what would work and what would not work. So I think what would you do differently? You would probably pilot earlier, you might pilot more extensively. I think it's taken us a bit of time to engineer the end-state design of the IT stack. That's not a criticism of the team, it's just complex. So perhaps we could have gone a bit faster and made a few different decisions. I think perhaps we've been in the pursuit of perfection, trying to get systems and processes that are best in class, or perhaps we could have gone faster if we've gone to a bit more 80-20 rather than trying to finesse things to the end of degree. But it's just me, pragmatism perhaps could have been a bit stronger than the pursuit of perfection. In terms of targeting consumers, I think that's just a great question. I don't think there's any doubt, if I just speak for the heritage Rentokil colleagues as opposed to the heritage Terminix colleagues, I think heritage Rentokil colleagues, there's not much that they don't know over 100 years now in business in terms of the commercial enterprise and the commercial side of the industry, particularly for large commercial customers. I do think we've had a lot to learn and quite apparently, we are still learning it in terms of residential and termite. I think residential and termite is far more transactional, far more tactical, far more day to day in the moment. What works on a Tuesday afternoon might not work on a Wednesday because the weather has changed or because some other factors has come in. So I do think we're getting better. We're growing the muscles in the residential side. But I think the point about, are you targeting in the right place, is a very fair question, and it's a question that I'll be talking to the team about further because, clearly, we need to do a better job than we're currently doing. Final one I've got here on the screen in front of me, and I'll come back to the operator in a second and see if we've got any final wrap up questions on the line. How do you feel about leadership team in the United States? Are you thinking about moving to the U.S. to be more involved in the turnaround? Do you need to change how information is communicated within the organization? I'll take the middle one first. I'm not currently thinking of moving back to the United States. I used to live there, loved it, a wonderful country, but we've been running this business virtually on video conference facilities for about the last 10 years or more. My American team, Americas big country, my American team is distributed right the way through the United States, the old model of having a head office where everyone comes into work on the Monday morning and goes home at the end of the week to wherever they came from, hasn't been in place for a long time. And so even if I move to the United States, I'd spend nearly all of my time on video conferences with people in California and through to the East Coast. So I don't think my physical location has got too much bearing. The North America team, I think we've created a new team. It's a very talented team. It's got a lot of experience in many, many areas, but it also lacks some experience in pest in trial. So we've got a blend now of long-time pesties and experts from various areas. And I think they are doing a good job. They're working incredibly hard, incredibly hard. And they need a bit more time to prove out the model and prove out that working together on this endeavor is going to deliver the results that we needed to. So I won't say there won't be any changes in the team. That would be rash of me. I'm sure we look at team changes all the time, not just in America. And if we make changes, it will be to upgrade the team. But I'm content, in aggregate, we've got an excellent team, and they will deliver. In terms of information flows, I think I'll pass that one to you, Stu. The question was, do you need to change how information is communicated within the organization?

Yes. Thanks, Andy. And I think this is a work in progress, if I'm honest. We brought 2 large organizations together. We implemented a new finance system, so we've got a single chart accounts, general ledger. We've got a single AP process and system now. But what we still have got is 2 operational reporting processes. So -- because we've integrated on a management basis, each of the 7 regions has a different flow of information from the operational system for either heritage Rentokil or heritage Terminix. And so as we go through the branch integration, that will, over time, consolidate, and it will make it much, much easier for regional and market managers to have a holistic view of the performance of their business rather than relying on it being consolidated at the center. So I think that's the biggest opportunity and the biggest win as we progress over the next 18 months, 2 years, which will enable us -- people to have a better single view of the organization, but also enable us to be more fleet of foot in responding to market trends that we're seeing. So that's the observational point there.

Final question we got on the screen here, and then I'll hand it to the operator because we got one last caller on the line. Given employee retention is improving, why do you not think you've seen an improved -- not yet seen an improvement in customer churn? How do you diagnose the root cause of that problem? I think the proven model, certainly in my experience in this industry for a very long period, is that if you get consistently high level of colleague retention, particularly service colleague retention, that typically feeds the high level of customer satisfaction and low level of customer churn. There is clearly a lag between that where that, just by staying longer, doesn't automatically equal better service. But typically, if you've got colleagues who've been here doing the same technician role for multiple years, the service experience for customers and the intimacy of the relationship between the technician and the customer tends to drive high levels of customer retention. So the fact that we haven't seen it yet does not mean that, that paradigm is broken. It simply means it needs more time for that to feed through. Customer retention, customer churn is a significant science. And you got to go -- the last question was about targeting of customers. The customer life cycle journey, like for many businesses, starts right at the very beginning with which customers need target to win in the first place and goes all the way through the first experience the customer has with you on the phone or the Internet, sales experience, the first technician visit, how easy you are to deal with when the technician -- when the customer wants to change the technician visit or whatever, billing inquiries, extra services all the way through to the end of the life cycle of the customer or the customer has got a problem and in the last resort wants to terminate. There are so many opportunities in that life cycle journey to make positive interventions to improve customer retention -- to improve customer experience and customer retention. So it's not a single point variable. Colleague retention is the building block, but then you've got all these other handoffs and interfaces with the customers that have got to be right. At the very, very back end of it, what we do know is even when the customer gets all the way to the end and says, "I want to terminate," we've still got a very decent chance of saving that termination. And so working back from the opportunity, we've put additional resources into the save team, but that's not a strategic response. What you want to do is reduce the number of people who want to terminate. But as a tactical response, saving more people on the back end is a smart thing to do whilst we improve the touch points for the customer service all the way through that customer service journey. Why do customers leave us in terms of diagnose root cause? The single -- typically, the single biggest challenge is no need. So a customer hired you when they had a mouse running around the kitchen or mosquitoes in the backyard, and then they realized after a period they don't have a mouse running around the kitchen or mosquitoes in the backyard and they conclude, I don't think I need this service anymore. Missing the obvious point that the reason they don't have the mouse or the mosquitoes is because they've got the service. So no need is our biggest battle. So that is a constant challenge to try and get customers to appreciate the value of the service. The next biggest typically is when customers move home. So we lose a lot of customers when they move house. And we need to do a much, much, much better job of following those customers. So when they move out of town or out of state, we need to do a much better job of giving them incentives to take a service when they land in their new home, but also to be incentivized to introduce us to the purchaser of their old homes. So multiple opportunities to improve colleague retention -- sorry, customer retention. Colleague retention is absolutely the core building block. I think we're out of time or a bit over time. We've done all the questions on the screen. Just in case I've missed anyone, can I just ask the operator, was there any final question on the live call?

Right now, we don't have any pending questions on the live call.

All right. Thank you very much, indeed. I appreciate you joining us today. Thanks, everyone. Bye-bye.

Thank you, everyone, for attending today's call. You may now disconnect. Have a wonderful day.