Terminix Global Holdings Inc (TMX) 2002 Q2 法說會逐字稿

Ladies and gentlemen, thank you for standing by. Welcome to the ServiceMaster Company second-quarter earnings conference call. During the presentation all participants will be in listen-only mode. Afterwards, you will be invited to participate in the question and answer session. At that time, if you have a question press the 1 followed by the 4 on your telephone. As reminder, this conference is being recorded, Tuesday July 30th, 2002. Your speakers for today are Steven Preston, Chief Financial Officer and John Ward, Chairman and CEO. I would like to turn the conference over to Steven Preston, Chief Financial Officer with ServiceMaster Company. Please go ahead.

Thank you, and thank you for joining us. In addition to John Ward, I am joined by Bruce [inaudible] V.P. for Investor Relationtions, Deb O'connor, or controller, Eric [inaudible] our treasurer, and Steve Bono our SVP for communications. I am going to start out our review today with a discussion of the financial results, and then get into a little more of a detailed review of the changes in accounting that we announced. When I finish, John will give you an update on the marketing and operational imperatives, and provide with you additional perspectives of how we see the year shaping up. Afterwards we will take questions.

Clearly the year has begun to take shape, and we are seeing support, as we elaborated last month for robustness in improvement in the nonfinancial metrics that we are beginning to share with you all. Just like last quarter, you have an exhibit of the press release that shows customer growth, account growth, and retention rate for our foremost profitable residential service lines. We began providing you with these metrics because we believe they will give you insight into the business momentum and customer initiatives. All these of these metrics are calculated on the last 12 months' bases to avoid seasonal anomalies and to give you a full-year perspective on what's happened. You will notice that customer counts, as well as retention rates, are up in all the service lines.

Another point in our press release and in our comments today, you'll hear us reference information on a comparable basis. Between the portfolio review we did last year and the accounting changes, obviously a number of things have changed, so we provided you with numbers comparable that reflect what we would have looked like in 2001 if we accounted for American home shield the same that by both years. If we accounted for good will because we, like the rest of America, adopted [inaudible] 42 this year. If we repay debt with the proceeds from the 2001 divestitures at the beginning of 2001. Now because companies are not allowed to adjust prior year results on the face of the interest statement to show changes in accounting, we provided you with that computation in the back of the press release, to show you how we adjusted the prior year and make them comparable. Even though all these adjustments in the aggregate provide a less favorable trend line for the company, you need to see that trend line on a apples-to-apples basis, truly to understand how we are performing. Turning to the financial reports. Revenue in the quarter increased by 2% to 1,billion 48 million with strong in Terminex and American Home Shield, largely offset by lower Revenue in the HVAC and plumbing business.

Operating income for the quarter was $180 million, compared to $107 million last year on a reported basis, and $122 million last year on a comparable basis, accounting for the -- adjusting for the accounting changes. Interest declined by $10 million due to lower debt resulting from the application of proceeds from divesture of managment services and Terminex, Europe, as well as strong cash flow from operations over the last 12 months.

Our tax rate declined in the quarter based on benefits we received from the consolidation of the ServiceMaster Home Service Center, and running in line roughly with our full-year estimate of 37%. Deluded shares outstanding increase by about 6 million shares primarily as a result of a higher share price, which results in a higher number of options treated as share equivalent in the number. Putting it all together, we have reported 20 cents a share in the second quarter of 2002 versus 15 cents a share from last year from continuing operations. If we adjust the 2001 numbers to reflect the accounting changes and reduction in debt, we would have reported 20 cents in the quarter last year, which is roughly in line with this year's number. Well, a flat quarter may not seem terribly exciting, this is the first time in 5 quarters that we have not seeing a decline in earnings per share. we are doing so at a time when we made significant investments and the bearing the burden of those investments in a number the new initiatives.

Referring to cash flow, cash flow for the year is continuing to show real strength. Cash from operations for the six months was $153 million, 75% higher than our earnings for the six months, and it is a 37% increase over the 112 million we reported last year before the sale of accounts receivable and prior year tax refunds. Once again, a significant component of the improvement is a $57 million reduction in the use of working cap in the period. That comes from a number of sources, including better receivables, payables, and inventory management.

Now, clearly during a time when the accounting industry, and its standards are under intense scrutiny, I appreciated a quote in an editorial in the journal yesterday, recounting an accounting professor's admonition that profit is an opinion and cash is a fact. The fact of the matter is, our cash flows continues to show a very strong growth trend.

In the quarter, we also completed the last major phase of the debt reduction program we [inaudible]in October of 2001 through the repurchase of $218 million in public notes. As a result, we reduced our debt level in the quarter to $862 million. That represents a reduction in debt outstanding by almost $1.1 billion in the last two years. For those of you who have known for for a long time, our debt has not been this low since the first quarter of 1997, when we bought Barefoot.

As we expected, we paid a premium to retire those notes, that shows up below the line as a $9 million after tax extraordinary item. In doing this repurchase, we took the opportunity to lengthen our maturity profile by concentrating on bonds a shorter maturity. 60% of our debt matures beyond seven years with 40% beyond 15 years. Our first maturity does not come up until 2005.

Now let me turn to the segment results. In the TruGreen, we are seeing a continuation of the positive trends we discussed with you in the lawn care business, as well as the more stable operation on the land care side. Revenue in the segment increased 1% while operating was $5 million below last year at $53 million. We are seeing better productivity and lower material costs in the segment; however, those benefits were offset by an increase in workers compensation claims in the landscape business.

In addition, as many of you know, we defer certain seasonal costs in the lawn care business, which we math with revenue throughout the year. Last year we deferred $2 million more in the quarter and $5 million more per date, based on an expectation of higher revenue that actually materialized. This year, because we have a more conservative deferral, we would expect to see that benefit later in the year. Before these two items, deferral and worker compensation increase, we saw branch level margins improve especially in the lawn care business where the improvement was significant. Also, the lawn care side, we continue to see our customer metrics improve relative to last year and right in line with our expectations.

You can see were the press release, at this time last year, our customer accounts had declined more 3% over the prior 12 months, and that compares with an improvement of 1.4% this year. You may recall last quarter, we were not yet showing any growth over the last 12 months. So we are seeing a clear improvement even since then. You can also see that our retention rate has improved over 2% to 64.5% when we compare to last 12 months with the same period last year. Three months ago, retention had improved only 1%. Even in the last 3 months, we have added another full retention point to the analysis. As we continue to trend -- if we continue to trend as we have to date, we will expect to see an increase in 3% in customer counts by the end of the year. This will be stronger internal growth in customers than we have seen in many years in TruGreen ChemLawn. If we couple this growth with a moderate price increase, you can clearly see how TruGreen will be on track to be a strong single-digit grower in the future. These metrics are all based again on last 12 months, which incorporates the last half of last year. If you look harder at the near-term number, those improvements are even stronger. None of this is by accident or luck. Stronger sales had been supported by employing more sophisticated marketing tools and reaching our customers more effectively through broader distribution channels.

On the retention side, the improvement has been driven by very specific initiatives to increase customer satisfaction through improving communication, and by more clearly demonstrating the value off our services. If the lawn care business to form as it has today, we believe we will see a solid improvement in operating margins through lower directed operating costs, supported by Six Sigma and more aggressive materials pricing, and better root efficiency by the end of the year. In the landscape business, although revenue was slightly lower, we are encouraged by the stability of the business following the significant restructuring last year.

One issue we did deal with in the quarter, as I mentioned earlier, which is not uncommon following a large restructuring, is the increase in the workers compensation claims related to last year. It is still unclear to us at this point how much of the issue is indicative of a trend, and how much do we suspect to subside following the restructuring. On the other hand, we are beginning to see better benefit of better management of direct cost including labor and materials, which we expect to continue through the year. It would also -- it will also be critical for this team to produce stronger sales of enhancements, as we continue through the summer, in order to get the top line moving in the right direction.

Also, theTrugreen segment capital declined 2% to 1 billion 73 million, reflecting better working capital management and capital equipment management. Terminex reported a strong quarter with an 11% increase in sales and 12% increase in operating income. Revenue growth was driven by both solid internal growth as well as by the addition of a the Sears business. We saw much stronger new unit sales in termite and pest control. In addition, by focusing more heavily on training and oncustomer service processes in the branches, Terminex has had steady improvement in all of its retention indicators. Terminex customer retention for the last 12 months has increased over 90% in the termite business, and pest retention increased to 78%. Both were increases over the prior year and over last quarter. Important step forward for Terminex is the Sears acquisition, which has met our expectations with respect to customer retention, remediation cost and overall profitability.

The one area where we had begun to see challenges was in the sale of new pest control customers to replace terminations in the Sears markets. In the branches where we acquired Sears customers, new sales have not increased in proportion to the customers we have added. It is unclear at this point whether it is competitive or market phenomenon, but as a result, we do expect to see some tail off in revenue growth in the 4th quarter. Capital Terminex segment increased 1% to 601 million dollars.

Another important -- excuse me, another important development at Terminex is the roll out of a new operating system to support its field operation. The mission system, as we call it, is expected to be operational in all of the branches within the next year. This system will provide significantly better customer and operational information, which will support better sales productivity, customer satisfaction, cost efficiency, and regulatory compliance. Terminex technology will be moved ahead 20 years. We have taken a little longer to develop a test system than we anticipated, but based on the strong reception of field, we are accelerating the roll out. In the coming quarters you will be hearing about continuing progress, the company overall, is making to support our strategic initiatives with incremental investments in information technology throughout the enterprise. It's a migration. It is not a stampede. Until recently we didn't have a viable way to connect customers with our branches through essential source.

Through the home center we now do, and can work effectively with third parties, like Yahoo!, for example, to track all customer activity through those channels. We have also begun to lay the groundwork to move the enterprise to a common financial platform, which will support many of our efficiency and customer-driven initiatives. We have laid the groundwork to move ARS to a platform that will support higher levels of service and productivity. So as we make progress in each of these fronts, we will be keeping you apprised of the status and impact we expect to have.

Moving to the Home Maintenance Improvement Group, revenue is up 4% below -- sorry, revenue was 4% below the prior year while operating income of 33 million was $2 million lower. Once again, we saw terrific results at American Home Shield. Sales through the real estate channel remain strong while higher renewal rate and improving leverage from third-party channel all contributed to the 15% growth in warranty contracts in force. The 12% customer retention rate improved more than 2% to over the prior year to over 53%, showing continuing improvement even from the last quarter. Margins continue to improve as we saw a lower level of claims and we managed to a lower cost per claim.

Turning now to the other businesses. The franchise business had a strong first quarter reflecting growth in disaster restoration and in the Merry Maid branch operation; however, our residential and commercial [inaudible] and plumbing businesses had a difficult quarter. They were the reason for the overall decline in the segment results. Once again, the most significant area of decline related to construction activity, although we continue to see pressure in base plumbing, heating and cooling business, much like the rest of the industry.

We do expect the second half of the year comparisons to be more favorable than the first half comparisons. In the second half of last year, we experienced a very significant drop off in the business, as a result of mild weather, September 11th, and weakening economy. As we look to the rest of 2002, we are counting on better external conditions, and have a leadership team in place that's heavily focused on stronger marketing programs, and on converting a higher percentage of the calls we receive into business. Capital employed in this business was reduced by 7% over last year, and that was a reflection of better working capital management. Revenue in the other operations segment was 19 million. A million below last year, while operating income was negative 13 million. This result reflects the investments made in the parent information for Six Sigma and other interprise initiatives to support marketing programs government relation initiatives, and purchasing efficiencies. As we look to the rest of the year, we expect it to increase as we continue to support these and other enterprise initiatives.

Now let me turn our attention to the changes in accounting we discussed. As you all know, we recently replaced Andersen with Deloitte & Touche as our independent auditors, and viewed this transition as an opportunity to get an external perspective of how we are doing in a number of areas. So when Deloitte came in we asked them to do a number things for us as they got up to speed and met with our companies. First we asked them to give us an evaluation of our financial organization by the end of the third quarter. We have been in the process for the last couple of years of improving the talent, as well as processes and systems in the financial organization, and we felt their input would be very helpful there. That's one thing they are working on. We also asked them to take a hard look at how we conduct the internal audit function, and how we manage various aspects of risk, as we consider how to improve our effectiveness in these areas. Finally, we asked them to look at us in taking a hard look at our critical accounting policies by the end of this quarter to see if they had any recommendations for change based on evolving industry practices.

Frankly even the four former Andersen partners who one time had been involved in our audit are now at Deloitte and Touche. We asked them to put an entirely new team of partners on the account to make sure we got the freshest, independent thinking in all these areas. As a result of our review of the accounting policies, we are adopting two changes. First, we are electing under FAS 123, accounting for stock-base compensation, to begin expensing stock options effective beginning next year. We share the view of so many institutions and accounting experts that options are compensation, and are most appropriately reflected on the income statement as compensation expense. We will take the next six months to evaluate our compensation programs to ensure that we are using equity-based compensation structures most effectively within those comp programs. In addition, we will take that time to take a harder look at evolving viewpoints on how to implement 123 most appropriately.

If our option-granting practices remain relatively consistent with our past practices, we believe the impact will be approximately one-half cent in the first year a share and then grow to 3 cents a share in the fifth year. Second, we are changing our current accounting policy at American Home Shield for recognizing customer acquisition costs from FAS 60,accounting reporting for insurance enterprises, to FAS technical 90-1, which is accounting for separately priced extended warranty and product maintenance contracts.

Let me give you a little background on this. Based on the accounting literature for insurance companies, which have been in place since 1982, we have recognized various costs related to customer acquisition over the life of the customer, most recently three years. You would see a similar practice, for example, in the disability insurance industry. Because we have very high initial marketing and setup costs, and a very stable and improving renewal pattern, this treatment really does provide the best view of customer economics. In addition we have viewed it as relatively conservative because the deferred revenue on our balance sheet from the existing prepaid contract base is twice as high as the deferred customer acquisition costs. So in other words, unrecognized revenue is twice unrecognized costs under the old accounting. However, practice -- more specifically among warranty companies, with single-year contracts, have evolved to a recognition of customer acquisition costs in the first year. This results in very little or no profit in the first year of the customer life, and very significantly higher profits in the later years of the customer life. This treatment is more conservative, especially for rapidly-growing companies and will result in lower reported earnings of about 3 cents a share in 2002.

The impact within the year will be felt most dramatically in the first and fourth quarter when earnings will be reduced by just over a penny a share. The impact from the second and third quarters will be less than half a cent a share in each quarter. Because the policies simply have to do with the timing of expense recognition, it has no effect in cash from operations. Reduction in earnings will simply be offset by reduction in working capital usage. Clearly, our change in accounting significantly alters the presentation of the American Home Shield earnings results.

Let me talk a little bit about what it means for quality of earnings. Under our old accounting, cash from operations at American Home Shield ran 40 to 50% above net income, which we believe is a pretty attractive relationship. Under the new accounting, cash from operations will run double net income, which is the strongest cash flow-to-earnings relationship of any of our businesses. We also took a one-time cumulative noncash charge of $45 million in the second quarter, which is reflected below the net income line to reflect that change. I should also note that our other businesses recognize customer acquisition costs in the first year of the customer life, which is similar to the new policy for American Home Shield.

Coming out of this review, Deloitte has provided management and Board of Directors with assurances that they have taken -- reviewed and support all of our critical accounting policies. So I would be happy to answer more questions about that when we get to the q and A.

At this time, I would like to turn it back over to John Ward, who is going to give you some perspectives on how we are doing on operational and marketing imperatives, as well as talk about how the year is shaping up.

Thanks, Steve. I am glad to have a chance to talk to you today. We are in the middle of the year, yes, our first year of phase two, of our new ServiceMaster. No doubt an important year for ServiceMaster, a company in transition. And quite honestly, We are where I expected us to be at this time. Some things are going better than planned, and some things are going better than I anticipated to get going. We ar not ahead. We are not behind. We are confident, encouraged and clearly on right course for phase 2.

Some of you attended our investor day in New York or listened to the replay on our web site. You know that our plan is to perform as we transform. Perform means making basic gains in our business. Transform means bringing new processes, disciplines, and expertise into our organization to prepare us for phase 3, when we want to use these new capabilities to drive growth and new models into our company. I'll talk about both of these today.

Before I get to that, let me comment about the current economic conditions. We went into this year without expecting any help from the economy. That forecast is coming true. No one can deny it, the last few weeks have truly been a roller coaster. No wonder the most recent study from the University of Michigan consumer confidence fell sharply in July. I think that was backed up by the conference board this morning.

It's hard to be confident when stock market is so volatile and so many investors are experiencing real losses, but once again, let's remember, these studies measures attitudes, not actual spendings. Will confidence return before spending falloff? Quite honestly, we don't know and we believe anybody does. We are not waiting. We have been working hard this year to make our brands more resistant to the variables of the economy and the weather. Once again, we control our own destiny. What we have found is that we can make real progress, as long as we have got a stable business.

With brands sitting on all cylinders like Terminex and TruGreen lawn care, the proactive marketing programs do get traction, direct tv, direct mail, teleSelling all become more resilient. We gain market share, get new customers, retain more of our current customers and improve margins. When a business like ARS, not only do we suffer from the loss of internal efficiency, but we are at the mercy of the economy and the weather. I don't like being in that position and we will not stand there for very long. It doesn't have to be that way and I am confident that a new marketing team at ARS headed by Brad Cummings will fix that.

Brad joined us from a background at Kraft where he was involved with a lot of consumer brands and also to Meritech, where he was responsible for helping marketing in their cable business. Traditional consumer marketing, coupled with the service industry experience. Just what we need. There is another aspect to the economy that really does favor our business. Money is coming out of the stock market. It is going to bank accounts, money markets, and, yes, homes. Right where we are. Again, I just said to you many times before, the home is the financial center of the American family. Consumers continue to spend money to maintain their largest asset.

The home is also the emotional center for the American family, and consumers spend money where they care. We are uniquely positioned as America's home service company that is fortified by complimentary set of commercial businesses.

I want to make a few comments about the KPIs that are now included in our press release. Some are there today and more as we go forward. Once again, to improve the outputs of our company, our income statement first, you have got to see progress on the inputs. We are seeing that progress. Steve Preston unbundled the details around this quarter's KPIs. The numbers show the business moving in the right direction.

These KPIs are particular important when you realize that 3/4 of our revenue base comes from our service. When retention rates get stronger, the business is getting healthier. TruGreen, total customer counts should end up at least 3% by the end of the year. A significant turnaround, specifically in light of the last three or four year, where customers accounts have been going down. Terminex, great double-digit growth. We are even taking it further and splitting our pest control business into separate residential and commercial businesses to make sure that we focus better on the commercial business where we believe there is significant opportunity to improve our presence and our market share. Our base system and guarantee, clearly the best in the industry. Retention rates 90% and consumer service is almost unheard of. The satisfaction, the value and quality of service is unparalleled in America today.

American Home Shield, you can see the benefit of growth in both retention rates and warranties, as new channels become less reliant on real estate, and move into new geographies. a business poise for an accelerated growth beyond what it is showing us today. We will be coupling this with new data from CFI, as we get our first round of feedback from the customer. Most of the businesses that have been measured so far have seen satisfaction scores, typically in the low 70s. As a comparison, FedEx scores in the 80s and cable TV as an industry scores in the 50s. That's an important thing is we made is that each branch is getting specific data.

We are pleased we are in the low 70s. We believe we can become more fed ex-like and are challenging those branches with scores in the 50s and 60s to get on improving their level of customer satisfaction and hold up the quality expectation that we have on every service call we make. Some branches are scoring higher, some are lower. With we know exactly what each branch needs to do to improve the retention rate, the customer satisfaction and represent their brand well. We will be developing sufficient data across from businesses and add these to the KPIs that are a part of this release. We are pleased with our position, but we know we have room to be better.

Another insight we have developed out of the CFI is a better price for feeling. Our new data on customer satisfaction shows the decision to purchase our service and stay with us as a provider is primarily based on quality, and our ability to resolve problems, not pricing. It needs to say, we have more pricing elastisity than we thought, and we will take advantage of that. We didn't take any price increases so far this year, so we will exercise some flexibility during the second half of the year, as it presents ourselves, and are strategically working with each one of the businesses to come up with much better pricing perspective as we enter a new selling season for '03.

A few comments on our accounting policy need to be made. During our transition to Deloitte & Touche from Andersen, we did take an opportunity to review all of our accounting policies. Management, the board, our audit and financial committee charged ourselves and Deloitte & Touche totook everything that we had to make sure that we are putting forward into the most transparent light we could,the economic statements that you rely on us every day. We sit here today and have scrubbed every aspect of this company and have come back with just two recommended changes.

The American Home Shield policy that has been in place for many years was appropriate and continues to be appropriate, but the new policy is even more conservative and lines us fully with industry direction. In our commitment to Increasing transparency, we want to tell it to you like it is. We think it is -- what really tells you like its is our cash flow, unparalleled in its match, unparalleled in it's ability to continue to foster growth for our company going forward.

We also took some time to look at expensing our stock options. Stock options are a form of employee compensation, so it is right that these costs are reflected in our financial statements. This method of accounting for stock employee options ensures that our earnings will more truly reflect the economic reality, since all compensation costs are recorded in financial statements. In the short-term, it puts us at a slightly disadvantage when reporting our earnings. Most companies aren't doing it, but our option expense and share overhang is less than most major companies, and it will help us live up to our commitment to be transparent in our full disclosure.

There is another important advantage of our option expensing policy. It puts options on equal footing with other types of compentsation, allowing the company to best design compensation packages that make the most sense. That will motivate our employees, and align ourselves with our share holders. It will allow our compensation committee the full latitude to balance reward and truly reward performance when it occurs.

This quarter, we did end our pilot program with Home Depot. Through this pilot, we learn a lot about how to sell off services in a retail setting.

In terms of the quality of our service, we more than held our own with one of the most recognizable brands and admired companies in America. We met and exceeded customer expectations in Home Depots for the quality of our service provided. In fact, I think they had 20-plus-something relationships and to date, they say only two of the companies would meet their service level agreements, ourselves and one other provider. We have reaffirmed our reputation in the service industry, and we learned what worked and doesn't work in this channel. We are going to take this knowledge and reapply it quickly.

Home Depot focus right now is on building same store product sales. Their priority for them is right. There is no way our model could get their time and attention, as they are striving to grow same store sales. We needed a partner fully dedicated to representing our brands today. We will be back on home improvement channel soon.

When it comes to developing new channel partners, we have an advantage of a family of brands that could be offered individually and with logical clusters, a whole series of collections tailored to meet the consumers' needs. This quarter we announced a deal with Yahoo!, opening another door for millions of consumers to know about our brands. New channels work and dedicated to testing, developing and maximizing them.

We are actively moving forward with other retailers in different channels and expect more announcements during the second half of this year to 2003. You've heard Steve talk about Six Sigma and certainly, we spent a lot of time talking about it. Let me give you an update. ServiceMaster is really plowing new turf as we apply the Six Sigma processes to the service business. That in and of itself is remarkable, and has historically been on manufacturing environments and clearly the cornerstone of our transformation in both our operational performance and our culture. Our secret weapon, is to take small gains and create big wins through the replication of hundreds of locations across the country. We are in the middle of a World-class first year. We completed training of thousands people. 24 full-fledge projects on final phase of rollout, and 50 more in development, and we are developing the core competency that is important for anything we do around replication. All this has required investment.

We are on track to capture operational improvement and stay expense -- expense neutral during the first year, and our projects are at the heart of the business. A few examples. We are reducing customer cancellations in ARS. already resulting in tens of thousands of dollars in savings. We are reducing plant and shrub expenses at TruGreen by nearly a million dollars, and recovering over $200,000 by improving our processes around finance contracts at Terminex. We are improving the collection process at TruGreen yielding a half million dollars by the time the year is out. The solutions developed for Six Sigma are often not complex, they just involve doing it differently and getting thousands of people to do it differently. For example, we have already talked to but reducing service, people's time and branch.

Here are two little improvements that together save us about a half an hour a day. One, how do they change the uniform and get ready to come to work? Now we have them show up and not punch in until they are in uniform. Less hassle for them, faster time out for the door. It is a true win-win,and we save about ten minutes per person per day. If you go to branch, particularly TruGreen branch at the end of the day, you typically came back and got your truck gassed up and new applications for the next day. The solution historically has been to wait in line. The solution now is to have one person at the branch assigned to get all the trucks gassed and next day's applications on board, less boredom, more production time, a win-win, saving once again, 15 minutes per truck day. Not huge savings in either case, but I think they give you some insight into the discipline, and how we are crawling around our company finding ways to save money every day, and every branch, real dollars, leading up to improved earnings in cash flow.

It is also encouraging when you take time to go in the field. I was in the field last week and visited 5 or 6 TruGreen branches. Each of them were responsible for implementing five to seven projects. And I can tell you, branch to branch, every one of those projects was being implemented by the branch manager, and not being told to do it just because they had to. They are doing it because they can see it was a better way to run their business. They didn't seem overwhelmed. They seemed encouraged, moral was terrific, and everybody was focused on improving our operations, focused on our customers, and focused on our shareholders. It means we are getting the simple, but tough part of the job done. It is hard. It is not easy. It is an inch. It is a dollar at a time. But we are dedicated to it and it is taking hold.

Also bringing [inaudible] to areas such as purchasing, fleet, real estate, and risk management. Fuel program, we issued 30,000 fuel car cards that have us buying gas through one enterprise. 2002 savings expected to be in excess $4 million. Full-year savings, in excess of 7.

Telecom. We began a company wide audit. We started looking at those phone bills to see if we are being charged the right amount for the lines we installed. Finding more ways to improve, eliminating certain features at certain branches, and capturing all the existing deals and pricing we have been afforded. Minimum saving this year in excess of a million and a half dollars.

I can spend more time in real estate, I can spend more time in other things we purchase, but these things are actions that are just starting to take hold in our company today. So as you put that all together, we in the quarter meet the expectations. Last quarter we were down than the previous quarter. This quarter we are even. Yes we were helped by a lower tax rate, but overcame a $5 million incremental initiative, a 1 cent per share insurance acruel, $1 million in American Home Shield accounting, and $2 million more seasonal deferral inTruGreen and still delivered results.

We are looking toward our full-year performance. Current combination of our strengths and weaknesses are challenges in our trends, lead us to the lower end of our previously standard range of 60 to 63 cents per share. This is before we take the American Home Shield accounting charge of 3 cents per share. We continue to see measurable improvements in the performance of Trugreen lawn care, Terminex and our American Home Shield, and our franchise business. The improvement in margins of customer attention in these businesses is due to the soundness of our operation initiatives, and we are getting this done in a phase of difficult economic conditions.

To stay within the guidance, these business also continue to perform. We also need to see improvements in land care in the top-line growth. We are looking at their top-line growth weekly at the business unit, and monthly at my level to ensure we have the right number of quotes and retention rate is there to ensure we get modest second-half growth. We also need to turn around on the stabilization [inaudible] to show progress toward business in the second half of the year. We were confident that steps were under way in leadership to stabilize this business in the second half of the year and prepare us for good growth into '03. ARS stood backwards for the first half and the last half of the year. We are working to stop that slide in the next two quarters and get us positioned for growth next year. We are pleased with our progress. Our people are fully engaged in making great strides. We are taking our first steps in our marketing revolution to back truly consumer-marketing focus company.

Our operational initiatives are on track. Our KPIs are moving in the right direction. We are are on track to reach our goal of becoming a high single-digit revenue growth company, and low double-digit return. Thank you for listening this morning. I will now take your questions after I turn it back to Steve for a few moments about our Safe Harbor policy.

As you are getting your questions ready, I want to remind that you our comments have included statements that are forward-looking in nature. Our actual results may differ materially from those stated. Additional information concerning factors that can cause actual results to differ from those in our forward-looking statements is in our company's press release, 10-k reports and other SEC filings. In addition we would like to read forward-looking statements in our press release for a broad discussion of risk. Now turn it back over to the Operator and if you can go through the Q and A process, we will be happy to take your questions

Operator: Thank you, ladies and gentlemen, if you wish to register a question for today's question and answer session, you will need to press the 1, followed by the 4 on your telephone. You will hear a three-tone prompt to acknowledge your request. If your question has been answered and you wish to withdraw your pulling request, do so by pressing the 1 followed by the 3. If you are on a speakerphone, please pick up your handset before entering your request. One moment please for the first question. Our first question comes from Adam waldo with Lehman Brothers. Go ahead with your question.

Thank you, everyone for the [inaudible] John, on your prepared remarks, you commented a little bit in the recent turbulence in consumer confidence in June and July. I wonder if you can tie that back into the specific leading indicators that you are monitoring in your business, and how those have been performing in June and July, and what expectations for the second half of the year in these key leading indicators underlies your slightly revised guidance this morning.

Adam, I don't think that the choppiness in the consumers' mind today -- quickly if you look at the recent studies out from the conference board put us back to a consumer confidence level to where we were in January. What we are really seeing is just choppiness over the last couple of quarters. In most our businesses, our primary selling season occurred in January and February. So we are not at a lot of exposure for "selling," in particularly Terminex and TruGreen at this point. There is discretionary spending in both those businesses, but by and large our sale season is behind us, and we can sit here and say we are confident about some of the customer trends and retemtion rates we have today. ARS, and AMS certainly - on the AMS side, new construction cannot be affected by consumer confidence but overall business confidence. In ARS we continually see people doing more repairs than replacements around, particulary around [inaudible] systems. We anticipate going into the year that the consumer would not give us a big lift. We haven't seen it. We don't believe there is a dire consumer cliff we are going -- going to fall off the next couple of quarters. We see it steady as it goes. Nothing robust, but nothing catastrophic to our business.

In your press release and also in your prepared remarks this morning, you spoke a little bit about performance improvement needed within ARS and land care, and also you eluded to performance levels required out of each of the 3 major business, TruGreen ChemLawn, Terminex, and AHS. In order to recieve your targets for 2002 as a whole, can you give us a sense for what expectations you are carrying into the 2nd half of the year as the performance in the 3 businesses, and also performance improvement in land care and ARS that allows you to reaffirm the low-end of your prior guidance range.

Adam, when we talk to transparency to you investors, the way I speak to you spokes is the same challenge in our business meetings. We sit down on a monthly basis and put the challenges in front of them. For TruGreen earlier this year, TruGreen, two things, one, get customers counts and retention rates, up in lawn care, and improve margins and that's happening. We said stabilize land care. We stabilized land care. We shed construction. Now the change for them for the second half of the year, let's see you grow revenues. So we are overhauling our growth-to-market approach, bringing in more sales, and keeping much better track on our log of open quotes and being much more disciplined about it. The whole breaking apart of construction for maintenance has gone relatively smooth, and we are now in a position where we have dedicated folks on land care maintenance and growing. Terminex, once again, retention rate, customer growth,and make sure they did a great job of integrated the sears acquisition. Most of that has been accomplished. We talked a little bit about the [inaudible] pest side and tthose branches where we rolled sears in, we have done great job of retaining the Sears customers quite honestly. But if you put 50% more revenue into a branch, our new sales has not been up 50%. So we have got to challenge ourselves of re-examining our new sales initiatives in those sales markets. Termite control, it's once again really just making sure that our reputation, our marketing, and our brand continues to have the consumer recognize we have got a differentiated offer. One other comment on Terminex. We talked a little bit -- my comments today was breaking up commercial from residential in pest control business. Just by happen stance, without alot of focus on it, we are the second-largest pest control company America today. We have put renewed focus on pest control on the commercial. giving separate branches with separate offering to make sure we can optimize that market potential. American Home Shield is once again just pushing them to grow as quickly as they can. We think they have great, great vision right now in taking their model to new channels. The real estate channel is so important to us, but we believe there are other channels that could be equally important. Mortgage channel is working great. Insurance channel is working great. We need creativity and imagination there. ARS, once again, my take, yellow page advertising vehicle, the -- 95% plus of our advertising today goes to yellow page placement. We significantly increased our yellow page investment during the first half of this year and late last year. Quite honestly I don't think it is paying off for us. We will look into that -- that's why I brought Brad Cummings in, to work with Mark burrell. We will continue to be a large yellow page advertiser, but in that business when I say 1% of the market share, 2% of the overall market, I don't care what's going on with weather, I don't care what's going on with the economy. You can grow if you do an effective job in marketing, and we just have to crack that code. The second half 9 year for them, if you remember last year, Adam, falling off of revenue and earnings for the second half of the year. Their challenge for the second half of the year is to match the second half of last year's performance. I hope that answered your question and we will take another question from someone else at this time.

Our next question comes from Matt Litchvin with William Blair and Company. Please go ahead with your question.

Based on second-quarter results, I wonder if you can give us an update on expectations for cash from OPs and CAPEX spending this year. Also, maybe you can update us as to your preferred uses of cash going forward.

Steve, you want to take that one?

Sure. I think that we continue to expect strong cash from Ops for the year. I think the key issue is what happens in working cap. At this point, we think the working cap relationship, increase in working cap, we have seen in the first six months is going to hold for the rest of the year, which obviously will provide with us a very favorable comparison. Obviously, that will take some work to do because it will require us to continue to work on receivables and payables side. There is really no other changes of any significance when you look to the full year I think. Depreciation is still trending sort of in the mid-50s, and, you know, CAPEX is not -- is not out line with that level, somewhat lower actually. No no significant changes. From the cash usage side, I would say that the debt reduction program that we completed in the quarter is primarily behind us. I don't think it precludes our reducing debt further. We still do have $7 million of excess cash in the balance sheet, but the other thing that we have not done this year, which we traditionally done in prior years, is have a moderate level of share repurchases that we would expect at the end of the year, that would probably pick that program back up modestly to mitigate the impact of increasing share dilution. Then once again, you know, we continue to keep our eyes open for tuck-ins, as there are always opportunities. They tend to be less common late in the year, but certainly as we kick off 2003 in the lawn care side and termite -- Terminex side, rather, we would expect to see good opportunities there.

Just one follow-up, and that is, what is your current authorization -- authorization for share repurchases in here? Thanks.

We announced a couple of years ago of a large authorization of -- I think it was $300 million. We have over $250 million of that still available. That having been said, we wouldn't expect to push forward with that type of a share repurchase program. We pulled back on that, as we begin to see operations impacted late in 2000, and then looking ahead to some of the credit issues we have had concerns about. We have full authorization to do whatever we think is reasonable, but before we did anything significant, believe me, we would be chatting with our board, chatting with the agencies, and have a different kind of strategy out there than we are employing route now.

Thank you.

Our next question comes from Amanda Tapper with J.P. Morgan.

Hi, good morning. I have a question on the pricing that you talked about. I'm wondering how -- you say you have done some surveys and you think you have more pricing power than you thought. What kind of pricing is in your guidance? How do you plan to roll it out? What is the current price differential between you and your competition now in general.

Amanda, certainly it varies by business and micro market. In our guidance -- certainly we don't have any guidance out there for '03 that we comment on right now, but our assumption going into the year was minimal for any price increase during the year. That's still where we are, and I mentioned that we are doing some price increase right now. It's on the margins. For instance, in land care and lawn care, you have some enhancements that occurred the second half the year, supplementary sales that occurred that might add, you know, might be total across the company, $100 million or so, areas in the short term looking for price increases. Most our contracts with consumers signed in the first quarter and fixed with a price for a year or two. What we look at are the surveys are put out in front of our current customers to ask them, why do they buy the service? What do they like, what don't they like. In most of the brands, we would hear, in most the locations, that price is probably the 4th or 5th highest level of dissatisfaction. Okay. So it means three or four other things that consumers are dissatisfied with before they hit price. In that type of environment, once again, we have got to do a lot more testing, it will say we have pricing flexibility. We have a gentleman by the name of Neil Breskman, who came to us from Meritech and AT&T, where he was one of the pricing gurus in consumer services there. We have really asked Neil to spend alot of time the next few months, and into the fourth quarter helping particuarly ARS, Terminex and TruGreen, think through pricing strategies for next year. So we will pick some things up on margin. When I talk about high single-digit revenue growth for our company, italked about four buckets of 2%. Talked about price being 2%. I talked about new customers acquisition being two, retention being 2 and tuck-ins being 2. My comments were more to portray as we get into the heart ever of phase 3, we believe and are affirming for the forseeable future that 2% price increase seems to be within our reach. So you can see the KPIs around retention. You can see the KPIs around new customer acquisition. We want to give you a KPI or some indication around price, you will certainly see tuck-ins as we talked about, use of our balance sheet going forward. So the third leg of a four-legged stool.

Okay, but you will be testing them before you roll them out?

We test everything. We need to become a much better testing organization. To say we are going to test pricing in a couple of branches, I would say that a significant number of our branches will have some pricing change. You know, your last comment?

Okay.

You had one other comment in there about our competitiveness. My sense is that we are competitively priced in pest, land, and lawn care, probably with our guarantee we will perceive to be premium priced in baiting systems in Terminex with our guarantee is where the value comes.

Okay. Thank you very much. And then my other question is on Six Sigma you say you have 24 projects in roll-out, 54 in development. ,Can you put a rough dollar range on savings and the time you expect to get from those and whether that's baked into the guidance or will be getting any of that this year?

Our '02 perspective is a $15 million investment that will challenge ourselves to break even this year and tracking to that or slightly below that. Some of the projects are taking a little bit of time to roll outl, but in our guidance we fully baked in whether we are going to be neutral or slightly below neutral in our Six Sigma rollout.

That's on the 24, right? Presumably? 24 projects you say you are rolling out now?

On the full investment. Where we will get the savings is on the 24 --.

Right, I am talking about the savings part.

On 24, but once again getting going now, the cost of wave two is figured in our guidance, although to be quite honest, very minimal if any benefit out of wave two, as we develop those projects in the second half of the year and the cost and benefits until next year.

Okay. What are you finding is average time to roll out these projects since you says it all in the replication?

I would say to get 80% compliance in a branch, once the idea is fully vested, is a 60 to 90-day issue.

In a given branch or in all of your branches?

All of our branches.

Okay. Great, thank you very much.

Our next question comes from Chris Guttig from Morgan Stanley.

Good morning, John and Steve. To the event that ARS is performing so poorly, what portion of that weakness would be purely do to the economy, and what portion will be company specific reasons that might require further integration and some other management attention.

Chris, we seem to be tracking about where the overall industry demands is, so, you know, if -- the best insight we get through our competitors when I see that demand side, we seem to be tracking about where our competitors are. So I can't say that we are doing significantly worse in than our competitors, but I think it is too easy to say it is the economy out there. So I think we are setting ourselves for higher standard. By the way, one of the things that we -- talk see, chris, is when you -- when you don't get a -- an easy lift from the economy or hot weather or in the summer or cold weather, winter, you fundamentally get to see the strength and weaknesses of your businesses. I think we are doing a lot of things operationally. I think we have a good team in place. There are three priorities for the business unit. One, an integrated management information system. Steve alluded to we have a great rollout going underway in mission. I think we will be talking about a new system to bring all of ARS under one system during the second half of the year. Second, we haven't done as complete a job as we should have around the rollout of the national brand, okay. I think we are dedicated and will be announcing once Mr. Cummings gets his feet under, we have some things we have been working on before he got here. We will be rolling out a national brand transformation, some of our branches are relying on their local brand. A third thing we are doing is overhaul on how reinvest our marketing dollars. Operation, a good team in place, I think we have got to think through a system that allows us to see what goes on in the business quicker and number two, the way we attract customers a dispatch business.

Okay, great, thanks. The second question, I guess [ inaudible ] -- six Sigma, I believe you have hired consultants to centralize some of the support functions. John, i think you mentioned significant examples, cost savings. Similar to Amanda's question, have you made an estimated cost savings at this point?

Yeah, we would say that in our numbers, we used BCG to look at some of our sourcing initiatives, that investment is in the $3million to $5 million range this year and our challenge -- our goal in that area, Chris, is to exceed that by the same amount. That's where we are tracking to. Once again, even my company -- go by gas at a certain station, use the right express card. You know, you can't buy premium unleaded fuel. You can't buy doughnuts. All the things -- when you think you have every truck driver out there, our route managers, we have taken a lot of flexibility away from them to bring discipline in. You've got, once again, every route manager checking the pressure on his tires twice a week to make sure they are 32 pounds per square inch. These are all the things we are doing. The Telecom stuff was kind of a no brainer, hiring some auditors to come in to make sure we are getting what we are paying for. These are the things we say we have $3 million to $5 million investment and looking to double the savings this year and that, once again, both the cost and the benefit is baked into our numbers for 2002.

I think Steve was staying that the expectation for corporate expense line was for that to come back up again in the back half of the year. The expenses are front-end loaded and once we get into 2003, that trend reverses, is that a fair assumption?

The viewpoint on that is that we expect the benefits to exceed the investments for making it at the parent center. But many of the investments -- I mean some of the investments will be going away. For example, we do have set-up costs with consultants, for example, both in Six Sigma and the sourcing issue that John discussed. One of the things that we are doing, and have done already, is actually putting in place talent within the organization that will make these programs sustainable and expandable. So we have a full purchasing organization now place. We have Six Sigma experts. We have head of government relation to help us work through any number of issues on that side. So part of an entire talent upgrade that we really do think will be beneficial and far exceeds the cost going forward, but a lot of it is a run rate issue.

Great, thanks.

Our next question comes from Alex Paris with Barrington Research. Go ahead with your question.

I have a follow-up question and want to clarify something from the press release. With regards to your accounting change for AHS, you said it is going to have a 3-cent impact this year. Does that mean you've go gone back and restated the first quarter to reflect the adoption?

Technically, we don't restate the first quarter, but if you look at our six-month results, it incorporates the first quarter as if we had made the change at the beginning of the year. So all of our -- all of our 6,, and 12-month results will incorporate the change as of the beginning of the year and when you see our statements at the end of the year with the quarterly breakouts in it, the first quarter will reflect the change. But technically, no restatement there.

Okay. The $45 million charge that was sort of a catch-up noncash charge to account for previous years?

Yes, that's a catch-up cumulative adjustment we call it.

Okay. And so you said the first and fourth quarters will be most affected to the tune of around a penny. Second and third quarters more like a half a penny?

Roughly speaking and I will tell you the number, first quarter $6 million. Second quarter about $1 million. The third quarter about $2 million, and the fourth quarter about 7. Those are all pretax numbers.

Okay.

That gives you an order of magnitude.

And then the guidance that was reiterated, though at the lower end of 60 to 63 does not include that 3 cents. So if I included that, obviously it would be 57 to 60, probably at the lower end, including that 3 cents?

That's correct.

Okay. Good. Thanks very much.

Thank you.

Ladies and gentlemen, as a reminder, to register for a question, press the 1-4. Our next question comes from Adam Waldo with Lehman Brothers. Please go ahead with your follow-up.

Follow-up on my question has been answered.

I am showing no further questions at this time. Please continue.

We thank you for all being with us today. We appreciate your comments and being on the phone with us, and please call Steve or myself with any follow-ups. Talk to you next quarter. Bye-bye

Ladies and gentlemen, that does conclude the conference call for today. We thank you for your participation and ask that you please disconnected your line.