Terminix Global Holdings Inc (TMX) 2007 Q4 法說會逐字稿

Ladies and gentlemen, welcome to the ServiceMaster Company's 2007 year-end earnings conference call. Today's call is being recorded and broadcast on the Internet. Beginning today's call is Marty Ketelaar, ServiceMaster's Vice President Investor Relations.

Mr. Ketelaar will introduce the other speakers on the call. As a reminder, during the question-and-answer session please limit yourself to one follow-up question. At this time we will begin today's call. Please go ahead Mr. Ketelaar.

Good morning and welcome to ServiceMaster's 2007 year-end investor conference call. Joining me today on today's call is ServiceMaster's Chief Executive Officer Pat Spainhour; and Chief Financial Officer, Steve Martin. We'll make approximately 20 minutes of prepared remarks and then we'll be happy to address your questions during the question and answer session.

Before we begin this morning, I would like to note that throughout today's call management may make forward-looking statements to assist you in understanding the Company's strategies and operating performance. All forward-looking statements are subject to forward-looking statement legend contained in our recently filed 8-K and our annual report on Form 10-K for 2007. These forward-looking statements are not guarantees of performance and are subject to risk factors contained in our 10-K that may cause actual results to vary materially from those contemplated in the forward-looking statements.

As mentioned on March 26, ServiceMaster filed its 10-K as well as an 8-K containing additional financial disclosures that we believe will enhance your understanding of our financial and operating results. Due to the inclusion of purchase accounting adjustments, merger and restructuring expenses, and noncash option and restricted stock expense among others our financial results may be more complex than in past periods. Therefore, we may reference throughout today's call terms such as EBITDA, comparable operating performance, and operating performance. We have included in our 10-K and Form 8-K definitions of these terms as well as relevant reconciliations to the most appropriate GAAP terms in order to better assist you in understanding our financial performance. Our 10-K and 8-K may be accessed by going to the Investor Relations page of our website which is www.servicemaster.com. I would also like to remind you that this call is being recorded by the Company.

Last, many of you from the call receive confidential information as part of the bond offering process in June. The confidentiality agreements you completed to obtain that information remain in place and we request that you refrain from asking any questions related to any confidential information you obtained from the Company. I'll now turn the call over to Pat Spainhour for opening comments. Pat.

Good morning and thank you for joining us on our call today. I'm excited to be back with you to provide an update on our strategy to reinvigorate ServiceMaster by improving efficiency and by bringing to market new ways of delighting our customers through both new and innovative products and a renewed commitment to delivering better systems. I will also spend some time talking about growth. Our efforts to build on the strong market positions of each of our brands. We know that to build a stronger, more profitable Company for the long term we must vigorously seek new ideas and introduce new ways of growing our businesses.

Nine months after being acquired by equity sponsors, led by Clayton Dubilier & Rice we are excited about the relationship that will help us capitalize on the investment made by our new partnership. In a few minutes our Chief Financial Officer Steve Martin will provide you with more details about our financial performance but I will tell you this. Since beginning this journey we have begun working on strategies and initiatives geared toward building a more customer focused, more agile, and more profitable Company. Let me quickly give you a summary of our 2007 results.

For the year ended December 31, 2007, operating revenues were $3.4 billion. If you exclude purchase accounting adjustments and expected declines in revenues due to the restructuring at TruGreen land care our revenues grew about 4%. However, we expect more from our businesses and have several initiatives in the works that are designed to grow our revenues over the long term.

For the year, our operating performance was $497 million which excludes among other things, merger and restructuring related charges, purchase accounting adjustments, and the impact of InStar's discontinued operations. Nine months into our transformation we are pleased with the improvement, but we believe we have only just begun to see the benefit of our program. Operating results showed improvement in all six of our continuing businesses. We have maintained strong cost control measures throughout the Company and we have seen improved customer retention in most of our businesses. For example, TruGreen lawn care improved customer retention by 220 basis points over 2006 levels. Terminix grew termite retention by 10 basis points and American Home Shield improved customer retention by 370 basis points. Steve will walk you through more of the specific financial details in a few moments.

Many of you have inquired how the current weak economy is affecting our businesses. We are in a tough economy and we do expect to see some impact on our businesses. Longer term we believe that our continued focus on improving customer retention, improved customer service and quality initiatives will benefit top and bottom line performance. Also, to help ensure we have a sustainable cost structure for the future, we are continuing the transformation process called fast forward which includes reorganization and restructuring a certain support functions. To date the Fast Forward process has identified a significant portion of our expected savings. As a reminder, once this transformation has been fully implemented we believe that estimated annualized savings of $60 million are achievable. Approximately $9 million of this amount was realized in 2007 with the remainder being fully realized by the end of 2009.

The employee severance and other restructuring costs incurred in 2007 related to Fast Forward were approximately $10 million. With our delayering exercise behind us we are now in the second phase of our transformation efforts. This phase involves the creation of centers of excellence in our corporate function such as finance, information technology, human resources, communications, and strategic sourcing. We have begun evaluating which business processes are candidates for outsourcing. Not every process will be suitable for outsourcing but we believe we can achieve additional efficiencies and savings through strategic partnerships with third parties that deliver corporate services. Our focus is to deliver more consistent processes, implement best practices across all of our businesses, and create a more sustainable cost effective cost structure for the future. By pulling noncore work out of our business units those businesses will be focusing more on our customers so in the future our business units and our branches will be focused on doing whatever it takes to serve the customer while our corporate team in Memphis will be focused on enabling the business units to do just that.

Our management remains heavily invested in our future. Last fall 99% of our senior management team across ServiceMaster invested approximately $20 million of their own money. With a substantial amount of skin in the game, not only does this participation signify support for the Company's strategic direction but it aligns the interests of management with our other stakeholders in making this Company a success.

As disclosed in our 10-K filing last week we announced plans to sell our InStar business. InStar is working hard to bring its business to sustained profitability and to stabilize operations but a heavy reliance on hurricane related activity has made it difficult for InStar to achieve the kind of financial performance we expect from our businesses.

We are continuing to put more resources into customer retention, a key driver of our growth and profitability. In 2007 we saw continued retention improvements in nearly every business unit. We're also converting to a metric called net promoter score that will help us change our relationships with our customers. NPS is based on the answer that customers give to a single question, would you refer our services to someone else?

As we improve the way we serve our customers we are also thinking differently about the way we bring new products to market. We want our associates to be as passionate about growth as we are about profits. To accomplish our growth goals we're working on new products today that we believe will impact our revenue and earnings growth over the next few years. We have previously discussed new initiatives such as our termite inspection protection plan, a new service that's designed to appeal to many of the 64 million nonuser households many of whom we believe have chosen not to purchase the traditional termite treatment because of price. We have also discussed our relationship with [Relegy] at American Home Shield and how it has allowed us to outperform in a slow real estate market by partnering with one of the world's largest real-estate franchisors and affiliating us with some of the world's strongest real estate brands. We see real potential from those initiatives and we are in the process of rolling out initiatives in our other business units that we expect to benefit our performance in the coming years.

As we look ahead I'm optimistic about our long-term future. We'll continue to streamline our operations and identify savings opportunity whenever possible. But long term sustainable growth won't come from just cutting costs and improving processes. It will come from thinking differently about our businesses and working smarter with customers, suppliers, and each other. It will come from tapping into our best and brightest ideas for growing our business.

The transition of our Company headquarters from Downers Grove, Illinois to Memphis is now complete. With that shift we have brought our Company leaders together working shoulder to shoulder in Memphis. That transition and some of the new leadership talent that we've brought on board are reinvigorating our leadership team in helping to drive our transformation. The actions we have taken will transform us to a leaner, more flexible innovative market leading Company led by associates who are determined not only to delight customers but to keep our businesses successful for years to come. All of these things will help us become more competitive as we channel savings into new products and services, innovative ideas and enhanced customer service.

Amid all these changes we've encountered we've stayed focused on our core objectives, to excel with customers, help people develop, and grow profitably while remaining deeply committed to our foundation to honor God in all that we do. By remaining faithful to our values and striving to do the right thing for our associates and our customers we've put ourselves in much better position for the future. I will now turn the call over to Steve Martin who will discuss our financial and operational results in greater detail. Steve.

Thanks, Pat. I appreciate everyone joining us for today's call and also look forward to meeting many of you throughout the year. As Marty mentioned at the beginning of the call, last week we filed our 2007 10-K and we also have filed an 8-K which reconciles our reported GAAP numbers to non-GAAP figures such as adjusted EBITDA and operating performance. Due to a variety of items which resulted from the acquisition led by CD&R, including, among other things, higher interest costs, non-capitalizable merger related expenses, restructuring costs and purchase accounting adjustments, we believe these non-GAAP figures will help you better understand the true operating performance and trends of the Company and our comments today will focus on these performance measures.

Let me turn to 2007 results, for the year, operating revenues totaled $3.4 billion, slightly above 2006 results. However, the 2007 results included approximately $61 million of noncash purchase accounting adjustments to record deferred revenue at Terminix and American Home Shield at its fair value. Excluding these noncash adjustments, revenues would have grown by $85 million, or 2.5%. For 2007, our operating performance from continuing operations as set forth in the 8-K was $497 million compared with $438 million in 2006. The operating performance of InStar, which is now reported as discontinued operations, was a loss of $12 million in 2007 compared with $8 million in 2006. Taken together, we saw an overall increase in operating performance of nearly 9%.

All six of our continuing businesses realized profit improvement over 2006 with particularly strong profit growth at Terminix, TruGreen Lawn Care, American Home Shield, and ServiceMaster Clean. Continued strong increases in customer retention and improved price realization, particularly in our TruGreen lawn care business helped to offset the adverse effects of rising fuel costs, material costs, and healthcare costs, as well as planned reductions in revenues at land care. Cash flow from operating activities of continuing operations was $263 million in 2007 compared to $299 million in the prior year. The decrease in cash flows was primarily attributable to higher restructuring charges of $25 million.

Now let's talk about the segment results. At TruGreen lawn care, revenues grew more than 4% to $1.1 billion, and operating performance grew 9% to $187 million. Growth in revenues and profits were due primarily to improved price realization of about 3.2%. Improved customer retention and price increases more than offset a slight decline in new sales, which was the result of a cold and snowy April during the heart of our selling season last year. The rolling 12-month customer retention rate at lawn care improved 220 basis points to 65.1%. This improvement is the result of our continued focus on improving the customer service experience, enhanced customer communication, lawn quality audits, or LQAs, and lower route manager turnover. During the year we saw an 18% improvement in route manager turnover which, in addition to improved customer retention, also contributes to improved labor productivity.

Turning to TruGreen land care, combined revenues decreased 7% to $412 million and operating performance with $10.4 million compared to $5.6 million a year ago. As we discussed last quarter, the decline in revenues reflect planned changes including the closing and consolidation of certain branches and the pruning of less profitable and unprofitable customers. We expect to see the revenue base of this segment decline in the near term as the full year effect of these changes are realized. However, operating performance has improved despite the lower revenues as a result of the restructuring of this segment's overhead cost and the more profitable customer base. Additionally, there's been a stricter adherence to pricing disciplines in our new sales opportunities and a greater focus on increasing the average size of new sales proposals.

At Terminix, revenues increased about 1.5% to $1.1 billion. Again that includes a $5 million noncash reduction associated with purchase accounting. If you add that back, revenues would have increased by 2%. Operating performance grew by 17% to $194 million, reflecting, among other things, lower material costs, effective management of sales labor, and reduced overhead costs. The increase in revenues at Terminix reflects strong growth in pest control services and gains in termite renewal revenues. Those were offset by 12.5% decline in revenues from new termite completions. This decline was the result of continued softness in demand as we saw continued weak swarm conditions. Pest revenues increased 8% as tuck-in acquisitions more than offset a decrease in new sales. Pest retention rates declined slightly to 78.1% due primarily to the Safeguard acquisition we completed in the fourth quarter of 2006. Termite renewal revenues increased 3.5% due to improved pricing and retention with retention rates increasing 10 basis points to 87.6%.

At American Home Shield, revenue was $541 million, a decline of 4%, but again that figure includes a $55 million noncash reduction related to purchase accounting. And if you add that back, revenues increased nearly 6%. Revenue -- excuse me, rolling 12-month retention rates increased 370 basis points with gains across all sales channels. The improvement in retention rates reflect an effort to improve the customer service experience. Our use of preferred service contractors, props, follow-up measures to ensure customer satisfaction, combined with enhancements to our renewal process, have also contributed to the significant improvement and retention rates.

Unit sales through the real estate channel increased 4.5% despite the pervasive weakness we've all heard about in the home resale market. That growth was driven by exclusive relationship with the Relegy brand. If you excluded Relegy sales, real estate unit sales declined more than 12% would be consistent with the trend of sharply lower home listings and closings throughout most key markets in the country. Although our Relegy relationship will help buffer the impact of the current housing market, we do expect to see a slowdown in unit sales from our real-estate channel.

Operating performance at American Home Shield was $111 million for the year, a 21% increase, primarily driven by three factors. A decrease in contract claims compared to the prior year, increases in contract pricing, and higher service fees per claim.

Last -- last is our other operations segment which includes the results of ServiceMaster clean, Merry Maids, and the Company's headquarters functions and certain enterprise-wide items. For the segment as a whole, revenues were $213 million compared to $196 million a year ago. The revenue increase of 9% resulted from strong increases in product sales and disaster restoration services at ServiceMaster Clean as well as the impact of acquisitions at Merry Maids. Operating performance for the year was a loss of $6 million compared to an income of $2 million a year ago. The decrease in performance reflects personnel overlap expenses associated with headquarters consolidation in Memphis which are not part of restructuring expenses, and favorable trending of prior insurance reserves. Compared to 2007. These items were partially offset by improved profitability at ServiceMaster Clean and Merry Maids.

As Pat mentioned earlier, during the fourth quarter we concluded that InStar, our disaster response and reconstruction business, no longer fits within the long-term strategy of ServiceMaster, and management has decided to sell that business. As a result of this decision, InStar is now shown as a discontinued operation for all periods presented in our financial statements instead of including it with our other operations segment. In conjunction with this decision, an $18 million asset impairment charge was recorded as well as a $13 million goodwill impairment charge. We are pleased with the initial level of interest from outside parties and will provide you with additional details as appropriate.

In summary, we've seen several positive developments during the year. We've been very pleased with the focus and resiliency of our teams as the Company goes through considerable change. We've been able to effectively overcome many external challenges we faced during the year and we remain focused on our operating goals in 2008 and beyond. That concludes my prepared remarks. At this time we would be happy to take your questions.

Thank you. (OPERATOR INSTRUCTIONS) Our first question comes from the line of Yilma Abebe with JPMorgan. Please proceed with your question.

Thank you. A few questions from me. In looking at contract renewals in your TruGreen businesses, I believe you sent out contract renewals sometime around the end of the year, what's the trend that you're getting so far? Is it in line with expectations? More so? Less so?

That applies to the first quarter and we're really not addressing the first quarter. We'll make some general comments about it, but the focus of our questions today should be on 2007 results.

Are you comfortable anecdotally in talking about what you're seeing in the overall business environment? Are you seeing any pullback from consumers? Can you address that broadly?

Well, when you look at our businesses, as we start our year up, we're just now in the beginning phases of our sales and getting in production here in the next several weeks here. So in our case, it's kind of too early to really have any overall evaluations about how we see it. 60 days, 70 days from now we'll be very smart about what the environmental situations, both the economy as well as the drought and other things, how they're impacting our start-up for this new year. But we're just now -- Tom Brackett, who is President of Terminix, would say give me to the end of the month before I can tell you anything about Swarm or about any uptick in business or any concern about the business. We're just not there yet in this season.

And historically, at what point in the year do you normally pass on price increases? Is that done around the beginning of the year around this time also?

I'll address that, Pat. It really is a continuous process, so we do, at the beginning of the year, update our pricing list, and that is -- those lists will reflect price increases for different segments, and then as the year progresses, at various points in the year we evaluate it and make decisions as we go along.

Okay, thanks. My other question, related to this $60 million of of cost saves you expect to realize, did I miss that? How much have you realized so far the fourth quarter?

We didn't put that out. What we said was we fully expect to be on the target that we teed up, the $60 million, fully accounted for by the end of fiscal '09. So it's a process started after midyear last year, continues this year, and we'll complete those initial things and be on our target of $60 million in fiscal '09.

Thanks. That's it for me.

Our next question--.

Sorry.

Our next question comes from the line of [Anton Koloski] with [Canon Capital]. Please proceed with your question.

Hey, guys. My first question is, on the key performance indicators that you went over and you put in the 10-K, can you go over what it was for the fourth quarter of '07 versus the fourth quarter of '06? Like what's the growth in accounts and the customer retention rates?

We always report that at the end of the period. So the growth at the end of the year is the same as the growth at the end of the fourth quarter. And we always report a rolling 12 month retention rate, so that--.

What I'm trying to get at, is in the fourth quarter, was there any kind of decline at all? The fourth quarter, was it trending up, or was it trending down?

In terms of the actual measurements that are in the 10-K, I mean our -- we had an extremely good year last year, and it actually built during the year, and without looking at the details in front of me on that 10-K compared to last year, I would probably say it was at least flat to slightly up over the fourth quarter of the prior year simply because the trend for the whole year in all of our businesses was the build in performance over the course of the year.

Another question that I had was on hedging LIBOR. Are you guys looking to hedge the rest of the floating rate in the next couple of quarters here?

We're going to continue to evaluate that. As you saw in the 10-K. We did place interest rate swaps in February. We'll continue to evaluate that as we go along and make decisions based on market conditions as we see them as we go.

So no more hedges are in place since the 10-K?

That is correct.

Okay. Thanks.

Our next question comes from the line of [Joe McFadden] with Aberdeen. Please proceed with your question.

Hi there. The 10-K states that you expect to pay about $50 million to acquire assets in connection with exiting certain of your fleet leases. Can you walk me through how this is going to be recorded in the 2008 financial statements?

You broke up on me a little bit there. Could you repeat that question?

Sure. The 10-K states you expect to pay about $50 million to acquire assets in connection with exiting certain of your fleet leases.

Yes.

Is -- I'm just curious how this is going to be recorded in the financial statements. Is there going to be -- is the $50 million going to show up as additional CapEx?

Yes, it really -- ultimately, it will depend on the final approach we take on that. If it is simple transaction of buying the assets, it will be a capital transaction that shows up as assets on the balance sheet. If it's a -- rolled into a different lease it would continue as an operating lease, and that is something we are evaluating different options for right now.

So potentially, you state that CapEx for the year is going to be in the range of 45 million to $55 million. So exiting these fleet leases, should I add that to -- should I add that $50 million of exiting the fleet leases to the 45 million to $55 million to get a true CapEx number?

Well, as I was saying, we haven't concluded on the final nature of that transaction, so it's premature to say go add it in. On the other hand, that 40 million to $50 million of annual capital expenditures does not include that type of transaction.

Okay. So you do have the option of just rolling this into another lease.

We're evaluating options to do that. Don't yet know if that's going to play out that way or not.

Okay. And franchise related profits jumped to 32% of operating income in '07 versus 16% in '06 and 14% in '05. What caused that jump last year?

You really have to look at it that way. Did you say it jumped to 30% of operating income?

According to the 10-K, franchise related profits jumped to 32% of total operating income, and that was just -- compares to the previous two years of 16% and 14%. So it was a larger proportion of total operating income. I was just curious what was the cause for that?

Tell you what, if you don't mind, let us take a look at that because I'm not real sure the numbers that you're using for your calculations is in sync with what we're showing. If you don't mind having Marty Ketelaar follow-up with you on that and just go through those components.

Okay. Thanks for your help. Sure.

(OPERATOR INSTRUCTIONS) Our next question comes from the line of [Brian Banes] with Fortis. Please proceed with your question.

Quick question about purchase accounting adjustments. You guys in your notes in the 10-K talk about revenue declining by about $60 million and expenses declining by about $54 million, which looks like it would be roughly a $6 million decrease to comparable operating performance. But then if I look at the notes, in your segment notes in the K, you are saying that in aggregate that adds up to about 16 million or $17 million increase to operating performance. Can you maybe explain the discrepancy there for me?

Well, I am going to give you a general answer, and then I'm going to refer to you Marty as well for some detail, because there were a number of individual components, individual purchase accounting adjustments. Some of those are the ones spelled out there, the revenues primarily deferred revenue, as well as deferred customer acquisition costs. But we had some other items flowing through, including our deferred seasonal costs. We had fixed asset depreciation. We had some other debt issuance costs and interest expense adjustments related to marking the debt to fair market value, so there's a lot of individual pieces to that to get you to the $16 million in the 10-K.

Okay. All right. I'll follow one Marty off-line then. Just one more follow-up question. You're talking about selling the InStar business. Do you guys have a plan for what you might do with the sales proceeds?

We'll evaluate it. Obviously, depending on the amount of the proceeds, along with our other cash needs and overall management of the balance sheet.

Okay. Great. Thank you.

Mr. Spainhour, there are no further questions at this time. I will turn the call back to you.

Well, thank you all for joining us today, and we appreciate the questions that we have. We appreciate your interest, and we look forward to the first quarter call.

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. Have a great day, everyone.