Terminix Global Holdings Inc (TMX) 2006 Q2 法說會逐字稿

Ladies and gentlemen, thank you for standing by. Welcome to the ServiceMaster Company second quarter 2006 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 the 4 on your telephone. If at any time during the conference you need to reach an operator, please press the star followed by the zero. As a reminder, this conference is being recorded Tuesday, August 1st, 2006. I would now like to turn the conference over to Mr.Bruce Byots, Vice President Investor Relations for ServiceMaster Company. Please go ahead, sir.

Good morning and thank you for joining us. On the call this morning is Pat Spainhour, our Chairman and CEO; and Ernie Mrozek, President and Chief Financial Officer. Also joining us is Deb O'Connor, our Controller; and Eric Zarnikow, Treasurer.

Before I turn the call over to Pat, I would like to remind that you today's 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, 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 results to differ. Additionally, in the press release and during the call, we are using certain non-GAAP measures as defined by the -- by the SEC in Regulation G. Please refer to the exhibit in our press release or our website at svm.com for the required reconciliation for the most directly comparable GAAP financial measure. Now, I'd like to turn the call over to Pat.

Good morning and is welcome to the call. As you saw in our press release for the first half, revenues were up 6% and earnings per share were up 7% before restructuring charges. You also saw that we continue to expect revenue growth to be in the mid single digit range for the year and that we also continue to expect earnings per share from continuing operations before restructuring charges in the low double digits for 2006. Obviously this means we are confident that we can deliver better performance in the second half just as we did last year with a relatively strong fourth quarter. We're already taking action to make sure that we keep up the momentum while we have it and make the fixes where we don't.

Ernie is ready to give you a detailed report on the quarter and the half, but before he does, I'd like to give you some perspective on the business and review some of the major actions we took this quarter. Originally I took the position as interim Chairman and CEO, I found out the more I worked with our leaders and diving in -- into the individual businesses, the more excited I became about our opportunities and the more passionate I became about the Company. Both the board and management team soon realized that if I could immediately step into the permanent CEO role, we wouldn't lose any momentum in delivering 2006 and planning for 2007 and beyond. So the board took action and we're hard at work. I've taken the helm during a time when our stock is down and we've had a difficult quarter from a revenue perspective. We'll move past these issues because the basics of the business haven't changed. The attributes of the Company that make this an attractive investment did not change with the change in leadership. We're in a very strong competitive position with the leading brands in a large and growing market. The competition is fragmented and demand for our services will continue to grow. We have completed the sale of AMS and are in negotiations to sell ARS in a single transaction which will leave with us a very healthy portfolio and a strong balance sheet.

Here's another aspect of the Company that did not change with the change in leadership. We have compelling business model built around recurring revenues and strong cash flows. In most of our businesses, we start each year with over half of our revenues already committed from repeat customers. Most of this repeat business is scheduled in advance, allowing us to reap the benefits of route density. We have low fixed asset requirements, many customers pay in advance, receivables at most of our businesses turn very quickly and inventory requirements are modest, totaling less than 10% of current assets. The strength of our cash flow enables us to consistently return cash to our shareholders in the form of dividends and share repurchases.

As you saw, the board is taking action to increase our third quarter dividend by 9%. We also increased our share repurchase target to $100 million in the second half, 150 million for the year, almost triple last year's level. The board took action to meaningfully increase both our dividend growth rate and share repurchase because we're confident about our strategies, our market positions and our prospects for future growth and because we firmly believe our shares are undervalued. During the fourth quarter, we'll host a major analyst and investor day and at that time, the senior management team will give you more details on our initiatives and plans for 2007 and beyond.

I would like to share three areas of focus for both our action now and in then those later years. Our most important priority across all our service lines is improving the customer experience. Our single greatest opportunity is right in front of us and in our control. Do a better job of serving the millions of customers we already have to date. We deliver over 40 million customer service visits every year and have tens of millions of additional contacts as we sell our services, answer customer questions, and resolve their issues. Every customer contact is an opportunity to increase satisfaction and retention. Given the right experience, customers will choose you, stay with you and recommend you. The di -- critical difference in our new approach will be to insure that we are driven by the customers' needs and meet the customers' ex -- expectations at every touchpoint. This means we can generate a very good payback by just focusing on the current base of our customers. For example, TruGreen ChemLawn -- TruGreen ChemLawn improved retention 2 points over the last 3 years. The best branches are up 8 to 10 points higher than the average. Each point in this -- in this one business unit alone increases companywide profits by half a -- a half per -- per -- half a cent per share. We fully expect to bring all of our branches to a higher standard that we have proven is achievable and reap the benefits of doing so.

Today, our retention lead conversion and acquisition rates are too low. Problem resolution and retention programs are in place in every business. Our operating teams have been armed with tools and techniques to capture this potential. New focus and unrelenting field discipline will insure that this effort is delivered with intensity and account -- accountability in the months ahead.

Another area of focus is leverage and integration. We will continually make progress to improve the basic infrastructure of the Company. Earlier this year, we launched project accelerate to improve the effectiveness and efficiency in our functional support areas, which represented an aggregate pool of costs of about $400 million. As we stated, our estimate is for ultimate pretax savings, net of reinvestments, to be in the 25 million to 35 range, or %0.05 to $0.07 per share, which we expect to fully realize beginning in 2008. We are currently on track to meet or beat those estimates.

Looking to the future, we believe there are tremendous additional opportunities with our branch and regional operations to better leverage our established infrastructure and expertise, reap proto-technology, A-productivity gains and improve our operating models in ways that further enhance the consistency and quality of the customer service experience. The total pool of cost at the branch and regional levels is roughly 2 billion. Several times larger than the amount reviewed as part of Project Accelerate. Our operating leaders are already beginning to explore the exciting opportunities that exist in these areas.

Over the past several years, we have made progress in rebuilding our back office capabilities. We also have made progress in increasing the capabilities of the branch and the technician, increasing their effectiveness and efficiency with routing and scheduling software. Additional enhancements like GPS and improved call handling technologies are successfully being piloted. Looking forward, we are making strong headway in using technology to change the customer experience, making it much easier for customers to buy, to schedule and to pay for our services.

Our third area of focus will be to expand our growth opportunities. Our businesses have opportunities that can be captured without straying from our core competencies or materially changing our financial characteristics. Even though we have a strong footprint in many of our businesses, we still have opportunity to move into adjacent and underserved areas through new branches, service or sales satellites or through tunk (ph) in acquisitions. At Terminix, we added 25 facilities last year and are still on track to add 35 facilities this year. There are great prospects available. Customers who want us, who need us, and who can afford us, but aren't being reached by our current sales and marketing vehicles. So we'll continue to form alliances with companies that have these prospects. We'll expand the number of channels and methods to reach them if they want to be reached.

American Home Shield has finalized a strategic alliance with Realogy, the world's largest real estate broker and franchiser in the residential real estate services sector. Realogy, the former Cendant real estate group is comprised of leading real estate brands Coldwell Banker, Century 21, ERA and Cartus Relocation and owns the largest real estate brokerage firm, National Realty Trust.. Realogy is involved in one out of every four real estate transactions in the United States. This partnership could generate as many as 100,000 additional new contracts per year in its first full year and will continue to help American Home Shield expand its geographic footprint in the residential real estate market. Market launch is scheduled for late September of '06.

So, that's my perspective from the first two months as -- as -- as interim and Chairman. Together our management team is focused on delivering good performance in 2006 and together we'll be working to unlock our untapped potential in the years ahead. I look forward to answering your questions. But first, here's Ernie with details on the quarter and half. Ernie?

Well, thanks, Pat. And hello again, everybody. My comments are going focus primarily on results from continuing operations and then I'll give you a brief update on the pending divestiture of ARS toward the end. Our EPS before restructuring charges increased 7% in the first 6 months to $0.31 and 4% in the second quarter, to $0.26, both of those numbers slightly favorable to our own prior expectations. If you include the charges, EPS was $0.2 for the 6 months and $0.25 for the quarter. Now, because of the timing differences that we discussed on our last call, especially including the acceleration of about $7.5 million of One Care Production from the second quarter into the first quarter of this year due to more favorable weather conditions than had existed in the prior year and by the way that revenue acceleration had the impact of about $0.01 a share and corresponding profit shifts. But because of those timing differences, we believe that the 6 month results are more comparable and more fairly reflect the fundamental trends in our business.

Our earned revenues increased 6%, both year to date and in the second quarter and totaled approximately 2% excluding acquisitions. Operating income before charges increased 8% in the 6 months and 7% in the quarter with a 20 basis point improvement in margins in each period. And I think the key story here is that we, by effectively focusing on those costs that we can control, we've offset some unusually rapid increases in fuel, healthcare and interest costs. On the positive side, we've maintained our focus and momentum in driving down safety-related costs. And that's most prominently manifested in the continued favorable trending of prior-year claims. In total, first half safety related costs were down almost $0.02 a share. They're expected to be relatively flat in the second quarter -- second half, excuse me, but that's consistent with very strong results achieved in the comparable period of 2005. And the great news in the safety area is we still have plenty of room for improvement.

We're also on track to meet or exceed our previously projected savings from Project Accelerate. And you'll recall that the implementation of that initiative began in the second quarter. For those of you who may be new to this call, the objectives of that initiative are to realign our support costs, in light of the divestitures of ARS and AMS, create a more effective and efficient functional support structure, provide funds for reinvestment and growth, and generate tangible savings to the bottom line. We remain confident that we'll ultimately realize annual pre-tax savings, net of reinvestments, in the $25 to $35 million range, that's $0.05 to $0.07 per share, and we'll get there by 2008. We'll get there progressively with at least $0.02 per share in 2006, mostly in the second half, $0.04 to $0.05 in 2007, and the balance in 2008. Now, severance and other time restructuring charges associated with this effort totaled almost 10 million in the 6 months and 6 million in the second quarter. All such charges will be incurred and recognized prior to year-end and should approximate $12 to $13 million in total.

Again, taking effective action in areas that we can control has helped us offset unusually rapid increases elsewhere. With respect to fuel, you'll recall that our large fleet consumes roughly 30 million gallons annually. Each year, we hedge approximately two-thirds of our estimated usage. But this year's hedge prices are well above last year's and pump prices, on the unhedged portion have continued to escalate rapidly. All factors considered, higher fuel costs adversely impacted the first half and the second quarter by $8 million and $5 million respectively. If pump prices stay at current levels, we would expect for the year as a whole an adverse incremental impact of almost $0.03 per share and that's roughly $0.01 higher than we had anticipated in our original budget. We're addressing this issue by implementing things like GPS and like routing and scheduling technologies that will reduce fuel consumption by tightening routes and reducing drive times.

Healthcare costs. They continue to experience strong inflationary pressures. And as we've discussed with you before, we're also making an incremental investment here of roughly $0.01 a share as part of our efforts to further enhance our position as an employer of choice. Healthcare costs increased about $0.01 in the first half, with an incremental impact of about $0.03 expected for the full year. These estimates are consistent with our original expectations.

Lastly, sharp increases in short-term interest rates have also impacted our business at the operating income level because they have an effect on floating rate-based fleet and occupancy leases. We estimate that impact adversely impact -- affected us by about a half a cent per share in the first half, and we would expect full-year impact about $0.01 per share.

Turning to cash flows, they remain strong. And they again meaningfully exceeded our reported net income. If you exclude tax payments associated with the favorable resolution of IRS audits, cash provided from operating activities declined by $21 million during the first half. That's primarily due to higher working capital requirements associated with the newly acquired InStar businesses during periods when it is growing rapidly. And it is. It's also partially attributable to the timing of certain insurance and tax payments.

Getting back to InStar, during the four months since closing, InStar's revenues have increased almost 30% over their corresponding prior-year levels. And its sales backlog has more than doubled since last June.

Our balance sheet remains strong. Cash and short-term marketable -- short and long-term marketable securities totaled almost $400 million. Virtually all of which is effectively required to support regulatory requirements at American Home Shield. Our debt totaled 800 million, that's up from year-end as a result of the first quarter acquisition of InStar, which consumed approximately $85 million in cash, as well as normal seasonal working capital requirements. Our current debt levels are very comparable to the amount that existed last June. We continue to believe that cash proceeds from the divestitures of ARS and AMS, which we expect to receive during the third quarter, will meaningfully exceed the amounts invested in InStar.

Turning now to the businesses, at TruGreen ChemLawn, revenues increased 3% during the first half as we had improved price realization, that's in about the 2.5% range, as well as a sharp increase in supplemental services and those offset a 3% reduction in residential customer counts. The primary challenge impacting customer counts has been significant declines in telemarketing sales. As a result of the expansion of both do not call lists and caller id net -- id mechanisms. Those declines have more than offset growth in sales from newer channels including direct mail and neighborhood programs. As we look to the future, our starting point here will have significantly less reliance on telemarketing. Since it now represents approximately 45% of new sales versus more than 90% just 3 or 4 years ago. In addition, and perhaps more importantly, we believe we can meaningfully expand our recent growth in direct mail and other newer channels by increasing our emphasis in these areas and by better leveraging the specialized expertise and best practices that exist elsewhere within our organization.

As we had predicted in our last call, retention trends in lawn care are improving. The 250 basis points disparity that existed at the end of March has been narrowed to 100 basis points in June. And we remain confident that we'll end the year with net gains in retention. Over the last 13 weeks, cancellations have been below prior-year levels with customers responding very favorably to our expanded efforts to improve their satisfaction and their retention. Those efforts include comprehensive annual lawn quality assessments, faster response standards and satisfaction follow-up calls on all reservices, and improved customer communication and problem resolution procedures.

At TruGreen land care we reported a 1% decline in earned revenues in both the 6 months and the second quarter. As previously discussed, year-to-date results have been adversely impacted by a $7.5 million decline in first quarter snow removal services. Delays in the timing of new contract maintenance sales relative to our original goals have also contributed. These factors have offset the positive effects of a 190 basis point improvement in customer retention and a 7% combined increase in enhancement and nursery revenues. As we've talked before, land care has substantially increased the size, the caliber and the training of its sales team, and provided better tools to them for identifying and pursuing at desired customers. And that's resulted in a substantial improvement in the relative size and quality of our outstanding sales proposals. Land care management is confident that we're going to end the year with annualized sales in line with our original plan. And if we accomplish that, when you combine it with the meaningful improvement in retention I just mentioned, that should enable us to realistically anticipate much stronger growth and maintenance revenues both in the fourth quarter and in 2007.

At Terminix we achieved a 1% overall increase in revenues year-to-date, as a 5% combined increase in pest control services and termite renewals, was offset by a 6% decline in revenues from initial -- initial termite applications. Now the decline in new termite jobs is an industry-wide phenomenon. And it was attributable to a very weak annual swarm season. What was unusual about this swarm season is its severity and its geographic pervasiveness. Our inflow of sales leads decreased at mid-double digit rates in almost every region of the country. The good news is that through more proactive efforts and improved training and techniques of our sales force, our sales conversion rates increased and substantially mitigated the decline in lead flow. Overall, the swarm is now over and we believe that we have maintained or improved our market share during its course.

On the positive side, we enter the heart of the pest control season with good momentum. We've been experiencing low double-digit increases in both second quarter and July lead flows and we're capitalizing on that with a more experienced and better-trained sales force. In addition, pest control customer retention is once again showing improvement, having swung from a 30 basis point decline at the end of March to a 60 basis point improvement in June. And we expect additional gains in the second half. All factors considered, we anticipate an increasing rate of growth in pest control revenues over the balance of the year.

At American Home Shield, growth in new sales and renewals, and you'll recall that those are recognized as earned revenues over the subsequent 12 month contract period, those new sales and renewals improved from 1% in the first quarter --growth of 1% in the first quarter, to 7% in the second quarter, combined that gives us a 5% year-to-date growth, and with meaningful additional acceleration expected in the second half.

In the real estate channel, which by the way represents about 30% of total annual contracts written, sales were down 4% in the first half. And that's due to a pervasive wakening -- weakening, excuse me, in the home resale market. That weakening was particularly acute in several of our largest volume states, especially California. But as Pat mentioned, the recently signed agreement with the Realogy Corporation, which includes the Coldwell Banker, Century 21 and ERA Brands, that's a very significant new deal and is expected to begin generating sales in the fourth quarter. Overall, we would expect incremental sales in the first full year of this contract to exceed 100,000 units, or roughly $40 million in annualized revenue. And this level of incremental sales should almost double from 100 to 200,000 units a year over the 5-year contract term. And that's going to happen as we expand penetration of the portion of these brands that's franchised, as well as increase contract renewals.

Mo -- I think it's most significant to note why were we -- we were rewarded this contract. It was based upon our strong customer service orientation, our national footprint, and the high quality of both our sales team and our subcontractor network. And that's critical because those are characteristics that benefit all American Home Shield sales channels and under -- and they underpin our confidence in the strong future growth in this business.

Our contract renewals represent approximately 55% of total annual contracts written and they increased double digits, or 11% in the first half. Our retention rates improved 200 basis points and that reflects a more favorable mix of renewing customers but also the effects of customer satisfaction follow-up calls, after every service visit, and a significant improvement in problem resolution ratings from our customers. Again, we're seeing progress. A relatively larger number of expiring contracts, combined with the effects of improvements and our renewal solicitation process, should lead us to even stronger rates -- rates of growth in renewals in the second half.

Finally, within our franchise businesses, ServiceMaster Clean, which has been one of our strongest and steadiest performers over the past several years, continued to achieve double-digit increases in disaster restoration services and solid overall profit growth. While Merry Maids again reported encouraging revenue gains as a result of strong internal growth and the effects of acquisitions.

Turning to divestitures. The divestitures of ARS and AMS are proceeding in accordance with our expectation. In July, we closed the sales of the AMS businesses to senior members of the MS management team. And with respect to ARS, we are currently engaged in detailed negotiations to sell the business in a single transaction.

Outlook? Overall, we continue to face specific cost head winds, as well as general economic uncertainties and they do reduce our visibility a little bit. However, please remember that these are not unprecedented challenges for us. And in fact over the last 36 months, we've demonstrated an ability to overcome similar obstacles and still deliver solid earnings growth and excellent cash flows. For this year, we continue to expect earnings per share before charges to increase at low double digit rates with the majority of the second half growth occurring in the fourth quarter. Now, the relative magnitude of the growth projected for the second half is very similar to that that we actually achieved last year in the second half. We believe that continued focus on customer retention increasingly positive effects from the recent InStar acquisition and increasing savings from Project Accelerate and other cost control efforts will enable us to achieve this forecast.

Dividends and share repurchase. For those again who are new to the call, annual cash flows from operations have consistently and significantly exceeded reported net income at ServiceMaster by a factor of almost 2 to 1 over the past 5 years. Our confidence in their continued strength supported the actions that were taken by our board last Friday and mentioned by Pat. The increase in the third quarter dividend of 9% over the level paid in the third quarter last year, that will insure that 2006 is our 36th consecutive year of increase, not just paying a dividend, but increasing that dividend. And that puts us in the top 2% of all public companies in America in terms of consistency of dividend growth. At ServiceMaster's current stock price, which we believe is substantially undervalued, the increased dividend provides an annual yield of approximately 4.5%. Which should be extremely attractive for a company like ours, which has both a long history and a future expectation of strong earnings growth. This is not the utility. Despite tough external challenges, earnings per share from continuing operations have increased an average of almost 10% per year over the past 36 months. And our current outlook as we just expressed, anticipates they'll continue to do so throughout the balance of 2006.

These considerations also led to the increase in targeted share repurchases for 2006 to $150 million, with over $100 million occuring over the next 5 months. Combined with the increased dividend, this would result in total cash returns to our shareholders this year of over $280 million, almost $1 a share. Repurchases at these levels reflect our confidence in the future as well as our commitment to retaining our investment grade status. So we're energized and we look forward to taking your questions. Thank you. Operator, you can open it up now.

Thank you. (OPERATOR INSTRUCTIONS) Our first question comes from the line of Kevin Monroe, Thomas Weisel Partners, please proceed with the question.

Good morning.

Good morning, Kevin.

On the TruGreen segment, this telemarketing issue is something you've been dealing with now for 2, 3 years. So why is it showing up maybe more so in this quarter and what gives you the confidence that you can sell through this in other channels going forward?

Well, we've seen a progressive decline in telemarketing sales. It was really a first half phenomenon more than a second quarter phenomenon. And I think the things that -- that give us confidence are that we're seeing good growth in direct mail, neighborhood programs and the Internet. Those are newer channels for us. And telemarketing is -- is -- is just a less significant base from which to grow over in the future. So it will continue to be a factor but we're highly capital expenditures that we can make the gains in the other channels, as well as the meaningful improvements in retention that we're starting to capture and that those combined will breed a much brighter future for this business.

Okay. And turning to the AHS business, the, kind of two questions here. First, your -- your growth is based on -- you have contracts that were booked --you booked the revenue over a 12 months life -- life of contract. So is there a benefit from a strong real estate market a year ago that's still showing up in your results? And if so, is there a point in time where that will mitigate now that the real estate market has turned a bit weaker?

No. No, Kevin. As you may recall, last year's real estate market was not gangbuster. It was weaker than the year before. So I don't think there's a -- there's a -- carryover positive impact that we're getting. To the contrary I would expect with the Realogy agreement that we just announced, we'll enter 2007 with substantially better momentum than we entered 2006 within the real estate channel.

Could you give us a little more detail on that Realogy agreement, just exactly what -- what the agreement is, what ServiceMaster will be doing in the partnership with these other companies?

Well, it's -- this is a relationship much like other large national brokerage relationships that we already have, where we are the exclusive provider of home warranties within these powerful national brands. Those locations that are Company-owned and within the franchise outlets of those brands, we are the exclusively endorsed provider. And as -- we have worked with these brands in our past and in fact, we've continued to work with some of the franchised outlets even as our competitor had a relationship with them. So, we know them well. We're highly confident that we'll have a smooth transition and we'll have more details available at our investor conference later in the year.

Okay. And one -- one final question if I can. The InStar business, if I'm doing the math right, it looks like it had about 7% or 8% operating margins in the quarter. I was under the impression it was a higher margin business.

I don't have the exact percentage in front of me, Kevin. But one thing you should realize is the effects of purchase accounting in a short-term impact, we had to assign a significant portion of the purchase accounting step-up to our sa -- order backlog and that's temporarily depressing the margins in this business. We definitely anticipate over the long term that this will continue to be a double digit margin business.

Okay, thank you.

Our next question comes from the line of Matt Litfin, William Blair & Company. Please proceed with the question.

Hi, good morning.

Good morning, Matt.

Follow-up on the last question on the backlog, amortization. If you can, I'd love to get a number on the call what -- what you recorded at InStar if the quarter for -- for that amortization. And then really, my question there is how quickly do you expect that to burn off? Are we -- is it -- are we done with the backlog amortization? Does it last one more quarter, another year? What are you thinking?

Matt, I don't have that number with me right now. I would just reiterate what I -- the comment that I made in the, in the -- in -- in my remarks. And that is, that our backlog is double last year's level. We expect a relatively short burnoff in some of these purchase accounting items and we expect increasing profit impact in the second half of the year.

Okay. What is the current thinking at TruGreen ChemLawn regarding lawn quality audits and how do you -- how are you expecting that to affect the second half expense levels?

The strategy of it, Matt, is -- is to insure that we have the final say-so, or the customer has the final say-so, in the work that was done, to insure that -- that we've answered every question to resolve any problem there. And also to provide the opportunity to add enhancement sales at that point in time if in fact they need aeration. In terms of the -- of the result that we've seen so far in the pilot, it's been phenomenal in terms of the metrics. It's 3 to 1, 2 to 1 in several of our metrics. And as far as the expense goes, what we think the opportunity that that this will bring in terms of 00 of retention will more than offset any additional expense we have to put out there. It should not be a factor relative to the balance of the year from the expense perspective but it has an opportunity to bring top line back to us going forward in a meaningful way.

Right.

The cost of the program, Matt, are embedded into our outlook here. I'll assure you of that. And we are getting the offsetting benefits thus far. It's -- it's still early in the program, but we're very encouraged by what we're seeing to date.

Okay, fine. Final question is the -- what level of restructuring charges are expected in the second half of this year? And I think you said that your guidance excluded that?

Yes. The guidance was before restructuring related charges and the total for the year should be 12 to 13 million and we're at 10 in 6 months. So there's an additional 2 to 3 coming in the second half.

And I assume that's weighted into this current third quarter?

It's what? I'm sorry, Matt. It's weighting meaning more heavily?

Yes.

It should be more heavily weighted in the third quarter.

Okay. Thank you.

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

Good morning, everyone.

Morning.

Pat, could you talk about since you've arrived, whether you perceive the need or you plan on changing any of the -- the management incentive systems, either for division managers or for those who report to those divisional managers?

We certainly looked at that as being something we have to look at. But the first thing we have to do, Jim, is to insure the -- the jobs that we want done, that we've got those jobs standardized, that the expectations of delivering the brand consistently has been defined and trained and we're training into that. And then, do we need to change the compensation to drive the right behavior? I don't think it's a significant issue at this point. I don't foresee any major changes relative to that. But -- but if we need to, to get the right behavior to deliver the brand consistently, we'll certainly put that in.

Okay. And then moving on to a different topic. When we look at pricing for your leading services, especially given what's happened from the inflation standpoint, where do you see the opportunities there relative across your portfolio, and where will it be easiest versus more difficult?

Jim, it -- it -- frankly, it's been a challenge but we -- we have seen improvement. I mentioned it specifically in TruGreen ChemLawn, we're trending toward realization of 2.5% to 3% improvement in pricing this year. If you look back 2, 3 years ago, our pricing was essentially flat.

Right.

So we -- we are taking -- we are take -- we are capturing some additional gains there in that area. And I -- I don't know that I could rate one versus another as easy or hard. All of our businesses are competitive. But we are making some gains in pricing in -- in almost every one of them.

Good. And then finally, there wasn't too much commentary about the consumer slowing down their purchasing behavior because of the economy or high energy prices or inflation. Are you seeing --is that sort of a fair characterization of TruGreen and Terminix and the other businesses at this point? That they're not being impacted on that front?

I - I think -- I think there's always going to be some impact, given the circumstances that exist out there. I think the thing to remember is that a good many of our services are non-discretionary in nature and I think first and foremost, that services like pest control, termite, American Home Shield is actually budget protection device as well as a great service vehicle. So I think that's one of the things that buffers us a little bit from -- from this. But there's no question that, you know, there is some impact right now. We're working our way through that. And our -- our challenge is to make our brands and our services better differentiated and even more valuable and just further enhance that customer experience so that we -- we do a better job of keeping those that we already have.

Okay. Well, thank you very much. And good luck.

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

Thank, good morning.

Good morning, Chris.

Pat, starting with just a big picture question, I'm curious, since your initial comments about 2 1/2 months ago in terms of the modest change in strategy and tactics relative to under the leadership of John Ward, it seemed like the initial thought was a little -- somewhat more focused on growth and customer retention and marketing initiatives and maybe conversely a little bit less focused on cash flow, dividends and share repurchases. And maybe I misinterpreted the initial message, but it's not, it seems as if the thinking has shifted a bit. What -- what is -- from a high level perspective, from your perspective, what is going to be the change in the Company's strategy and tactics explicitly relative to the previous strategy under John and does that in fact imply not focus not just in the short term but longer term focus on higher dividends and share repurchases?

Chris, from what we said on May the 16th on that press release, we're pretty much still there in the sense that we -- we've always believed that the strategy was a correct strategy and that's been even more reinforced as I've done deep dives in all the different companies and -- and looked at the opportunities that the strategy is the correct strategy, the tactical side of what we're doing, how we execute that strategy is where the focus needs to be. It's how we in fact get to the customer as opposed to getting our branches which need to be as automated as they can be, get those things working correctly. We need to better understand the customers' needs so we know that all the money that we're spending, the efforts we're putting in, are going to be accepted by the -- by the customers. So the execution, the timing of how we're doing things, retention rates, leads, all those things, customer satisfaction scores that we have, they have been improving, but the pace of change is not -- is not relevant to creating that right customer environment. And so that's the focus. It's the execution of a strategy which has been a good strategy, it's how do we get it in the customer, in the customer positive constructive way quicker than the way that we were going? And in terms of --

Chris, on the share repurchase and dividend side, I think of two things. First and foremost, we took the actions because of our confidence in future growth, not because we're backing away from future growth. In fact, when we -- we carefully considered the levels of both, the share repurchase and the rate of dividend increase, and we set them at levels that leave us plenty of flexibility to pursue growth opportunities. And lastly, on the dividend, I'll just remind you that we are going from a growth rate of 2% to one closer to 9%. But that's still below our expected growth rate. So we're actually maintaining our payout ratio. So this is not in any way, shape, or form, an indication of an expectation of slowing growth. In my opinion, quite the contrary. As I presented it to the board, I justified it based on our confidence in future growth. That is stronger than we've experienced in the recent past.

Okay. Thanks. Another big picture question if I could. In the lan care business, Ernie you talked in your prepared comments in detail about some of the growth initiatives and some improved accel -- improved traction with those initiative going forward. But from a profitability perspective, land care after more than 7 years of ownership by the Company still is not performing particularly well. Are you guys still committed to keeping this business? And if so, what gives you the confidence that in the fairly short term, the business can experience some meaningful improvement in profitability?

Chris, from two perspectives, number one, even before I got involved in running the Company, we changed management with Rick Ascolese and he has been working very diligently and very hard in putting together a -- a brand-new front end, that the whole sales organization has been refined, professionalized, and -- and it's making progress. As I got in and began to do the deep dives and -- and -- and understood about that great front end and -- and it will deliver for us, we're not supporting that back end with the operating piece of it. Our branches are not -- are not performing at the rate that they need to. And we got into that and found out that the biggest issue is -- is management and process. The leaders and their process. We have several branches that are knocking the ball out of the ball park and we have branches that are well underperforming. And so we -- we have started a project of -- of -- about 6 weeks ago of working with each one of those bran -- branches, taking the branches that are -- that are knocking the ball out of the park, defining the leadership capabilities, the processes they use and we're putting those in -- in place in each of the bran -- branches. That will continue for the balance of this year and into next year.

But with the strength of the front end and new leadership that came out of Terminix, to really professionalize the sales force, the opportunity that we have there, backed up with the operating improvement that we see coming, we feel like this can turn into a profitable situation going forward. But as I've said and -- and -- and in many investor meetings and so on, we're constantly looking at all options and opportunities. And -- and -- and we know what our target is out there that we're trying to achieve. And if at any point in time we see with any company or that we can't make the number happen and -- and -- and add the value back to the shareholder, then the board is very responsible and we'll take whatever actions we need to take. But this one we feel like if we stay focused, we'll deliver -- we'll deliver a -- a better return than obviously it has been and continue to grow that over the next couple of years.

Great. Thanks.

Our next question comes from the line of Mike Hamilton, RBC Dain Rauscher. Please proceed with the question.

Good morning.

Hi, Mike.

Three questions if I may. First you did a very nice job on -- on SG&A. I'm wondering if you can comment on -- on what you're doing the cost side, if there's -- if there's anything structurally beyond some of the program savings that you've discussed. And if you could tie that into the improvement in -- in the other operating line in your segment data. In other words, if could you give some of the components of the improvement from the 12.5 million expense last year to the 5.3 this year.

Okay, Mike. On the SG&A line, I'll focus on the quarter first. Again, we are seeing meaningful impact from Project Accelerate and related cost control efforts. Secondly, InStar's coming in with a slightly lower percentage of SG&A, the revenues, than the average for the enterprise. And then third, we -- we did mention in here that the accounting rules require us to make an entry related to our deferred compensation trust and the basically, when -- when the market is down, we get a favorable impact on operating earnings and an unfavorable impact in interest income. And vice versa when the market is up. So we did get some benefit from there in the second quarter when the market was weak. But really, fundamentally, I think it's the impacts of the first two factors that I mentioned. And those exist as well in the first half all three of them, but for different reasons to a lesser extent.

Thanks. If you could do the -- on the pending AMS sale, and knowing that here won't be any detail there frequently in this kind of sale when it's management led, there's a little more baggage than a clean sell-off, do you perceive any debt guarantees, anything in terms of earn outs or multi-step transactions in this sale, or do you anticipate that it's going to be as clean as an independent transaction?

Actually, Mike, I actually think it may be cleaner because these guys know the business. And we were able to negotiate on that basis and didn't have to provide a lot of the protections that independent buyers might ask for. That's not to say that there aren't some bridge assurances that we're providing to our fleet lessors and others, but none that we would anticipate giving rise to a meaningful exposure down the road. So, I feel pretty good about -- about the transaction, frankly. And I feel that our people are in good hands. That management team s solid and I think the business will do well in the future.

Thanks. Then lastly, in the sweet spot of your -- your TruGreen ChemLawn operations, weather's taken a fairly significant turn for the worse here in recent weeks. From where I speak, we've hit the first triple digit heat in 6, 7 years. What's your anticipation here in third quarter off of weather?

Well, the other thing you got to watch besides heat is precipitation. And I know in the midwest, where I sit, we've had a lot of heat but we've also had a lot of precipitation and the lawns actually look great. So that'll be the challenge. And at the moment we're -- we continue to feel overall like weather conditions are more favorable than they were last year. Clearly, there's always a spot in the country that's an exception. But overall, we're feeling pretty good about it.

Thanks.

(OPERATOR INSTRUCTIONS) Our next question comes from the line of Sam Darkatsh of Raymond James. Please proceed with the question.

Good morning. This is actually Jeff Reed, Sam's not able to make the call.

Good morning, Jeff.

Good morning. My first question is for Pat and on the home center initiatives. Is that something you've looked at trying to get back into and given your experience in real estate --

Jeff, when you say home center, are you talking about the Realogy deal?

No, I'm talking about Home Depot, Lowe's Home Center.

Oh, I'm sorry, I'm sorry.

We -- we think the big box opportunity is out there. And we've done pilots and continued to work on developing that and we think that's something that is a growth opportunity for us. The big boxes tend to move a little slow in -- in -- in how relative to doing things like this. But it's something that we're seeing a good results from, from the pilots we're going in. And -- and we'll continue to build on that.

On the cash flow from operations, I know you talked about historically hitting two times net income, approximately. Is that -- is that what we should be looking at this year and then next year and on?

Again, we've also talked about InStar does have some different cash flow characteristics, especially if it continues to grow in the 30% to 40% range but net net that's going to be very good news. So I think we will be down a little bit this year versus last. But again, still, significantly above our reported net income and with the relationship that is in my view very unique. I don't think you're going to find too many other companies who consistently have cash flow exceeding reported net income by such a wide margin. So less than 2 to 1, yes, but still extraordinarily strong.

And then lastly, in the couple of months since Pat's appointment, have you noticed any --an increase in senior management turnover?

Not a one that I'm aware of, Jeff.

All right. Thank you very much.

I am showing no further questions at this time.

Well, I want to thank you all for your time and your interest in ServiceMaster. And we look forward to talking to you again in a few months. Thank you very much.

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