Terminix Global Holdings Inc (TMX) 2002 Q3 法說會逐字稿

Thank you for standing by. Welcome to the ServiceMaster Company third quarter earnings conference call. We are in the presentation. All participants will be in a listen-only mode. Afterwards, we'll come back to the question and answers session. At that time if you have a question, please press the "1" followed by the * on your telephone. As a reminder this conference is being recorded Tuesday, October 29, 2002. The speakers for today are John Ward CEO and Steven Preston CFO. I would now like to turn the conference over to Mr. Steven Preston. Please go-ahead sir.

Thank you. Good morning. Thank you for joining us. I am here with a group of people, including John Ward our Chairman and CEO. Few other colleagues include Bruce Biach Investor Relations, Steve Bono our SVP for Corporate Communications, Deb O'Connor our Controller and Eric Zonaco our Treasurer. To start it out I will review today with the discussion of finance results and when I am finished John is going to give you an update on marketing and operational apparatus and give you some additional perspectives on how we see the remainder of this year and initial view of next year. Three quarters of the year is behind us now and as we look to the end of the year where we have a pretty good sense that how so many of the things we have been discussing with you are trending. We are clearly seeing traction in the initiatives we've been discussing with you this year. We can see or you can see from the key performance indicators, that our marketing and satisfaction initiatives are already increases in both in customer counts and retention in all four of our of most profitable consumer services even in this difficult environment. In addition to six sigma effort and the strategic sourcing program which is our effort designed to reduce our spend for materials and services are both showing results and will be an important part of the equation for profit growth next year. Not all of these are moving as quickly as we hoped. For example we are hoped to break even in six sigma this year. At this point, we expect it will be a net cost of about $3 million, but all this initiatives are moving in the right direction and we certainly have a green light to expand in going forward. As you look at the quarter, total operating income for each of the three operating segments as well our over overall operating income is up for the first time since the first quarter of 2000. And I will get into the details of what's behind that in just a minute.

First let me remind you of a couple of items to assist you in understanding and sort of navigating through the financials in our press release. In 2002 we did adopt FAS142 which eliminates the need to amortize goodwill and we adopted a new counting method for American Home Shield which resulted in an acceleration of recognition of customer acquisitions cost, we went through some of that in that last quarter. To help you understand comparability and operating income we have included a memo line just below the reported operating income on the face of the income statement with 2001 adjusted for comparability. In addition we have paid down a lot of debt over last year in part from divestitures so our interest expense is down. Then note you would see our EPS would have looked like last year if we have paid down the debt at the beginning of last year and made obvious aforementioned accounting changes. So even though all these adjustments in the aggregate actually provide a less favorable turn line for the company, we think you need to understand them to see the turn line on an apples-to-apples basis, truly understand how we are performing. Turning now to the financial results, revenue in the quarter increased 3% to a $1 billion with strong growth in Terminex and American Home Shield, offset and in part by lower Revenue in our HVAC and plumbing business. Operating income for the quarter was 105 million. That compared with 89 million last year on a reported basis, and 103 million last year on a comparable basis, accounting for the -- adjusting for the accounting changes. Interest expense declined by 14 million due to lower debt resulting from the application of proceeds from the management services in Terminex Europe divestitures, as well as from strong cash flow from operations. Interest income for the quarter was $6 million lower than last year primarily because we had venture capital gains in the quarter last year. Our tax rate in the quarter is running roughly in line with our full-year estimate of 37%. This compares to full-year 2001 tax rate on a comparable basis of approximately 40% and is improved due to the benefits we received through the consolidation of the ServiceMaster Home Service Center. Putting it all together, we reported 18 cents a share in 2002 versus 12 cents a share last year from continuing operations. If we adjusted last year's numbers to reflect the accounting changes and the proforma reduction in interest, we would have reported 18 cents of share in 2001. We are in line with this years' number. So this has been our second consecutive quarter now of flat growth in EPS which follows 7 quarters of declining EPS and as we look to the rest of the year we are very confident that we will return to EPS growth next quarter. Cash flow for the year continues to be strong. Cash from operations for the nine months was 246 million, that is almost 75% better than our earnings for the nine months, and a 24% increase over the 199 million we reported last year before the sale of accounts receivable in prior year tax refunds. Once again, a significant component of the improvement is a $58 million reduction in the use of working capital in the period. This comes from a number of sources, including better receivables, and better payables management. We continue to reduce our debt in the quarter to 827 million, which is at its lowest level in our five years. That number represents reduction in debt outstanding by a billion one over the last two years and a further strengthening of the companies credit profile. Once again very strong cash flows continue to define our business. Revenue in the TruGreen segment increased 1% while operating income was up 4%. This is the first profitability increase we have seen in this segment since the first quarter of 2000 and it is all based on solid and what we believe to be sustainable improvement from this business. Underlying this result is steady progress, is a steady progress we have seen on so many fronts this year in the LawnCare business where revenue increased 2%. Customer counts are turning to be up a full 2 % this year. That compares to a 4% decline last year. We achieved this through higher sales in non-telemarketing channels, higher customer retention, which you can see in the release and stronger sales in additional services. In addition we are beginning to see marching leverage from top-line growth and clear benefits from the Six Sigma effort in this unit. As we couple this level of growth with moderate price increases and a tuck in acquisition program which we are putting back in place for next year, you can see how truly we could be back on track to become a strong single digit grower in the future. And as many of your heard a highlight in the past once the top-line gets going in this business, the marginal profitability is tremendous because the leverage we get on our fixed cost structure. As we look to the end of the year, it will be important for us to realize the anticipated benefits from Six Sigma and the purchasing initiatives here and also achieve strong sales of late season services as well as maintain our higher customer counts relative to last year. In TruGreen LandCare revenue was down about a percent, looked flat branch margins, but we did have higher overhead to support various selling retention in the initiatives. This time last year, TruGreen LandCare was about to begin winding down the entire construction business, requiring separation for many existing maintenance branches and resulting in disruption to the business and distraction to the management team. As we look at the business now one year later, the operations have stabilized. We put in place a very accomplished sales leader, who led the $25 billion sales effort, global sales effort at Fedex and we have also bolstered the financial team there. We are beginning to see the clear benefits from the initiatives to improve our sourcing material from this business and we are putting in place programs to leverage an ERP system, which was in implemented in the unit. We are clearly out of slot team mode here and we are putting in place the building blocks we need to grow this business at both the top and the bottom line. As we look forward, even though we are currently running at a level roughly flat to last year. We all believe that this is business that will begin to breakout in 2003 and that it can become a very important growth engine for the company in the future. So specifically in the fourth quarter, sales of enhancement services will be a priority along with managing down the late seasonal labor levels as the business winds down. Capital employed in the TruGreen segment improved 2% reflecting better working capital and fixed assets efficiency at both the LawnCare and Landscape businesses offset by securitization of receivables last year. Revenue in the Terminix unit increased 12% the quarter. We continue to see internal growth in the unit and strong comparisons from the addition of the Sears business. Operating income increased 9%. We have seen particular strength from the sales of termite contracts, both new and renewals. Next quarter the comparisons to the Sears business will become more difficult because we both had Sears in both quarters for the first time, because of the state that business was in when we bought it as we expected and as we projected, we have seen pretty significant fall off in the pest control customers over the first year. As a result, profitable pest control contracts have rolled off and it has been difficult to replace at the same rate. The other impact we would expect to see at Terminix in the fourth quarter is a beginning of a noticeable impact to rolling out the new mission IT platforms throughout the branches that will continue thorough 2003. This new system will be a very important tool to support better sales productivity, customer satisfaction, cost efficiency in regulatory confines. However, as in any major system implementation, our near-term expenses associated with the development, the process improvement and the roll out of the system. Both of these items will make the year-over-year comparisons at Terminix more challenging in the fourth quarter and probably through the middle of next year, especially at the margin level, but after that point, we do expect to begin seeing the benefits of the operating leverage from the mission system kick in and the Sears impact to give more comparable on a year-over-year basis. Our capital employed in Terminix segment increased 7% primarily reflecting the acquisition of the Sears business. Now, revenue at the Home Maintenance and Improvement Segment was up 1%, excuse me was 1% below last year, while operating income increased 2% on a comparable basis. However, underlying that result was a real mixture of results in the individual businesses. American Home Shield increased revenue 17% in the quarter. Sales in real estate channel continued to grow. Customer retention was stronger and direct sales to consumers increased dramatically. In addition because of various initiatives to improve our cost structure in a more profitable geographic mix, this quarter we saw very significant increase in margins. In fact, even though we have a number of units with much larger revenue than American Home Shield, this unit has had the largest dollar increase in operating profit of all of our units in both the quarter in the 9-month periods for having an absolutely outstanding year. We also had a solid quarter with franchise business based on the strengths of our disaster restoration business and in our Merry Maid operations. On the other hand, we are having a very difficult year in the HVAC and plumbing business, and we have not yet seen the trends as favorable although we are stepping up the turn around offer. Revenues down 10% for the quarter, the profitability in this business so far has declined $24 million this year relative to last year. That represents a negative impact of 5 cents a share to the 9-month numbers. With these business were flat, the enterprise would be turning to beat the high-end of our earnings range that we've communicated at the beginning of the year. I mentioned that not because I want to accentuate a problem but rather I want to communicate how the rest of the enterprise looks in comparison. Although we are beginning to see modest growth in the residential HVAC repair business, it's clear that people are repairing more than replacing as product sales are down. Replacements are obviously much more profitable. In addition to construction business, both residential and commercial have been most heavily affected. The other thing I would note, however, is that there is a tremendous amount of dispersion in the performance of those branches. Truly the bottom 25-30% that continues to provide us, present us with real difficulty. In fact, in the quarter two thirds of the network is actually showing solid growth in spite of the economy. Now, clearly we own the whole thing then we have to address the whole thing, however, it does give us a subset of the business to address most intensively. John is going to get into that a little more in his comments. Capital employed HMI Segment declined 6%. That was primarily due to the change in accounting at American Home Shield, adjusted for the accounting change at capital employed increased 1%. And, finally, in the other operation segment, the revenue increased to $10 million from $3 million for the quarter. We sold the Terminix UK business in the quarter. You saw that announcement that resulted in a $6 million licensing fee and let us re-classify that business, its discontinued operations. As a result, under SEC guidelines for former Anderson client we will be only have to re audit 2000 and 2001 and that project will begin to take place in the fourth quarter, will be finished up by the time we talk to you next quarter. Operating income is also 4 million lower at negative 19 million for the other operation segment. That was due to the higher provisions for workers comp insurance and investments in various initiatives at the enterprise level. Capital employed at the other operational segment declined $731 million that all related to the divestitures in the restructurings coming out of the portfolio review last year. So that pretty much concludes my comments on the financial results. Now I would like to turn it over to John, he is going to give you a little more perspective on the business and the training going in to next year. When he is finished, we will then turn it around and take your questions.

Thanks Steve. We are making headway even though the conditions are tough and the economy is sluggish. The conference board announced today that consumer confidence is at a 5-year low. So we are not dealing in steady state economic times, but in spite of that, our customer counts, customer's retention both key performance indicators are improving across our enterprise. Our cash flow is strong, our debt is at a 5-year low and we have a very healthy balance sheet. We are not getting a boost from the economic conditions right now, and quite honestly we planned for O3, we are not going to assume a lift. Progress is tough, but our progress is real. There has been some steady slide as I said in the sentiment. We are not immune to this, but we think we are succeeding and I will talk in a few minutes why does consumer confidence, we believe, we are not affected by as much as some other companies. We are feeling an economic impact yet, particularly in the HVAC and plumbing business, but we are making progress. What's happening is that consumers are diverting money away from large purchases like cars and travel into other areas especially their homes. They have bunkered down, they are spending more time in their homes, and spending more time and money on their homes. Also in tough economic times, consumers move and stay with brands they trust. Our brands are truly the trusted brands and we will take advantages and grow in this environment. Tough times are great for tough companies. They're the companies that focus on cost, have true value propositions for the customers, crave and take advantage of acquisition opportunities and stick to the knitting. We are one of those tough companies and we're committed to seeing our way through this. There are factors out of control, but we're focused on succeeding by focusing on what we do control. I'm proud of our team and every part of our company that bring energy and discipline to their work. Five of our six largest business units are essentially at or above budgets for the year. We know we have issues in our HVAC and plumbing business, which accounts for the vast majority of our shortfall. If not for their shortfall, and AMS and ARS, we will beat the high-end or exceeding original guidance for the year. And just like last year when there were issues in Trugreen, we were taking a lot of action in ARS. We own these actions they are part of our company and we're dedicated to fixing. Inside of ARS, we recently added Joe Phineoa as head of operations. Joe was our operating leader in TruGreen and before that turned around the Terminix UK and turned into a profitable business that culminated in a successful sales at enterprise during the third quarter. Joe Mark Perrell, President of ARS bringing new operational discipline to the business. We've narrowed the stands of controls in troubled areas. We've eliminated a full layer of management for greater speed and control. And we're developing specific turn around plans for each and every location. It's location by location, it's leader by leader, it's service line by service line. We've strength to build an ARS and that's the good news. Our recent customer satisfaction scores have ARS ratings at the top-end of our companies. This was driven by their known, the reliability factors that they have, the staff response times, 24/7 availability and professionalism, all key brand strengths that we tend to exploit in the months and quarters ahead. And we are breaking the code in sales and marketing, a key driver in this business. As mentioned before we've added a new Chief Marketing Officer who brings a balance of service industry from Ameritech and consumer marketing. We have to change and we are in a process of changing of how we get and pick up customers. We're moving away from a complete dependency on yellow pages. We're centralizing our marketing planning and placement. We're improving our marketing efforts in the region and implementing an improved lead and sales tracking system across the entire enterprise. Overall, our short-term goal is to stabilize the business, and then we will start to rebuild it in 2003. And we will develop momentum that will carry us back to where we think this business can be in the quarters ahead. I'd like to move to an area that's adding immediate value to our company and that's a new process for use of the customers. Majority of our business unit results are in. Just to give you an external context. Just let me give you an external context. Typically in these scores, the Mercedes Benz and FedEx were scoring in the low 70s - low 80s. Wal-Mart in the mid-to-low 70s, and companies in cable TV might be in the 50s. Another example for benchmark is McDonalds who typically scores in the low 60s. That of our third of business including ARS and ServiceMaster Clean were above 80s. FedEx like in their brand reputation. Most of our brands were where Walmart is in the mid 70s, which included Terminix Pest, Merry Maids, American Home Shield, TruGreen and Terminix Termite doing low 70s, high 60s. The good news, these are very, very solid scores. It is clear that we are positioned with respective brands, but there is room for improvement and our focus in the months ahead will be the focus on those branches that are lagging behind in the norms for our industry across each one of our businesses. The research also tells us that although price is not completely elastic, the reason people leave us are not the price. They tend to focus on problem resolution, scheduling and flexibility, and desiring a more intimate and close contacts with our people. These are the important issues that we will focus on first and more importantly on our consumer's mind than price. Every branch across our enterprise now has an action plan based on these customer satisfaction scores to go out and improvement next year, that in the end of the day will improve profitability, customer attention, and the brand reputation. Since, research showed that our customers are much more likely to be satisfied if they had direct contact with our technicians or someone from the branch. We know it and we say time and time again, that it is our people who make a difference and in the field our biggest asset, our greatest asset is our people. They are dedicated, they are skilled, they are customer oriented, and this research reaffirms that. We are challenging ourselves to find more ways to make the connection personal and meaningful for the consumer. One customer at a time, one service call at a time. We also continue to add talented people across our enterprise with impressive experience. They come into ServiceMaster because they see and join the vision that we are creating. (Beth Reise) announced as Senior Vice President People Services, bringing 15 years of experience from GE and C& A Insurance. (Bill Friese)has joined LandCare as the national head of sales. Before joining ServiceMaster he literally headed global sales for FedEx, a $25 billion enterprise. He was attracted to the opportunity and said Jon just like we built FedEx, and I am going to build a national presence here with LandCare. Dave Hough, our new risk management leader, formally with Rider Systems, who has one of the largest fleets in America. We spent over a $100 million in risk alone. Our goal is not only to buy better, but also to manage better and reduce risks, and incidents that occur, whether those be accidents, injuries, and damage claims. Once again, creating a centralized repository of knowledge of expertise and systems that work within our company to better manage this $100 million expense we have in the company today.

At our investor conference in New York in June, we told you that we will continue to develop new ways of leveraging the entire enterprise. Six Sigma is one of those. An update on our efforts there; Over 10,000 people have now participated and trained in Six Sigma. We have launched 93 projects. 3100 improvements or installs of these projects have been taken place to date and will exceed 4000 by yearend and we are targeting to grow this to a cumulative number to 12,000 by the end of '03. The investment will be clear as Steve mentioned, we are little short of our goal of breaking even this year. Not significantly, and it's all about the timing, not about whether the savings are there. At our November executive committee meetings, we are going to focus on finding ways to pick up the pace and make sure we capture all the savings. Strategic sourcing is another area of expertise and competency and competitive advantage when building enterprise wide disciplines and bringing together under a common functional leadership. We talked about the focus on purchasing, fleet, real estate, safety and risk management. The new leaders in these areas are instituting superior practices that are turning ideas into money today. Let me give an example. Let me take three areas, fuel, telecom, HVAC and plumbing units. We projected that the savings alone these areas can and should total over $20 million. To date, we've captured about 25% of these potential savings. No company gets to 100%, but we are ramping up to capture much more than the 25% we captured today. The good news, the discipline is in place, the volumes in place, the active plans in place in field to move across this ramp and bring these savings to our company and in turn to our shareholders. We really have a strong focus on the next wave and that will be lower statement fee, as we take these huge expense within our company and bring the same discipline to them that we brought to telecom, fuel, and HVAC and plumbing supplies. Let me turn to marking, a continued opportunity for us as we go into 2003. The bottom line is that we are dedicated to growing our top line and top line will grow in this environment or more healthy environment, and Mitch Engel, as our marketing leader that continues to make progress and lead these efforts. We are leveraged in the collective knowledge of our marketing leaders across the brands to a new across the business unit marketing council. We are focusing and working on this from thinking from the customer back. Historically, we have been a strong operation company, but everything we are doing is focused on the brand, focused on the value proposition for the consumer, and make sure we work back and create our business model around the consumer. For the first time we are commissioning a company wide research on everyone of our brand. It is not a research about our customers, this is basic consumer research. We got to focus on the prospects. The result of these is to sharpen up brand platforms. What's their value proposition? And then we will bring those offerings to the consumer in the most effective and the way they prefer, not the way we think they want it today. This is where no one else in our verticals across the country is doing. It is with the scaled brand, with brand identity behind we can afford to invest and must invest and work to maximize its market opportunities. We recognized together that our brands are the biggest yellow page advertised in the country and as we get to 2003, every brand is moving away from a single dependency on one channel to an integrated marketing approach. A year from now, we will be using a full range of marketing techniques to reach our prospects and customers in each one of our businesses. We will reduce our reliance on telemarketing, yellow pages, and the single way of going to market that most of our brands have relied on historically.

I will take a few minutes before turning it back over Steve to give you an updated outlook. Because of the persistent challenges in our HVAC and plumbing business, we are updating our guidance for the 2002 full year range to be in a 55-57 cents range. However, we are confident that our fourth quarter will show first, our first year-on-year growth of our last seven quarters. There is evidence that our new strategies are taking holds and we believe this is a platform to ramp and go forward. As far as 2003, we'll give you an updated guidance no latter than our next conference call. But let me give you some indications. I believe that we are on track to generate solid mid-to-high single digit growth rates in 2003 driven primarily by new sales, increased retention rate, and a resumption of tuck and acquisition. Let me tell you, most of it by new sales and retention rates with tuck lagging behind. Our continued focus on productivity and quality initiative should produce improved margins and even a stronger balance sheet and that as we started to grow, we believe that earnings will grow quicker than sales probably in a range of 50% quicker. With that I will turn it back our to Steve, for closing comments and then your questions.

Great, I would just like to read our, our forward-looking statement before we take your questions. I would like to remind you that our comments included statements, which are forward-looking in nature. Our actual results may differ materially from those stated. Additional information concerning factors that cause actual results to differ materially from those in our forward looking statements as contained in our company's press release, 10-K reports, and other SEC filings. In addition, I would like to invite you to read the forward-looking statement in our press release for a broader discussion of the risk. At this time, [Tim] I think, we are ready to turn it around and invite questions.

Thank you sir. Ladies and gentlemen, if you would like to register for a question, you'll need to press "1" followed by the "4" on your telephone. You will hear three tones to acknowledge you request. If your question has been answered and you would like to withdraw your registration you may do so by pressing number "1" followed by the "3". If you are using you're a speakerphone, please lift your handset before entering your request. One moment please for the first question. The first question is from the line of Chris Gutek with Morgan Stanley. Please go ahead.

Thanks. Good Morning John, Steve and rest of the group there. Couple of question if I could and that is first starting with the ARS, HVAC, and plumbing business. Its sounds as if the performance there continues to be a bit challenging and since there was quite a diverse range of performance by office location, its not truly a cyclical issue, but some secular issues as well. I'm just curious what are the one or two single biggest challenges you are facing there? Is it that you still need to upgrade some of the regional management teams or is there something more fundamental than that and also could you give some sense of the timing over which you expect to make these improvements happen?

Chris I'll try and answer that. This is John, as completely as I can. First of all whenever business is running its always a combination of issues, but yes we have and we will continue to make significant changes in our general management and some of the regional manager within the business, number one. Number two we have simplified the structure. So Mark Burrell, the President of Business Unit has much better visibility right down to the general manager. My assessment also was last year as the business stared to get in trouble, we did two things. We, and it was about this time of the year, you know, we were able to make a change in the business leadership in February and one of the issues that let us to do that is the way we actually support the business late last year was to cut out our sales executives and to cut back on the number of technicians. Any business such as in the service business, you've got to find ways to support your sales people and your technicians because they are the heart and blood of the organization. And then pulling back our sales and technicians, you know, our ability then to generate in service development where they came in was greatly diminished during the second and third quarter of this year. So number one, we have kind of refocused and re-launched our sales effort, I think Brad Cummings from a marketing perspective spending a lot of time on that. Number two, the way we fight for market share today is to buy the biggest and the best placed yellow page advertisements and that will be part of the model for a significant period of time. But I would look for a fundamental shift to occur in this business as Brad and his team finally to go to market to compliment not totally replace yellow page advertising. So right now we're spending lot of time book-by-book across the country understanding what the yellow page effectiveness is and in the last half of '02 to early '03 we increased our investment in yellow page advertising in excess of 15%. My take is, we chased bad dollar after bad dollar there instead of redeploying dollars. So as you go forward, what I would say Chris is look for us to not increase our margin investment, but to redirect it in more effective ways, not to outlook. What I said to Mark Burrell and his team, Joe, Fenny and all the other teams is lets focus in the next two quarters for stabilization, getting to make sure you've got the right work mix in the branches. Some of our branches we'll pull back a little bit on new home construction as a dependency. We've to pull regions that's working well. But once again we want to move more towards the service business and in the short term the best service business is plumbing. It is less economic dependent. You do not have the up sales in plumbing, you do have an HVAC. The HVAC business, clearly what is going on there Chris is people are now making decisions across the entire sector. You can see it in all our comps to repair rather than replace and that it's a significantly different price point in margin as far as service. Short term, let stabilize the business in the fourth quarter this year, first quarter next year, and then be ready for growth from there as we get into the middle of 2003.

Great. Thanks for the answer. I appreciate that. And if I can ask one quick second question, unrelated. Looking to company in aggregate, John I think on the second quarter call you mentioned that you thought you might have more pricing power going into back half of this year and end of '03 than previously expected. I'm curious with the economy continuing to be fairly weak and with the poor customer confidence out there.

All right.

Consumer sentiments. What your thinking is currently for pricing?

Yes. Chris a real good question. Two things, the consumer, you know, research we've done does indicate we have pricing leverage. In this economic environment what we determine to do is not be overly aggressive in price but do a lot of testing as we go into next year. So, as we go forward we're seeing, you know, some price increase for '03, the average in the 1-2%, but more importantly what we are going to be doing is really focusing on testing of the consumer research we saw. So we're incredibly fact based about the pricing leverage. So, you know, historically some of our businesses that put a price increase out there and let the consumer come back and say, "I don't like it", and we might negotiate that away. You know we are not going to change to a non-negotiable price increase across all of our business, but we will take some branches in each one of our businesses and try some different schemes. One of the things I have found about this business is both from a marketing and a pricing perspective, you get one whack at it at a year. The sales season lasts for weeks, you have to learn from that. You've to always be testing so when you come back next year, you've refined your data and then can make more aggressive stands and build out a complete matrix whether its on pricing or consumer acceptance.

That's great. Thanks John.

The next question is from the line of Jim Barrett from C. L. King and Associates. Please go ahead.

Good morning everyone.

Good morning.

John, can you talk once again about ARS, about the branches that are under performing. How do their customer satisfaction surveys compare to the branches that are performing well?

You know I don't have all of that in front of me. But let me say that the data of ARS customer satisfaction is both high and relatively consistent across the brand and that's why I'd say it's not about, you know, it's more of a marketing issue in my opinion, than a sales effort. You have two ways that you would sell, you either try and grow by great placements in the yellow pages, which is all how we do it today, but there is similar other ways to turn the marketing model around from "Oh my gosh, I have got to plumb my home, let me open the yellow pages and see what pops out at me", to having embedded in the consumer's mind that when they have an issue in the home that the place they want to call I would say channel number one. The second channel is we have a significant number of sales people that are embedded in the businesses and we have recently taken a gentleman by the name Jack [Keser] and said across the company we want you to focus on the sales, training, sales discipline, sales execution in each one of the branches. So my sense is this is more of a up-scale sales, someone coming in and the technician saying, "I was just in Mr. Works house and although I'd enough time or an opportunity, it seemed to me that they could use someone that they're talking about doing some plumbing replacement or a faucet replacement or ball replacements. That we have turned over to a sales executive in the branch when there is no one in a position to go out and close it. Quite honestly my senses is that we cut back some of that manning late last year into this year in order to "the short-term make the number" under prior leadership and let those kind of momentum not prepare to take advantage or continue to go out there and push forward services. So, I think that's the issue around revenue generation, you know, we underwent in yellow page dependency. It's not something to do, you know, figure out in the September and have it fixed in October. You think about you have placed an ad and its there for 12 months and will probably look in three months in front of that. So you have got a 15-month cycle market-by-market that you are going to work on as far as which our integrated marketing approach is going to be and that's what Brad commented spending his time on.

I see and then in the case of TruGreen, the 2% increase in sales there. Can you discuss what if any leverage, a profit leverage,you had as a result of that?

Well once again to get back into, we're seeing margins improve in that business year-to-date. I think it's a combination of once again, you know, TruGreen was where ARS was probably 15 months ago, and I think you will see what we have done. In the short term we said lets get customer count going in TruGreen and stabilize LandCare. Now we're putting the pay roll ground to LandCare and said Bill [Frank] get that puppy growing and we think it can grow nicely and grow profitably. But in TruGreen, the 2% increase, you know, does translate to a little bit of our densities, but my take is where we're seeing the margin expansion is coming from the Six Sigma initiative, the purchasing initiative, and [Don Card] and [Dave Slot] literally being on top of every branch and just getting that whole team energized and focused and back to be the leader that it should be and will be feared in the industry.

And then finally can you discuss, how you plan to manage healthcare cost in 2003 and beyond?

It is a tough issue. I talked about our new manager in David [Hobbs] in risk management. There are two aspects, I think, about healthcare. One is what is passed on to employees. Once again all the good work we're putting in the Six Sigma and purchasing, you know, we talked about margin expansion and some of what we are seeing is an environment where healthcare costs are going up. Number one, we continue to communicate that to our employees. Number two, we are offering them more choice that is that it can be more reasonable for them and more reasonable for us, and that is an expansion of HMOs across our network. So, what we want to communicate to our employees is you have a choice here depending on how, you know, custom you want your healthcare, we want to offer you a better efficiency for your dollar invested, but maybe lose a little bit of choice, and once again communicating with every worker that whether they are on the job or off the job, their health and their safety is important and a lot of what they do controls the outcome. So, if they're working safe, if they're eating safe, both their health on and off the job can be increased. And quite honestly, I think we have lot of room for improvement to just be a much better communicator out in the branches around the health and safety issues both related to our business and lifestyles that people choose.

Okay, thank you very much.

The next question from the line of Kevin Monroe with Thomas Weisel Partners, please go ahead.

Good morning.

Good morning

A couple of questions. First on some of the metrics you gave out, can you maybe explain why that the customer retention rates are down on a quarter-over-quarter basis in TruGreen and Terminix?

Yes, Steve it looks like you want to answer that one. I'll let him do it and see if he is right.

At this time, you have a lot of the numbers, right. Two different circumstances there, Kevin. In the TruGreen case, there actually is a seasonal factor and so you really do just seem to look at it year to year, but seasonally we begin to see the business come down in the third quarter as the customer accounts decline, that affects the computation for the retention rates. So, the trending continues to be positive. In fact it's stronger -- but slightly stronger than it was last quarter to the tune of about 30 days at this point. So the trending is still strong there. In the case of Terminix, we actually saw a little bit of a pull back in the trending, relative to the last quarter. And it specifically relates to the Sears acquisition. The way that we look at our customer retention is, if we do a large acquisition like Sears, we actually put all those Sears customers in our base numbers, and to the extent that they cancel we look at them in the cancellation numbers. But as we've expected and as we've talked about all along, the Sears cancellation rates are higher than the cancellation rates in our base. And as the year has progressed, we've seen that those cancellation numbers come through. So to the best of our understanding, if you pull Sears out of it, we don't believe that there is an increase in the cancellation rate in the non-Sears customers. We still think that we're seeing pretty good trends. And you can see here even with that circumstance, when there were no Sears customers in the prior year, we're still seeing an improvement even against that phenomenon. So, there is a very specific reason in the Terminix case and we really think it's attributed to Sears

In light of that what is the growth in the Terminix business, kind of the organic growth, excluding Sears, and what is your customer growth, excluding Sears, on the Terminix business?

Overall the growth in the, if you fully pull out Sears' customers, its, you know, you'd say it was a strong single digit in Terminix. And if you assume that we didn't lose in any Sears' customers, it would be a weaker single digit. So it's a little bit difficult for us to track on a customer-by-customer basis and back all that just because they are fully integrated in the brands. But in our best judgment, internal growth in that business is solid single digits right now.

What you guys have to do to kind of bring customer retention on the Sears business in line with traditional?

It will be -- it is going to be, maybe jump in there a little bit. One of the things that we're -- I won't say prohibited, but not allowed to do is a lot of marketing under the Sears brand. Those and once again, it shows the strength of brands here. A lot of people who bought from Sears [GACs] or got an add on sale, etcetera, etcetera. When we bought the business from Sears, we fully anticipated this lower renewal rate. It was part of our plan, number one. Number two, we knew we had the right to use the Sears Yellow Page name in the Yellow Pages for 5 years. And the agreement specifically said that the companies will mutually explore other ways of marketing under the Sears name. Today quite honestly, we haven't made much progress in coming up with programs that we can market to the Sears customer list under the Terminix and Sears name. We've actually got some meetings in the very, very near future with Sears to see if we can get those reenergized. So there was no firm commitment to allow -- with the only place we are allowed to use the Sears name was in the yellow pages and, I think, that was for a 3 or 5 year period, I don't remember which one it was. But we would like to be able to do some more marketing to the Sears customers. So this transition here has nothing, my judgment, to do with the level of service we're giving them. It's just an affinity for the Sears name that some customers have.

And to John's point, effectively that outcome is down to marketing through the issue. And we certainly believe that we are getting some benefit in marketing in the Sears market without -- with the absence of their getting in there, the issues we are just not getting as much leverage out of the Sears name as we'd like.

Okay. And then just kind of changing the tone a little bit, but talking about marketing, how is the Yahoo agreement going and, you know, where you guys stand in terms of may be some other alternative channels?

I think if you look at the alternative channels, we've got a lot into play; we've got Yahoo. I don't have the Yahoo metrics in front of me, but for those you who aren't familiar with it, you can actually order our services out of Yahoo through our home services area. We've got other arrangements that are ramping nicely in the mortgage channel. And if you look at our individual business units, we see a lot excitement in the disaster recovery business increasing their ability to market through our insurance channels, as well as American Home Shield, looking at various insurance channels. So the whole world of third party channels to ServiceMaster, whether it be through enterprise arrangements, where we're looking at doing adding number of services or whether it be through business specific arrangements, mostly in American Home Shield and ServiceMaster Clean, I think, what we all feel looking in the future that whether it's Yahoo through the internet channel or through a strong channel partner in insurance, credit cards, mortgages or other areas, that it's going to be an important avenue of growth for us in the future.

Okay and two more questions just on your guidance. The 55-57 cents guidance is that before or after the 3 cents impact from the accounting changes at HAS or AHS?

It's just answered so in any case that...

Okay.

That all gets back to our expectations for growth in the fourth quarter. And we just felt that some of the issue that we're facing in ARS, we needed little bit more latitude about uncertainty in the fourth quarter.

Okay and when you talked about high to single digit growth in '03, were you talking about revenue or EPS?

Yes, I think, as I said revenue, Mark profits will grow quicker than revenue. You know, we're building a model out that would like us to see organic revenue without a lot of pricing leverage, without lot of pricing going into mid-single digits. And as I said, you know, our profits are expanding much quicker than that. So that's the model. It's a little off, but this high single digit model we talked about and my assessment is we're losing a little bit leverage on price, you know, my take is, great there is, okay, so I am losing 2% revenue growth on price, but if there's no inflation out there, I am probably come out ahead. So price sometimes makes top line look good, but if my cost are going up, you know, price is kind of, you know, just helping you to defeat marginal origin. So I don't mind giving that back in a non-inflationary environment, because it's put a lot less pressure on our technicians both from wage and caliber hiring. So I hope that gives you a little more insight to what we think about next year and no later then and possibly before we have [this] some firm guidance in 2003 no later than our next conference call and possibly or probably before.

Okay. One more question, sorry for all the questions here but when you talk about next quarter or the fourth quarter '02 being the first earnings growth quarter, what's the fourth quarter '01 EPS number you ?

It is 8 cents per share adjusted for the American Home Shield accounting change.

And is that 8 cents also adjusted for if you have paid down the debt?

Yeah. We are assuming that, we're actually making this apples-to-apples.

So it is like the same 18 cents a share use in Q3.

That's exactly right, so once again we are making our comps, we think fair but tougher for ourselves in a way because that's we want to think about ourselves as being good stewards of total shareholder capital.

Okay. Thank you.

The next question is from Matt Litfin with William Blair. Please go ahead.

You mentioned that you'd be picking up talking activity next year. Can you give us some more detail on which segments you will be focusing on there and what the acquisition pipeline?

Yeah Matt, I'd say ARS has a big red light, don't buy anything till you figure out your businesses. TruGreen, you know, we put great little matrix in place, there a kind of branches divided in quadrants, something are red light, something else in green and it really depends on the profitability, their customer pension and the price point per dollar of revenue their buying. I'd say probably, you know, 50-60% of branches in TruGreen have pretty much, if you can find something out there go tuck it in, you know, couple things different, one they're accountable for the post acquisition capital, and number two, in this environment you find a lot of you know small businesses getting shaky and so I think the deal flow and we were out of this market mass a year and a half as we are fixing the business. You talk to our leaders in the business in the last quarter or two and they would say that the acquisition opportunities are starting to flow and come in. We're being disciplined about it. It easy to go out and get a lot of short term growth and pay a lot of money but as [Don Con] says if you buy you eventually have to run it then we are going to be disciplined in prudent buyers. Terminix we have been very pleased with the acquisition of Allied not only from having them become part of our organization, but they also provide some great leadership that has been dispersed throughout the business. So we got both the good you know franchise back would also give us some good folks as part of our leadership team and [inaudible] were still very pleased with the Sears acquisition. Terminix essentially wasn't open to spend to look at acquisitions that make sense either for tuck-ins or geography expansion. We continue to work hand in glove with some of our owners and Merry Maid's that are still looking to leave the business and that we have and we'll just continue to look at buying back owners and business in our Maid service. So those would be the three big ones and you know where we think we'll have some action over the next quarters.

What can you tell us about recent trends and employee turnover at ServiceMaster?

I don't have it in front of me Matt. But I will just tell you a couple things. One turnover in most of businesses is down. Number one we'll be in a much better position to comment, what I'll say is we lose the curtain behind that next quarter. We have surveyed and allowed every employee in the company to participate in the business unit survey and what we call the Book of the Employee. So what are the issues that we focused on, what are the issues that are meaningful for you. And the biggest issue we find across most our businesses is our need to be great communicators about what company they're a part of, where we're taking the company and why we're taking this very, very important to them. And it looks like Steve wants to add something.

Just and adjunct to that. Now I think one of the issues that we face is, as we were talking about these days, the labor issue a year and two years ago was -- it was almost, it was an issue turnover but it was also and actually a bigger issue replacing the turnover we had. We had to dip much deeper into the labor pool. It was much more difficult to find people to even candidate through the positions and as we look at the labor market today, probably position turnaround has not an access to people that we really think are quality people which down the road should lead to productivity improvement. And that really goes not only to the technician level but you know top to the bottom of the company. So our ability to tap the labor pool is in a significantly different position today than it was even a year ago.

Thanks.

Our next question is from the line of Jim Wilson with [JMP] Securities. Please go ahead.

Good morning. Couple, just couple added questions, otherwise most might have been answered. Besides tuck-in I know at the analysts meeting you were talking about some potential additional lines of business you might look to get into in '03. You're sort of looking to table that may be '04 at this point?

Well we talked about is building out a strategy [line on] phase three which is as we get all our businesses, I'm pleased to say by the way we're got seven out of eight, seven is working pretty well. And we'll get the eight one working. As we get the eight one working I think we'll be in a position to have credibility with our investors to move outside the box. We've in a process of trading a lot more work in this area, nothing I'm going to talk about this point. I can't tell you whether it's '03 or '04. I'd love to, you know my engineers [are to think serially], I'd love to say hey phase 2 is working. Everything's all our businesses are working relatively well to very well. The reality is if there was a great opportunity that came long tomorrow with my balance sheet, we would not -- have really looking at it and sometimes in tough economic environments ther is wonderous opportunity so we think we got the balance sheet and we believe job number 1 is to run the businesses were doing better today, we think it's yet another year or so to work through that but we wouldn't avoid an opportunity that comes along now. If it was there.

And so there is where you might look at it still in a very complementary businesses?

Yeah, I don't, think you are going to see us moving to far up field. I think its complementary businesses in and around the home and businesses for services number one, the only other area might that were developing some competences within a business around such as Fleet management, Real Estate, other things and I am not so sure that one of two those could be [determined] to a business but no, you know I am not going to take this company some place where our skills such aren't meant to be and by the way we have more convinced than never if the opportunity stays in place have a great long-term value creation for ourselves and our shareholders.

Okay and then the second question is related to stock repurchase strategy given the level of free cash flown out?

Yeah, stock repurchase strategy, I think we announced earlier that we would have a modified buy back I think we are thinking in the range of $30-50 million. We have been buying moderately in the market not in the last month because we had a lock up period at the end of the quarter. But we will expect to continue to buy modestly back in the market place and opportunistically, that having been said you know certainly we would expect to retain our flexibility on the applications side. At this point on our balance sheet we do have about a $100 million in available cash and we continue to trend more strongly for the year cash flows on our expectations so we think we got some latitude around there but we are not going to do anything outsized.

Okay, very good. Thanks.

Our next question is from line of Steve Marnison of Australise Capital Management. Please go ahead.

Good morning. I have two questions about ARS. First when you talked about the bottom third of the branches, is it, did I understand it correctly that the bottom one-third was responsible for the $24 million shortfall?

No, the whole business is under performing. But once again we have -- a third of the branches right now that we would say both on a historical prospect than have it performing today. We've got a leadership or what next issue that we can go with a short-term.

And is that bottom one-third losing money?

Yes.

And could you give us some quantification behind some mix issue in the HVAC business between replacement and construction comparing this year to last year?

I don't have, I am not really going to answer the question in detail, maybe we can have you follow up with Bruce but let me kind of peek at it. It's really three areas in HVAC that we think about; one is the new construction. Wherever new one construction, going and install the unit.

Right.

The second is an add-on replacement for an existing home where my air conditioner has been working for 10 years, and you know, it's gone kaput and you need a new unit and the third is just the service of the existing units. So two things have occurred. In the existing home the tradeoff between percent of revenue that is add-on replacements versus service has skewed towards service. So people are saying, give me another 5 pounds of Freon and keep this thing going for year or two versus, you know, that's a couple on the dollar service call versus a $8,000 or $9,000 investment in new system. So that's one thing that's going on that is affecting the work mix and both the margins, the revenue -- margins more than revenue are what we focus on, but we have a much higher margin with the effort put forward on the add-on replacement in this service call. The new construction at the overall service market gets tighter though they are that use their leverage a little bit to, you know, try and be more efficient and then how much they are going to pay per unit of HVAC installed in a home. So you come in a builder's building 100 units and you are going to be bid on, you know, putting in the 100 units in this track homes or track housing. Depending on geography in the country, we are in some markets doing very well in that business and others not returning the type of profitability we should. And those markets where we are not returning, we will examine and understand what the market dynamics are and either make changes in there or choose not to compete in the new housing market, but it is not a correct launch, we don't like construction, it's we've got to have a proven business model unlike the end market dynamics both in the competitive sets and how many homes have been built, and what [across] just want to continue to participate going forward and that's just much more detail location by location geography by geography work that shows any mark for only few of us that are working on it right now.

Yes, but I'd look forward to following up with Bruce to quantify that data? Thank you.

We probably have time for one more question.

All right, the last question is from Chris Gutek with Morgan Stanley, please go ahead with your follow up.

Thanks John. There are a couple of quick follow-up questions here. One on the tuck-in acquisitions for TruGreen ChemLawn going forward. I am curious what your update would be on the competitive landscape and coming from Scott in particular. I am curious if they have slowed their pace of acquisitions in that business following the postponement of their equity deal?

Well, you know, they did buy a significant piece of business from Centex interestingly enough, the two leaders with Centex business shortly after that acquisition going TruGreen. So it's something about how two people of Centex launch their business spoke about discussed prospects, which is ours, number one. Number two, it was one of the business that we recently started, I am going after Chris -- couple of 3 to 4 million that I think they are priced and what they are going to pay just doesn't make economic sense, particularly when you are trying out, you know, -- when they don't have the ability to put on so put into an existing business. I give our guys credit with being disciplined, with being focused, you know, and we believe that there will be plenty of opportunities for us to make the right level of acquisitions at the right price point and take advantage of our local brand and the network we have in place.

Okay and then one final follow-up. How are healthcare cost tracking and what you are expecting for cost increases going into next year?

Well, we are tracking probably in the mid teens at this point and would anticipate that in 14-15% and anticipate a little bit higher than that in next year.

Okay great, thank you.

Great. Thank you for your time today and both Steve, Bruce and I will be available for any calls that -- we will also be on Bloomberg TV this afternoon between 12:45 and 1:00 p.m. Central Time if you are interested in seeing what we have to say there. So, thank you for your time today and we appreciate your attention. Bye, bye.

Ladies and gentlemen, that does conclude your conference call for today. We thank you for your participation and [inaudible] you please disconnect your lines.