Terminix Global Holdings Inc (TMX) 2003 Q2 法說會逐字稿

Ladies and gentlemen, thank you for standing by and welcome to the ServiceMaster Company second quarter 2003 earnings conference call. During the presentation, all participants will be in a listen-only mode. Afterwards we'll conduct a question and answer session. At that time, if you have a question, press the one followed by a four on your telephone. This conference is being recorded, Tuesday, August 5th, 2003. I would like to turn the conference over to Bruce Byots. Vice President of Investor Relations. Good morning.

On the call this morning will be Jon Ward, our Chairman even CEO and Steve Preston, the company's CFO. Also with us today will be (inaudible) Connor, our controller. The second quarter earnings report discusses our business outlook and contains forward-looking statements. These particular forward-looking statements and all other statements that may be made on the call excluding historical facts are subject to a number of risks and uncertainties and actual results may differ materially. Please refer to the press release and SEC filings for more information on the risk factors that could cause actual results to differ. Additionally, if during this call we use any non-GAAP financial measures as defined by the SEC in regulation G, you'll find on our website, www.svm.com the required reconciliation to the comparable GAAP financial measures. I would now like to introduce Jon Ward to discuss our second quarter performance and his views on the company's outlook. Jon?

Thanks, Bruce and welcome to the call. Last quarter we talked about how warm weather and worries converged early this year creating tough conditions across the business. Cold and snow delayed and colder than normal weather reduced service calls to the plumbing business during the quarter. As we turn to the second quarter we predicted we have been able to almost totally catch up in TruGreen Chemlawn during the quarter, although there has been additional cost in getting it done. This additional cost is still better off than the alternative of losing production later this year and hoping for good weather in November. American Home Shield got the benefit of reduced service calls due to a mild start to the summer an lower heat in key states. As we -- Unemployment hasn't changed much. Consumer confidence is mixed. The university of Michigan says consumer confidence is up, yet the conference board says it's trending down again. Our business reflects these fluctuations in consumer confidence.

For instance, termite and pest leads shot up in June dramatically, yet they settled back down in July as did the consumer confidence index. The actual spending is more important in confidence and consumer reports that they're likely to start resuming large spending later this year. My estimation is that the Christmas retail season will be a good barometer for our likely success as we enter '04. It's simply a healthy economy and sales season in November, October and December should bode well for us next year we're not counting on it, but we are thinking that is a likely scenario. Business customers are tightening their belts as we sit here today. Many TruGreen LandCare customers continue to reduce their enhancements of seasonal plantings beyond the maintenance contracts. Yet, at the same time, the backlog of sole business in our AMS was up 65% from the beginning of the year. These are large contracts, have a long lead time, but are showing trends of renewed business confidence.

In spite of the difficult conditions, we continue to target 2003 earnings in the range of 56 cents. This figure reflects higher healthcare insurance costs that are partially offset by savings in Six Sigma and strategic sourcing. Although we're not overly optimistic about the speed of the economic recovery, our ability to hit the targets depends on a moderate but not significant upturn in the economy in the second half. We are starting to see the signs. Finally, to ensure we hit the numbers, we are putting cost controls in place to make sure we stay on track for expectations in the year. That means a little bit of a delay in some of the new initiatives we're taking and making sure we're focused on our internal cost control as relates to wage and other cost structures within the company. During these difficult times, however, we are keeping efforts up on revenue generation. Revenue did grow during the quarter.

We're doing a lot of things to improve our value proposition to make sure that we start to differentiate ourselves from our customer. Revenue for the quarter was up 2% over prior year. An example is ARS. We've expanded our offer to Show up on a two-hour window. It will be implemented Nationwide by October 1st, with a guarentee if we don't hit the two-hour service window There's a $50 rebate to the

Our ServiceMaster Clean Business particularly in disaster and recovery continues to grow nicely. Leads are up over 60% in disaster recovery from this time last year.

The number and quality of leads in our TruGreen LandCare commercial business continue to grow. New sales are up strongly double digit from this time last year. Additionally, we have commenced a search for a separate leader in our LandCare business. This will allow for more focus on our LandCare business, which I believe is our strongest short-term growth opportunity but also along Don and Dave more time to focus on the growth opportunities in lawn care. These include new branches and sales office we have discussed with you, enhanced retention and continued revamping of our marketing away from telemarketing. We'll talk about that more in our conference call. Our belief is that more focus and more leadership attention will lead to more aggressive growth and improve results out of both these businesses. The new business leader in LandCare will report to Don Carnes and share the staff resources already existing in TruGreen. Simply put, more operational focus on LandCare with not adding significantly to overhead.

In lawn care, we're beginning to see the midseason sales pitch targeted on upgrades and expanded services with direct marketing being supported by telemarketing. We are very, very good signs of the improving economy and good soil conditions lead us to be optimistic about our expanded services sales opportunities in the third and fourth quarter. And we're proud of the fact that even in this tough economic time while consumers are cutting back we are experiencing organic growth within TruGreen of a little less than 1%. That coupled with acquisitions have us at this point up in 3% in total customer counts in TruGreen lawn care this year. While I'm on the subject of telemarketing, let me take a moment to tell you what's happening and how it is, or more importantly is not likely to affect our business.

First of all, telemarketing is the primary sales channel used by one of our businesses, just TruGreen. It has minimal or no impact on most of our other businesses. The federal trade commission do not call us list have gotten a lot of press over the past few months. There are about 30 million at the phones already on it. Predictions it will grow to $60 million by the time it goes live in October. Since our last call, the FCC, which controls interstate calls has joined the FTC in calling for this list. That makes this list applicable to our TruGreen businesses where most calls originate from local offices.

What does it mean? We have already been successful in dealing with do not call lists over the last several years. In fact, they exist in 37 states and we completely comply with regulations in those states. In fact, the number of customers from nontelemarketing initiatives over the last two years has grown from 5% to about 25% this year. We go down further and we will talk more about this in September when we're together with a lot of you in New York. Let's look at Indiana and Missouri, two states have very strict do not call lists for the last year, year and a half. Indiana and Missouri are much more restrictive than the national list. First and foremost, we comply with the law in these states. And then we've made three key changes. We've reallocated our markings spend, increasing direct mail, cable TV and grassroots marketing such as little league and other things that put us as a community-based marketer.

Two, we've tightened processes in costing branch. We direct dollars in improving performance. Most importantly, there's a psychological shift that is occurring in these branches. Historically, this is a business that believed it could outsell its customers. With a loss of telemarketing, our current customers are becoming more valuable. Renewed efforts on retention, renewed efforts on customer service are basically creating a mindshift in our branch managers away from just being selling machines to make sure they have a much better integrated balanced approach to running a branch, retaining customers and relationships they build day in and day out, another example of how we're becoming much more of a customer organization.

The result, there's been less of a decline before the do not call list existed in both Indiana and Missouri. Better improved operations and increased profitability. In other words, we are attracting and keeping more valuable customers and improving their satisfaction. That better value creation for us and our investors as we go forward. We understand we're into a multiyear process of implementing changes in marketing, operations and service to successfully deal with the do not call list. Once again, remember, nothing says or there is no indication that the basic demand for our services has diminished. We are finding and creating ways to attract and retain these customers each and every day. In fact, I'd say that differentiation brand that we're working on will gain mind share and share of dollar. We're going to use these principles across TruGreen to put us in the best possible position as we approach 2004 and our main sales season next spring.

Before I turn it back over to Steve Preston for a detailed review of the quarter, I'd like to remind you that our major platform for growth is developing deeper understanding of our customers. Change or operations to align with that, being the brand and deliver that service every day. Our research shows us that we have tremendous opportunities to create competitively advantaged brand positions. We are confident that our differentiated brands as they emerge in the months and years ahead will lead to better service, better retention, a better line business and the opportunity for pricing leverage as we differentiate ourselves.

The same time, that's not all we're doing. We believe and have identified great opportunities for geographic growth in both TruGreen and Terminix and that is our second platform for growth as we go into '04 and beyond.

Finally, as I talk about revenue generation, new partnerships in child development will help us fuel growth. Powerful relationships with insurance companies, grassroot organizations, relationships with online providers allow us to go and continue to think that we can bring the family of brands together and create much better revenue momentum going forward. The opportunity to bring sales and service to mass retailers such as our relationship with Home Depot and others. We have the opportunity to think differently about this business. We'll talk more about that with you on September 17th in New York and our ability to transform the service experience for home owners and business owners by providing expert service predictably on time, guaranteed. That's where we're going and after Steve gives you some more details on the quarter we'll both be available for questions. Steve?

Thanks, Jon. When we discussed our results at the last quarter, with we had limited visibility because of the difficulty we experienced with the weather conditions which affected most of our businesses. We knew that much of the foregone revenue in the first quarter at Terminix and ARS would be difficult to make up, but we had a fighting chance of getting it back at TruGreen Chemlawn because the customers bought the service, we just couldn't get out and complete it. As we look back now at the second quarter, I'd like to bring forward some of those headlines before getting into a discussion of the detailed financial results.

First, TruGreen Chemlawn was able to get out and complete the services which were delayed from the first quarter. In fact, we had a number of our highest production days in the history of the company during the second quarter. Our labor costs were somewhat higher to achieve that result but we still enjoyed a high level of profitability under those services which we didn't want to put at risk by delaying production further. In addition, American Home Shield and our franchise businesses continued to produce strong results as they have reliably for such a long time.

These businesses together provided about 2 cents a share in growth to the results in the quarter compared to last year. At Terminix, however, we did continue to see lower leads in the termite business through May. Jon discussed some of the statistics since then. That has a particularly strong impact on our performance because new termite contracts have a high price point and attracted margins. The cold weather leading to lower termite and pest control leads, going into the rest of the year, we are much less reliant on visible swarming activity which generates most of the leads in the first half. Later in the year, our selling focuses much more in prevention and we're counting on a warming summer to support our selling efforts in our pest control business.

Lower earnings from Terminix along with the continuing challenges we saw at LandCare and ARS offset our growth by about 3 cents a share. In addition, enterprise level investments and marketing, compliance and technology added about a penny a share in cost, which we see in the other operations segment. Below the operating income line, lower interest expense provided more than 4 cents a share in benefit. It is important to note that 3 cents a share of that amount was due to the adoption of FAS 145 which requires us to reclassify of impact of our bond repurchase last year from a below the line extraordinary loss back above the line into interest expense. That has the effect of lowering the 2002 results by that 3 cents a share. All that adds up to, higher earnings per share of 2 cents in the quarter.

Last quarter we discussed a number of broader factors which cut across the enterprise. I'd like to give you our most current thinking on how we think they're likely to affect this year once again. We continue to see progress in our Six Sigma and strategic sourcing initiatives which we believe can contribute 4 cents to 5 cents a share in earning in 2003, net of their costs. Increasingly, Six Sigma will parallel not only in helping the cost structure, but also in addressing processes to improve the ways in which we serve our customers and increase our satisfaction level. Longer term we believe this is going to be the most reliable avenue to sustainable growth. Also embedded in the numbers, there's a continuation of the cost trends we discussed last quarter. We continue to believe that healthcare and insurance could cost the company as much as 4 cents to 5 cents a share this year.

Also last quarter we discussed higher investments of 3 cents to 4 cents in marketing, technology and process improvements which we believe are critical in helping us meet the demands of our customers, develop clear strategic advantage in our markets and address the demands of the increasingly intense regulatory environment. Finally, as we discussed with you in the past, last year our tax provision was reduced because of an NOL, which we fully utilized in 2002, a return to a more normalized tax rate would cost about 3 cents a share this year.

Turning now to the consolidated results for the quarter, revenue for the second quarter of $1.053 billion was up 2% as compared to the prior year. Contributing TruGreen Chemlawn and American home were the primary contributors to that growth. (inaudible) in part by the lower revenue at the ARS/AMS segment. Operating income for the quarter of $125 million compared to $135 million last year based on the facts that I just laid out for you. Below the operating income line, net income expense for the quarter decreased $22 million. That included $15 million from the FAS-145 adjustment I just described as well as about $7 million due to lower debt levels and slightly lower interest income.

As we discussed previously, our tax rate returned to a more normalized rate, about 39% in the quarter compared to 36% last year. Which was reduced by the utilization of the NOL. Shares outstanding in the quarter were reduced almost 8 million shares as a result of the company's share repurchase program last year and in the first half of this year. When you put that all together, net income for the quarter was $66 million compared to $63 million in the prior year. While earnings per share in the quarter were 22 cents a share, compared to 20 cents in the prior year. We take into account, the first quarter we look at the six-month period, revenue increased 1% to $1.786 billion with operating income of 149 million compared to $174 million in the prior year.

That decline in operating income is largely based on the fact as we discussed in the TruGreen Chemlawn and Terminix businesses. Net income expense was reduced by 26 million in the first half, reflecting at FAS of FAS-145. The tax rate for the six months, once again was 36.3%, about 3% higher than the prior year, while shares outstanding for the six months were reduced by 7 million shares. Getting to the bottom line, net income of 71 million in the first half compared with 74 million last year, while earnings per share in the first half of 24 cents a share was at the same level as last year.

Turning now to the cash flow statement. We had a solid quarter in cash flows, generating about 95 million in cash from operations. Taking into account the cash usage in the first quarter of 37 million, cash from operations for the first half total 58 million, compared to 143 last year. Most of the differential compared with last year occurred in the first quarter and was based on a number of factors. I'll highlight for you the largest among those.

First simply stated, if you adjust for the adoption of FASAS-145, earnings have been lower. That does contribute obviously to lower cash flows. Secondly, as we described last quarter, lower deferred revenue played an important role. TruGreen prepayments in the period were more than $20 million lower than the prior year. That was based on two factors, first, we made a conscious decision to reduce the prepayment discount. After testing various discounting levels last year. Because our tests showed that the margin benefit from a higher pricing level clearly outweighed the working capital of benefit of accelerating prepayments. As expected, fewer customers did prepay.

In addition, we initiated our prepayment campaign earlier this year than last year. That pulled about $16 million in prepayments into late 2002, which would otherwise have come in the first quarter of 2003. Although that's good news, it makes the comparisons to last year look less attractive. Deferred revenue is also affected by lower levels of absolute growth at Terminix. And while our DSOs continued to improve in all major business units, the major receivables reduction services we had in place at ARS and LandCare last year resulted in about $15 million in additional cash flow in the first half relative to this year.

Once again, both of those units did seek better DSOs this year, it's just that the improvement last year was dramatic. First, the timing of payroll and incentive and insurance contributed $25 million to the decline. A few remarks regarding some of the uses of free cash flow. Share repurchases completed in the first half total about $49 million. The majority occurring in May and June.

We anticipate using available cash to repurchase additional $25 to $50 million in the second half based on current expectations for cash flow and investment needs. I would like to continue to reiterate that our repurchase policy will remain consistent with our standard objective and commitment to remain investment grade.

In July, we announced a declaration of a fourth quarter dividend of 0.105 cents per share. It provides for a total payment in 2003 of 42 cents a share. That's a 2.4 increase over 2002. And when that payment is made in October, we will have completed our 33rd consecutive year of annual growth and dividends. Finally, cash payments for [ Inaudible ] acquisitions in the second half total 17 million. We're focused primarily at the TruGreen Chemlawn business.

On the balance sheet, total debt was $827 million, down slightly from the year-end level of $835 million. Cash and marketable securities at quarter end totaled $197 million, that was approximately $105 million below the level at the beginning of the year. We do expect that cash balance to build significantly through the end of the year as we receive our seasonally high levels of cash flow through the third and fourth quarters.

Under the segments now, revenue in the TruGreen segment increased by 5% while operating income was flat compared to last year. Revenues in the lawn care unit increased by 8% with full program lawn care customer counts up over 2% which is supported by (inaudible) acquisitions. Our selling efforts have hold their own relative to last year. Lower telemarketing sales have been offset by other channels. Our overall sales in marketing costs have risen somewhat. It's a cost effective channel relative to other channels.

Our retention rate is down slightly, which is disappointing following the consistent quarterly increases we have been seeing in TruGreen. We do think, however, there is a good chance to show improving retention again over the next two quarters. Last year, we saw a higher level of drought-related cancellations later in the season than you would expect to see this year because of the high moisture levels we're seeing this year. In addition, we are seeing stronger sales of expanded services and a higher number of average applications per customer as we move into southern markets. These factors along with stronger retention will be important for us in meeting our target for the year.

As mentioned early, TruGreen imcreased production significantly in the quarter to make up for the weather-related operating delays experienced in the first quarter. Although the increase in production led to higher labor costs, we still saw solid growth in operating income in the quarter at TruGreen Chemlawn. In the landscaping unit, a revenue decrease of 1% and lower operating margins offset the earnings growth in the lawn care business. We saw stability in the level of core maintenance revenue and margins, which is a mainstay of the business, however, earnings were pressured from two areas where we saw belt tightening in the part of our customers.

First, a lower level of enhancement sales, which are higher margin services that we try to upsell to our customers and are important to our overall profitability. In addition, we've seen significant price pressure coming from the utility industry which has led to lower operating income and margins in our utility line clearing operations.

Capital in the segment decreased -- or increased 2% rather. Primarily due to (inaudible) acquisitions. Second quarter revenues increased 2%, supported by growth and higher priced bait contracts within the termite renewal base. As well as increased volume in its commercial pest-control accounts. This growth was partially offset by fewer sales of new termite contracts caused, we believe, by the adverse weather conditions discussed earlier.

Overall, customer accounts were down about 2% in the termite business, but up 1% in the pest control business. This is in part due to the pressure we're seeing in retention rates. Operating income for the quarter was $42 million. That compared with $44 million the prior year, reflecting a reduction in higher margin new termite customers in incremental costs associated with Terminix' new system. This decline was offset in part by lower than expected damage claims in its acquired Sears termite customer base. We worked hard to manage the risk down in that customer base. It's beginning to pay off for us.

We also began to see growth in pest control lead flow in June and early July. While it's too early to understand how sustainable that is, it does give us optimism in our ability to produce a stronger second half in Terminex. Capital in that segment was consistent with last year.

Revenue in American Home Shield for the second quarter increased 8% based on strong growth in renewals. We did see a somewhat lower level of sales in the real estate channel based on a decline in the number of listings in our markets. Operating income increased almost 30% in American Home Shield reflecting a margin increase of over 300 basis points. Part of this benefit is due to the same weather patterns which have affected some of our other businesses negatively. Cooler summer weather generally means fewer air conditioning repairs for the Home Shield team, and therefore lower costs. We saw a solid decline in the incident rate, in line with the decline we saw in the first quarter. We also continue to manage our contractor rates tightly and experience some benefit from the favorable trending in prior year claims.

Clearly if the summer heats up, certain other businesses will benefit while AHS will seek pressure on its margins. The overall renewal rate in this business was in line with last year, whereas we had been seeing improvement in the last quarter. We indicated last quarter that renewal rates were coming under some pressure due to key installations in our mortgage channel. Many of our customers in that channel participate in a program where the warranty payment is on a mortgage statement. When the customer refinances, our contract is effectively terminated because we don't have a clear mechanism to migrate them to their new mortage at this time. We are working on ways to bridge those transitions more effectively. We get cancellation risks -- lists, rather, which do allow us to follow up with customer subsequently and we're beginning to work on those.

Capital employed in the American Home Shield business increased 34%, which can be entirely attributed to growth in cash. Combined revenue in American Residential Services and American Mechanical Services segment declined 10%. Although revenues lower in both residential HVAC and plumbing, we are continuing to see the largest impact on the construction side of the business, both residential and commercial. Nonetheless, we have begun to see a strong increase in the backlog as Jon mentioned in the commercial business.

In addition to higher level of sales in the residential add-on replacement business. This change is particularly encouraging because it includes the sale of a piece of new equipment which carries with it a higher price point and higher margins. Growth in this service line is key to overall improvement in the business. It's also consistent with the increase we've seen in shipments that have been reported by a number of equipment manufacturers in the quarter.

It's too early to call either of these factors a trend, however, I will say both of these areas of activity were among the first to turn negative when the economy began slowing down. So we are encouraged to see the upward trend specifically in these areas. Operating income for the quarter in the segment was $4 million compared with $10 million in the prior year, reflecting the decrease in revenues and increase in marketing and sales expense. Capital employed in the segment decreased by 7% as working capital and equipment have been managed down to reflect the size of the business.

Revenue in the other operations segment increased 6%, reflecting growth of Merry Maids and ServiceMaster Clean. Operating margins and the combined franchise operations also improved on the strength of the disaster restoration service line. This segment reported a loss in the second quarter of 12 million that compared with 6 million in the prior year, resulting from the marketing compliance and technology initiatives I mentioned earlier. These costs appear in this segment because many of the initiatives are being coordinated at the enterprise level across the business units. Capital employed in the other operations segment declined $114 million based on an increase in deferred taxes for the enterprise and a reduction of cash.

Before we move on to any questions, I would like to remind you that we are planning our second annual investor conference at the Sofe Hotel in New York City on September 17 And at that time we would expect to layout much the brand positioning work we're doing to differentiate our position following our market research we've conducted this year as well as last year. We will also discuss our perspectives on some of the breakthrough growth opportunities that we will be pursuing had the businesses to accelerate growth profiles going into next year. As last year, a number of operators will be on hand.

We look forward to seeing many of you in New York City next month. And at this time, I would like to turn it back over to Tracey to give you instructions on how to queue up for questions. Thank you.

Thank you, ladies and gentlemen. If you would like to register a question, please press the one followed by the four on your telephone. You will hear a three-tone prompt to acknowledge your request. If you would like to withdraw your registration, press the one followed by the three. If you're using a speaker phone, please lift the handset before answering the request. The first question comes from the line of Matt Litfin with William Blair & Company.

Good morning. So you guys are halfway through the year here, not quite that far and your earnings to date relative to the guidance that you put in the press release here, were there any signs or backlog increases in July that encouraged you to maintain that guidance or would you characterize it more as the seasonality of the business?

Well, I think, you know, Jon mentioned a couple of the signs we began to see taking through. We saw backlog increases in some of our commercial businesses. We did see increase in lead flow on the pest control side. In June on the termite side as well. I think looking at the rest of the year, we got more comfort around some of the production levels in TruGreen. I will also say with what happened in the first and second quarters, at the same time, we've taken additional actions on cost side, which we think will be important for us in achieving the projection.

Okay. One more follow-up if I might, then I'll get back in the queue. For you, Steve, I guess you have fuel hedges on this year. Are those hedges in the money right now? What are your plans for next year regarding fuel?

The hedges, you know, are all across, you know, we hedge in over time. And I don't think they're significantly in the money at this time, but they certainly manage the potential fluctuation into the back half of the year. When we go out and project what's going to happen in the back half of the year and going into early next year, we effectively have about a third of our spend that we have to consider as being potentially at risk for an opportunity in fluctuations in fuel.

But they're not significantly in the money right now. They're pretty close to where current trading levels.

Plans for next year?

Plans for next year, we would expect to continue with the fuel hedging program layering it systematically to cover about two-thirds, three-quarters of our fuel spent.

Great. Thank you.

The next question is from the line of Chris Gutek from Morgan Stanley.

Good morning.

Good morning.

In the press release and your prepared comments you guys did allude to additional cost cutting and potential head count reductions or wage controls. Can you please elaborate on what you're doing there and also can you quantify the magnitude in terms of dollar savings in the back half of the year?

Let me take a step back and put a preamble on that. If I look back on this year, we went into the year anticipating a couple percent of inflation, probably priced about the same and felt that in that environment we decided we did raise wages about 3%, 3.5%. If I look back on first six months of the year, there's been very little price realization, there's been very little inflation out there in general. So my perspective is that we have been for the last couple years. Our wages have been increasing quicker than even inflation or pricing in the marketplace. So where I would anticipate some management going forward both in the second half of this year into early next year is making sure that we're not in front of inflation and in front of what we can get from our customers as far as wage management.

I would say that the most important thing we have is a high caliber work force that's dedicated to doing the job well. We always walk the fine line of being fair to our people and making sure we manage our costs in balance with -- in balance with, you know, what we can realize from our customers. I think there's an area there that quite honestly, I think we've been not overly generous, but more than fair to our employees in wage.

Looking back, I probably would not have been as generous in wage and appreciation this year. I think the other areas, as we look at business units, I'm not going to give you a cost figure right now of actually why, but just we are taking appropriate steps, as all businesses should, to make sure both in hiring and the structure of the organization that we've got the appropriate cost structure in place. You can clearly see by our results, we are starting to get, in this tough environment, we've had a good increase, not terrific, but a solid start to turn the hockey stick here on our ability to generate revenue. We're not dropping to the bottom line the way I'd like us to.

It has has us at all the business unit levels and at the corporate level understanding what we should be doing to ensure that as we generate revenue we're dropping it to the bottom line. One last comment, you heard me talk and present a lot of places where we have invested in this company, Sigma, safety, insurance, purchasing, these are all areas that are starting to pay off. But there was a significant upfront investment. Having said that, we need to continue to go back and look at these and make sure the business units are absorbing them. As we say, we're getting insights. Are the insights bringing the right actions to produce the results we want.

I'm disappointed in our ability to bring the insights into tangible actions, but I know we're working on the right issues and going in the right direction.

One quick follow-up if I could. With the ARS business, you talked about having an idea on the table, potentially closing some of the worst-perform offices. Are you significantly happy with the rate of progress you're making as you expect the economy to improve? Is that concept off the table or not necessarily.

All our businesses continue to look at Lee structuring. We need to have appropriate branches in good locations. I think in our ARS business, the two areas we challenge ourselves is where are the right locations particularly in air conditioning and construction. We're not talking any dramatic issues here, but once again, we like plumbing and drain cleaning we like the air conditioning where we know there could be a significant and consistent flow, i.e., an extended season. My judgment is, if you're depending on the heating side of the business, there just isn't enough revenue at a heating to compliment air conditioning.

I would say there's a likelihood of a few more branches being looked at either for a service line exits or shutdown, but nothing that's significant and the business is openly communicating and working with those locations that are both challenged and being looked at at this time.

That's great. Thanks.

Ladies and gentlemen, as a reminder, to register for a question, please press the one followed by the four on our telephone. The next question is from the line of Jim Barrett with C.L. King. Please go ahead.

Good morning, everyone. Jon, could you talk about pricing at Terminix in termites specifically, what's your outlook, if you're looking out 12, 18 months?

It's interesting, Jim. We have a lot of new things going on there. If you go back over the last couple of years, we're one of the early doctors of Centricon, the baiting system. And over the last two to three years, we've seen an average 2-5% decline in bait systems as more and more people adopt it and quite honestly, the economy got tough, some people started gulping at the ticket so to speak.

Early this year, we started doing a lot of work with a new liquid treatment out there that we think gives us a segmented offering. We're not going back to liquid, but essentially in the regions where we have brought in this liquid treatment, we have had the ability to hold the rate card, if you will, on bait systems and introduce a lower price, initial install response for those customers who make, $1500, $1700 is too high for termite protection. In the markets we've seen two things, appreciation in bait pricing, the customer is allowed to make the choice between bait and liquid and varying amounts of warranties and service that may be applicable in either sale. The value to the company over the lifetime value of the customer is about the same. The lifetime value of the customer, a little bit more than $1,000. How and when that value accrues to us as a company is significantly different.

In September, and as we get into this later this year, if we make a determination to roll out this segmented offering, we have to communicate with you folks. More of the profitability is front-end loaded in the bait customer than the liquid customer. I want to do some things for you folks if we feel there will be a significant shift. In those markets where we've had the segmented offering, we've seen somewhere between 40% to 50% of our customers adopt liquid versus the bait only system. We're now examining our team is making decisions about rolling out. The ability to realize price is somewhat offset by more complexity in the brands. Now you're running two systems versus just one. In general, I think this is a perfect example of how we can bring a segmented offer to the customer, give the customer more of what they want, even if it means a little bit harder operational system for us. We'll be talking about more on this in September and making sure we have good metrics for you folks as we go forward.

Considering your comments about wages going forward, on a related topic, healthcare cost control, is there any new thinking on that front?

Steve is shaking his head yes. I'll let him answer it.

Okay.

Actually, we're seeing a good opportunity to get out there, frankly just in terms of getting to our vendors, to get additional concessions and better network discounts. So I would say even though we have come out and talked about it, as an initial cost pressure to the company, we are beginning to feel the impact of that mitigated going forward. So from, you know, when you look at the whole nut of healthcare and insurance together, I think we're still fighting a little bit more of a battle on the other areas of insurance. But healthcare we feel is beginning to come in line a little bit more relative to the upper pressure we've seen over the last couple of years.

Finally, Steve, could you talk about the spending on marketing technology compliance and other operations? How should we view that on an annualized basis going forward over the next two or three years?

Steve Well, I think, you know, a lot of the uptick we've seen in those expenses, I think, has hit us this year. We put money into marketing research. We bolstered our spending in the units through adding more talent. I think you've heard us talk pretty consistently about additional channels we're going after, the ways we're adjusting telemarketing, those sorts of things. On the marketing side we've seen this year compliance. I think the other ramp, we've seen this year. In the technology side, I also think that a lot of the ramp would have been in this year's number. We've seen increases coming through the implementation of the Terminix system throughout the field. We're investing somebody getting our systems consistent here across the enterprise level.

So there may be some, you know, incremental growth going forward in those areas, but I think the big jump is really probably in this year's numbers.

Thank you very much.

The next question comes from the line of Chris Gutek with Morgan Stanley. Please go ahead with your follow-up.

A couple quick follow-ups. Jon and Steve, I'm curious, your dividend has been growing steadily for a number years. And it's a pretty high payout ration already. but it's still only about half of your free cash flow for the year. Do you have any thoughts in accelerating the growth of dividends.

I'd say right now we sit here at looking at use of free cash flow. I think we're still where we were a year ago. Our challenge is to grow earnings quicker than dividend. We think we've got a good payout in the 4% range. I don't think any significant changes although we'll continue to look at how to re-deploy excess cash. I think we're overall happy with our dividend payout is as percentage of earnings and feel it's very easily supported. As you know, we're a low capital company. On the cash flow basis we can support what we are doing.

The federal Do Not Call Us, I believe you said in the prior conference call that your interpretation was that the federal Do Not Call Us would only affect interstate calls, not the majority of your calls which is intrastate. Your new interpretation is that essentially all the calls will be affected?

No. I was correcting what I had said in April. The initial legislation came out of the FTC, which controls only interstate calls, calls between states. All our calls are local. About thirty days after the FTC adopted it in May or June, the FCC introduced piggyback legislation that said whatever the FTC adopts, we will adopt to cover intrastate calls, the local calls we're involved in. What I said in April was correct and it has been resized, the FCC piggy backing on this as the legislation emerged in May and June.

I understand. Thanks.

The next question comes from the line of Kevin Monroe with Thomas Wiesel partners. Please go ahead with your question.

Good morning. I was wondering if you could provide what internal growth was for this quarter and the past couple quarters for the company as a whole?

Internal growth is slightly positive. Basically, if you look at the whole picture, you would have seen internal growth from TruGreen, from Terminix, from American Home Shield and then the combined franchise operation. And we saw fairly significant decline in the ARS/AMS segment which you can see in the segment analysis.

Right.

So that really offset the nice growth we saw in a lot of the other businesses. To bring us slightly positive. That wouldn't have been significantly different in prior quarters.

Okay. Jon, in your comments you mentioned that LandCare is a big short-term opportunity. Why so and what are some of the factor there's?

I think a couple things. One, it's a $22 billion marketplace and we're about $400 million in it. We have a -- we've got a significant number, probably a third of our regions in my judgment are performing well above the cost of capital. We have significant regions that are disappointing in their results.

We also know we have a privately-held competitor out there that does very well across all their branches and have pretty good returns. We were able to see numbers from them early this year, a, large market, b, we have about 30%, 40% of our businesses performing well. We know there's a national footprint out there, the name of the company is Brickman. Our notion is, I think Dave and Don have done a terrific job in wrestling with both TruGreen Lawn Care and Land Care. But to grow this business, we have to get more dedicated attention to LandCare and let Dave particularly take advantage of the great opportunities in lawn care and geographic penetration. We haven't talked about the last couple conference calls, but we still have the home lawn service as part of lawn care. I sit here saying I have a $22 billion marketplace we have a couple percent of it, what we want to do is bring in a disciplined leader that will bring in a common, repeatable process across all regions in LandCare and get everybody doing it the same way. There's too much entrepreneurship going out there.

The good news, we go to our best regions, create the template of how we're going to conduct business. It will take full-time leadership attention to get the regions aligned, get a common way of doing business, a common way of what TruGreen LandCare stands for. I want to say short term, it means '04 into '05.

Okay. And Steve, you also mentioned in the ARS/AMS segment, I know you mentioned this on the call, but I kind of missed it. What are the areas where you're seeing upward trends that were leading indicators of a downturn that are turning around?

I think two areas, both of them involve large spent. First of all, on the residential site, the add-on replacement business is the business where people are buying a new system or expanding their system. Those include larger ticket purchases. They're attractive margins. That was the first piece of the business on the residential side we saw coming down.

We began to see, if you recall, about two years ago, yeah, two years ago now, people beginning to opt more for repair than replacement. You know, which simply stated they're going to get their AC fixed before they make a large capital investment. We were seeing that shift a little bit in the other direction now.

And the other item which John mentioned is in the commercial business. We have begun to see backlog growth fairly significantly. Which is an early indicator of future activity on the commercial side.

Thank you.

The next question comes from the line of Matt Litfin with William Blair & Company. Please go ahead with your follow-up.

A couple quick follow-ups on cash flow. As did you last quarter, can you share with us your best guess as to the dollar change of working capital, net of acquisition this year.

This year we're still going to be slightly positive. Which is not inconsistent with what we said historically. Part of that is based on anticipated growth in the business. As you know, a number of our customers prepay and an important part of the working capital equation is getting deferred revenue in as we see growth in American Home Shield and Terminix. That particularly -- in those two businesses for the back half of the year and TruGreen way in the fourth quarter.

So we'd still be hopeful for a positive working capital, but it will be important for us to hit some of the sales initiative for us to get there.

Yeah, just one final follow-up here. Can you give us any -- are there any changes in your estimate of the capital expenditures for the company this year?

Neither in CAPEX nor in acquisitions. And those, you know, are probably the two primary fluctuation points which we could typically see. We don't expect much of a fluctuation in either of those. The other primary uses are the dividend insured purchase and we'll be giving guidance on those as well.

Great. Thank you very much.

Thank you, Matt.

The next question comes from the line of Jim Barrett with C.L. King. Please go ahead.

Jon, can you tell us what qualifications you're seeking in the new head of LandCare?

Someone who brings process, discipline and replication that once again was a partial rollup, I think we started with a good business, we bought LandCare. We didn't buy a common operating system or process or methodology in LandCare. So I think someone that brings both leadership capabilities and a proven track record of good replication and good growth.

The other thing is this person is going to be joining a team, not creating their own team in TruGreen. It's very important that they are both a collaborative leader and one that's going to be a good partner with Don Carnes and Dave. They will be sharing staff within the business. So someone that fits well in, but is also strong enough to quite honestly say this is the way I'm going to do business in LandCare, listen to the expertise, but create his or her vision for the business ahead.

So it does not necessarily need to be someone from the commercial landscaping industry?

No, I would not say that. I think again and again, across most of the businesses, we do have a lot of understanding of LandCare inside our company, it's not like we're new to it. But I would say if we find someone with that background, terrific, but most importantly, it's to find someone who's a good leader with the characteristics I talked about.

Okay, fine. Steve, just to clarify your question concerning the run rate and the spending and other operations, you said there would be incremental growth but the big jump has occurred this year. She we be modeling out $10, $12 million in that line item going quarter for quarter?

No, I don't think so. I think we'll get a much better perspective of that as we finish the season going into next year. We're about to go into our annual growth meetings where we take a look at specifically what marketing initiatives we would expect to be rolling out next year. I think we'll get better visibility into that by the time we're around next quarter, but I certainly wouldn't expect anything of that magnitude on a quarterly basis.

You might even be blunt here. There's no way we'll model a business model that has G&A growing quicker than sales going forward from where we are. But coming back to the question Chris talked about earlier, we'll be examining how we can today, in today's environment bring G & A down in terms of today's sales. I don't think there's anything incremental you should be modeling going forward there.

I think that's a really important point, because what we are looking at in many cases on the investment side is designed to offset G & A costs throughout the businesses. Some of these investments begin to take hold, I think we'll begin seeing some efficiencies as well.

I see. Thank you again.

I am showing no further questions. Please continue with your presentation or any closing remarks.

If there are no further questions, we thank you for all joining us today. Bruce, Steve and I will be available this afternoon and tomorrow for any follow-up one-on-one or individual questions. Just a reminder, we look to see each of you in New York on the 17th of September. One other comment I have to make. We've had a few questions about this call being a week or so later. Just so everybody understands what's going on, this is likely to be the period where we'll be with our quarterly calls. What we're doing as we see, you know, the need to move ques from a 45-day reporting period down to 35 days the next couple years, we want to make sure what we present in the Qs is aligned with our press release and board meetings. So between a board meeting, a press release and a Q filing, where right now -- last year we might have had upwards of a couple, three weeks, our challenge over the next 18 months is to bring that down to no more than a few days. That's what's behind it. There is no mystery. We're just, once again, as we move forward with Sarbanes Oxley we'll be doing more things to bring consistency, continuity and standardization to our filings and press releases and how we react to the board.

I hope that gives you insight if there were issues about that as we move back to early August.

Thank you for your time today. Once again, Steve, Bruce and I are available if you need us. Bye-bye.

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