Terminix Global Holdings Inc (TMX) 2004 Q1 法說會逐字稿

Ladies and gentlemen, thank you for standing by. Welcome to the ServiceMaster Company first quarter 2004 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 star then the number one on your telephone. If you would like to withdraw your question, press the pound key on your telephone. As a reminder, this conference is being recorded Wednesday, April the 28th.

I would now like to turn the conference over to Mr. Bruce Boyts, Vice President of Investor Relations. Please go ahead, sir.

Thank you, and good morning everybody. Thank you for joining us. On the call this morning is John Ward, our Chairman and Chief Executive Officer, and Ernie Mrozek, President and Chief Financial Officer. Also joining us is Deb O'Connor, our controller, and Eric Zarnaco, our treasurer.

Before I turn the call over to John, I'd like to remind you that our first 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 this call, excluding historical facts are subject to a number of risks and uncertainties. Actual results may differ materially. Please refer to our press release and S.E.C. filings for more information on the risk factors that could cause actual results to differ. Additionally, to the extent that we use any non-GAAP measures as defined by the S.E.C. and reg G, you will find on our website at www.svm.com the required reconciliation to the most directly comparable GAAP financial measure.

Now I would like to turn the call over to John Ward.

Good morning, and thank you, Bruce.

Our first quarter saw a lot of continued progress on the things we have been talking about for the last two years -- internal improvement in operations, focusing on brand, customer retention, and how we go to market. This was the third quarter of growth in a row; that started in the second half of 2003. Revenue grew in every one of our segments for the first time in a very, very long time. Although our Q1 is a small earnings quarter, it is a very important quarter that sets the platform for growth and performance throughout the rest of the year. In our last conference call we talked about us being cautiously optimistic about the year. I would say now, having seen most of the sales season come through, our operational efficiencies, we are reasonably optimistic about our year. I will talk about that in a few minutes.

First, a few comments on the external environment. Certainly, the external environment is a lot better than it was a year ago. We are still at war, but there is not an invasion moving over our heads as we were working through in our first quarter. It is still immobilize consumers to some degree, but not the strong deterrent to any spending at all that we had a year ago. Consumer confidence is stronger, but not robust. The consumer is cautious, willing to spend money, but challenging to make sure that value is received and that there is a good proposition for them to spend their money. Weather was not a drag on our business this year like it was last year. We did not have fantastic weather this year; last year we had unusual weather that hurt us in our lawn care business and affected some of our go-to-market strategies and customer acquisition, and we believe, customer retention. The housing market continues to be strong. In some markets, perhaps, maybe too strong. For in some markets some people no longer view a warranty as part of the seller's requirement to put a house on the market. Not too low that our employment becomes hard to get, and not too high that the consumer doesn't have spending. So this unemployment rate we see now and the slight trend down we do not believe will cause issues for us in 2004. We are experiencing some unusual factor costs -- fuel, insurance are challenges this year. We budgeted appropriately, yet we are challenged to make sure that we can handle the fuel and insurance issues that we are confronting in daily running our business. This has also spilled into some of our material costs, sheet metal and air conditioning, fertilizer and pesticide costs that do have a natural gas derivative as far as price.

I will turn to a few comments on our big three engines in our company -- TruGreen lawn care, Terminix, and American Home Shield. First, TruGreen lawn care. First quarter revenue up 18%. More importantly than revenue up in this quarter was a customer account growth of approximately 2%. Over the last two years, we had a lot of skeptics out there that did not believe we could grow customer accounts in this business when faced with a total change in our marketing strategy from a centralized telemarketing strategy to one that needed many channels to work in order to sustain and grow customer accounts. Once again, the second year in a row that we have grown customer accounts organically in the last five, and it has been in a very challenging environment. The dropoff in telemarketing has been significant. Ernie will talk about the numbers in more detail in a few minutes, but we have made that up, if not likely to exceed it by greatly enhancing our door-to-door capability that, by the way, had only been tested in two states last year at this time. We took those warnings in Indiana/Missouri, as we said on our conference call last fall, and took it out not nationally, but to areas we knew would be challenged by telemarketing. It is growing; it is growing daily; it is becoming an effective channel. We are getting a lot more customers this year through direct mail than we had last year, a growing channel. Equally important, our retention rate is up significantly, and we are getting some price realization. That, and the continued efforts of our new channel group who are generating leads through the internet and other channels is allowing us to sit here today and say we are once again growing customer accounts in TruGreen organically. It is part of our grand proposition and value position, a position we put together around visible results. And as you know, we've talked about it before, it's not just the words around it, it's the things we do every day to make visible results come alive. We talked about an execution plan to make sure TruGreen could get through a challenging telemarketing environment in New York last fall. We are sitting here today saying we are executing pretty well against that plan.

Terminix. They got off to a slow start in January and February. They have seen a strong rebound since in both post and termite leads and customers in March continuing into April. Lead flow is up significantly over 2003, but more importantly, it is up significantly over 2002, a more normal weather year. We have revamped the entire sales organization. As we saw soft sales last year, we have downsized our sales organization. Albert [Canto] and his team revamped and reorganized the sales leadership and actually put together dedicated sales leadership last -- late last year. This has allowed us to develop Trane and put a sales organization out there better advantaged to take advantage of the leads we are generating today. The brand position around Choice and Best Guarantee is resonating with consumers and allowing us to grow. Ernie will talk more about the mix, the price, and volume and how it is working and working well within termite sales and lead conversion today. Once again, we presented a plan to you in New York last year. It hasn't come out exactly the way we thought it, but we are managing it every day and managing it with very, very good results. We feel the same thing is happening in pest patrol. Good lead flow, good sales conversion, good execution.

American Home Shield. Earnings were up strong in the first quarter. We are managing the service network very well, and we have seen a slight drop in the number of service calls per contract. Our customer growth is up strong single digit. This is a little bit below expectation, basically due to a drop off in real estate sales. Real estate sales have been soft, particularly in a couple of our key markets. But that has been offset by an increased number of consumers we're getting through a direct mail campaign that we have broadened this, once again, customer acquisition channel beyond the real estate channel. Renewals are a little bit below where we would like them to be at this time. We are very pleased with the renewal rates at TruGreen and Terminex, a little disappointed here. Our first year real estate renewals are down somewhat, and consumer cancels -- these are cancels that occur before the contract comes up for renewal -- are an issue we're looking into. We believe we understand the issue around consumer cancels and are aggressively attacking it, particularly through the mortgage refinance channel.

Our franchise businesses performed well during the quarter. Strong revenue growth. They are having a solid year. They are performing as we planned. They have become predictable and accountable businesses. We are seeing much better focus, effort, and success in our Merry Maids in the branches, around sales, sales leads, sales conversions, and that's also true in our franchise business. ServiceMaster Clean is performing well. They have seen a slight softening in our disaster recovery business. Occassionally that comes in cycles and we just happen to be in a soft cycle right now, but that business is performing well.

A few comments on our fix-it businesses. Landcare, (INAUDIBLE) AMS, and then I'll move to the outlook for the year. Landcare had a solid first quarter, veiled by a lack of snow. Last year we had a tremendous amount of high margin snow revenue that did not reoccur this year, but our basic maintenance business and our operation performance every day are accomplished around execution and understanding the business is growing. We have got a solid united leadership team aggressively attacking the market. We are totally focused on a disciplined, consistent operation model from branch to branch across the country. Revenue growth will be priority number two. We will see some revenue growth this year around enhancements, those seasonal plantings we do around properties, and a revamped sales effort to make sure the base contract grows nicely in 2005 and beyond. At AMS, Ernie will elaborate more on these. This has been a challenging, challenging, segment, but I got to tell you, we have teams that up to the challenge doing all the right things. As I say, the cake is in the oven, we are waiting for the results. The key initiatives are being followed. They are now stable businesses. They are not deteriorating around us in ways that we do not know what is going on. We are ramping up to improve. We are launching. We have got a committed team and committed leadership from Ernie and I to make sure we are successful in these businesses in the quarters and years ahead.

A few comments on our outlook. We are re-affirming our outlook for the year today. Mid-single digit revenue growth with earnings growing faster than our revenue. We have put a foundation in place for a solid year. We are focused on execution. We are going to have another strong year around cash flow. Last year, you were asking us the question, Can you, in fact, get these businesses unstuck and grow? We believe the question now is, Can you sustain it? We are working hard on our key initiatives around brand position, channel development, field technology, making sure we are a compliance company, and making sure we are developing the leaders we need to run our business to ensure that the success we have enjoyed in the last three quarters that we believe will sustain in 2004 will be sustained in 2005 and beyond.

With that, I will turn it over to Ernie for some more detailed comments. Ernie?

Thank you, John, and hello again, everyone. As you see, revenue was up 6% and almost all of that was internal. Operating income grew 24% with a 60 basis point improvement in margins. Net interest expense decreased by $5 million in the quarter. That primarily reflected higher investment income realized by gains in our American Home Shields securities portfolio. Also contributing to that decline were savings resulting from the interest rate swap agreements that we entered into late last year. As a result of share repurchases over the last 12 months, shares outstanding are 66 million, or about 2% below first quarter '03 levels. We are encouraged by the fundamental strength of our results. But before we turn to the details, there are a few big picture take-aways that I want to make sure we don't want to miss. First, our fundamental operating results were solid. All of our businesses experienced increases in revenue, and many had meaningful improvement in growth rate trends. Most units also had solid increases in profits. Second, our results benefited from a few favorable comparisons. However, these were virtually offset by unfavorable grow-overs of nearly equal value. On the positive side, TruGreen clearly benefited from more normal weather conditions than existed last year when late snows adversely impacted our production schedules. Our lawn care business was able to return to more typical production schedules, which helped offset the effects of reduced snow removal and land care. In addition, as I mentioned, we realized approximately $3 million more in gains this year on our equity investments at American Home Shield due to substantially improved market conditions. But given the size of their portfolio, this represented a return to more normal levels. And it's important to remember and recognize that investment gains are a very integral part of the business model at American Home Shield. Third, results were adversely impacted by some unfavorable grow-overs. More normal levels of variable compensation throughout the enterprise increased costs by almost $7 million, and branch consolidations at LandCare led to increased charges of approximately $1.5 million. Finally, the strong cost controls and the focus on improved efficiencies that were so evident throughout the enterprise during the second half of last year remain firmly in place, and that helped us to offset disproportionately large increases in certain key costs such as insurance and fuel. Overall, I believe the numbers are solid and as a team are encouraged. But it's early, and we remain very tightly focused.

The solid improvement in results were reflected in cash flows, which improved by almost $50 million. That reflected strong management of both sides of the balance sheet, as well as a $10 million temporary benefit from the timing of certain payments. As with earnings, the improvements were pervasive, with nearly all of our business units experiencing strong increases. Days sales outstanding declined in several key businesses and on an overall basis. Inventories also declined from prior year levels, despite the increased revenues. For the year as a whole, we continue to believe that our operating cash flows will again significantly exceed reported net income and will increase at a rate consistent with earnings growth.

Notable uses of cash included acquisitions and share repurchases. The decrease in acquisitions shown in the first quarter is strictly a timing matter, and we continue to expect tuck-ins to nearly double for the year as a whole due to the resumption activity at Terminix. We repurchased approximately $40 million of shares during the quarter. That was consistent with our previously announced plans, and we did so at an average price of $11.20 per share. For the balance of the year, repurchases will be based on operating trends and business acquisition opportunities, but we currently expect that full-year amounts will approximate last year's level. We remain firmly committed to retaining our investment grade status.

Looking at our balance sheet, most accounts were clearly in line with revenue growth or even favorable to it. Cash and short- and long-term marketable securities totaled approximately $330 million, with about $250 million of that effectively required to support regulatory requirements at American Home Shield and for other purposes.

Turning now to the segments. Improved performance in the TruGreen segment was driven by the lawn care business. TruGreen ChemLawn did an outstanding job in efficiently capitalizing on more normal weather. Last year, late snow delayed the start of production in many parts of the country. As a result, lawn care revenues and profits increased significantly over last year's first quarter. Customer counts increased 2%, and that was slightly favorable to our initial expectations. As we had previously disclosed, we had expected an adverse impact in the first quarter as a result of the change in the timing of our customer acquisition efforts. We're diversifying our sales channels. We're placing less reliance an telemarketing, which has historically been heaviest in the first quarter, and placing more emphasis on direct mail, door to door, and other efforts which are more heavily concentrated in the second quarter. As a result of the enactment of the national do not call registry last fall, our telemarketing sales declined about 11%. However, on a year-to-date basis, this loss has been fully offset by a sharp improvement in customer retention and strong growth in non-telemarketing sales. In our press release, customer retention rates are presented on a rolling 12-month basis, and for lawn care that showed a modest increase of 10 basis point. However when measured discretely for the first quarter, retention increased more dramatically at almost two full percentage points. Improvements were pervasive, with nearly every region and division of the company showing gains. That's the result of steady focus on improving customer service and problem resolution, as well as more strategic pricing policies for existing customers.

Our recently-announced Canadian acquisition closed in early April, and had no impact on first quarter results. We are now the largest lawn care company in Canada, and we are pleased to welcome GreenSpace to our family and are encouraged by the progress we have made in these first few weeks. TruGreen land care experienced flat revenues and an increased operating loss in the quarter, primarily as a result of a reduction in high margin snow removal business. Increased insurance and label-related costs as well as the $1.2 million in branch consolidation charges I mentioned earlier also contributed to the profit erosion. Base maintenance revenues were flat, as increases from new sales were offset by lower customer retention. A very encouraging sign was a sharp increase in enhancement revenues. This is the result of more focused sales efforts throughout the company and an improving economy, and those factors are also expected to benefit future quarters.

Management is dedicated to improving performance, and we anticipate better results in future quarters. Key areas of focus include strengthening our sales team and our maintenance base, continuing to increase enhancement revenues, and improving operating consistency through better process disciplines, especially in labor management and in the pricing and bidding of new work. After a slow start, the annual termite swarm at Terminix began to pick up steam in March, and we achieved a solid increase in termite completion unit volume for the quarter. The shift in mix from bake to liquid that we had previously anticipated and disclosed is generally proceeding in line with our expectations, but at a slightly slower pace. But the liquid alternative is less expensive than the bait alternative, the combined average unit price for the quarter declined. When you take that into account with the volume increase I mentioned previously, that resulted in a marginal net increase in overall revenue dollars for termite completions. One key thing to note is that by offering the customer choice and tightening controls over discounting, we were able to increase the average price realized for each of these two treatment alternatives, thus partially offsetting the potential adverse effects of the mix shift. As we previously disclosed, liquid treatments are generally less profitable than bait treatments during the first year, but more profitable in subsequent years with approximately equal value over the average life of a customer. In the first quarter, the effects of increased volume and better price realization virtually offset the impact of the shift in mix.

In other parts of the business, Terminix benefited from increased pricing of termite renewals and a solid improvement in pest control retention, and these more than offset increased costs associated with the rollout of the mission operating system, which, by the ways is now nearly complete, and higher variable compensation expenses. That resulted in an 8% overall improvement in operating profits.

At American Home Shield, new contract sales increased 9%, with strong growth in our direct to consumer channel that resulted from continued expansion of our marketing efforts with premier mortgage lenders and financial institutions. The company also experienced a solid increase in renewal revenues despite less favorable customer retention rates. Real estate sales increased, though modestly, with challenging conditions in our two largest volume states. Our pilot to expand sales in underpenetrated markets was launched at quarter's end in Chicago and Atlanta. Operating income jumped 24%, much faster than revenues, as a result of continued effective management of cost per claim. As we looked to the future, AHS's core momentum is expected to remain strong. However, income comparisons for the second quarter will be adversely impacted by favorable claim adjustments that were recorded last year as well as certain strategic growth investments, both of which have been previously considered in our full-year guidance for both American Home Shield and the enterprise as a whole.

Revenues in our HVAC and plumbing businesses increased 2% overall, but 6% excluding the effects of discontinued branches with strong increases in residential construction and commercial project revenues offset by declines in HVAC service revenues. Plumbing revenues were virtually flat, which is somewhat encouraging because of the declines that have been experienced in recent periods. Operating losses increased by $2.5 million as a result of higher advertising costs as well as insurance expenses at ARS as well as lower margins at AMS due to secretly depressed industry conditions in commercial real estate. At ARS, where customer satisfaction scores are among the highest in our company, meaningful progress is being made on specific initiatives to improve brand differentiation through such measures as our on-time reliable guarantee, expand Suhr line repair revenues, an increased average ticket prices on replacement HVAC sales. However, these have not yet been enough to offset the effect of continued softness in our core service revenues in both HVAC and plumbing. These initiatives, as well as improved sales training, increased advertising, and more targeted direct mail efforts are aimed at stimulating Q2 revenue growth. At AMS, bidding activity has shown sporadic signs of improvement, although this has not yet resulted in firmer pricing. Maintenance revenues have increased, with improved customer retention.

Finally, other operations includes our franchise businesses and headquarters functions. ServiceMaster Clean and Merry Maids both enjoyed an encouraging start to the year with solid increases in revenues and profits. Clean continued to experience strong growth in disaster restoration services despite an industry-wide reduction in water damage claims due to milder weather. Our unique service capabilities, combined with an unmatched geographic footprint has helped us establish significant relationships with several national insurance carriers. Solid increases were also achieved in franchise sales and at Furniture Medic. At Merry Maids, a better economy and an improved sales process have resulted in steadily increasing internal revenue growth rates in both our franchise and branch operations. At the headquarters level, the overall increase in costs was attributable to higher variable compensation expense as well as increased insurance costs.

So in closing, we feel like we've some made good progress in the past three quarters, and we believe that that provides us with a solid platform for the rest of 2004 and beyond. At this point, we welcome your questions. And now I'll turn it back over to Sandra.

Thank you. Ladies and gentlemen, if you would like to register a question, please press star one on your telephone. If your question has been answered and you would like to withdraw your registration, please press the pound key. If you are using a speakerphone, please lift your handset before entering your request. One moment, please, for the first question. Our first question comes from the line of Matt Liftin of William Blair & Company. Please proceed with your question.

Good morning.

Morning, Matt.

Question on Terminix. It was very good information you gave, there, Ernie, and the termite situation between baiting and liquid. Can you give us the percentage breakouts that you saw in the quarter for those specifically? And also, could you comment on your close rate in termite completions by having the dual offering? Is that up, down? How does it look?

Go ahead, Ernie.

We don't normally provide the breakout in specific detail, Matt, but I will tell you that because of a surge in leads we have experienced, our close rates have temporarily declined. Although as we get our newly-hired sales force up and fully trained, we see that picking up again as we enter April here.

Matt, one other comment. We had a six sigma project on this last year that look at the number of leads. As we did some at last year, we came to the conclusion we were under-reporting leads in the business unit because we were challenging people on conversion rate. Now, as we become a more marketing-oriented company, we have got to know very specifically by every ad we run, every piece of direct mail we do, what the lead response is. So Albert and his team got very granular with the branches saying, You got to report every lead. We're not paying attention to conversion rate as we are to leads as a sign of the health of the business. This has put much more valuable information into Steve Good's and the marketing hands within that business unit as to where our leads are coming in. So we're going to track conversion rate. We will improve it, but we think we're doing a much better job now of accounting for and understanding the original source of every lead that comes into a branch. So I think that's more important. One of the caveats, we're not likely to give a lot of information on mix, on price, on this choice, because we think it is competitive information. There are a lot of people trying to figure out what we're doing; we're trying to figure out what they're doing, so we're going to be a little evasive right there in that area and just say that we have laid out last year some plans that we're working on, but we're not likely to give a lot of detailed information until this thing settles down in a year or to two.

Okay. Thanks. And a final question, if I might, on ARS. Last year ARS posted an operating loss in Q1, and then was profitability for the final three quarters of the year. As it stands today, do you view this year as showing a similar pattern to that?

We expect improvement over the remaining three quarters, and you need to recognize there is a seasonal factor to that business, particularly on the HVAC side. So yes.

Okay. Thank you very much.

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

Thanks. Good morning. John, starting with the big picture question, regarding the macro recovery, it certainly makes sense that your business would have a bit more of a lag in a recovering economy than certainly some other business service type companies. Can you remind us based on historical precedents in the company how much lag you think the company has, and specifically as the year plays out, assuming that the U.S. GDP growth stays 4, 4.5%, maybe even a higher percent growth year over year, how do you expect that to impact the business positively as the year progresses?

Chris, I'm not sure. Maybe I will ask you to explain for thirty seconds why we have a lag. I don't know if I have ever said that or if that is your assumption, so I'm not sure I can answer the question based on a basic premise. So help me. Maybe elaborate on your -- why you come to that conclusion, I can help think that through with you.

I guess the premise would be that consumer confidence -- I mean certainly until the unemployment rate becomes meaningfully lower and we have had several months of strong job data, consumer confidence will stay at relatively low levels and take some time to recover. But as we have several months of strong labor market reports, consumers will become a bit more confident, the labor market is recovering, the economy is recovering, they will be more confident spending money on semi-discretionary services like lawn care and maid service.

A couple of things. One, in our two large businesses, literally 80% of our customers come in a four-month window. So there isn't a lot of lag. It probably helps us on retention rate through the year. As we talked last year, we hit the absolute worst period of time to have a war. The economy worry and weather as we were in our good sales season. Our big customer attraction, I don't think we can say we have got to hit a good window in February, March, April, and May in order to have favorable sales conditions. Clearly any business such as ours would be favorably affected by a positive consumer sentiment in that period of time. After that, I'd say customer retention probably has some impact for the year, but a lot of our retention, particularly in TruGreen occurs in the first application or two. Merry Maids, it appears from what I've seen, is the most sensitive, but it doesn't necessarily lag. It seems to fall right line with consumer confidence. So not much of a lag factor, but as consumer confidence grows, we will see people that reduce their skips. If we are supposed to go to your house every week, in tough times they cut to every other week. As soon as the economy comes back or they get confidence, it comes back right away. Air conditioning sales, we'll know more -- you know, this has been a sector that has been down both commercial and residential for the last two or three years across the country. Once again, you would think there would be pretty favorable consumer confidence on those things right now. Certainly, as Ernie talked to your earlier, there is weather dependency on that. One other area that we would see, once again, not so much of a lag in consumer confidence, but on the business side is the whole area of enhancements in our land care business. As soon as we start seeing the economy pick up late last year, we saw seasonal plantings around the holidays increased nicely. That has continued into the first four or five months of this year. So we see some trends. I don't think necessarily they lag that much as they seem to be occurring as the consumer confidence and basic economy seems to be performing. I will also let you keep in mind that we did say that we felt in planning our year that the GDP would be in this 3 to 4% range. So we're seeing is kind of what we would have anticipated in our business plan, maybe slightly favorable, but not much favorable from what we anticipated, and we have had some negative impacts strictly around some factor costs -- insurance and fuel -- that in my mind offset any positives from the slightly more robust GDP than we would have anticipated.

Okay, great. That is helpful. Thank you.

Thanks, Chris.

Our next question comes from the line of Jim Barrett of C.L. King & Associates. Please proceed with your question.

Good morning, John and Ernie and Bruce.

Good morning.

John, can you talk about the level, the minimum level of performance required for the company to pay bonuses? I assume it would vary by division, but could you give us sort of an overview on that?

Yeah. We basically, Jim, as you saw in our proxy, we had a flat year and it got us goose egg. I'm not proud of goose egg. I am proud that we put a compensation plan in place that says if we're not improving, we're net getting bonus compensation. So basically, Jim, we have an improvement over prior year earnings that has to be achieved for the basic bonus plan to be put in place. And even despite that, we have another component called an LPTA that kicks in at a lower threshold, but last year we made recommendation to the board that despite it being payable, we didn't feel our performance warranted it, and we asked the board not to give us the cash compensation. They agreed with our recommendation and gave us some restricted stock over five years. So basically, I think, Jim, we have to be improving from prior year earnings. We have to hit our budgeted plans, and when we hit our budgeted plans, we get a full payout. But we think that is very well in line with value creation for our shareholders.

And I take it the budgeted plan is in line with your guidance?

I won't ever tie those together for you.

You would not?

I will not ever on our budget versus your consensus. We'll just tell you what we think we're going to do for the year. You guys can put your consensus together. We don't talk much about budget outside our company.

Okay. Can you quantify what the the pricing is in the TruGreen/ChemLawn lawn care business that you realized this year?

Overall, we expect about a 1 to 1.5% improve in the in pricing on an overall basis across the entire customer base for the year.

Okay. And finally, I don't know whether it's Ernie or John, can you talk about the land care business? What are the current retention rates, and what are your near-term aspirations?

Jim, here's the deal -- we're bringing together a common operating system in this business right now. When we get real confident that we have a great retention rate and measurement in it, we're going to start publishing it. We have looked at about five different ways. We just know that A., we can into do a better job in retention. The way we are measuring it now, we are down slightly, but it's also us walking away from business that were poorly-priced last year. We have got a very focused team right now turning this business around. As I said before, the first priority is getting the operational model. They're actually totally changing our whole sales approach, moving it out from local branch management to a dedicated national organization that will report to the regions. They will still be accountable to the branch managers, but separating the sales function from the operational function, and it's very core how we run the business. So I can give you percentages. I would much rather wait. Jim, I think as we come out of this year, we will have something we'll be putting in our KPI's. We'll publish it. We can give you trends now that we think our retention is down slightly, but I want to give you facts that I can back up quarter to quarter. Then they will be in our press release and we'll go forward from there. So I feel I'm being a little evasive because I don't think we're measuring in exactly the right way right now, and I'd rather not quote you figures that will possibly give you some misguidance. To say it's down, down slightly, and that's where we are.

Okay. I understand. Thank you very much.

You bet.

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

Good morning.

Good morning, Kevin.

A couple of questions, first on TruGreen. You had some strong growth in that segment this quarter. Is that sustainable, or did we see pull-forward of some revenue that may have come in the second quarter due to the favorable weather?

Once again, last year was unfavorable weather. This year was kind of normal weather. So we definitely did more -- we did more revenue this year because we were able to do it. Last year, we caught up that revenue. Remember we talked a lot about working hard, spending some more time in the second and third quarter to make sure we get all the applications done. There is always a risk that we will get shut off at the end of the year this year, which we didn't in '03, but as we sit here, you know, our revenue is up 18%, there is a little price in there, but our customer counts were not up nearly that much to support that revenue growth. That's why we come back and talk to customer counts. Once again, we're still projecting this business in that mid-single digit revenue growth for the year. That's where we think we'll be. Clearly, our ability to achieve that and the risk of achieving that has been greatly reduced, and the efficiency of achieving it has been increased by what happened in the first quarter.

Okay. The next question on the margins, again, you had some pretty significant margin expansion this quarter. Is that sustainable as we go through '04? Will we see some similar type expansion, or are there some other issues that will offset that?

The magnitude of the margin improvement -- are you talk about TruGreen chemical or overall?

Overall operating margins.

A lot of that overall margin improvement was attributable to TruGreen ChemLawn. And certainly we do not expect that rate of improvement to be sustainable. However, as we have said repeatedly in the past, we definitely think there are a number of ways to continue to improve efficiencies in our operations through the use of technology and other measures. And we expect to be able to increase margins over the next three to five years in the 20 to 50 basis point a year range. Overall, all of our businesses foresee opportunities to steadily increase margins over the next three to five years.

Okay.

I do think, though, that the first quarter rate of improvement may have been a little disproportionately high because of the comparisons to last year.

Right.

One other comment to remember, though. As we look to the balance of the year, last year, we were playing catch-up in TruGreen and were seeing a lot of overtime labor to catch up. We will have that to our advantage working in our favor as we enter the last nine months of this year.

Okay. One last question. In the ARS/AMS segment, you had the first growth in that business for at least two years or so, but your margins were down a bit. Now, is that growth profitable?

As I mentioned in my comments, right now, a big factor on the commercial side of the business, AMS, is the conditions in the commercial real estate industry. We are encouraged because we're seeing bidding activity start to pick up. But right now, contractors are still bidding jobs to get the job to keep their people paid. Once that's happened, future bidding activity will, we believe, return to more normal and profitable pricing levels. So it's profitable work, but less profitable than it has historically been.

Okay. Thank you.

Thanks, Kevin.

Ladies and gentlemen, as a reminder, to register for a question, press star one. Our next question comes from the line of Chris Gutek of Morgan Stanley. Please proceed with your question.

Thanks. I have two follow-up questions to dig a bit deeper. First, starting with the Terminix business. Would it be possible for you guys to give us some sense for the net cost and net benefits for the initial systems system development, and also if you could remind us of what operational advantages you expect to achieve from that system?

We don't have it here today, and let me think whether we want to do that. Obviously that's a question my board of directors asks me every time we come in with a systems update. The good news in this is it up and running. It is working very well. It gives us a lot more visibility into our customer throughout our network. It was over cost and a year and a half behind getting in. We will still get a positive return on it. Let me take that off line, Chris, and we'll just figure out how to answer that question, and if we do we'll have to do it in an empty way. The second part is what do we see in operational efficiencies with it? Across all of our business, we are putting in a common platform as we regenerate our systems that allow us much more visibility into our customers. Let me give you an example. If Chris Gutek called at 9:00 at night to 1-800-Terminix because you had a -- you are a current customer and you had a reoccurrence of an ant problem, your call would have been answered by our call center probably in Memphis, Tennessee. Up until this, they would have not been able to call Chris Gutek up, understood your account, where you lived, what your issue was. They would have just taken your number down and said someone will call you back tomorrow. We're now in a 24 by 7 operation. We can call up the issue. We understand your account. We understand what issues you might have, so we're much more in a pro-customer response arena in order to afford us better customer service. The next step is now connecting that information to a hand-held environment to our technicians in the field. So a year and a half from now when someone is riding up to your home, they can download from a computer the last time someone was there, what was the issue, what your dog's name is, whether they go in the back or front door, or any special requirements you may have. So we're adding a lot more realtime information to our system. The backbone of that is to give us an intelligent management system which Mission has created for Terminex. So I think we're just starting to realize the potential of that system. It's certainly a system we believe that will last us five to seven years at least, and is the first what I'd stall state-of-the-art system we have put out in the field in years. We have got a pilot underway in ARS right now. We would anticipate doing some work with TruGreen over the next 12 to 18 months to be accomplishing the same type of capabilities within our business.

Great. And then a follow up on ARS as well. John, just from a big picture perspective, have you become more positive or I guess less positive since your last conference call regarding the long-term outlook for the possibility --

I have been very consistent. This is a team working hard to turn around a business, to what I say fly where no other company has, IE, putting a national brand in a segment that many have tried and none have succeeded, quite honestly. We believe we're on the right path. The great thing about this management team is sometimes they get pretty tense with each other because they are trying to figure out how to get the job done. They are working hard at it. I see no reason to believe we are not going to succeed. We are going to continue to work with them. But we are also very pragmatic. If at some point they don't make progress, but I think that decision point is a long way off in the future.

Okay. Great. Thank you.

Mr. Byots, there are no further questions at this time. I will turn the call back to you. Please continue with your presentation or closing remarks.

Okay. Well thank you, everyone, for joining us today. Feel free to follow up with me with any more questions. Thank you.

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