Terminix Global Holdings Inc (TMX) 2008 Q2 法說會逐字稿

Ladies and gentlemen, welcome to the ServiceMaster Company's second quarter 2008 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 of Investor Relations and Assistant Treasurer. 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.

Thank you. Good morning and welcome to ServiceMaster's second quarter 2008 earnings conference call. Joining me today for today's call is ServiceMaster's Chief Executive Officer Pat Spainhour, Chief Financial Officer Steve Martin, Treasurer Mark Peterson, and Controller David Martin. We will make some prepared remarks and then we will be happy to address your questions during the question-and-answer session.

Before we begin this morning I would like to remind you 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 the forward-looking statement legend contained in our recently filed Form 10-Q and Form 8-K. These forward-looking statements are not guarantees of performance and are subject to risk factors contained in our public filings that may cause actual results to vary materially from those contemplated in the forward-looking statements.

On August 14, ServiceMaster filed a Form 10-Q 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 non-cash option and restricted stock expense, among others, or financial results may be more complex than in past periods. Therefore, we may refer throughout today's call to terms such as EBITDA, comparable operating performance, and operating performance.

We have included in our 10-Q and Form 8-K the 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-Q and 8-K may be accessed by going to the Investor Relations page of our website which is www.ServiceMaster.com. I would like to remind you that this call is being recorded by the Company.

During the question-and-answer session we encourage you to ask any question that you may have. Due to our disclosure policy, we are limited in our ability to hold follow-up conversations with our public side investors and as such we request that you please ask any question during this public forum.

Last, many of you received confidential information as part of the bond offering process in June 2007. The confidentiality agreements that you obtained contain information -- that information remains in place and we request that you refrain from asking any questions related to confidential information that you obtained at that time. I will now turn the call over to Pat Spainhour for opening comments. Pat?

Good morning, everyone, and thanks for joining us today. As you have seen in our 10-Q that we filed last week, our second-quarter performance held up well in the face of some stiff challenges in the US economy. A cooler and wetter than expected spring, rising fuel and commodity prices, and the housing market affected some of our businesses during the second quarter. But overall, our year-over-year revenue results were comparable to 2007 and we are aggressively working on plans to try to manage through the current economy in the second half of the year.

In a few minutes, Steve Martin will provide you with more details about our second-quarter financial performance and the marketplace conditions that we are experiencing. But first let me give you a brief summary of our second quarter 2008 results. Through June 30 the Company reported second-quarter revenues of $997 million. That is down slightly from 2007, but not totally unexpected considering the current economy and our planned reductions at TruGreen LandCare.

Like many companies, we have been watching closely as the slower consumer spending further dampened by the sluggish real estate market contributed to lower than expected revenue results. Despite the economic headwinds, our customer account levels in termite, pest control, and home warranty businesses remain above prior-year levels.

With increased emphasis on improving service in the overall customer experience, we have been able to keep our retention rates in lawn care and pest control essentially flat with 2007 results. Customer retention rates in our termite and home warranty businesses actually are up over 2007 and in one of the toughest housing markets in years we continue to benefit from our relationship with realty.

Last month marked the first anniversary of our acquisition led CD&R and now a full year into our transformation we are on track with our cost savings goals to deliver $60 million in annualized savings by the end of 2009. The first phase of our fast-forward initiative is substantially complete and focused on rightsizing the organization and reducing layers of bureaucracy that were slowing us down.

The second phase of this initiative is now well underway. We continue to comprehensively evaluate our functional business processes for outsourcing and process reengineering opportunities. Specifically, we are reviewing our information technology, finance, and strategic sourcing functions. Working toward a common IT infrastructure and standardized procurement practices, as examples, are just common sense approaches for a company of our size.

In each business we will be making a step-by-step analysis to ensure that we choose the best solution for our company and for our customers. But there was no cookie-cutter approach here. In some cases we will make an investment and reengineer the work in-house using our own internal experts to develop a better way of working. In other cases, we may find that outsourcing to a third party is a better answer. We are committed to a prudent approach that will create a new ServiceMaster, a great company made up of many great brands that operates more efficiently and cost effectively than ever before.

Creating synergies across the Company will help unlock the true potential of our brands to focus on future growth. With the collective input of customers, associates, and selected third-party advisers we plan to build on the strong market-leading positions of each of our brands., increase market share, and pursue the strategies that will drive both top-line and bottom-line growth.

Customer retention continues to be a linchpin to our future revenue growth and profitability. To help us develop and execute our growth strategy we recently hired Jim Kunihiro as our new Senior Vice President of Corporate Strategy and Marketing.

Jim comes to us with a terrific history, a history of experience in leading and developing competitive marketing strategies most recently a Culligan International and previously at PepsiCo and Bain Consulting. Jim's background will specifically help us as we continue to transform ServiceMaster into an organization that satisfies customers at every touch point.

I also want to let you know that Dennis Sutton, President of TruGreen Lawn Care, is leaving the company effective September 9. While we search for Dennis's replacement, I will assume the responsibility for TruGreen's operations. For over 30 years, Dennis has held numerous management positions and he has been very instrumental in TruGreen growing its annual sales to more than $1 billion. We thank Dennis for his years of service and wish him the very best in the future.

To execute our transformational strategy we will be relying on the continued support and dedication of our associates and a commitment to our one company strategy. ServiceMaster is a great company with many great brands, but as we have worked to improve our performance we have come to realize that our path to long-term growth rests on what we are calling a one company strategy.

What that basically says is we are a company made up of many great brands and we are going to do everything we possibly -- we can possibly do to protect the integrity of each unique brand's promise to our customers. But while protecting each brand's uniqueness, we also are learning that our operations have many similarities. With that in mind, we are going to add to the value of the Company through standardization and consolidation wherever we can.

We are going to leverage technology, our people, and our processes as much as possible. We are going to identify ways for our business units and our people to work more effectively together across the different brands, always in the best interest of the total ServiceMaster company.

As we have said before, at the heart of our company is a commitment to our core objectives to help people develop, excel with customers, and to grow profitably while remaining faithful to our foundation to honor God in all that we do. By remaining faithful to our values and striving to always do the right thing for our customers and our associates, we will be in an excellent position to succeed in the future.

I will now turn the call over to Steve Martin who will discuss our financial and operational results in greater detail.

Thanks, Pat. As Marty mentioned at the beginning of the call, last week we filed our second quarter 10-Q and we also filed our 8-K, which furnishes reconciliations of our reported GAAP numbers to non-GAAP figures such as adjusted EBITDA and operating performance. We believe these non-GAAP measures will help you better understand the operating performance and trends of the Company. Our comments today will primarily focus on these non-GAAP performance measures.

Let me now turn to our results. For the second quarter, operating revenues totaled $997 million compared to $1.009 billion a year ago. The second quarter results included approximately $12 million of non-cash adjustments resulting from recording deferred revenue at its fair value in connection with purchase accounting. Excluding this purchase accounting adjustment, revenues in the second quarter of 2008 were comparable with second quarter levels.

Our second-quarter operating performance, as set forth in the 8-K, increased 6% to $190 million compared with $179 million a year ago. Increases in customer retention and improved price realization helped to offset the adverse effects of rising fuel costs, material, and other factor costs. Additionally, improved segment results and lower merger and restructuring related costs contributed to the improved -- the improvement in operating performance.

Cash flow provided by operating activities of continuing operations was $13.9 million in the first six months of 2008 compared to $136.7 million a year ago. The decrease in cash flows was primarily attributable to higher interest payments and restructuring payments. Last month, we successfully converted our interim bridge loan into bond structure maturing in July 2015. The new note bears fixed interest at 10.75% on a semiannual basis and completes the last required step in firming up our capital structure.

Moving now to the second quarter segment results. At TruGreen Lawn Care revenues grew slightly to $377 million, primarily due to improved price realization offset by lower customer counts. New sales and the rolling retention rate declined by 10 basis points each resulting in a 2% decline in customer accounts compared to 2007.

New sales at Lawn Care have been negatively impacted by cold and rainy weather in the spring, as well as the overall slowdown in the economy. As Pat discussed earlier, we have a great deal of focus on customer retention and have several initiatives underway to help ensure we improve our customer service every time we make contact with our customers.

Operating performance was $75.4 million compared with $76.6 million a year ago. The lower results are a direct reflection of increased fuel and fertilizer cost, primarily offset by lower overhead spending.

Turning to TruGreen LandCare, operating revenues decreased 25% to $83.9 million, while operating performance improved to $600,000 compared to a loss of $700,000 a year ago. As we have discussed for the past several quarters, the decline in LandCare revenues includes planned changes such as the closing and consolidation of certain branches and the pruning of less profitable and unprofitable customers. We expect the effect of these changes to continue for the near term.

For the past couple of quarters, we are now seeing improved profit results despite the lower revenues due to the restructuring of this segment's cost structure and the shift to more profitable customer base. Longer term, we expect to show margin improvement at LandCare by improving the customer mix, including larger average job sizes and new pricing guidelines on sales, in addition to better branch manager training and selection, and increased customer retention efforts.

At Terminix, revenues were $312 million, essentially flat with second quarter of 2007 and includes a $1 million reduction in revenues due to purchase accounting adjustments. These results reflect growth of 2.3% in pest-control revenues and a 2.9% increase in termite renewal revenues offset by a 3.3% decrease in termite completion revenue. Termite completion revenue was lower as reduced termite swarm activity negatively impacted demand for termite completion services and due to reduced average pricing on new termite treatments.

Operating performance and grew nearly 9% to $73.5 million reflecting, among other things, lower termite material costs, sales and production labor, vehicle fleet counts, and overhead costs. This was partially offset by higher fuel costs.

Retention rates continue to show good results at Terminix. Pest retention rates declined slightly to 78.5%, due primarily to the impact of new sales declines. Termite retention rates increased 50 basis points due to improved customer counts as it relates to the termite inspection and protection plan program with retention rates growing to 88.1%.

At American Home Shield, revenues grew more than 7% to $168 million including a purchase price, or excuse me, a purchase accounting adjustment of $10.6 million. Excluding this purchase accounting adjustment, revenues grew more than 14% compared to 2007 results. This increase was largely due to timing as AHS saw a higher percentage of its annual contract claims occur in the second quarter of 2008 versus 2007.

Since American Home Shield recognizes revenues over the contract period in proportion to expected direct costs, this resulted in an increase of approximately $15 million of revenue being recognized in the second quarter of which approximately $10 million was accelerated from the second half of 2008. Total new contract sales and renewal units were consistent with second quarter 2007 results. Unit sales from customer renewals increased nearly 6% reflecting a growing renewable base of customers and improved customer retention.

Operating performance for the quarter was $36.9 million, which was comparable to the $37 million a year ago, primarily due to the higher revenues recognized during the quarter resulting from the higher claim cost, the implementation and pricing increases, as well as the increases in the service fee per claim offset by a $12 million decrease in interest and net investment income.

Unit sales through the real estate channel declined 15.9% in the second quarter reflecting the continued softness in the home resale market throughout most of the country. Although our realty relationship has helped buffer the negative impact of the current housing market, we did see a slowdown in unit sales from our real estate channel.

At the other operations segment, which includes the results of ServiceMaster Clean, Merry Maids, and the Company's headquarters functions, revenues grew 6.1% to $57 million compared to $54 million a year ago, primarily reflecting growth in franchise revenues at ServiceMaster Clean and company-owned branch revenues at Merry Maids. Operating performance for the segment totaled $3.5 million compared to a loss of $1.1 million last year. The improvement in operating performance primarily reflects improved performance at ServiceMaster Clean and Merry Maids and lower functional costs.

Despite the continuing challenges we are seeing in the general economy and the housing market, we delivered solid results during the quarter. Based on the latest available public data, we expect high commodity prices, most notably fuel and fertilizer, to present a challenge for the remainder of the year. However, the management team and associates at ServiceMaster will remain focused on those initiatives that will create and deliver long-term value. I look forward to providing you an update on our progress later this fall when we report our third-quarter results.

That concludes my prepared remarks. At this time we would be happy to take your questions.

(Operator Instructions) Emily Shanks, Lehman Brothers.

Hi, good afternoon. This is actually Jason Trujillo in place of Emily. My question relates to the loan facility that matured here in July. Is there any indication from the purchaser what that might be -- whether that is going to be renewed at some point or not? Or is that completely closed now?

I am sorry. Could you repeat your question, please?

Sure. Regarding the loan facility that matured in July, is there any chance that that can be renewed or is that closed now, now that it has turned into permanent notes?

Okay, you are talking about the bridge loan, the interim loan?

Yes.

Yes, that did convert to permanent notes in July.

Okay.

So the facility is no longer available. The bridge is no longer available to us. We have got our permanent financing now.

Great. Just wanted to clarify that. Thank you very much.

Joe McFadden, Aberdeen Asset Management.

Hi there. The leases that were terminating this month, have you acquired those assets yet?

You are talking about the lease that is being put back to us --

Yes.

That has not yet taken place. That will happen by the end of the month, however.

What is the -- how do you intend to finance the purchase of those assets?

We intend to use cash we currently have available from operations.

Okay, thank you.

(Operator Instructions). [Brian Hilco], Commercial and Industrial Finance.

Hi, good afternoon or good morning. You mentioned that at American Home Shield that claims were higher for the period and that resulted in higher revenues. Can you just clarify for us how you know that higher claims in this quarter will result in lower claims for future quarters?

What we do and have always done at American Home Shield is look at historical trends and historical averages of our claims. We look at them on the season, so in the summertime primarily we look at the cooling season, which is the air-conditioning claims fall. Those claims do tend to fall at different points in that season.

Last year we had a significant proportion fall in the month of August. This year they tended to fall primarily in June or much more so in June, I should say. That, as we look at the trends, that led us to expect that the claims for the whole season would play out as we had expected and based on historical trends. But it was a timing item from later in the season to earlier in the season.

Given that we are two-thirds of the way through August is that assumption holding up?

We still feel good about our conclusion.

Thanks. My second question, you mentioned improved price realization at TruGreen. Were those price increases present for all of Q2 or are the price increases still being rolled out?

They are still in the process. I don't think we got them fully rolled out by the end of Q2, so that occurs over the season. We -- so that is still taking place.

Thanks very much.

[Aaron Marsh], Duquesne Capital.

Yes, hi. I was a wondering if you could talk a little bit about the competitive dynamic in the lawn care business? Scotts had mentioned that their retention rates declined a couple hundred basis points in their last quarter and, obviously, they have done a great job there. Can you maybe talk about that dynamic a bit?

Well, first of all on retention, let me just talk about it and Pat can chime in. That is an area that we have been focusing on for quite a while with long quality audits and other retention efforts that we have enumerated in the past. And that we are pleased with and we feel like it's helping keep our retention rates up and in the climate that we face.

As far as the competitive landscape, you know there are a lot of competitors out there, most of which are independents from market to market. You know, they are all lots of good competitors out there and we see opportunity with our business by focusing on these retention efforts. That is where our focus is.

Thanks.

Ed Russell, New York Life.

Hi, just a couple of quick questions. As far as your cash flow from operating activities on page 36 of the Q, you had noted a $52 million increase in working capital requirements. You broke it down into a couple of different categories. Could you break that down a little bit further or quantify that as far as advertising payments that were paid in advance?

Yes, the higher use of working capital was due to three items primarily -- a shift in the timing of advertising payments, increased seasonal inventory growth, and a big item is the increased tax assets reflecting the impact of future tax deductions related to the Company's net operating loss carryforwards generated in 2008.

Okay. So that was the lion's share was in the tax portion?

Yes, that was a big item in the tax line.

Okay, great. Also on your financing of this lease that is being put back to you, cash flow from operations, I guess at least according to our calculations, may not be able to cover the whole thing. Would you be using the proceeds from some of your divestitures possibly to pay that note?

Yes, I mean that is obviously a source. We will be using cash from the divestiture as available for working capital purposes, as well as cash generated to-date from operations.

Great and can you comment out all on the movement of some of those divestitures at this point?

I can tell you that with respect to our InStar business the transaction to sell that business did close yesterday.

Oh good, congratulations.

Thank you very much. The team worked very hard on that. The buyer was an affiliate of BlackEagle Partners LLC. The agreed-upon price was approximately $22.5 million, of which $3 million was in the form of a deferred payment that we will receive in approximately 39 months.

All right, great. Thank you.

Emily Shanks, Lehman Brothers.

Hello, just one quick follow-up. On the AR facility that matures, I guess in July -- July 17 -- or has matured, has that been renewed yet?

Yes, it has been renewed.

Okay, great. Thank you very much.

Mr. Ketelaar, there are no further questions at this time. I will now turn the conference -- actually, we just had one queue up and it comes from the line of [Dale Store] from Angelo Gordon.

A question for you, I want to go back to American Home Shield. The revenue that was moved forward into the second half, you said that was $10 million of the $15 million, correct?

That is correct.

The costs associated with that revenue were moved forward as well?

That is correct. That is correct.

So I guess, what did the business look like year-over-year if you stripped out the reduction related to investment and interest income on a margin basis? Was it consistent or were there factors that are driving it one way or the other?

Well, the dollar amounts for the investment activity are set forth in the filing, both the 8-K and the 10-Q. Overall, the margins are up slightly but substantially consistent with the margins we have been experiencing in the business.

Okay. Nothing associated with this move forward would really have had an impact on the margins, I guess, is what I am getting at.

That is correct. That is correct.

Okay, thank you very much.

Oliver Corlett, R.W. Pressprich.

Good morning and thanks for taking my call. I am just following up on that AHS, if one were to try and model revenues going forward and just took a sort of naive approach of same percent increase for the following quarters, would that be justifiable based on that accounting? Do you see what I am saying?

Well, as you know, Oliver, we really don't give forward-looking guidance.

Right, no, I understand that. But if your model was that you were just going to extrapolate that percentage change versus last year, I would say for the first six months. Would that -- the accounting treatment on AHS distort that model going forward? In other words is it taking revenues from future quarters? Is it taking -- is the second quarter taking revenues from the first quarter? I don't quite get how that works.

We tried to give you sufficient information here and as -- responding to the last question, it really doesn't impact margins of the business.

No, I understand that. I am just talking about revenues here.

Yes, and so it is moving $10 million out of the back half into the second quarter.

Okay, I see. Now on CapEx, do you have any kind of change in your strategy either on CapEx or acquisitions for the year? Are you likely to be roughly at historical levels? Have you cut back on CapEx? What is your attitude towards that?

No change of significance there. You know timing does fluctuate a little bit, but fundamentally same strategy and same levels as you have historically seen.

Okay. Can you give some idea of what your maintenance CapEx level is?

We have been incurring roughly $50 million a year.

Right. I think there is a disclosure in the Q that we -- over the last several years we have run between $40 million and $50 million of CapEx.

Right, but what level of that is for maintenance and what level is for growth?

I don't think we have -- we haven't split that out, Oliver.

Okay, thanks. On the lease that is being put back to you, how much is that?

It is roughly $50 million.

$50 million, okay. Finally, just on the -- you always usually point it out in your Q how much of your cash and securities are related to AHS. Is that a discretionary number on your part? Or how much of that cash is actually restricted for regulatory reasons or any other reason and how much is sort of your choice?

Yes, the amount we disclose that is -- does have restrictions is set forth in the Q. It's $358 million, I believe is the amount set forth. We are currently evaluating opportunities to free up reserves that have been historically required by the various state regulatory agencies. So we hope to be able to give you some better information on that in future calls.

Great. Thank you and congratulations on a good performance, given the conditions.

Thank you very much.

[Dayton Judd], [Q Investments].

Hey, just noticed in the Q you guys hedged some more on the interest rate. My calculations put it right around 35%, 36% hedged. Can you talk a bit about how you feel with regard to that? Is that a level you guys are comfortable with or would you consider locking in more given where long-term rates are?

We are continuing to monitor that and watch it very closely. We are comfortable with where we are, but at the same time we continue to look at possibilities to add to it, if the rates are at the right level for us.

Okay, thank you very much.

We have no further questions at this time. I will now turn the conference back to you.

Okay. Well, thanks everybody for participating. We appreciate the questions and we look forward to talking with you next quarter. Thanks.

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 rest of the day, everyone.