Terminix Global Holdings Inc (TMX) 2002 Q4 法說會逐字稿

Ladies and gentlemen, thank you for standing by. Welcome to the ServiceMaster Company fourth quarter earnings conference call. During the presentation, all participants will be in a listen-only mode. Afterwards, we will conduct a question and answer session. At that time, if you have a question please press the 1 followed by the 4 on your telephone. As a reminder, this conference call is being recorded Monday, March 17 of 2003.

I would now like to turn the conference call over to Steven Preston, executive vice president and CFO. Please go ahead, sir.

Great. Thank you very much. Good morning. Thanks for joining us.

We've all been waiting a long time to get to this point, so we thank you for your patience.

I'm here with Jon Ward, our chairman and chief executive officer, as well as Bruce Byats, our VP for investor relations, Dema Conar, our controller, and Eric Zarnaco, our treasurer.

I'd like to kick off the call by giving you an overview of the 2002 results for the enterprise overall, then I'm going to spend some time going through the restatements and then Jon will provide you more flavor on 2002 by giving you a recap of the business by segment and discussing how those trends look early for 2003, and then getting you a discussion of our early outlook for the year.

2002 was a year when we saw a number of factors affect the outcome, some of which were in our control like the initiatives we've been discussing and some we are working to control. We are through the first full year of Phase II of the company's operating strategy, and we believe we've made very big steps forward. We ended our first full year of Six Sigma with it being a slight cost to 2002, but with the entire program to date becoming accretive in the first quarter. The 2002 cost was offset by benefits we received from our strategic sourcing initiative, where we focus on becoming a much more effective acquirer of goods and services.

As we look at 2003, we think both of these initiatives will be significantly accretive, and they will be important sources of earnings to fund initiatives elsewhere in the company and to offset cost pressures we are seeing in the marketplace. At the same time, we're getting smarter about purchasing goods and services. We are seeing prices trend higher in health care, insurance, and, of course, to a lesser extent in fuel.

While we have initiatives in place to manage all these costs, insurance and health care costs alone increased $33 million in 2002. While we don't think the increases in 2003 will be quite to that degree, we do believe they could be substantial. In 2002, we also reported throughout the year that we began to see a number of benefits coming out of the company's marketing and retention initiatives. We have new sales or marketing leadership at the ServiceMaster level and in most of our larger businesses. This group is working to increase the sophistication of how we market our services through much better customer research insights and more effective selling programs.

We did see customer account growth in lawn care, American Home Shield and in pest control. As you can see from our KPI statistics. lawn care and American Home Shield have had improving retention rates as well. The retention in Terminix did take a step back for the full year because of attrition that we have been discussing in this year's pest control business. We also believe that the decline in consumer confidence could be playing a role here.

Now, while marketing is on the top of the list of areas we're investing in which we believe will add long term value, we're also investing in technology, legal and people initiatives. As we've discussed, Terminix is rolling out a field level system designed to improve branch efficiencies and improve our ability to understand and serve the customers. We're also at the front end of driving the enterprise to a common financial platform, which is targeted for completion in 2002. This system will not only give us better and more consistent data to run our businesses better, but IT will be a background in driving process efficiency and in supporting our commitment to strong compliance and controls.

Let me remind you that there are a number of items which have made it difficult to compare reported results in 2001 and 2002. Those items include our adoption of FAS142, which eliminated the need to amortize goodwill, charges we took to restructure the business and a significant debt reduction with the proceeds from 2001 divestitures.

In the past, we provided you with a table to give you a better understanding of how adjusting for these items would have affected the results of the company in an effort to give you more perspective on comparability. Because of restrictions on our ability to provide investors with non-GAAP financial measures, we are unable to provide you with that table anymore. We can provide you with the components, but we just can't add them up for you.

Now let's turn to the financial results. Revenue in 2002 finished up 1% to 3.6 billion. During the year we experienced strong growth in Terminix and American Home Shield, which is offset by lower revenue in our HVAC and plumbing businesses. Operating income for the first year was 339 million, that compared with a loss of 72 million in 2001.

2002 operating income was affected by a number of strong trending issues, including the rise in health care and insurance costs I just mentioned as well as the decline of 31 million in the ARSAMS segment and an increase of 22 million in the American Home Shield segment.

Now in considering 2001 on a comparable basis, I would mention three items. First, it included charges for impaired assets and other items of $394 million. Second, it included goodwill amortization of $61 million, which went away with the adoption of FAS 142 in 2002. And then finally, it included the benefit of a $15 million license fee, which we have discussed with you in the past.

Below the operating income line, the company reported a $51 million reduction in interest expense. The company continued to reduce debt in 2002 as it further applied the proceeds from the divestitures in 2001 as well as from operating cash flows that were very strong this year. Interest income was 5 million lower than last year because of higher security gains in 2001.

We were able to reduce our tax provision in 2002 by about $11 million. That was primarily as a result of consolidation of the Home Service Center. That's 11 million off of what we would have otherwise reported not off of last year. This benefit reduced our tax rate to about 35%. Without that benefit, the tax rate would have been approximately 40%, which is much more representative of the run rate of the company.

Cash flow continues to be strong. Cash from operations for 2002 was 380 million. That's more than double our net income. It's 17 million over the 363 million we reported last year. Last year had about 50 million in prior-year tax refunds so if you adjust for that, it's $67 million increase. Once again, a significant component of that improvement was an $86 million reduction in the use of working capital. That comes from better working capital management throughout the company, especially in the TruGreen, ChemLawn and ARS businesses.

In addition, we had a $67 million deferred tax benefit. As many of you know, over $50 million from this number, about 17 cents a share, is a cash tax benefit we receive from the deductibility of intangible assets, which will continue for another 10 years, but it is not reflected on the income statement.

This year, we've reduced our debt by about 320 million to 835 million. It's our lowest level in almost six years. That represents a reduction in debt outstanding by about a billion dollars over the last two years. Cash and marketable securities on the balance sheet was 302 million. About half of that was discretionary cash.

So once again, very strong cash flow and a strong balance sheet continue to define our business and support our strategy going forward.

Let's turn now to the use of that cash flow. Share repurchases in 2002 equaled 52 million, and during 2003, we would expect to continue to repurchase shares. The amount will be a function of the trends in our business, our share price and the alternative uses we have for our capital. At this point, we do believe we'll be roughly at the same level or possibly even higher in 2003.

We also continue to be committed to paying a strong dividend. We just completed our 33rd year of consecutive dividend growth and on Friday we announced a second quarter dividend of 10.5 cents. Acquisitions were less than 20 million in 2002. We've announced a greater focus on tuck-ins in 2003. We are seeing attractive transactions in the marketplace, and we are focusing entirely on the TruGreen and the Terminix market, actually I should say to a lesser extent on Merry Maids as well. At this point, we would expect acquisitions this year to be in the 40 to 50 million range, but it is obviously too early to get a firm handle on that number.

Now I'd like to comment on the restatements. As a reminder, the preliminary restated financial information is the result of two processes that the company has been conducting. First, Deloitte & Touche has been re-auditing the company's financials from the year-end '99 balance sheet through 2001. And although the process is largely complete, there's always the possibility that until the 10-K is filed, there could be unexpected adjustments. So out of conservatism, we are calling this information preliminary.

In addition, as part of the SEC's previously announced review of all Fortune 500 companies, they did review our most recent 10-K and the first and second quarter 10-Q filings. And once again, although that outcome could change, it looks like we're down to one issue with the SEC which will not affect annual results but it could affect the quarterly information. That issue relates to the seasonal recognition of costs attributing. We would expect to have a conclusion to the issue when we file the 10-K, so we will expect to file all the updated quarterly information at that time. We do apologize for not being able to give you the quarterly comparisons until we file the 10-K.

We can tell you generally that the fourth quarter results were in line with our expectations, otherwise we would not have been able to report the 56 cents a share for the full year, but the quarterly comparisons, we'll need to wait until we make that filing. So once again, the restatement reflects the initial results from both the re-audit and the discussions with the SEC.

So here are the headlines. Overall, the initial results from the re-audit and restatement do not have a material impact on 2002 earnings or on future earnings. They have no impact on the historical or future cash flows of the business. In addition, most of the items you see on the list in the press release, we've already discussed with you and disclosed publicly in one fashion or another.

Before I get into that more detailed discussion, let me just make a couple of other comments by way of background. When our new auditors came in, we talked to a number of people out there. We specifically asked for a very deep audit company. This was the most important factor to us and particularly to me as the chief financial officer. Even though a number of Andersen partners went to Deloitte & Touche, we specifically asked for a new leadership team on the audit. We wanted a fresh perspective. And in addition, in the second quarter, you will recall that we asked Deloitte to undertake a full review of the company's accounting policies to get their perspectives right out of the box. Following that review, we announced a change in the American Home Shield recognition -- deferred acquisition cost recognition policy, and we announced that we would be changing our accounting to begin expensing stock options.

When we opened up our books in the prior years as a result of the re-audit, we began a deep dive into judgments we had made in those prior years, which would not have received the same kind of deep review that we went through in the second quarter, because these items generally didn't have an effect on 2002. This review has been very, very extensive. It highlighted any adjustments over 50,000 -- this is an extremely low threshold. But it added to the thoroughness of the review and it helped us actually get insight into smaller issues that we might not have seen otherwise if we hadn't gone to that degree, and that was very helpful for us.

So the review was extremely thorough in looking at the company's policies, its historical transactions, its accounting mechanics, and I want to note and I think it's important to understand, we are treating all of these changes we are making as having resulted from accounting errors.

Now I'd like to go through those items, and once again you're familiar with many of them. First let me talk about American Home Shield. We discussed with you in the second quarter earnings release that we were changing our policy for recognizing deferred customer acquisition costs for 2002 and future years in American Home Shield. We also discussed the impact of that change with you at that time. We are now restating prior years to put them on a comparable basis. So that's all that's happening in that American Home Shield line.

Next, the trade name license fee. We disclosed when we filed our third quarter 10-Q last year that we would be restating 2001 to increase operating income by 15 million to reflect a three-year licensing agreement we had with Amerck for use of the ServiceMaster name in those businesses that they acquired. We had been recognizing that revenue over three years to match the contract life because there is not a significant duty to perform services over that period and because it occurred concurrent with the sale of the business that generated a gain, it was deemed appropriate to recognize that up front.

And in the other line, I mentioned that we'd opened up prior years to miscellaneous adjustments the net impact of those adjustments just shown on that other line. Now, the reincorporation tax adjustment, for years, we've been discussing the fact that we have major ongoing tax benefits from the reincorporation in that it gave rise to a significant tax deductible step-up in intangibles. The challenging thing has been understanding how to reflect this cash benefit on the accounting books. For 2002 and beyond the accounting answer is easy, the entire benefit flows to the cash flow statement in the deferred tax line just as we discussed.

The challenge comes that when we sell companies that were affected by the step-up, simply put, when we reincorporated in 1997 and got the benefit of the tax step-up, we needed to determine how much of the future benefit to allocate to assets and how much would be reflected in a gain. If you compare what we did back then to the restatement, the restated accounting would say that we put too much on assets and did not reflect enough of it in a gain in 1997. So when we sold some of those assets in 2001, we should have booked a higher tax provision on the gain.

So when you put it all together, the restated numbers show a higher retained earnings number at the year-end of 1999, which reflects the gain we would have taken in 1997, a somewhat higher tax rate for 2000-2001, and a higher tax impact on the sale of businesses in 2001. At the end of 2002, as we stand here today, there's a net positive impact on retained earnings from all these items. I just want to emphasize, none of these adjustments have an impact on cash. They only have to do with how and when we recognize this benefit on our accounting books.

Finally, I'd like to mention an item we disclosed in the press release that's not related to the re-audit -- in the fourth quarter of 2001, we did announce the sale of certain subsidiaries of our European pest control and property services operation. In the fourth quarter of 2002, the buyer of those businesses made a claim for a purchase price adjustment following the true-up of the 2001 financials. In the course of responding to that claim, we did discover that personnel in those operations had made unsupported adjustments to the monthly accounts. In recognition of those facts, we agreed to make a purchase price adjustment consisting of a payment of $8 million and a cancellation of a note which we'd actually had reserved. So the impact of that payment is to reduce earnings from continuing - discontinued operations by about 1-1/2 cents a share in 2002. And as part of our commitment to full disclosure, because of the nature of these items, we did contact the SEC and volunteered to provide them with any information that they would like to see regarding those activities.

Now I would like to turn it over to Jon for his comments and then we will open it up to all of you for questions.

Thank you, Steve, and good morning.

As we enter 2003, the vast majority of our revenue is now or shortly will be returning above the cost of capital. That means our focus and intention is in three areas. One, revenue growth in those businesses that are above the cost of capital, two, maximizing the use of our scale to build competitive advantage, gain share and expand margins, and three, streamlining the underperforming 15% of our business. Getting those businesses focused right going forward to once again return above the cost of capital. It's a straightforward approach that recognizes that we have powerful brands, needed services, and significant market opportunity.

ServiceMaster remains well positioned to produce annual earnings growth over the next several years. This year, we will maintain a strong focus on top-line sales, increased retention, controlling expenses, and generating even stronger cash flow. But the economic uncertainty and world events both contribute to consumer confidence being at a 10-year low. It makes it difficult for us to have full visibility to 2003's full-year results. If the current conditions persist, we would expect to achieve mid single digit earnings growth in 2003.

We believe that the trends coming out of first quarter will provide us with greater visibility to the year-end results. We will talk this further through in our April conference call. Let me just add there that between this being a significant period of our sales season and the world events right now, it's too uncertain to make significant calls, and I will discuss in further detail in this call what we're seeing in each one of our businesses.

Let me tell you what I am seeing across the businesses. As you see in the press release, we've enhanced our segment disclosure by breaking up home maintenance and improvement. The segments are separated into the following areas. A separate segment for American Home Shield, a segment combining ARS and AMS, and we have moved ServiceMaster Clean and Merry Maids into other operations.

Let me now turn to these segments. TruGreen -- TruGreen lawn care. In 2002, our lawn care business increased revenues by 1%. Full program customer accounts finished the year up 2%, compared with a 4% decline in 2001. It's encouraging to see growth in customer counts through higher sales in non-telemarketing channels such as direct mail and television advertising and an increase in customer attention of 160 basis points.

In addition, we continue to see margin leverage resulting from top-line growth and clear benefits of our Six Sigma and strategic sourcing initiatives. As the top line gets going in this business, the incremental profitability will be tremendous because of the leverage we get in our fixed cost structure and route density of the business.

We began 2003 with higher customer counts in TruGreen lawn care. So far this season, our customer counts are tracking towards budget. We have a large direct mail campaign in the next month, so there are still some unknowns, but overall, we are pleased with the results so far. Cancellations are running below budget, which is a further sign of the hard work and better data being used along with the measurements we put in place last year. Year-to-date prices are up slightly, a change of 1 to 2% from this time last year, and we're pleased with our tuck-in acquisition program so far. There are good opportunities for us and we're taking a more disciplined and focused approach than we have historically.

Let me move to LandCare now for a few minutes. In 2002, our commercial landscaping business, TruGreen LandCare, revenues were down about 1% with flat branch margins but higher overheads due to sales retentions and efficiency initiatives. We entered 2002 at the end of a very difficult two-year period. If you remember, we restructured this business, focusing the unit on recurring revenue and moving out of construction. We now believe we are in position to achieve strong top-line and bottom-line growth in LandCare. We believe the TruGreen team has accomplished this task and we're excited about the prospects going forward. Although workman's comp cost negatively hit this business in 2002, we've taken steps to increase our safety programs in LandCare and throughout our organization.

In the second half, we began to see clear improvements from our sourcing materials and the use of the new ERP system in this business. In 2003, prospects for LandCare have really improved. LandCare has seen a significant increase in new sales. Year-to-date comparisons with 2002 updated as recently as this morning are up 23% from prior year. This is largely due to new sales leadership in this business. Additionally, retention rates are improving and forecasted to be up at least 2% from prior year, and I'm confident we may do even better than this.

We believe the sales momentum, increasing pricing discipline and continued focus from the leadership team will lead this business to be a strong contributor in ServiceMaster over the next 18 months, and confident it will become a business above the cost of capital.

The first quarter results reflect a positive effect on snow, that means more snow removal for LandCare. It was somewhere offset, however, by lower enhancement sales in this same business, and it has caused a delay in some services in lawn care, although we are highly confident we'll make it up in the second and third quarter.

On balance, it's good news. We should recover the lawn care revenue. If we do, then the snowfall revenue becomes a bonus. The downside risk is if the cold weather persists so long that it hurts the spring sales season, then some revenue can be lost. We are not anticipating that at this time.

Let me move my comments now to Terminix. Revenue in Terminix surpassed $900 million last year, up 9% for the year reflecting good internal growth and some strong comparisons from the addition of Sears' business in 2001. We had particularly strong sales in termites, both renewals and new sales. Operating income in 2002 increased 3%, but overall margins declined slightly. As we said before, Terminix experienced a significant fall-off in the Sears pest control business over the first year, yet this acquisition is still a solid addition to our business. As the profitable pest contracts have rolled off, they've been difficult to replace at the same rate, but we are working on it.

2003 does have some challenges, particularly in pests for Terminix. Year-to-date leads in pest control are down double-digit from the year before. The good news is that our leads are closing at a much stronger rate. Year-to-date sales are only down 2 to 3% from prior year. Our ability to generate leads and maintain retention rates is being affected somewhat in pest by lower consumer confidence. We've seen short term swings like this before, which can bounce back quickly as they left, but it's still too early to call.

As we go into the main pest and termite season, moisture and climate conditions across the country seem favorable to a good season, although it now appears it's running a couple weeks late. These conditions must continue if we're going to offset the slowdown in lead flow and consumer spending.

So as I said before, we'll have great visibility to this by the time our first quarter conference call in April, which is only four weeks away.

In the fourth quarter, Terminix began to roll out our new mission system, its IT platform integrated system across all of the branches. The roll-out will continue through 2003. The new system will give us a competitive advantage in our sales productivity, customer satisfaction, cost efficiency and importantly, regulatory compliance. However, like any other system, there are near-term expenses associated with deployment, rollout and development.

Later this year, we expect to begin seeing the benefits of the operating leverage of our mission system realized along with the impact of the Sears acquisition being more favorable.

Let me now move to American Home Shield. The new American Home Shield segment reported in 2002 had revenues of 422 million, up 16% compared to '01. This reflects strong growth in all sales channels. Operating income for 2002 was 48 million, up 26% from --excuse me -- up 26 million from the prior year. In addition, because of various initiatives to improve its cost structure and more unprofitable geographic mix, American Home Shield experienced very significant an increase in margins and finished the year with the largest dollar increase of operating profit of all our businesses. These improvements were somewhat -- in some part due to favorable weather trends that adversely affected other businesses such as ARS.

Strong sales in real estate channel in 2002 were supported by record home resales and increased usage, customer retention that increased by 110 basis points.

Going into 2003, our direct to consumer channel continues to accelerate and grow daily. We've also seen a dramatic fall-off in new home listings. It's dropped 15 to 20% during the first two months of this year. Once again, this may be temporary, but in the short term, it does lead our -- slow down the leads for our real estate channel. Despite these challenges, we continue to gain share at our competitors' expense. Year-to-date, we've also seen a reduction in service calls and lower cost per service call offset some of this real estate softness.

Let me also move to our new segment now on ARS and AMS. The revenues of American Residential Services and American Mechanical Services segment were 719 million, a decline of 12% for the full year, reflecting a continued lower call volume for residential air conditioning and plumbing repairs, and our adoption in HVAC, commercial and construction activity along with electrical work. Operating income in the business declined by approximately $31 million from 2001 to 2002. This represented a full 6 cents impact on our earnings statement.

Profits at ARS and AMS declined as they continue to comprehensively rebuild our marketing sales strategies to reflect this decrease in demand. The trend of consumers choosing to repair versus replace their HVAC equipment which has been going on now for about a year and a half has continued to put pressure on this business because simply a replacement is much more profitable than a service offering.

In addition, the construction business, both commercial and residential, has been negatively affected by the slow economy. Going into 2003, AMS, our commercial HVAC and mechanical systems company, has increased their backlog by 25% since the beginning of the year. A more focused sales effort and some disarray among our competitors is leading to this opportunity. This backlog increase is the first such in almost a year.

In ARS, we really feel like we hit bottom during the fourth quarter of 2002. We've narrowed our geographic focus and offerings in HVAC. More locations are being refocused on their core service line, plumbing or HVAC, instead of splitting their attention across multiple service lines. The leaders of ARS are conducting a thorough review of individual branches to determine the long term profit potential and whether underperforming operations should be exited.

Also we're excited about our expanded HVAC installation relationship with Home Depot, moving the relationship from 27 stores early this year to 90 by mid year. We believe that we're focused on the right issues in this business. In February, we saw our first year to year increase in add-on replacement sales in a very long time.

ServiceMaster Clean and Merry Maids, our largest franchise businesses, continue to make solid contribution to the company. ServiceMaster Clean 2002 revenue, which included the Pentagon clean-up, was replaced by strong disaster recovery coming across the businesses. Let me restate that. We had to overcome some Pentagon revenue. The Pentagon revenue was in 2001, and despite having to replace that, we had strong sales in disaster recovery across the business.

Merry Maids, our most discretionary service line, continues to feel the impact of the economy, yet the business model is good, and we continue to acquire branches. The business model has been basically flat to slightly down.

In conclusion, we are moving ahead with our vision for ServiceMaster to be America's service branch for homes and businesses. We are on track, ready to take on a year with strong focus on top-line sales, increased retention, controlling expenses, and generating positive cash flow.

Thanks. Now it's time for your questions.

Before we take your questions, I would like to remind you that the comments have included statements that are forward-looking in nature. Our actual results may differ materially from those stated. Additional information concerning factors that could cause actual results to differ materially from those in our forward-looking statements is contained in the company's press release, 10-K, annual report and other SEC filings.

In addition, I would invite you to read the forward-looking statement in our press release for broader discussion of these risks.

Now I'll turn it over to Amy to get our questions.

Thank you. Ladies and gentlemen, if you would like to register for a question, please press the 1 followed by the 4 on your telephone. You'll hear a three-tone prompt to acknowledge your request. If your question has been answered and would you like to withdraw your registration, please press 1 followed by 3. If you are using a speakerphone, please lift your handset before entering your request.

One moment please for our first question. Our first question comes from the line of Jim Barrett with CL King and Associates. Please go ahead, sir.

Good morning, everyone.

Good morning, Jim.

Jon, could you talk a little bit about ARS and discuss how the economics of the business would change if you were to close or just maintain those branches that are achieving their cost of capital or are likely to do so in a reasonably short period of time?

Let me not maybe answer your question directly but let me tell you what we are doing. As we've gotten into the business this past year under Mark Burrell's leadership, we took extensive review that the strategy before had to have close to all 100 locations aggressively expanding at the same time into heating and cooling along with plumbing. So if you were a Rescue Rooter branch, you might have a great $5 million business, you were being challenged by leadership to get in the air conditioning business. As we started looking into this around the country, we said we've got some great air conditioning locations, we've got some great plumbing locations, and we do have a significant number of combined shops. What we said in the short term is, if your combined shop that's profitable, stay with the strategy. If you're basically a plumbing shop, you might be $5 million plumbing shop with a half a million dollar air conditioning revenue, we said don't bother with the air conditioning revenue.

So in the short term, what we've done is focused product lines and service lines. It does a couple things. It makes our advertising more focused. We will also be moving our operational structure to be aligned by service line so we'll have someone really in charge of our plumbing locations, someone in charge of our combo shops, and someone running our air conditioning and cooling -- heating and cooling locations.

That all said, we will also look at number of locations we are in. I would not expect a significant reduction as we go through this, if any, in the number of locations. We have 100 locations. I think as we talk it through, there's a dozen or so where we're trying to figure out if we've got the right business mix and the right location, but outside of this, I think the business is solid.

What we would say, if you take all the plumbing locations, those that are dedicated to plumbing, we think they're a highly attractive business today. We haven't quite finished the math, but I'm confident when we get done, we will say they either are at the cost of capitol or easily will be above the cost of capital in the short term.

On the air conditioning side, we think we know what we want to have in that business. I'm not going to go any further on this call because I think we have figured out what we believe is the competitive advantage and sweet spot in air conditioning. We're going to work very hard on it, and we think our scale in our marketing organization under Brad Cummings and how we're going to approach the air conditioning market can lead to significant enhancement. Now, we believe the full opportunity in air conditioning may not be seen for 12 to 24 months, but we've got a very focused strategy on air conditioning.

I think what you're also going to see later this year is we're going to start to aggressively grow our plumbing locations because as I said, they are at or moving quickly above the cost of capital. Our combo shops, it is still part of our long-term vision, but the short term, we think separating our business lines apart and letting those guys who have proven model in being a combo shop run ahead with both service lines.

You may have somewhat answered it, but AMS and their new construction economics versus LandCare's new construction economics when LandCare was a new construction, are there any differences or nuances between those two businesses in terms of how attractive that segment is?

Yeah, I think the biggest difference is that Ed Dunn and his team have a very deep-rooted understanding of how to run a construction business, the cost to dates, so I look back on it and say if you have a dedicated team that understands construction, it could be a good business. My judgment, both from our TruGreen side and our LandCare acquisitions, they had a bias and an understanding of the recurring revenue model, and we chose not to invest -- to get those skill sets in our lawn business but are very comfortable with the leadership skill sets we have around the tight management needed to make sure you don't get surprises in construction in AMS.

Thank you very much.

Our next question comes from Matt Liftin with William Blair and Company.

Good morning. I was looking for a little more color on the new guidance. The mid-single digit EPS growth for 2003, do you still expect margin improvement for ServiceMaster overall in 2003, or is that 5% or so growth coming all from revenue? You could also maybe address what is your new view of pricing power?

Matt, maybe I'll take the first half of that. One thing we want to say is this conference call is coming much later in the quarter obviously. We're four weeks away and Steve and I were debating how much better guidance to give you. We want to give you guys firm guidance. We're right in the middle as you know our peak sales season, so we're not trying to be evasive here, but we'd much rather wait four weeks and give you a more thorough review. By then we'll have a real good visibility what this warm season looks like as - does TruGreen continue on the trend.

Having said that, I'll let Steve comment on margins as it relates to 2003 earnings in relation to sales.

Yeah, Matt, I think we do see the opportunity to improve margins. It is very early in the year. There's some strong benefits we're getting from a number of the cost base initiatives, but as we highlighted in the script, there are some trends in the healthcare insurance side and to a lesser extent fuel that we're going to be dealing with in 2003. So frankly I don't think that the positive trend in margins is going to be really significant this year because of sort of balancing factors, but it really is early to tell right now.

Matt, one of the comments that I would get into is we have seen -- new sales has really been on a roller coaster this year. We started the year ahead of budget. February, the consumer shutdown in our two largest businesses and since the first of March, response to our leads and advertising has been very, very strong, so that's why we're just really saying here, let's wait four weeks -- you know, my judgment would be if the events that are likely happening on a world basis, which I think is a very, very high probability they'll happen this week and it's a relatively short duration and the weather continues as it has in the last week, I think we're going to come out of the sales season in pretty good shape.

Between that war worry and very, very unusual weather patterns in February, we saw some things that were very hard for us to read, but I would say the last couple weeks, things have rebounded terrifically.

That's very helpful. Let me just throw one more follow-up in there on the same point. I didn't hear a lot of change from previously in your segment discussion, Jon. You actually seem a bit encouraged by LandCare here. Is there any particular business that you really feel that that roller coaster has really kicked in on and that you feel less confident about that sort of made you decide to reduce the guidance a little bit?

Yeah, I think the one that's gotten the - the discretionary spend in Terminix is the one that seems to be pulling back, Matt. We're coming into a swarm season, and as I think you know, if you have termites in your house it doesn't matter if there's a war going on or the economy is good or bad, you call Terminix. Also, a significant number of our customers, new customers in Terminix aregenerated from what we call creative sales where there isn't an apparent swarm in the house, and it's just our lead generation, sale comes in and our salesperson goes out and sells it. That's the one segment right now that looks a little bit -- to be a little bit soft as we go into our prime selling season.

Great. Thanks very much.

Our next question comes from the line of Chris Gutek with Morgan Stanley. Please go ahead with your question.

Thanks. A couple follow-up questions on the customer retention rate, the TruGreen in particular. In the press release, we see on a year-over-year basis the retention rates did improve, but when we compare the rolling 12 months data at the end of December versus the 12 month rolling data at the end of September we saw a decline. I assume that would have removed seasonality. Is there some seasonal effect there or was there actually a sequential decrease in retention?

There is a seasonal effect, and it's a little hard to describe computationally, but it just has to do with the timing and the progression of customer accounts getting added in throughout the year and the cancellation trending and how those move from quarter to quarter. But there definitely is seasonality to it.

Ok. And then the marketing initiatives, you mentioned in the prepared speech that there were some -- you're basically halfway through an aggressive direct mail marketing campaign. Could you talk specifically about how much you're using telemarketing this year versus last year and how much of the negative impact you're feeling because of increasing state regulation -

We strive to be in full compliance with the do-not-call list. In some states, Chris, we have seen a fall-off of 50% in the number of households that are available to call. These numbers are --you know, plus or minus a couple percent, in 2001, we generated around 50,000 customers through non-telemarketing sales. Last year, that went over 100,000, and our budget this year is to be over 200,000. And we generate about a million new customers a year.

So you can see a significant change, and once again, we're calling for our customer counts to be up more than a couple percent this year despite that environment of having to retool on the fly as we go here. We have moved back -- you know, we held some direct mail as most direct marketers did in this type of business in February. With a significant amount of snow on the ground, we said let's hold our direct mail, so it's kind of shortened the cycle. Our direct mail response is coming in as we anticipated with the revised response curve. So we see nothing that says that's not falling as it should.

Our telemarketing sales continue to be basically -- except for that one four-week period I talked about in February, on track with our budget, so overall, I'm pleased with how this business unit is responding to a very, very changing consumer marketing availability over the last 18 months.

Great. And finally a follow-up on Terminix. When we look at the growth in customer accounts in December versus the same data for September of '02, there's a significant deceleration in the customer accounts both in the pest control and the termite side. Any explanation there?

Yeah -- Steve?

Year over year, the Sears business would have been included both in the fourth quarter of last year and the fourth quarter of this year. And the fourth quarter of last year would have had really a full impact of initially bringing those accounts over to us. Throughout the year, we did see some attrition, so on a year-over-year basis for the fourth quarters, that comparison for a particular piece of business is difficult.

Ok. Great. Thanks.

Chris, just one other comment there. We're doing some more work on it, but as we look back over the last 36 months, we do find particularly in the pest side that new sales follow very, very closely to consumer confidence, so we're doing some aggressive analysis. We've got a good proxy there to start talking to you guys about. I would also say a little bit of that fourth quarter is when we started seeing the consumer confidence start tumbling here, so I think there's a little bit of aspect in new sales in Terminix fourth quarter related to reduced consumer con confidence during that period.

Great. Thanks.

Our next question comes from the line of Kevin Monroe with Thomas Weisel Partners. Please go ahead.

Good morning. Couple questions, and one of them maybe a follow-up to Chris's. First is, when do you expect the 10-K to come out?

10-K would be filed at the end of this month.

Ok. Secondly, on the Terminix Europe sale, could you just go over what the issues were there, and is there any other potential repercussions from this other than just, you know, the 8 million or 9 million that you had to kind of reduce -

We have come to complete and final settlement with NIC Max Nordic Capital so there are no other financial impacts that we can even think about at this time, so that seems to be closed in. Basically, the results that happened here is we were contacted by the buyer. They felt there were some issues in running the business. We launched our own independent investigation to understand the facts. We came to the conclusion, quite honestly, that the books that had been presented were not consistent with what we believed. We felt in good faith effort, our responsibility was to make an adjustment. We concluded that and resolved it. Part of that internal investigation, we looked into responsibility both in oversight and conduct. We have taken some actions particularly with two individuals inside the organization. I've got a basic zero tolerance on making sure that both conduct and accountability is full and appropriate within an organization, and we have taken those steps and are executing them with the company right now.

Ok. On Terminix business, backing out kind of the Sears impact, what's internal growth of the business and how has it been trending the past couple quarters?

The overall growth was about half internal and half Sears for the full year. So that should give you sense of internal growth. Once the full year inclusion of Sears comes into the numbers, you then look at that base as being part of your internal growth. So that did have an impact on the internal growth portion of the fourth quarter.

And on the retention rate, I know you said the decline versus the third quarter was somewhat seasonal, but it seems to be trending down after a peak in the second quarter of 2002. Is that seasonal factors there or is there just -- what's going on there?

As it relates to Terminix, we did not say it was seasonal. We said it was really two things. One, our ability to retain the Sears customers is not what we thought it would be. Quite honestly they didn't allow us quite as much use of their name as we would have anticipated during the sale, so the branding of Sears to Terminix, we lost some. The other thing we said was consumer confidence, not seasonality.

Ok.

So those are the two issues that I'd point you back to.

The seasonality issue, Kevin, was on the TruGreen.

Ok. What was customer retention in American Home Shield?

Customer retention was up a little over a percent to 53-1/2. Now, the American Home Shield business, if you look at people that have actually purchased that service for themselves either through a renewal or through direct sale, the retention rates are much higher. This is really a blend of people who've effectively inherited the warranty upon the purchase of a home, and a blend of those with who actually purchased for themselves.

Ok. Thank you.

Our next question comes from the line of Jon Fox with Fennimore Asset Management. Please go ahead.

Hello, everyone. First of all, thank you for the expanded segment results. I appreciate it. Related to that, maybe Steve, could you talk about American Home Shield, the margin really increased last year. Give us a sense, what is kind of a normal run rate margin in that business going forward?

Yeah, we do think that -- 2002 was exceptionally strong for a number of reasons. Number one, the business did take some very clear actions to improve the cost structure. They've increased to some extent the deductible, we call it the trade call fee, when somebody comes out to the home, so it effectively reduces -- I don't want to call them nuisance calls, but sort of low importance-type calls. We've continued to be very aggressive in managing our rates with the third parties that provide the services and continue to work to provide more volume to the largest partners that we have and those over whom we have the most leverage.

So there are some very strong factors in the managing of that cost structure that have taken place. The other thing we will say, and Jon mentioned it in his script, that the weather did provide a favorable benefit last year, so we did see a decline in the incident rate among the customer base. So that was clearly favorable. So we would expect potentially to see some give back in those margins in 2003, but most, I'd probably say our expectation at this point is probably 75 or 80% of the margin gain that we've seen here is expected to continue into 2003.

Ok. That's helpful. And the working capital is wonderful. What do you think for this year will happen on the working capital side?

Working cap capital this year, we had a great year, and it really came all across the board. A big part of that was, you know, increased deferred revenue at TruGreen and American Home Shield, stronger working cap management throughout the business. ARS, even though we have had some challenges on the operating side did a great job in managing working capital. I don't think we're going to see the same level of improvement next year because it really was just an outstanding year there.

My assumption, and this is probably one of the most difficult things for us to project because there are kind of monthly fluctuations in this, my estimation would be next year you'd probably see, you know, something in the $50 million range there, but that really is --it's very difficult for us to project at this time.

As a positive?

As a positive.

Ok. That would be great.

The thing I would point, to if you look at our balance sheet, you pull out our excess cash, this company is in a negative working capital position. So if we can continue to even maintain the working capital structure we have in place right now, it continues to generate positive working capital. Just by maintaining what it is today wouldn't generate $50 million. It would have to come from continuing efforts in the business and continued growth in the businesses that generate deferred revenue, particularly like American Home Shield.

Ok. And is there any off balance sheet debt out on the securitization or anything?

There's no off balance sheet debt on the securitization.

There's nothing outstanding?

We haven't had anything outstanding since late 2001.

Thank you.

Our next question comes from the line of Alex Paris with Barrington Research. Please go ahead.

Hi, guys.

Morning, Alex.

Couple questions and just a clarification, I guess. You mentioned, I think, Steve, about plans to expense stock options on a go-forward basis. What are you going to specifically do for 2003 and beyond at this point?

We think 2003 is going to affect the P & L to the tune of about a half penny. Over the next five years it will be probably be an incremental half cent each year. The way the accounting layers in is you only expense the portion that vests, so it's sort of fully incorporated by the end of five years if you've got a five-year vesting plan.

Just a clarification with regard to share purchases. Would you target somewhere around the same level that you made in 2002, which would suggest 50 to $60 million for the share repurchases in the coming year?

Yes. That's what we've said. We'll also be putting in a little bit more capital out there. We would anticipate on the acquisition side and continue with the dividend. So that would allow us to sustain the balance sheet, but also, you know, return a lot of capital to the shareholders.

What do you have on your repurchase authorization now?

It's well over $200 million. I don't have the exact number in my head.

And did you repurchase any shares I guess since the end of 2002? Have you been in an extended quiet period? That's sort of my question.

We have been in an extended quiet period, and we will continue that quiet period until we release first quarter earnings.

Ok. Did you give an estimate of cap-ex for the coming year? You were 54 million last year.

We didn't give an estimate. We think it will be roughly in line with this year.

Great. Thanks very much.

Our next question comes from the line of Steve Marnison with Alster Weiss Capital Management.

Good morning. You're talking about LandCare, and you talked about new sales growth up 23% so far this year, is that new sales or total growth? I just want to be clear.

That is new sales compared to the period of prior year, so what we do is there's two pieces of the business, both retention rate and new customers coming in, so you're trying to improve our retention rate, which we are doing right now, and we're highly confident we'll move that up at least two percentage points and optimistic that may be more, and under Bill Frame's leadership on the sales side, we've got a much more disciplined, aggressive and consistent both sales strategy and pricing strategy as we go out in the marketplace.

Historically, our sales efforts here have honestly been left to the local general manager, branch manager with the other sales forces as we overhauled our sales organization, we brought in weekly follow-up calls. Every salesperson submits both a prospect list and an account status list each week. It's all done on kind of a web-based system. We've just got much better discipline and the guys are now being measured on how active they are, being out there, how many quotes they're putting out, what's the percent of quotes won, what's the pricing on it, so we've just got for the first time a much more disciplined strategy, along with an emerging national account perspective which is leading to some very, very nice opportunities for some of the multi-property managers around the country.

Thank you.

Ladies and gentlemen, if there are any additional questions, please press the 1 followed by the 4.

Our next question is a follow-up from the line of Jim Barrett with CL King & Associates. Please go ahead.

Yes, Jon, could you tell us what the retention rate first of all is in LandCare currently?

We haven't prior disclosed that so I'd rather not put that out right now. I would say this, that, you know, we've had other B to B business management services that you typically see 90% retention rates, plus we know a couple of our competitors' rate. We have a ways to get to that level, so there is opportunity to grow there and we will take that. We've been debating whether to give you a retention number on that one. We may make a decision on that as early as first quarter.

I see. And then in the lawn care business, the revenues appear to be up 1%, the customer count was down 2. Does that indicate pricing was down a bit or is that a rounding error? What's the story there?

Customer counts were up 2%, pricing was down 1. Here's what happens. You start adding customers during the year, so if you remember, if we go back to the year before, our customer count was down 4%, so we didn't cross over to a positive customer count until sometime late second quarter of last year from the prior year. So the benefit of that, we get a little -- we'll get that natural lift coming into this year. As we said, we started this year up significantly, in our mind significantly, business has been down three or four years in a row, you know, single digit type of accounting going this year and we're anticipating to build from that again. So the hard work we do in 2002 in improving retention rates, increasing your customer accounts, you really almost get no benefit from it in that calendar year, but it does give you a little bit of a favorable breeze as we come into 2003.

I see. Thank you.

Our next question is also a follow-up from the line of Chris Gutek with Morgan Stanley. Please go ahead.

Thanks, Steve. Just wanted to clarify management's thinking regarding the dividends because when I saw the quote in the press release, it basically says while maintaining a sound dividend policy during the year, we may take advantage of additional opportunities to purchase stock. In your prepared remarks, you basically said you're committed to I believe maintaining the dividend but I'm curious what the thought is for expected growth of the dividend going forward.

Right now, we've got a quarterly rate of about 10-1/2 cents, which would lead us to, if we continue at that rate, for 42 cents for the full year, and we really haven't announced an expectation to increase that on a quarterly basis. As I said, it would bring us up for the full year, but at this point, you know, there's no -- there's nothing else to report on the dividend growth. Next year, obviously if we did want to report our 35th year in 2004, we would need to address the quarterly dividend at that time.

And just to push a little bit further, so in other words there's no specific strategy as it relates to the pay out ratio for the dividend?

Chris, I would say that where we want to go with this is that our -- we believe over the next several years that earnings will be increasing quicker than our dividend. You know, you've constantly got to be looking at your capital structure. It's got to be -- dividend policy should always follow strategy. We believe as we're transitioning here, staying in - supporting our dividend policy as investors get better visibility to us as becoming a growth-oriented organization. Certainly the economy isn't helping us become a growth-oriented company, but we're pretty pleased with what we see going on right now. This is a tough economy out there. We see a lot of companies not even contemplating any revenue growth, and where we are right now on a very, very tough economy, we're still committed to profitable growth, getting customers, earning them. It's very tough to earn a customer right now. And we're still out there earning them one day at a time, one at a time, and feel for the next 12 to 24 months, our current dividend policy is appropriate to support us where we are and where the stock market in general is.

Ok. Great. Thank you.

Ladies and gentlemen, if there are any additional questions, please press 1, 4 at this time.

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

Good morning. I was wondering, Jon, maybe if you could discuss as relates to American Home Shield your success rate. I know it's changed with driving the other services to those American Home Shield customers. How you think that might improve or roll out in the next year or so?

Yeah. We're talking about across elements broader than American Home Shield, you know, we will continue to say for the foreseeable future, the best brand equity we have is each individual brand. And the majority of our efforts, we're doing a tremendous amount of work. Those of you that get to our investor day in June, I think you'll see some of it and we'll get it out to others in one on one's, but we've done a tremendous amount of basic consumer research over the last quarter. It's got some very interesting things about the current perception each one of our brands has, the value proposition and whether they're differentiated or not compared to their competitors.

When I talk about becoming a customer facing company, consumer orienting company, first we start with consumer satisfaction, now we've got the basic research, you see those SG&A numbers, that's part of this because we've invested a lot of money to understand what the consumer currently perceives about our brands and what they're really looking for in each one of our verticals. That's going to lead to a significant overhaul of our value propositioning to one of our brands. Our brands start basically with great brand awareness. Ok? Unparalleled brand awareness in each one of the verticals. But quite honestly, a somewhat undifferentiated value proposition. You take our brand strength, couple it with the value proposition and that's why we are highly confident we can move ahead in our ability to attract and retain customers. So that's number one.

As relates back to Home Shield, more and more what we're starting to see, and it's just the beginning of it, is individual micromarkets working on how do branch managers in the Bay area or in Tulsa or Florida get together and say, hey, let's reference, let's get our technicians talking about each one of our brands, so when I think about the cross sell and where it's going to be most effective, it's the skunk works with two branch managers in a given town can now compare customer satisfaction scores, each have a high degree of confidence they're doing well and meeting customers' expectations, and then say, ok, how can we start to work together and collaboratively locally here in order to bring together the brands.

Coupled with that is we'll start to put a tag on out there around TruGreen Terminix, all brands of linking them together as ServiceMaster companies. So in our literature, our trucks, our uniforms or invoices, it will start to say "TruGreen, a ServiceMaster Company." We're not going to be pouring hundreds of millions of dollars to building out an umbrella brand of ServiceMaster in advertising, it will just become part of who we are and once again, as we shape what we call the fully managed experience, we want it to be very consistent from brand to brand to brand so it becomes known as any time you call a ServiceMaster company, here's what you can expect from the home service or the business service.

Ok. Fair enough. Thanks.

Gentlemen, I am showing no further questions at this time. I'll now turn the conference call back to you to continue with your presentation or any closing remarks.

We thank you for your time and attention. We know it's been a long wait for the fourth quarter. We feel pleased about our progress. As I said earlier, it is a very, very tough economy out there and it is guerilla warfare, you're measuring success an inch at a time, a customer at a time. We're dedicated to that, but we're also working on the things that we think will lead to breakthrough improvements both in our ability to grow revenue and work on our margins.

So we thank you, we appreciate it. We'll be putting out a scheduled press release date for our first quarter sometime in late April, but we're only probably four or five weeks away from that at most, and Bruce, Steve and myself will be available for any follow-up calls throughout today and tomorrow. Thank you so much.

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