Terminix Global Holdings Inc (TMX) 2005 Q1 法說會逐字稿

Ladies and gentlemen, thank you for standing by. Welcome to the ServiceMaster Company's first-quarter 2005 earnings conference call. During the presentation all participants will be in a listen-only mode. Afterwards, we will conduct a question-and-answer session. At that time, if you have a question, please press the 1 followed by the 4 on your telephone. As a reminder, this conference is being recorded Tuesday, May 10, 2005. I would now like to turn call over to Bruce Byots, Vice President Investor Relations. Please proceed, 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 today is Deb O'Connor, our Controller and Eric Zarnikow, our Treasurer. Before I turn the call over to Jon, I would like to remind that you our quarterly 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 our press release and, SEC filings for more information on the risk factors that could cause additional results to differ. Additionally during the call, we may use certain non-GAAP measures as defined by the SEC and regulation G. Please refer to our web site at SVM.com and our press release for the required reconciliation for the most directly comparable GAAP financial measures. Finally, I'd like to inform you we have targeted September 13 or our investor day conference to be held in New York City. I will be sending out a save the date blast note to you on the call and to our investors and analysts in the next few weeks. Now I would like to turn the call over to Jon Ward.

Good morning and welcome to the call. We set a course for this company three years ago, and we started gaining great momentum on that during the second half of 2003. We maintained and grew that momentum in 2004 and now 2005 is also off to a good start. As a result, we continue to expect revenue growth to be in the mid to high single-digit range for 2005 and our that our earnings per share will grow faster than our revenues. In short, we're doing what we said we would do, keeping focused and executing.

In every one our businesses we are finding new ways to expand our horizons and gain additional customers. We are making investments in our salespeople and our marketing programs to drive our top-line growth. There is no doubt that our business can support it. The market is healthy. The competition is fragmented. And our services are in demand. Households are under penetrated. In short, there's customers and consumers are there when we get our message in an appropriate way to meet their need.

Our service people want to be more productive, to rid their job of the unnecessary hassles and to be more effective in delivering a great customer experience. We're helping them do that, be able to be their best every day through technology and ongoing training. Our safety initiative is making real progress and our branch expansion pilots are showing real promise. So most days we are asking ourselves how fast we can move to take full advantage of these opportunities, not where our opportunities are. I'm going to turn it over to Ernie who will review with you the quarter, but before I do, I'd like to mention that last Friday at our annual shareholder meeting we ratified a change to our corporate objectives.

We replaced "pursue excellence" with "excel with customers." What makes "excel with customers" so fitting is that already embraced by tens of thousands of our people, are technicians who are in the field all day. Over 45 million times each year our service team delivers a superior experience to the residential and consumer customers who make up our company. There's no company in America that can match their skill, their dedication and as they say, they're not ServiceMaster or Terminix customers, they're my customers. That's a level of commitment we like and "excel with customers" really sharpens that focus.

I'll thank you now and be back later to answer questions after Ernie gives you more details on the quarter. Ernie?

Thanks, Jon, and hello again, everyone. I'm delighted to be here to share with you some of the details regarding our performance. Overall, we were encouraged by first-quarter results. We achieved an improvement in gross profit dollars and margins as a result of favorable shifts in mix, improved price realization, and better performance at TruGreen Land Care. Selling and administrative expenses increased 11% and hence were a meaningful drag on first-quarter operating income growth. Over half of this increase represented incremental investments in sales, marketing, and other strategic initiatives which are expected to benefit future periods.

The investments and their short-term effects were previously anticipated, and you'll recall that we discussed them during our Febru -- our February conference call. The first quarter was also meaningfully impacted by two significant costs that are going in opposite directions. As you know, fuel costs have risen significantly. Since we consume over 36 million gallons of fuel annually, that has a big effect. We hedge approximately two-thirds of our estimated usage every year, but even net of the hedge, fuel cost adversely impacted our first-quarter results by approximately half cent per share.

We are currently piloting, routing and scheduling software and GPS technologies, which, among other benefits, would tighten routes and reduce drive time and fuel consumption in future years. On the positive side, we are beginning to experience tangible results from our efforts to reduce safety-related costs, which include workers compensation, auto, and general liability claims. Such costs total over $120 million annually and had been increasing at double-digit rates.

We're succeeding in our efforts to create a safety culture throughout the Company, and are experiencing a sharp decline in both the number and the severity of incidents. In total, first-quarter costs were relatively flat and $2.5 million below our original expectations. And we're targeting additional savings in this area over the balance of the year.

Turning now to our cash flows, the decrease in cash from operations primarily resulted from two nonrecurring factors. First, the impact of increased incentive payments made earlier in the year relating to 2004 performance. You'll recall that incentive payments in 2004 for 2003 were substantially reduced. In addition, we have made $131 million in tax payments that resulted from the agreement with the IRS that was discussed in dep -- in depth on our last call. Please remember that this agreement was only one part of a four-part agreement.

As previously disclosed, that overall agreement also resulted in realized tax savings of 25 million in 2004, again, those are already in the bank, a reduction in estimated tax payments in the second half of this year of $45 million, and a deferred tax annuity totaling $57 million, which we will recoup over the next 11 years. So overall, we believe the agreement was very favorable and fair. Cash flows have consistently and significantly exceeded net income at ServiceMaster, and we expect them to continue to do so in 2005.

Although we would expect the rate of growth to temporarily subside due to the nonrecurring tax and incentive items I just mentioned. Over the past five years, operating cash flows have averaged 200% of reported net income. They support our attractive dividend and share repurchase policies. Our dividend is increasing this year for the 35 consecutive year and currently yields almost 3.5%. Even after the significant payments made in the first quarter, our balance sheet remains very strong.

With cash and short-term and long-term marketable securities totaling almost $360 million. With about $60 million of that deemed unrestricted and available for general corporate purposes. Total debt at March 31 was $876 million. And as always, we remain committed and confident in our investment-grade status.

Turning now to the segments. At TruGreen ChemLawn first quarter revenue profits were adversely impacted by late snows in six operating regions in the northeast and Midwest which forced us to delay service that had previously been sold and scheduled. On average, production in these regions was more than five days below both last year and six-year historical averages, resulting in delayed revenues of over $9 million. We expect that these amounts will be recovered over the second and third quarters with only modest incremental costs.

Our Lawn Care teams continue to make good progress in key strategic areas that will benefit future periods. First the more strategic and targeted approach, combined with improved customer satisfaction are helping us achieve improved price realization over what has historically been the norm. Second, we continue to experience solid improvements in customer retention, which increased 190 basis points during the quarter and 330 basis points over the course of the past three years. There are several things that have combined to help produce this result, including better customer communication and problem resolution procedures, improved weed control, and focused incentives at all levels of our management team.

Third, we continue to successfully expand new sales channels, primarily neighborhood selling and direct mail, which are helping to offset the previously anticipated decline in telemarketing sales. Overall, our neighborhood selling efforts are over three times as extensive as our inaugural efforts last year, and now involve over three quarters of our branches. As we enhance this technique and implement best practices, we are also starting to experience improvements in our productivity per sales rep.

All told, our sales for this new channel tripled during the first quarter, matching our expectations, and giving us solid momentum entering the second quarter. You may recall that neighborhood selling is more dominant in the second quarter than the first when telemarketing sales have historically been stronger. There are also some exciting indications that affective use of this neighborhood selling technique can officially extend the selling season at least in certain key regions of the country.

Overall, when you look at what we were faced a few years ago as telemarketing restrictions started to expand, we're very pleased with the progress that we've made. Neighborhood selling has enabled us to avoid what could have been a major-league derailer for this business. Instead, we continued to grow the business while reducing our reliance on telemarketing from over 90% of sales just three years ago, to under 50% expected for this year.

Turning to TruGreen Land Care. Seasonal losses in our commer -- in these commercial landscaping operations were sharply reduced during the quarter. Approximately $3 million of the improvement was due to increased volume and improved profit margins. The balance was due to the absence of approximately $2 million of nonrecurring branch closure costs incurred last year. Poor results reflected steady growth and higher margin enhancement revenues as well as increased but still modest growth in contract maintenance revenue. Customer decreased slightly from last year's level and continues to be an area requiring improvement.

But it also provides an achievable opportunity for this business, with strong focus being placed on better communications and service level consistency at each branch's top 25 customer locations. Our operating and sales leadership teams have been significantly strengthened in land care over the past few months. Key process are be -- key processes are being improved and standardized and efforts to stimulate stronger growth and profitability in the future. I had the pleasure of spending a few days with the senior leadership team last week, and as a team, they are focused, confident, and really starting to make progress in the sales and profit -- process improvements that will help make this a very attractive business for us for the long term.

Turning to Terminix, that business experienced reduced seasonal profits primarily as a result of planned investments to increase the sales force and reorganize our field operations. As part of our efforts to expand market penetration, our sales force head counts were increased approximately 15%. Unit sales increased 15% in pest control and 9% in renewable termite treatments and frankly would have grown even faster had we had a normal termite swarm. We experienced a modest additional shift in termite sales to lower priced liquid treatments which increased as a percentage of first-quarter totals from 60% last year to 68% this year.

However, price realization improved as the result of focused pricing discipline and our efforts to continue to offer the customer with choice. And that improved price realization offset much of the adverse mix impact that I just mentioned. In March, we introduced a new beta option which utilizes an active ingredient from day one, and provides meaningful cost and marketing advantages. And since introduction, we've seen base sales as a percentage of the total sales rebound back toward prior year levels.

Management is evaluating the 40-basis point decline in termite retention that is shown in our release. That might not sound like much, but something our team takes very, very seriously. Actions have already been taken to improve customer communication and problem resolution in order to reverse this trend and get back on the trend of improvement. Overall, we expect stronger profit comparisons from Terminix in subsequent periods.

American Home Shield once again achieved exceptional results. Even after considering incremental investments to increase market penetration and improve customer retention. Operating income increased over 40% on a 8% increase in revenues. We continued to experience very strong control over costs per plan, which were down 4% or $2.3 million in comparison to last year's levels. And to put that in perspective, that represented a compound rate of increase over the past three years of under 1% in this key cost category. Again, exceptional cost controls.

Mild weather also resulted in a 3% decrease in the rate of incidents in claims, which favorably impacted profits by an additional $1.7 million. Our overall customer retention rate improved approximately 100 basis points, reflecting changes in mix and a reduction in the number of customers we lost as a result of mortgage refinancings, which have slowed with rising interest rates. New warranty contracts written increased 7%, a sharp rebound from fourth quarter levels. Real estate sales were relatively flat. Renewals, our largest channel, increased with improved retention, and consumer sales experienced rapid growth due to higher volume and improved closing rates with targeted direct mail.

Our ARS and AMS segments achieved 3% revenue growth and a comparable seasonal loss. American Mechanical Services , our commercial heating, cooling, and electrical installation business, experienced strong increases in project revenues and backlog and profitability that was improved over last year, but still below historical norms. ARS Service Express again experienced declines in core service calls in both HVAC and plumbing, and unfortunately, those more than offset modest increases in residential new construction and solid continuing growth in sewer line repairs, Commercial plumbing, and our HVAC initiatives in the retail channel.

Finally, in our other operations segment, both ServiceMaster Clean and Merry Maids experienced solid growth in revenues and profits. ServiceMaster Clean experienced strong continued growth in disaster restoration services and very good momentum in new franchise sales. Merry Maids experienced double-digit internal growth in both its branch and franchise operations, as well as an improved mix of weekly and bi-weekly services. Now increased profits from ServiceMaster Clean and Merry Maids, combined with lower insurance costs, offset increased parent level investments in productivity-enhancing initiatives within this segment. At this point, we'd welcome your questions, and now I will turn it back over to the operator. Thank you.

Thank you. [Operator Instructions] One moment please for our first question. Our first question comes from the line of Sharat Shroff from Morgan Stanley. Please proceed.

Yeah, hi, guys. A couple of questions from me. First of all, looking at your revenue guidance for the full year, you are re-affirming mid to high single-digit growth and that would point to some acceleration in the second half of the year. My question is, which segments you expect that acceleration to come from, especially in the context of a decline in the forward expectation in the consumer confidence index?

Yeah. Remember that -- this is Ernie. Remember that first quarter is our off-season quarter, plus some of revenues that were delayed from first quarter will actually benefit the second half. So in addition, we enter the, the -- the higher peak second half with the benefit of the sales and marketing investments that we made in the first quarter, and that combination of factors we do expect will lead to faster revenue growth in the balance of the year.

[Inaudible] only in the cooling segment that you'd expect to pick up or is it across the board pretty much at [ Inaudible ] as well as in Terminix?

No, I think we expect relative to first quarter -- again, first quarter's our off season -- but relative to first quarter, I would expect faster growth in TruGreen, Terminix, ARS and Land Care. So really, a very significant part of the business.

Okay.

Just once again the first-quarter revenue generation numbers are -- I don't want to say, you know, not important. It's why Ernie spent much more time talking about price and customer acquisition. Literally by the time -- we always say our year is kind of set up by the time we get to May, cooling consumer confidence can affect a little bit ongoing customer retention rates in the second half of the year but not in a large way.

What you're talking about in consumer confidence we are seeing slight ticks down. We've been through these cycles over the last three years. I would also say and agree with you that we have not been in a period of time in the last three or four years where we've seen an incredibly robust consumer, but the consumer is a little bit cautious and we feel we have been operating effective flee that environment in the last 8 to 12 months.

Okay. Thanks. And then my final question on the pricing utilization. Jon, you mentioned that you're getting better pricing for the services. Is it a question of being a little bit more strategic or the fact that the competitive environment allows you to raise prices? What exactly are the drivers there?

Our real success this year in price has been in TruGreen Lawn Care and I credit two things. One, Dennis Sutton, as he got into the business said, guys, we've been talking about price for a long time and really haven't focused on it and I think Dennis set a tone of leadership at the top, and also it was a great combination of some work with an outside -- outside consultant and our internal six sigma teams, that went in branch by branch and looked at baseline pricing, how much what we were doing, quote, unquote, discounting off a rate card, and we have had an incredibly disciplined process, kind of, first the analysis was done by some outside parties and then our six sigma teams grabbed in with the support of regional, divisional and branch managers and have just done a terrific job throughout TruGreen of putting it in place.

Okay. Thanks

As a reminder, ladies and gentlemen, to register a question press 1, 4 on your telephone keypad. And our next question comes from the line of Matt Lif -- Lifton from William Blair. Please proceed.

Hi, good morning. Ernie, you mentioned fuel costs impacted by half a cent in the quarter. Are you talking about versus the prior year? Or is that versus your original thoughts that you had going into the quarter?

No, that's versus prior year, Matt.

Unless we see a big spike higher in fuel costs this should probably be encapsulated in your current guidance here?

Our current guidance would make -- would anticipate prices staying pretty much where they're right now, not moving materially up or down. Okay. Thank you. And, maybe, Jon, can you give us a sense of what the sales and marketing investments that you made in the Q1 were exactly? Maybe give us some examples of some things you did there that you expect to pay off later this year?

Sure. Obviously the biggest investment was a 15% increase in the size of the Terminix sales force. We did a lot of work on -- and by the way, also this year we're opening up 25 new Terminix locations, branch splits and seven satellites. So we've made an investment both in real estate and in sales organization and typically when you -- we've done this, what you take is a branch that's gotten fairly large but under penetrated areas. Split it in half. so you have a profitability impact from not leveraging the scale but as you put another location in a geographic market such as Los Angeles, you do end up getting penetration over time. So, one, better training, better recruitment in Terminix.

Let's go to TruGreen Lawn Care. Clearly a big ramp-up in door-to-door salespeople, neighborhood selling . Going from, I'll say, 500 to 600 this year to maybe even 800 next year, to an excess of 3,000. We're still debugging this, Matt, to make sure we've got great productivity. The bottom line this year is, we spend a little bit more money this year than we did last year to get the same number of sales out of a telemarketing splash, direct mail, neighborhood selling channel. We believe over time that the neighborhood selling channel can be close to being as effective as, as telemarketing but will never, quite honestly, be as cost effective.

But, it is the way we are now going to market and as we continue to work on our brand differentiation, we think putting stronger messages in our neighborhood selling organizations hands, along with the work that we do in retention has us feeling comfortable around TruGreen growth in the years ahead. If I had a disappointment, it'd be in Land Care. We made some changes in sales leadership about this time last year. We honestly came back in and rejigged it again, Matt, in the fall. We took one of our senior Terminix salespeople and moved him into Land Care earlier this year.

We have made an outside hire in the fall. Someone I had worked with over the last ten years and also took our best, best internal salesperson and kind of bridged across Land Care and Lawn Care and put them across the top of Land Care sales. We've had an okay new generation sales this year in Land Care, but I think the -- sky is the limit as we really get better disciplined and have a better sales approach in place, particularly for seasonal markets next year. Maybe I'll comment on one other business unit . That would be American Home Shield. You see a tale of two cities here. Flat real estate sales.

We are working -- hard to get big states in California and Texas rejigged and we've made excellent progress by changing in what we would call the customer response side the equation and I think our sales folks recognizing we're putting more value into how we interact with our consumers after the sale which will improve our real estate relations and once again, we have a incredibly strong market share in California -- we don't want to rest on it, we want to grow. We've also mentioned in prior calls that we've extended the real estate channel to three new markets in the last 18 months.

They are all coming well -- along very well, but each new market has 1 million or $2 million up front investment to make it happen. We're pleased with that. Steve Burnett and the marketing team continue to make great progress in American Home Shield in expanding particularly the direct to consumer, our direct mail program, where we don't use the real estate channel to sell a product, and this is just a continuing growing area for us, a grower double digit area where we literally through third-party mortgage brokers and then with our own direct mail campaign to go direct to consumers. So we're finding the vitality of a home warranty far exceeds just a home sale transaction.

It is a good value for homeowners whether they're in their home for five years, five minutes, or, you know, somewhere in between. So we're, we're increasingly confident we've got robustness in Home Shield that can expand itself very nicely and nationally over the next three or five years. So that kind of walks you through most of them. Ernie, anything you'd add that I didn't touch on?

No, I think that was a pretty accurate and comprehensive summary.

We are feeling very good, Matt, about the sales efforts and as we talked about, the sales efforts for February today may set up the year a lot for our company.

Got it, thank you very much

At this time, we are not showing any further questions. I will turn the call back over to you.

Okay, thanks very much for your questions. And, again, any follow-ups, please feel free to give me a call. And thank you very much. Have a good day.

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