Terminix Global Holdings Inc (TMX) 2004 Q3 法說會逐字稿

Ladies and gentlemen, thank you for standing by. Welcome to The ServiceMaster Company third 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. (Operator Instructions). As a reminder, this conference is being recorded Thursday, November 4, 2004. I would now like to turn the call over to Mr. Bruce Byots, Vice President of Investor Relations for ServiceMaster. Please go ahead, sir.

Good morning and thank you for joining us. On the call this morning is Jon Ward, our Chairman and CEO and Ernie Mrozek, the Company's President and Chief Financial Officer. Also joining us is Deb O'Connor, our Controller and Eric Zarnico (ph), our Treasurer.

Before I turn the call over to Jon, I'd like to remind you that our third quarter earnings report discusses our business outlook and contains forward-looking statements. These particular forward-looking statements and all other statements that we 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 our press release and SEC filings for more information on the risk factors that could cause additional results to differ. Additionally in our press release and during the call, we will be using certain non-GAAP measures as defined by the SEC and Regulation G. Please refer to our website, svm.com, and our press release for the required reconciliation to the most directly comparable GAAP financial measures. Now I would like to turn the call over to Jon Ward.

Thank you, Bruce, and good morning and thank you for being on our call. Looking at the first nine months of the year, every one of our business segments delivered top line growth and we're on track for our growth targets for the year. Our focus on improving sales, pricing and retention, combined with disciplined cost controls helped us overcome challenging conditions this quarter. We had some very extreme regional weather conditions that affected both our customers and our employees. There were very uneven spending patterns, particularly in the soft summer and there was unrelenting pressure on fuel, chemicals and churns (ph) that we and other companies are challenged by in the current environment. Although our revenue growth was somewhat below our expectations in this quarter, we remain confident about our future growth in the fourth quarter and into '05. Ernie will walk you through this quarter's results, which will give you better insight into our current revenue trends.

Earlier this year, our first quarter was aided by favorable conditions. This quarter was hurt by conditions, but overall, even with these challenges, in many ways, the third quarter was a typical period for our company. Our actions continue to be more important than the lift or drag that any external conditions put in front of us. We control our destiny and our trajectory. We continue to focus on reaching and keeping more customers by delivering a consistently better service experience. We're focused on it and it's working, differentiating our service and the service around our service and also expanding our sales efforts by strengthening our sales force, expanding our methods of attracting customers, looking at new channels and getting into new geographies and continue to (indiscernible) our brand positions and our offering. We're strengthening our field management and bringing better process and discipline to all we do.

Let me talk a little bit about the business units -- TruGreen ChemLawn. This has been a watershed year for the business. We're making the most dramatic change in our customer acquisition model in probably two decades. There are now 65 million numbers on our do not call national registry. Despite this, we continue to find ways to attract customers. We knew it was coming and we started the year with a plan to expand and change our customer acquisition model and we're staying with that plan and greatly expanding it. The results speak for themselves. I'm really proud of Dave Slott, Don Carnes and the entire lawn care team. They've responded to the challenge of changing market conditions and driven results this year. We have moved from getting 93 percent of our new sales from telemarketing down to 60 percent or so this year, and that will further be reduced next year. For the rolling 12 months, growth in full (indiscernible) and contracts is up 7 percent with retention rate at an all-time high of 64.8 percent.

We're working on growing the business, but we're also building on the competencies we need for sustained growth. For example, next year during our peak sales month, we'll triple our commitment to neighborhood selling. We know it worked this year and we're going to expand the model in '05.

A few comments on land care. We said for land care this year we're focused on rebuilding the business not growing revenue, and that is exactly what we have done. Excluding the impact of brands consolidations, revenues are slightly higher. In these branches, we're making gains in base contract maintenance revenue and seeing stronger enhancements sales revenues. Enhancements are up 14 percent for the first nine months of the year. This is important for two reasons; one, a trending positive impact that the economy is having on our commercial customers, and more important, it speaks to the changing sales relationship we're challenging ourselves to have with our customers, more sales involvement, more field development to have ongoing relationships. It helps enhancements and will also improve retention rates as we go into '05.

American Residential Services, ARS. Plumbing and construction had positive growth, while HVAC was down in the quarter. The field team is focused on the most important services which are critical to the turnaround and HVAC is to (indiscernible) our replacement sales and we saw nice progress in that area despite unfavorable weather conditions. And we're also concentrated on selling high-efficiency units to better margins for us and better performance for the consumers. Our sewer line work and plumbing and drain cleaning is adding nicely to our average tickets in this business.

We continue to differentiate (technical difficulty) on delivering the brand position of on-time know-how. Today, we show up on-time 98 percent of the time. Our competitors still don't believe we're doing it and are amazed, and our business leaders say their performance is better, the whole branch runs better with this discipline. Technology and changing processes is the key to putting the punch behind the on-time know-how guarantee.

As we're doing this, we're also building brand awareness. In key advertising markets during 2004, we have seen awareness rise as much as 26 percent. Our year-to-date customer satisfaction has moved from an already high 79 to a company high 83. We're working on the right stuff between brand position, execution and on-time know-how, brand awareness and customer satisfaction. We're making progress and we are seeing the results.

Let's move to Terminix for a minute. This year, we announced our strategy was to offer a greater to customers, both in termite and pest production. We've been executing on that strategy, making significant changes across the system to offer choice in both liquid and bait in termite protection and a variety of service frequencies in pest control. At the same time, we've been working to implement and improve our commercial customer model. We already found out we need to make a change in our customer mix in both account size and quality and we've been challenged operationally to meet the effect exact needs of our commercial customer. Again for the rolling 12 months, rodent and pest control customers is up 6 percent and year-over-year retention rates have improved 340 basis points.

In termites, we've seen a very slight improvement in 12 month retention rates while new sales in units is up 9 percent year to date. This has allowed us to make up for the lost customers in 2003 due to a very soft termite season and mediocre sales results during that time period. We've also been expanding our sales force. By this time next year, we will have 225 additional reps on the street in both pest and termite control and we're planning to add up to 31 branches and depots by the end of 2005. Obviously, we feel good about our performance and the prospects for this business.

All of this is taking place while we've been making a significant change across the system to offer choice -- liquid and bait, termite production and as I said, the variety of pest services, because customers are buying the type of protection with our guarantee that they want and they want value. We're seeing price realization as we communicate this clearer (ph) to our customers in both termite, liquid and bait completions, as well as in pest sales. Again, Ernie will walk you through this when he talks about the quarter.

With the exception of slight disappointment in pest sales and commercial growth, we're pleased with how the year is shaping up for Terminix as they transition to a brand-driven customer focused company. American Home Shield has performed so well for so many quarters, we have taken their performance sometimes for granted, forgetting what it takes to deliver the great performance they've put up for the last three years, working hard both on sales and service every day. We have seen some slowing of their growth rate over the last couple quarters and we are completing this year, we're taking steps to ensure that Home Shield has strong growth in 2005 and beyond. We're focused on three initiatives; first, continued expansion of our direct to consumer and third-party sales. We believe by focusing better on lists and partner selection, we will be able to realize the full potential and have excellent growth in underpenetrated real estate markets.

We're also focused on renewals, particularly first-year real estate customers. Our pilot test markets in Georgia and Nevada are exciting, working on callbacks and problem resolution. Additionally, we're taking those learnings, along with those on some key real estate brokerage tests that we've done and tolling that out to key markets nationally during the fourth quarter and into 2005. We're highly confident based on these pilot results that we will be able to do a better job and improve the all-time high our first-year real estate retention rates. These are meaningful improvements and an important way in our ability to reach and keep more customers.

Lastly but most importantly, we're also working with our account rep leadership team and account reps in the field. Our real estate channel is very important to it and is the backbone of this company. We're working to improve coverage, give them more support and develop the next generation of sales professionals. Today, we have the best trained and most professional sales team in the industry, and we're dedicated to maintaining that leadership position and continuing to be the number one employer in this industry for sales representatives.

In conclusion, the third quarter was a solid quarter, delivered by a great team in the field. We continue to take a work and make the investments to ensure we can sustain growth into the future. Our markets are deep enough and strong enough to sustain this growth. Our team is focused on delivering revenue and earnings growth by reaching and keeping more customer. The external channels challenges predictably as fuel and insurance or as unpredictable as weather are just part of the competitive landscape. Great companies blow through that stuff and keep going forward. And our actions will continue to give us the lift that we have now seen over the last 1.52 years. We're winning and continue to believe we're making the right investments to sustain that growth for the future. Now I'll turn it over to Ernie to talk more about the quarter.

Thanks, Jon and hello again, everyone. Our third quarter revenue growth was below our recent trends, but as I will mention later, there were a few factors that temporarily disrupted our progress. As Jon stated, we believe we're on track to achievement mid-single digit revenue growth for the year as a whole and most importantly, we continue to make tangible progress in our efforts to differentiate our brands, expand sales channels and methods and improve customer satisfaction and retention.

Operating income was down $1 million, or about 1 percent after excluding a nonrecurring impairment charge from last year's results. Our benefits that were derived from revenue growth and improved efficiencies were offset by significant one time step-ups in two key costs that we have been discussing with you throughout the year. First, the return to normal levels of variable compensation and second, a big hike in our umbrella insurance premiums, which increased significantly earlier this year when a multiyear fixed premium contract expired. The combined impact of these two items was approximately $9.5 million.

Also impacting operating income were two nonrecurring items, which had a combined negative effect of approximately 1.5 million. Specifically, Home Shield recorded by a $5 million non-cash charge that related to a conversion of its deferred revenue calculation from a manual process to an automated one. This was partially offset by a $4 million gain from the sale of a support facility at TruGreen ChemLawn.

Absent these unusual items and one-time step-ups in cost, our operating income grew at a solid rate that was both faster than our topline, which we're accustomed to seeing, and more consistent with our long-term expectations.

Finally, earnings per share increased for the fifth consecutive quarter. Our net interest expense improved by approximately $3 million in the quarter, and that primarily reflects a 2.5 million increase in investment gains realized from the Home Shield investment portfolio, as well as savings resulting from the interest rate swap agreements that we entered into late last year. Now it's important to remember that investment gains are an integral part of the business model at American Home Shield. There will always be some market-based variability in the amount of gains from quarter to quarter. But such gains which were abnormally low in 2003 returned to more normal levels in 2004, based on historical market returns and the size of our equity portfolio.

Looking at cash flows, cash from operations was up $20 million in the quarter and a whopping $75 million year to date. This improvement reflects reduced working capital usage of $58 million, as well as increased profits. And for the full year, we remain confident that our operating cash flows will again exceed our reported net income by at least 50 percent and will increase at a rate at or above our earnings growth.

Looking at the uses of cash, our acquisitions during the first nine months were up modestly and that reflects the purchase of GreenSpace in Canada by TruGreen ChemLawn at the beginning of the second quarter. And by the way, that acquisition continues to perform very well, as well as normal levels that tuck into Terminix and TruGreen. And for the full year, we continue to expect that about 50 million in cash will be used for acquisitions. We have completed about $14 million in share repurchases during the quarter, bringing our nine-month total to 55 million. We plan to continue that program in the fourth quarter and are currently pacing toward a full year total in the $75 million range.

Lastly, our fourth quarter dividend reflects a 2.5 percent increase for the full year and that will represent our 34th consecutive year of dividend increases. That is a record of consistency that places us in the top 3 percent of dividend paying companies. The balance sheet remains strong. It includes cash and marketable equity securities totaling approximately $420 million with about 300 million of that amount effectively required to support regulatory requirements at Home Shield and for other purposes. Total debt of 108 million was at its lowest level since 1997.

Turning quickly to the segments, the TruGreen segment over all experienced 5 percent revenue growth with a 6 percent increase in lawncare offset by flat revenues in the commercial landscaping business. In lawncare, full program customer counts increased 7 percent with half of that growth achieved organically. A net growth in customers contributed to a 6 percent growth in third-quarter revenue dollars. Of the nine-month growth rate of 8 percent of which 4 percent is internal is very encouraging, especially considering the do not call issue that Jon mentioned.

Our lawncare business continued to achieve significant improvement and retention, which improved 260 basis points over last year. And as we have discussed in prior calls, this improvement is geographically broad-based and reflects the effects of our visible results program, as well as improved problem resolution procedures, revised incentive compensation systems and favorable weather. This unprecedented rate of improvement reflects three years of intense focus on customer satisfaction by the entire TruGreen team.

Looking at our marketing efforts, overall year to date new sales were down less than 2 percent after absorbing a 10 percent decline in telemarketing sales, which was consistent with our expectations at the start of the year given the do not call issues. That decline was mostly offset by substantial increases in sales from new channels, such as direct mail and neighborhood sales efforts. We are very pleased with the progress TruGreen has made in diversifying its marketing model. Our telemarketing sales accounted for over 90 percent of the total just a few years ago and that has been reduced to about 60 percent currently.

Lawncare's operating income benefited from the revenue increase and the gain realized from the sale of the support facility. Partially offsetting these benefits were higher selling expenses associated with those new sales channels that we have mentioned, which are costlier, but do produce customers who tend to stick with us longer. Lawncare also experienced hurricane-related production delays, as well as sharp increases in fuel and insurance costs.

At land care, base contract maintenance revenues was flat as solid growth in revenues from new customers was offset by lower retention, some of which we initiated. Enhancement revenues continued to experience strong momentum, reflecting conservative sales focus. And it is important to note that if you exclude the effect of branch consolidations and closures made earlier this year, revenues in the quarter in total increased by 4 percent, an encouraging sign that this business is starting to turn. That is also reflected in improved operating results, which were caused by growth in the higher market enhancement business that was partially offset by higher fuel and insurance. Our management continues to focus on strengthening its leadership team and expanding and developing its sales force. The team is focused on improving operating consistency through better process disciplines, especially as they pertain to labor management and the pricing and bidding of new work.

Turning to Terminix, it continues to make very encouraging progress through the significant changes made in its operating model, both with respect to the implementation of a dual termite offering in 2004, as well as the continuing migration in its pest control business from monthly to quarterly service. On the termite side, we continue to experience strong growth in renewal revenue, which was supported by improved pricing. As we had anticipated and explained in our second quarter conference call, termite completion revenue dollars were down as very solid increases in unit volume and improvements in realized prices were offset by the negative effects on revenues of the mix shift from higher priced bait treatments to lower-priced liquid treatments.

Finally, we were encouraged by the strong growth in termite completion unit volume, which has been achieved in the post-swarm season where weather is not as prominent of a factor. On the pest control side, the continuing shift to quarterly service has had an adverse short-term effect on revenues, but with an offsetting improvement in labor efficiencies. And along with other operating measures that we have taken, this shift has contributed to the sharp improvement in customer retention that Jon mentioned earlier. Our third quarter operating decline was primarily caused by the termite mix shift, as well as increases in our sales force, again, as Jon mentioned and higher fuel and bad debt costs.

The hurricanes also had an inverse impact as they hit areas where Terminix has a very strong competitive presence. Overall, we believe the Terminix team is making solid progress on the key operating and marketing initiatives and we expect that they will finish on an upbeat note and achieve good full year growth in revenues and profits.

At Home Shield, reported revenues increased by 4 percent. But excluding an accounting adjustment, the growth rate would have been 9 percent, which is consistent with our year-to-date trends. We continue to experience strong growth in direct to consumer sales and in renewals, which was partially offset by a decline from our real estate channel.

Sales in two major real estate usage states were negatively impacted by sharp declines and home listings. And as Jon mentioned, we have comprehensive initiatives in-place to increase both sales and market share in the real estate sector.

Briefly, with respect to the accounting adjustment that we have mentioned, it was identified during a systems automation project. It arose in individually small amounts of our number of prior years and it is both non-cash and nonrecurring in nature. The cumulative adverse effect on both revenue and operating income was $5.5 million.

In total, the operating income improvement reflected in the financial statements is the result of revenue growth and lower air-conditioning claims costs due to cooler seasonal temperatures. These were partially offset by continuing investments in key marketing and customer service initiatives, as well as the previously mentioned accounting adjustment.

Turning to AMS, revenues in our HVAC and plumbing businesses were flat overall, but up 3 percent after excluding the effects of year-end branch closures. Positive trending in two of our three service lines continued from the second to the third quarter. While mean revenues again increased modestly with relatively strong improvements in sewer line repairs and commercial services and residential construction and commercial project revenues had another strong quarter. But the cooler seasonal temperatures which benefited American Home Shield posed a significant challenge to ARS's air-conditioning business, which experienced a sharp decline in both service and add-on replacement revenues. Unfortunately, that negated encouraging progress on several underlying operating initiatives, including our two hour on-time arrivals guarantee, our retail initiative and the steps we're taking to increase sales closing rates and average ticket prices.

Looking at operating income again excluding the effects of a third quarter goodwill impairment charge last year, profits declined by $3 million as a result mostly of that air-conditioning softness, as well as higher marketing, fuel and insurance expenses. At AMS, project backlog and revenues have shown strong increases over the past several months and profits, while still cyclically reduced, were improved over prior year. However, due to continued competitive industry conditions, related margins are still below prior year and our backlog consists of a greater mix of longer duration contracts. If bidding activity continues to strengthen as we anticipate, we would expect to see margins begin to improve for more normal levels.

Finally, in our other operations segment, ServiceMaster Clean and Merry Maids both experienced solid growth in revenues and profits during the quarter. Our Clean benefited from continued strong growth in disaster restoration services, and that momentum will continue in the fourth quarter due to a significant increased demand stemming from the cleanup work related to the hurricanes. At Merry Maids, a better economy and improved sales and marketing processes have resulted in steadily increasing in total revenue growth rates in both our franchise and branch operations.

In closing, we feel like we continue to make solid overall progress that is going to provide us with a solid platform for stronger and sustainable growth in the future. At this point, we welcome your questions, and I will now turn it back over the operator.

(Operator Instructions). Matt Litfin, William Blair & Co.

Good morning. Question is on TruGreen LandCare. You mentioned some nice growth in the higher margin enhancements. I guess the real question is, can that growth persist into the future in enhancements? And I guess one way to look at that would be where are we, in terms of enhancements as a percent of the business versus prior cyclical peaks?

We're coming up from a lower-level of enhancements over the last 18 months. I don't have the exact number in my head, but we have not peaked at prior peaks yet. I cannot tell you exactly how much more there is to go. But significantly in this business, this has been a year where we've been putting together the operational platform, we've brought in a couple of senior sales executives. We haven't challenged the business to grow its customer base this year. That will start to come in in '05 and beyond. So between a lot more available revenue, you have to remember, this a $20 billion market -- that is a serveable (ph) market, not the whole market size, that's what we believe we can serve. So I am not overly concerned at all about more base contract work with higher retention rates and better enhancements once we have the operating platform exactly where we want it or close to where we want it, and we've made some real nice progress in that area this year.

One follow-up if I might, and I'll jump back in the queue. It's on Terminix in the termite completion business. Where is the bait versus liquid mix now as a percent of termite completions? And obviously, you saw a little bit of margin pressure in the quarter in that unit. I think Ernie had said there's some onetime factors. Can you talk about how much of the margin pressure was onetime factors versus this ongoing treatment mix shift? And really what I'm really getting at is, do you see next year’s operating margin continue to be pressured, or do you see it where it has been this year and really in the past couple of years as well, close to 14 percent?

I think I caught all of that. I know I caught the front part of it. It's just to remind everyone. Last year, we had a mix that was about 80/20 base to liquid. This year, we will end the year at about a 45, 55-ish mix bait to liquid again. We do believe that the substantial portion of the shift is behind us. We don't anticipate significant further shifts next year for the reasons we've talked about in the past. So from that perspective, I think it is somewhat of a onetime phenomenon that we're working through here. Remembering that over the lifetime of a customer, the lifetime value of a customer is about equal between these two alternatives. So we give up a little in the early years and gain it back in subsequent years. I'm sorry -- the other parts of your questions?

The other part is about margin. So if you take the increased renewal profitability coming off of this liquid customer next year, Matt, we would not anticipate the challenge we've had around margin as we've gone through this transition. And we're also seeing some things bait make us believe that our ability to monitor bait stations will be less labor-intensive as we go into '05 as we and the entire industry work with our product suppliers in ways to make that more efficient.

This was a complex quarter for Terminix, but there were a lot of factors that impacted comparisons. But, the mix shift was a significant piece of it.

Thank you and congratulations on the quarter.

Chris Gutek, Morgan Stanley.

Good morning, a couple of questions. The Company has had a number of modest accounting changes in recent quarters. And in fact, if you go back to the readuit to the 2002 results, one can say maybe quite a few accounting changes. In that context, can you guys give us an update on where you are with your Sarbanes-Oxley review of your control and reporting systems?

Chris, I think we're ahead of the curve on Sarbanes-Oxley. It's one of those things where you don't want to jinx yourself. It is a tremendous amount of work, it involves a substantial number of our accounting, financial and operating people, both at headquarters and throughout the field. But, we've been approaching this very aggressively. We know we're making progress and our external auditors tell us that, relative to most other companies from a timing and results perspective, we are ahead of the curve. I don't want to jinx myself with those comments. There's still a lot of work to be done. Don't let me mislead anybody.

And then for Jon, we saw -- I guess you signed a new employment contract recently that goes through May of the year 2012. Quite a long duration contract. Maybe it's more of a question for the compensation committee than for you. So I think the question for you would be, given the length of the contract, does this imply any change in your strategy for the Company as it relates --?

Actually, the Board approached me early this year about (indiscernible). I've never had one in my entire life, and quite honestly, I'm kind of agnostic about employment agreements because I've been managing the business for 20 years without them. The Board said we have a (indiscernible) responsibility to make sure that we, A, have continuity; B, if someone were to leave at your level, what you can do with either employees, you got to work for competition. So I worked with the Board and I believe we've put together a reasonable transition perspective on -- if I were to leave or they ask me to leave, do I get some compensation (indiscernible) line on that. You've seen us Chris in my tenure here under Bill and Carlos not to be egregious at all on executive compensation. The other piece that you're referring to, that's an employment contract.

The other piece was a restricted stock grant. That was just to make sure that I have and the Board has continuity in a plan. If you noticed how that accrues to me, it accrues to me basically at a tail end -- I've kind of said running this Company and retiring when my daughter gets out of high school is kind of my plan. And I don't think there's any proof to the pudding that's subject to good performance and good support from the Board that my plan is to be here in this Company and run it for most of the decade. I have to perform every quarter, I have to perform every year, but that's my plan.

Historically, our Board has sat down with the CEO around retirement and put together retirement agreements with Carlos and Bill and people for them. And as we went through that with Carlos and Bill a couple of years back, Chris, both I and the Board came to the conclusion that it would be better for everybody if we did it upfront. So what you're seeing there is preparation for retirement, a plan on my perspective to put my working days in here and a plan to make sure that if for any reason the Board were not wanting to me be here, the Board would have protection about me competing against the Company, and/or taking people with me where I might go. So I think overall, it's good corporate governance. You continue to see us have corporate governance in place. And once again, nothing in that agreement stops the Board from saying we don't like what you're doing and we're going to ask you to leave tomorrow. So all in all, I think it's good for the board and good for me and good for ServiceMaster and good for our shareholders.

Thank you.

(Operator Instructions) Jim Barrett, CL King & Associates.

Jon, can you talk a bit about what you mean by uneven consumer spending as it applies to your various key divisions?

I'd say consumer spending in general, when I'm out talking to the business leaders across the country, whether it's at a business roundtable or Executive Club in Chicago, clearly, everybody saw the tail end of the tax rebates, tax money that went into consumers' pockets kind of giving a strong lift to the overall consumer economy in the first and second quarter, I think the economy has run through that money a little bit and people are just getting a little bit more stingy. So nothing particular to us, no big warning signals, just the overall trends that we're seeing in consumer spending and consumer activity.

I see. And price increases, you've touched upon them as you spoke about the various divisions. Can you quantify for the key divisions to what degree you either took pricing recently or announced it recently or envisioned taking it in the near future?

I might a couple of (indiscernible) ask Ernie to join in. TruGreen, we put some price into our new customer acquisition strategy in 2004 and probably overall realized about a percent, 1.5 percent there. In both bait and liquid by offering our consumers choice, this is in Terminix on termite renewals, we've seen a nice increase, particularly in bait new contract prices. I'd rather not disclose with that amount, I think it's competitive. But we've been able to by offering choice, raise our price in bait. We went into the year with a perspective on liquid and we're somewhat above our liquid price when we put our budget together for the year. Once again, I think the strength of our guarantee and the kind of toll protection concept that we give consumers and what people buy in termite control is, one, (indiscernible) termites, but they want to know if the guarantee is there and that total protection concept in total control we're working on is making a lot of sense. So those would the two I comment on. Ernie, I don't know if you want to talk about ARS and a few other ones?

I think it would be fair to say that across the rest of the board, we have averaged somewhere in the 1.5 to 2 percent improvement in net realized prices.

Okay, thanks Ernie. And Ernie, other operations, corporate overhead excluding the franchising businesses, what sort of growth would you expect to see in that number on a going forward basis over the next couple of years?

That bucket includes a lot of different things. The increased cost this year is again all part of that return to, normal variable compensation levels. With respect to pure overhead costs, we have a pretty strong discipline in place that they are not going to increase more than 4 to 5 percent a year.

And less than our revenue growth.

Right.

Thank you both.

Matt Litfin, William Blair & Company.

I have a follow-up on TruGreen ChemLawn this time. Are you still seeing more Americans being added to the do not call list, or has the pace of that slowed? And where do you expect the customer mix between telemarketing and other to be maybe next year?

We see the significant slowing, sure, there's a few names trickling on (ph), but we think we have absorbed 95 percent-plus of the adds to the name. I don't know off the top of my head, but clearly, over a 2 to 3-year period of time, telemarketing will be significantly less than 50 percent of our new sales acquisition. So I think it falls somewhat below 50 percent in next year; don't hold me to it, but you're seeing a trend down into the 30, 35 percent range over the next couple of three years.

Just a quick follow-up on that. Maybe you could give us a little color about some of the non-telemarketing channels that you're using. Can you build on that from here, or did you just sort of pick up some low-hanging fruit in '04 after years and years of the telemarketing being --?

Unquestionably, we have new channels that we are working very hard to roll out. Our neighborhood selling effort, we really went from in '02 and '03 really within the state of Indiana, it was one of the early adopters of do not call list. We (indiscernible) branches kind of piloting neighborhood selling. We rolled it out to maybe a third of our branches last year at most -- excuse me -- this year. That has been a significant success story. I talk about tripling our sales force going from about 800 to over 2000 next year. That takes it to about 65 percent of our net worth. We're still telemarketing in areas and regions where there has not been a significant increase in do not call lists. So we're learning new skill sets. In addition to that, our brand platform visible results which will be expanded and reenergized for 2005 will be even more focused on the consumer is happening. And we continue to work on direct-mail, we continue to work on newspaper insertions, freestanding inserts, all sorts of channels, along with neighborhood selling and electronic lead flow in this area. We're also in the position to continue to try, we have a very small test, not with a major store location -- excuse me -- a home store, but we'll probably be in 70, 80 stores next year, once again, continue the pilot work on in-store selling. So a lot of things to multichannel TruGreen lawncare and become less and less reliant each day on telemarketing.

Thank you.

(Operator Instructions). Alex Paris, Barrington Research.

I have one last cleanup sort of question. The investment income from AHS, driven off the $300 million or so portfolio. Where does that largely come from and what is the best way to think of it? Is it related to equity market returns? And is this a level that we should sort of expect going forward?

I misspoke slightly in my remarks. The 300 million is our total portfolio, of which 100 million is equity as the other's in bonds and fixed-income investments. The way I look at it is that over time, if you get a 7 to 8 percent return on equity portfolio, that is well supported by history. Now as you know as well as any of us, you can't always predict that will occur consistently from quarter to quarter. But the amounts that we have realized this year both in the third quarter and the year to date are very close to -- they are very much in that 7, 8 percent return range. So that is why I believe that, A, this is an integral part of the operating what model of Home Shield and, B, it was more of a case where the gains reverted to more normal levels this year than last year, which was were abnormally low. I hope that answers you question.

It does. Thank you very much.

Alex, just one other comment. We're trying to take a lot of the dampening and peaks and valleys out of our performance as we work here on this type of thing. We will clearly be very transparent with all of these investors if there is a significant change in either our planning or what we report in this 6, 7, 8 percent return on our equity portfolio. We're not out to make our quarters or our years by not taking gains in years where it doesn't occur. We've just said flat on, whatever it is, our size of that equity portfolio, our planning process will be to return a 7 percent return on that and have that reflected on our income statement each year. And if we don't for some reason achieve that or we have go beyond that, we will be very clear about that in a way that I think is consistent with transparency that we've been giving you historically.

Two supporting points I would add is, number one, we have very definitive investment guidelines that our Board of Directors reviews and approves annually. And secondly, these funds are not managed by me; they are managed by a group of independent professional money managers.

Great, thanks for the color.

Jim Barrett, CL King & Associates.

Jon, I had a question that probably applies to both ARS and LandCare. Both, certainly if one looks in the review mirror, have margins that I assume are well below where you believe they can be longer-term. Broadly speaking, at what point in time would you expect the margins in each of those divisions to improve materially? And what do you see as the endgame, in terms of the margins in each of those businesses once your plan is fully implemented and you have a normal year where you don't have a cold summer with ARS for example and you have, again, sort of normal industry conditions?

Let me take LandCare first. We've talked about outside comparisons to a privately held competitor called Brickman. They are in the low teens. An equivalent margin for us would be in the high-single digits, and the only difference for that would be that we get most of our fertilizing or lawn control reporting through our lawncare business. So we would say 8, 9 percent margins for that business is a target. Ernie and I are having a full-day strategy review with that business unit next week, and we anticipate that is the progress they're going to show in a two to four year period and the business plan will be put together.

I think we have isolated the two or three variables, and once again, 25 percent of our business has at least performed at that level today. So it's not about we don't know how to do it, it's getting the rest of the country to do it. We'll have more announcements on this in the near future. We have added some management strength to this team and we will focus on getting this turned around and remain very confident.

ARS, it's probably, once again, 10 percent margins would be a good performance in this segment. ARS, we've worked with Mark Morrell (ph), I've talked about things on branding, I've talked about the things on customer satisfaction, on-time know-how. These are all the things that you say fundamentally are the right business. Clearly, 2005 is an important year for this business to show progress, both in revenue and margins. And as we've talked about before that we felt we were unable to make that progress, we contemplate different alternatives. But right now, we sit here and believe that both of these businesses are today and will continue to be a significant part of our portfolio. And if anything changes on that, you guys will be the first to know.

Is a 10 percent margin goal, is that a 2006, 2008 type of expectation?

I would say 2006 would be too optimistic, and I'd say 2008, we should -- we better be there.

Thank you very much.

Chris Gutek, Morgan Stanley.

Thank you. Ernie, looking at the American Home Shield business, just to be clear, the higher interest income is booked as interest income, not as operating income in the segment. And if you strip out the nonrecurring accounting adjustment in the quarter, the operating margin was incredibly high, up about 450 basis points year-over-year versus a very difficult comparison. I'm a little confused as to why that underlying operating performance seems to be as strong as it was?

As I mentioned in my remarks, Chris, we had have, with respect to the heating and cooling season, we had an usually mild summer across most of the country. And that benefited Home Shield in the form of lower claims and it hurt ARS pretty substantially. So that is the key reconciling item (MULTIPLE SPEAKERS) what's that?

Wasn't it a similar situation last year? So, kind of a similar comparison, a difficult comparison?

It is true that we've had two relatively mild years in a row, but I do think last year was closer to normal. I think this year was a little more pronounced.

The final question I had was on the Terminix business, I would like to better understand this mix shift issue. And it seems to me that if the mix shift has now pretty much played out towards a liquid treatment system, my understanding of the accounting is you book the revenues up front with the liquid treatments, as opposed over a twelve-month period with the baiting treatment. And, therefore, that mix shift because of the change in accounting, the mix shift would have had a positive impact on the revenue growth, obviously offset by the fact that it's a lower revenue per treatment. Now that the mix shift has stopped and you're at a stable mix, you should simply be seeing the year-over-year effect of lower revenue per treatment, as opposed to the earlier booking of the revenue. Doesn't that imply that over the next couple quarters, we're going to see the Terminix year-over-year revenue growth fall significantly, maybe go negative, or am I misunderstanding something?

Deb, you want to jump in on this one? Deb and I have spent a lot of time talking about this, but she is our internal expert on this subject.

I would say for the full year and for year-to-date, what you just said is right because we saw a lot of revenue from the prior year come through. What we're talking about really is a timing difference as you look sort of in the third and probably in the fourth quarter as well to how, when the storm hit versus also the shift that was coming down when he look '03 over '02, and what is flowing through. So I think when you have a bunch of those factors, the third and fourth quarter had some timing issues associated with it. When you go into next year, your point is right. And I think you'll see that play out as the shift is gone and you'll have a much less effect from any of the deferred aspect of it.

Okay, thank you.

Chris, I would also say that the underlying health of that business once again is going to be determined by customer count. And let's not lose focus on the profitability. And I think about it a little differently, that we have built an annuity into our future profit stream by the transition to liquid customers, which are more profitable after year one. And since we have increased our base, our customer based basically where it was last year. We have overcome the (indiscernible) swarm and some unsatisfactory sales efforts last year. Our base customers are the same. We have more liquid customers, and those are more profitable in future years. So in my way of thinking about it, we've actually put an annuity out there, a future profit stream that has been delayed into future years based on the renewal strategies that we have in place and the renewal rates that we do see out of these two customer sets.

By offering choice, we're seeing our closing rates improve.

More customers (multiple speakers).

A reduced level of discounting. So it's complicated, but on balance, I believe it is a net positive.

Great thank you.

I can't find anything I don't like about it.

Thanks, guys.

Okay?

Gentlemen, at this time, there are no further questions. I'll turn the call back to you.

We appreciate the call today, the questions. And Bruce, Ernie and I and, Deb, and Eric and the entire table available for all follow-up questions. And thank you for taking the time this morning.

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