Rollins Inc

NYSE:ROL

Earnings Call Transcript 2023-Q2

[Operator]

Greetings. Welcome to the Rollins, Inc. Second Quarter 2023 Earnings Conference Call. [Operator Instructions] Please note this conference is being recorded.

I will now turn the conference over to your host, Joe Calabrese. You may begin.

[Joe Calabrese, IR]

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 [phone], and we'll send your release and make sure you're on the company's distribution list. Additionally, the call is being webcast at www.rollins.com, and a replay will be available for 180 days. The company is also offering investors a supporting slide presentation, which can be found on Rollins' website at www.rollins.com.

We will be following that slide presentation on our call this morning and encourage you to do that with us. We have included certain non-GAAP financial measures as part of our discussion this morning. The non-GAAP reconciliations are available in the appendix of today's presentation as well as in our press release. Presentation and press release are available on our Investor Relations website. The company's earnings release discusses the business outlook and contains certain forward-looking statements.

These particular forward-looking statements and all other statements that have been made on this call, excluding historical facts, are subject to a number of risks and uncertainties, and actual results may differ materially from any statement we make today. Please refer to yesterday's press release and the company's SEC filings, including the Risk Factors section of our Form 10-K for the year ended December 31, 2022. More information and the risk factors that could cause actual results to differ.

On the line with me today and speaking are Jerry Gahlhoff Jr., President and Chief Executive Officer; John Wilson, Vice Chairman; and Kenneth Krause, Executive Vice President, Chief Financial Officer and Treasurer. Management will make some opening remarks, and then we'll open the line for your questions. John, would you like to begin?

[John Wilson, Vice Chairman]

Yes. Thank you, Joe, and good morning. We appreciate all of you joining us today for our second quarter 2023 earnings call. We posted very strong revenue and earnings growth for both our second quarter and first 6 months of 2023. We continued to deliver solid performance across most -- all of our brands and achieved healthy levels of customer growth. Before I turn the call over to Jerry, I want to comment briefly on the results of our recent acquisition of Fox Pest Control.

We closed on the Fox acquisition in April, just prior to the ramp-up of their selling season, and they have performed exceptionally well as they achieved solid growth in the first quarter of our ownership. In addition, we have been pleased with their earnings contribution as they achieved over $2 million of GAAP earnings in the first quarter of ownership. This is inclusive of a $1 million charge associated with our earn-out of the deal. Our transition with Fox has gone quite well, and we're excited to have their great team and the Fox brand as part of Rollins.

Now let me turn the call over to Jerry, who will provide more details on our quarter.

[Jerry Gahlhoff, President & CEO]

Thank you, John. Good morning, everyone. I'm pleased to report that Rollins delivered another good quarter of growth and profitability, reflecting consistent execution of our operating strategies and continuous improvement in our business. Our financial performance for the second quarter was highlighted by an increase in revenue of approximately 15% to $821 million. I'm very pleased to report that we continue to see organic growth of approximately 8%. Further, this reflects a solid performance across all major service lines. Commercial pest control rose approximately 11%, residential increased over 18%, and termite was up approximately 14% this quarter.

Revenue performance in the quarter was healthy, although a little uneven due to pest seasonality. On a month-to-month basis, organic growth was very robust at 10% in May before slowing a bit in June. We're back on a good trajectory now in July, in line with what we saw in May. Importantly, our frontline team member staffing levels are better than we've seen in several years, and that is providing us with an opportunity to capitalize on demand for our services.

I'm also quite pleased with the progress we're making this far with the Fox Pest Control acquisition, the second largest acquisition in the history of our company. Taking a closer look, the integration of Fox has gone smoothly over the past few months. The Fox teams are executing and doing very well. The transaction was accretive to our second quarter earnings. This continues to be an exciting, highly complementary addition and we believe the revenue growth achieved this quarter is reflective of the team's focus on execution. The team at Fox was not distracted by the shift in ownership to Rollins and was focused on their customers and growing their business.

Making for a smooth transition is a key tenet of our acquisition integration strategy, and our collective teams were diligent about not disrupting these efforts of our frontline team members post close. I'd like to express my thanks to the Fox team and all our teammates that have worked hard to make this happen, and we're very excited about the growth opportunities ahead for the Fox brand.

Next, we continue to have an enhanced capital structure and a robust acquisition pipeline as we're actively evaluating acquisition opportunities, both domestically and internationally. As I've highlighted in the past, Acquisitions are an important component in helping us expand our market position while also complementing efforts to accelerate recurring organic growth. We remain disciplined in evaluating M&A opportunities and feel very good about our continued ability to invest in strategic acquisitions while delivering strong organic growth across the business.

Another important part of our culture is our dedication to continuous improvement. As you've heard us discuss previously, we're constantly looking to improve our service levels and operating efficiencies. As a result, we continue to see opportunities for margin expansion as we move forward and execute our strategy. We are currently evaluating several streamlining efforts. Kim will provide more detail and address the margins in the quarter shortly. In addition to the unrelenting focus on productivity and improving our margin profile, we're also more strongly focused on safety.

Our experience was disappointing in this area in Q2 as we continue to see higher settlements associated primarily with auto accidents. This was a $0.01 per share drag on earnings this quarter versus a year ago. We have ramped up efforts to significantly reduce automobile accidents moving forward. Our drivers now utilize an app that begins monitoring driving behaviors once our vehicle is in motion. This app detects unsafe driving maneuvers, such as acceleration, braking, distractions and speed and then converts these data into an industry-accepted FICO driving score from 100 to 850, with 850 being the best.

The data indicate that drivers with scores below 710 are 30% more likely to have a collision than those with higher scores. We're working hard in the field to increase driver safety awareness and get these scores up by coaching and training those with lower scores while recognizing and rewarding those that score the highest. We believe these efforts will help us keep people safe and mitigate negative potential financial impact to our business.

On the investment side, we proactively increased customer acquisition-related efforts during the second quarter and strategically invested more heavily on advertising spend when compared with the same quarter a year ago and sequentially versus the first quarter of 2023. While these costs were a $0.01 drag on second quarter earnings, we saw meaningful opportunities to go after and acquire new customers during the start of the busier spring and summer seasons.

Given that approximately 80% of our business is recurring, I want to emphasize that the opportunity for us to attract potential new customers is very important and it's a strategic investment over the long term. To date, we're extremely pleased with our targeted marketing and advertising efforts, which we believe is reflected in our strong organic growth performance for the quarter, and we expect this momentum to continue into the third quarter of 2023.

Next, we continue to focus on modernizing our business, our capital structure and our organization. As you may recall, in February, we enhanced our capital structure by refinancing our revolver, increasing it from $175 million in 2 banks up to $1 billion in 8 banks, providing us with investment-grade flexibility. More recently, our approximately $1.5 billion universal shelf facility was declared effective by the SEC. This facility provides additional financial capital and flexibility to the company, and Ken will share some additional details on this in a moment. Operationally, we're committed to developing great talent and investing in our teams.

Hiring has been healthy, and we've put a lot of energy into onboarding the right people in both the support functions and the customer-facing side of our business. As we look ahead to the improvement opportunity in front of us, we're focused on upgrading and realigning key areas in our home office support functions. You've heard us talk about opportunities in this area, and we are evaluating several initiatives as we start the second half of 2023.

We believe that driving this type of change will provide opportunities to accelerate our growth goals and enable our home office to become a better, more efficient provider of shared services to our frontline operations. Our modernization efforts are progressing well, but we're not done yet, and we look forward to sharing additional developments on this front later. In closing, before I turn the call over to Ken, we're pleased about where our business stands today. We're well positioned for the remainder of the year and remain focused on robust organic growth, delivering healthy incremental margins and continuing to attract, hire and retain top talent across the business. I'll now turn the call over to Ken.

[Kenneth Krause, EVP, CFO & Treasurer]

Thanks, Jerry, and good morning, everyone. The second quarter reflects strong execution by the Rollins team. Let me begin with a few highlights. First, we delivered strong revenue growth of approximately 15% year-over-year. We saw good growth across each of our service offerings. Organic revenue was up approximately 8% in the quarter and to finish the first half. Acquisitions drove the other 7% of the total revenue growth in the quarter. The integration of the Fox acquisition is progressing well, and we have a growing sense of optimism around this recent investment.

Second, our gross margins were healthy, exceeding 53% this quarter. We were positive on the price/cost equation and saw good performance across several key cost categories. An adjusted EBITDA margin of 22.3% was pressured primarily by higher insurance premiums and casualty loss developments on 4 legacy auto cases. Our GAAP earnings were $0.22 per share and excluding certain expenses related to the Fox acquisition, adjusted earnings were $0.23 per share. And last but not least, we delivered approximately 16% improvement in operating cash flow while free cash flow was up approximately 18% versus the same period a year ago.

Let's look at the quarterly results in a little bit more detail. Quarterly revenue was $821 million, up 15% on a reported basis. Currencies reduced revenue growth by 30 basis points as the Canadian dollar and the Australian dollar weakened relative to the U.S. dollar.

Turning to profitability. We realized a 40-basis point improvement in gross profit margin, where we saw good performance on gross profit as pricing more than offset inflationary pressures. We continue to see the benefit of a more consistent pricing discipline across all our brands this year. Looking at our 4 major buckets of service costs, people, fleet, materials and supplies and insurance and claims, we saw improvements in margins associated with materials and supplies as well as fleet costs, while insurance and claims were a headwind.

People costs were also somewhat favorable to margins even as we added a significant level of pest control and termite control technicians to support strong demand trends. As Jerry said earlier, staffing levels for our frontline team members are the best they've been in years. This timing sets up well as we see strong customer demand to start the third quarter. SG&A costs as a percentage of revenue increased by 30 basis points in the quarter.

Peeling back the SG&A layers a bit more, people cost, advertising and selling costs, along with insurance and claims make up the bulk of our SG&A spend. We saw headwinds to margins from higher insurance and automobile-related claim costs, as previously mentioned, there were settlement developments on a few auto claims cases this quarter, and we're seeing higher costs in general for auto insurance and related claims due to inflationary pressures. We continue to invest heavily in advertising efforts in the quarter, and that has helped us go after and capture healthy levels of growth.

As I mentioned earlier, we had non-GAAP adjustments this quarter for Fox acquisition-related items. These totaled approximately $5 million on a pretax basis and were related to purchase accounting amortization and the fair value of contingent consideration on this material acquisition. GAAP operating income was $155 million, up almost 15% year-over-year. Adjusted operating income was $160 million, up almost 19% versus the prior year. EBITDA was $182 million, up over 14% year-over-year and EBITDA margin was a healthy 22.2%. Our adjusted EBITDA was $183 million, up over 15% and representing a 22.3% margin.

And for the first half, EBITDA margins were just under 22%. It is good to see EBITDA compounding at 16% in the first half. As I have consistently indicated, I'd like to look at the business using incremental margins or meaning what percentage of every additional dollar of revenue growth is converted to EBITDA. On an as-reported basis, we generated incremental margins in line with our overall EBITDA margin. However, excluding the headwinds I mentioned from insurance and auto claim developments and the additional costs associated with the earn-out on our recent acquisition incremental margins were accretive to our margin profile.

Quarterly GAAP net income was $110 million or $0.22 per share, increasing from $0.21 per share in the same period a year ago. Adjusted net income was $114 million or $0.23 per share. The effective tax rate was 27% in the quarter, up 200 basis points versus the prior year, driven by higher foreign income taxes. We expect the rate to normalize at approximately 26% over the second half of this year.

Turning to cash flow and the balance sheet. Quarterly free cash flow remained very strong. We generated $141 million of free cash flow on $110 million of earnings. Quarterly free cash flow increased by almost 18% and is compounding at just under 18% in the first 6 months of this year. Cash flow conversion, the percent of income that was converted to cash, was also a bright spot coming in well above 100%. We made acquisitions totaling $312 million, and we paid $64 million in dividends. That remains negligible and debt-to-EBITDA is well below 1x on a gross level.

We continue to be active in pursuing additional tuck-in acquisitions and remain very well positioned to continue to maintain a balanced capital allocation strategy. As Jerry mentioned previously, we are excited about the strategic growth opportunities that Fox provides. So far, the Fox team and business have exceeded our expectations from a growth perspective and we see continued opportunity and momentum in their door-to-door model.

A quick update on financial details. In April, we shared our expectations that Fox would add between $90 million and $100 million of revenue and $18 million to $22 million of EBITDA to our 2023 results. We now expect to deliver financial performance at the high end of both of those ranges. We continue to make progress on a number of general financial housekeeping items that will help position us best as we continue to grow our business.

Of note, we filed a shelf with the SEC on June 3. This filing allows for up to $1.5 billion of primary securities. And while we have no immediate need for this capital, it provides flexibility for long-term fixed rate financing and other options that complement the bank revolver that we put in place earlier this year. Additionally, the shelf allows the company to work proactively with the family should they decide to divest a portion of their holdings at some point in the future.

In summary, our performance this quarter continues to demonstrate the strength of our business model and the engagement level of our team. We remain focused on providing our customers with the best customer experience and driving growth organically and through disciplined acquisitions.

With that, I'll turn the call back over to Jerry.

[Jerry Gahlhoff, President & CEO]

Thank you, Ken. We're happy to take any questions at this time.

[Operator]

[Operator Instructions] Our first question comes from the line of Josh Chan with UBS.

[Josh Chan, UBS]

I wanted to ask about the comments that you made regarding the trends in May and June and July. Kenneth, what do you make of the fluctuation? And I guess, based on that, how do you see the trends going forward?

[Jerry Gahlhoff, President & CEO]

Yes. This is Jerry. The quarter was a little different than we've seen in the past. If you'll recall, back in April at our call with everyone, we talked about April was off to a really strong start, and it was, and April finished strong. May was good as well. And then we saw a pretty significant shift in and some of the demand, especially in the back half of June where it just slid. We've since gotten some of the data from Google on Google search query data that showed there was a pretty significant decline in the back half of June, and that's really what drove the volume down overall in the quarter.

But then right when we got near the end of June, very beginning of July, get close to the 4th of July, it really popped. It just came back again. I think the temperatures rose considerably and the number of unique visitors to our website, just in the first couple of weeks in July improved by over 18% year-over-year. So it was it was a little weird. Normally, you see that kind of seasonality earlier in the quarter, not later, but it was a little different than we've ever seen in the past.

[Josh Chan, UBS]

Okay. That's really helpful color, and that makes sense. And then I guess my follow-up, you also mentioned advertising increasing. Certainly, it makes sense to invest in that given your business model. I was just wondering what causes you to ramp up or down the advertising spend. I'm curious what you saw in Q2 that made you decide to do more advertising versus less?

[Jerry Gahlhoff, President & CEO]

Well, when we started, we had good signs in April that the environment was good. And plus, we were staffed for it. So when you're better staffed and you've got the people to service the customers and get the new customers coming in the door, that's when it's there to take there to take advantage of it. And in our business, and if you look at the fiscal year, selling recurring revenue, the earlier in the year, you get it the more revenue you get. And so we just thought the conditions were right. And I think that's worked out well for us as evidenced by the organic growth levels that we saw in the quarter.

[Kenneth Krause, EVP, CFO & Treasurer]

That’s great commentary, Jerry. Josh. Just one additional item with respect to advertising. If you go back and you look at our results, say, for the fourth quarter of last year, we were conscientious in disclosing that advertising was down. And so what you saw was during the winter season, during the fourth quarter, advertising was certainly lower because demand levels are generally lower. But as you go throughout the year, you generally will see a ramping of the advertising in Q2 and Q3. And before it starts to recede a bit in Q4. So I think we’ll continue to follow that same trajectory when we think about demand season for our business.

[Operator]

Our next question comes from the line of Luke McFadden with William Blair.

[Luke McFadden, William Blair]

This is Luke McFadden on for Tim Mulrooney. I'm curious, with inflation beginning to ease, is your above-average pricing adding any effect on new customer growth or retention? In other words, are you seeing any pushback or pricing from customer -- on pricing from customers? And how should investors think about pricing more broadly as you head into the second half of this year.

[Jerry Gahlhoff, President & CEO]

I would say we've had a little more pushback than we've had in prior years, but nothing that's insurmountable. It's still early to truly judge as we go through the year and get further into the year, we'll look closer at our rollback data and exclusion data, this really get an effect of what happened and whether or not customers canceled over. We'll have all our metrics as we move through the year.

I would say it hasn't, it hasn't been a significant issue for us thus far this year. Now the questions as you move through the year, we watch that further depending on the economic environment. We have to moderate that. Ken will -- our plan is to evaluate pricing towards the latter part of this year once all the data and we'll go from there as we think about a futuristic...

[Kenneth Krause, EVP, CFO & Treasurer]

Yes, that's correct. But I do I also want to add that we continue to believe that our services are essential. We do believe that there's definitely value in our pricing model. But we are conscientious of price and what impact that has in our customer base. And so we'll continue to monitor that. We'll continue to monitor economic trends, but we won't lose sight of the essential value of our services. So Stay tuned on that. But that's, I think, how we think about it, Josh.

[Jerry Gahlhoff, President & CEO]

That was Luke.

[Luke McFadden, William Blair]

Great. And if I can follow up just with one more maybe on gross margins here. It looks like gross margins were up 40 basis points year-over-year in the second quarter. We know Fox has pretty high gross margins, just given the nature of that business. How much of that gross margin expansion do you think could be attributed to the contribution from Fox? And can you touch on the other factors just helping to drive that gross margin expansion in the second quarter? I know you mentioned it in your prepared remarks, but -- any further commentary there would be helpful.

[Kenneth Krause, EVP, CFO & Treasurer]

Yes. It’s Ken, Luke, and I’ll take that question. You’re exactly right. The Fox acquisition is a very valuable acquisition and the gross margin reflects the value on their business model. It is accretive to the overall margin profile of Rollins. But it only contributed about $39 million of revenue in the quarter. So it’s not that meaningful. It did have a positive impact on the gross margin, but we also saw a positive impact across our organic business, primarily through better leveraging of fleet costs, better leveraging of people costs and materials and supplies.

It's interesting, when I step back and I look at the fleet cost, you would expect fleet costs to improve with gasoline prices. But the thing I think people are missing at times is the fact that used car prices aren’t as attractive. So when we turn in lease vehicles or when we sell lease vehicles, we’re not seeing as much of a gain as we did last year at this time. So we’re seeing good improvement in our organic business despite that headwind. And we also are seeing improvement associated with the Fox acquisition coming through our gross profit margin.

[Operator]

Our next question comes from the line of Stephanie Moore with Jefferies.

[Harold Antor, Jefferies]

This is Harold Antor on for Stephanie Moore. So you talked about productivity initiatives. So I just want to get an idea of what investments that you're making out of the company becoming a little bit more productive.

[Kenneth Krause, EVP, CFO & Treasurer]

Yes. I would add -- or I would say to that point, we, like most other companies have a list of a number of opportunities that we continue to evaluate across the restructuring area. We're looking at all areas of the business. And as Jerry had talked about as well as myself, continuous improvement is a big focus of our company. And so when we look at, for example, our home office, we are continuing to look at ways we can enhance and improve the home office, but we're also looking more broadly across the business. So can't give you one specific initiative, but it's really across all of our footprint that we're really evaluating opportunities to improve the business from a productivity perspective.

[Harold Antor, Jefferies]

And then just on the residential deceleration. It looks like resi slowed down. And sequentially on year-over-year. So if you could give us any puts and takes on resi growth, resi organic growth? And how should we think about resi organic growth looking forward to the back half of the year?

[Jerry Gahlhoff, President & CEO]

Yes. When we look back at the quarter and compare it to other recent quarters, we look at it as though June was a bit of an anomaly. June was a really weird month that affected that. I mean we were – in April and May, organic growth was in that double-digit range, that we were expecting. And then in June kind of threw us for a loop with what went on there. So we’ve started the quarter out back on track with more in line with what we expected, and we don’t see any signs.

Of course, you don’t have a crystal ball, but certainly, we’ll make every attempt to continue to drive higher levels on the organic residential growth side.

[Operator]

Our next question comes from the line of Jason Haas with Bank of America.

[Jason Haas, Bank of America]

Just following up on that monthly sales cadence. It sounds like maybe it was some cold spring weather maybe push them sales out into July. I'm curious, in prior years where you've had a cold spring, do you see the business shift into July and maybe even further into August and September? Just trying to think about that 10% organic growth number you started in July, and if there's anything to be cognizant of in terms of the compares, whether they get easier and harder through the quarter in August and September?

[Jerry Gahlhoff, President & CEO]

Again, you think about seasonality, and sorry to say this last quarter was different because normally, when we talk about cooler spring, cooler early summer, that's usually happening in March and April. And usually, it hits. So this quarter, it was just -- it was really different than one I'd say we've seen in many, many years. Now is that to say there's some pent-up demand. We certainly have seen that in July, where once temperatures got to -- I don't know, a few weeks ago, we were in California, Ken, and when we arrived that day, in the middle of the day, it was like 75 degrees. But then by the weekend, it was 110 degrees in Northern California and the phones were ringing off the hook. So it was very -- So we had some very unseasonably cool weather in June, which is kind of an anomaly. So I don't know what else to say...

[Kenneth Krause, EVP, CFO & Treasurer]

Yes. It's just adding on there. Weather always has an impact across the business. What really helps us to is those warm evenings when evening stay above a certain level, the low temperature doesn't get too low. And so when you see that, you certainly have a benefit in the business. And so it certainly does continue to have a nice positive impact on the business.

As we think about comparables, I don't see anything year-over-year that has a huge impact on comparables from a weather or from a revenue performance perspective. Jason. But we feel, as we said in our prepared comments, we feel very good about how we're positioned to deliver a strong second half in 2023.

[Jason Haas, Bank of America]

That's great. And then for a follow-up, I was going to ask on the incremental EBITDA margins. I know you said previously, and we're seeing it play out that the plan was to invest more in some customer acquisition costs. So you're a little bit below the 30% target this quarter. Is that a fair framework? I think you're in the low 20% range or so this quarter. Is that a fair assumption to use for the near term? Or do you think in the next few quarters, you can get back to that 30% level that you target?

[Kenneth Krause, EVP, CFO & Treasurer]

So it’s interesting, Jason. If you look at the LTM number as of June 30, the LTM incremental margin is 29.3%. So it’s almost 30%. That’s up strongly from the prior year. And so when we look over a long period of time a 12-month period, we’re certainly trending at those levels that we talked about. This one quarter, what we saw in the second quarter, you might see it a bit in the third quarter, is you’re investing. It’s time to invest. It’s time to go after and acquire those customers that you’re going to keep for years to come.

And so you see even our incrementals may be weighed down a little bit by that. But the fact that the incrementals were accretive to our actual margin profile that provides me a sense of optimism. We’re in an investment period, and we’re actually still seeing incrementals that are accretive to our EBITDA margin. That’s a good thing to see. And so we’re hopeful that, that will continue as we go into the third quarter. But our goal long term is that 30% incremental margin profile.

There’s no reason this business shouldn’t get to those levels based upon the pricing that we get based upon the essential nature of our services, based upon our customer experience that our service technicians and our associates are providing our customers. And so we feel good about that incremental margin target longer term.

[Operator]

[Operator Instructions] Our next question comes from the line of John Mazzoni with Wells Fargo Securities.

[John Mazzoni, Wells Fargo]

Maybe just following up on this insurance issue. I think you believe you mentioned 4 claims in the quarter and about a 40-basis point drag. Could you maybe just quantify if there's any other kind of legacy settlements in the pipeline that could hit in the future quarters? And also, how should we think about higher insurance costs as we move through the year? Should they maybe step down as the driver safety improves? Or are higher insurance costs more of a function of just the environment we're currently in?

[Kenneth Krause, EVP, CFO & Treasurer]

Yes. First and foremost, what I would say is our accruals at June 30 are complete and accurate. And so when we look at the liability associated, for example, with auto claims, we feel like it's complete. We do know that things change. And so as facts, as circumstances change, estimates change. And that's what we would do as we move forward. you really started to see this tick up last year in the third quarter. We had around $10 million of claims that came through that settlements came through.

And it's interesting when you look at what happened during COVID, claims have certainly -- they've certainly trended down quite a bit, courts closed a bit, settlement activity went down. And then coming out of COVID, you start to ramp. We're hopeful that we'll see that turn down as we go into the future. But you're just not sure what's going to happen on that front. What you can do, however, is focus on the controllables. And what Jerry had talked about in his comments, was focusing on putting systems and processes and the focus behind behavioral-based safety into the business that will mitigate these exposures as we move forward. And so we're doing just that. And we're hopeful that, that activity will have a positive impact on our experience in this -- our unfortunate experience in this area.

[John Mazzoni, Wells Fargo]

Got it. Great color. And maybe also just following up on this investment period. Could you just quantify the kind of return on ad spend or maybe even at a high level, just your kind of customer acquisition cost at kind of either digital or linear. We've seen kind of a lower TV upfront market and potentially others pulling back. So could that be potential upside if you can get these kind of ad dollars and your customer acquisition costs down.

[Kenneth Krause, EVP, CFO & Treasurer]

What I would say and I would ask Jerry to comment, too, was if I look at our organic growth profile and I compare it to our overall market growth, our organic growth, as we said in our prepared commentary, is roughly 8%. The markets, what we expect the markets to be growing at are much below 8%. So when we think about the organic growth profile and we think about the share that we are gaining in our markets, we feel good about the return levels knowing that incremental margins can be around that 30% and a customer might stay with us for 3, 5 or even 7 years. So we feel really good about the returns that we're getting on those ad dollars.

[Jerry Gahlhoff, President & CEO]

Yes. I mean just factor in the lifetime value of a customer and what that customer means to us over the long term as a worthy spends. And we do a very good job of monitoring cost of customer acquisition, cost to lead, and we’re very comfortable with what we’re spending to generate that long-term recurring revenue stream.

[Operator]

And our next question comes from the line of Aadit Shrestha with Stifel.

[Aadit Shrestha, Stifel]

This is Aadit Shrestha from Stifel filling in for Michael Hoffman today. So just going to your cash flow, you had a very strong free cash flow conversion in 2Q. Were there any specific factors that influence this in the period? And would you expect the conversion to be like lower in the second half?

[Kenneth Krause, EVP, CFO & Treasurer]

When we look at the cash flow conversion, we're really happy with the performance that we saw in Q2, but also the first half of the year. Our focus is to continue to drive compounding of free cash flow in that mid-teen range. And the fact that we saw free cash flow compound at roughly 17%, 18% in the quarter, it provides us a sense of optimism heading into the future. I don't know that we're ready to increase our expectations in the 18% or 20% compounding of cash flow. But if we can continue to see compounding of cash flow in that 14% to 15% or so percent, which is in line with what we've compounded cash flow at over the last 20 or so years.

I think we would be happy with that performance. Nothing really jumps off the page at me in terms of what's driving cash flow improvement in the quarter. I know the FOX business has a bit of a different business model when you look at the door-to-door side. And so payables stepped up a little bit with respect to that business model, that actually had a positive impact on cash flow. But overall, we feel good about cash flow and we feel good about the generation of cash that we're seeing.

[Aadit Shrestha, Stifel]

And just as a follow-up. Your largest customer mentioned that the deal valuations have come down as private equity is spending less for deals. Are you seeing a similar trend? And does this drive like an outsized year of deals, excluding the Fox acquisition?

[Jerry Gahlhoff, President & CEO]

Sure. I completely heard or understood the question. Were you asking more about the PE space and what we're seeing from a...

[Aadit Shrestha, Stifel]

Just overall sort of what multiples are being paid for acquisitions are lower now. That's what they're seeing. And if you're seeing a sort of similar type of trend. And would this sort of mean you do more M&A than usual?

[Jerry Gahlhoff, President & CEO]

I wouldn't necessarily say it's come down significantly. I've seen some PE deals that have transacted at pretty high valuations early this year. I would say there's also been maybe some PE deals out there that haven't made it to closing. So it seems to be it's still a pretty rich environment. It may have softened a little bit, Ken. We measure that pretty closely and kind of watch all of our transactions. I don't necessarily think it means we're going to go more aggressive or try to bite off more than we can choose. We will always remain disciplined about picking the right -- the right acquisitions, the companies with the right culture, the people that care about the business and have the right type of fit for Rollins. And that no matter what the valuation is, that's the biggest thing we look. That's where we start. Ken, what would you add?

[Kenneth Krause, EVP, CFO & Treasurer]

Yes. The only thing I would add is, I mean, we can speak about our experience. And our experience is we’ve been investing at very healthy multiples, not necessarily aggressive levels we are getting deals at fair values. But it’s interesting. The one thing that certainly has an impact on the M&A markets is interest rates. And as interest rates tick up, ultimately, some buyers value businesses at a much lower level. You just can’t get there with certain levels of interest rates.

So that certainly has potentially an impact on the M&A environment. But what Jerry said is spot on. We’re going to continue to focus on buying good businesses, paying fair values and businesses that align with our culture and our focus and value their team members, value their brands. That’s the kind of business we want to bring into the fold, and we feel like we got that with Fox.

[Operator]

And our next question comes from the line of Ollie Davies with Redburn Partners.

[Ollie Davies, Redburn Partners]

On the residential side, can you just talk about the split of organic growth between kind of cross-selling into the existing customer base and your ability to add new customers, given the macro environment?

[Kenneth Krause, EVP, CFO & Treasurer]

The focus on cross-sell, the focus on ancillary is a key part of the strategy. We don't necessarily provide the detailed growth levels for ancillary or for cross-sell or multiple services with any one customer. But what I can tell you is we're seeing really good growth from a number of different services. Like, for example, you might have an individual that signs up for pest control and they're adding mosquito because mosquito demand is incredibly strong or you might see a termite customer or another pest control customer that is signing up for cross space work or insulation work. And so we're still seeing continued good demand for those ancillary and additional services across the business.

[Ollie Davies, Redburn Partners]

Great. And then as a follow-up, on the commercial, obviously remains very strong. What are the sort of typical types of commercial venues that you're adding at the moment? And do you think this can continue, given, I guess, the kind of historical volume growth that Commercial delivered before the pandemic?

[Jerry Gahlhoff, President & CEO]

We haven't seen any slowdown in our ability to sell and bring on new commercial customers. We are more focused on certain verticals that we really like to sell into -- logistics, health care, hospitality, things along those lines where we try to be pretty fairly disciplined about the customers that we're really proactively targeting. But we have a very effective sales force. We've continued to invest in that sales force and ramp up those sales efforts, and we feel very positively about the future of the commercial business.

[Operator]

And we have reached the end of the question-and-answer session. And I'll now turn the call back over to management for closing remarks.

[Jerry Gahlhoff, President & CEO]

Thank you, everyone, for joining us today. We appreciate your interest in our company, and we look forward to updating you on the third quarter earnings call in October. Thanks again.

[Operator]

And this concludes today's conference, and you may disconnect your lines at this time. Thank you for your participation.