Terminix Global Holdings Inc (TMX) 2008 Q3 法說會逐字稿

Ladies and Gentlemen, welcome to the ServiceMaster Company third quarter 2008 earnings Conference Call. (OPERATOR INSTRUCTIONS)

Mr. Ketalaar 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. Please go ahead.

Thanks, Jose. Good morning and welcome to ServiceMaster's third quarter 2008 earnings Conference Call. Joining me for today's call are ServiceMaster's Chief Executive Officer, Pat Spainhour, Chief Financial Officer, Steve Martin, Treasurer Mark Peterson and Controller David Martin. We'll make some prepared remarks and then be happy to address your questions during the question and answer session.

Before we begin this morning, I'd 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 legends contained in our recently filed form 10-Q, and our form 8-K. These forward-looking statements are not guarantees performance 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 November 14, ServiceMaster filed it's 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, our financial results may be more complex than in periods that ended prior to completion of our merger transaction on July 24, 2007. Therefore, we may reference throughout today's call, terms such as adjusted EBITDA, comparable operating performance, and operating performance.

We have included in our 10-Q 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-Q 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. During the question and answer session we encourage you to ask any questions that you may have. Due to our disclosure policy we're limited in our ability to hold follow-up conversations with our public side investors, and as such, we request that you please ask the questions 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 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, everyone and happy Thanksgiving. Thanks for joining us today. I know many of you have been watching closely as negative economic news rolls in on a daily, sometimes hourly basis. We're not immune to the effects of the economy, as you seen in our 10-Q that we recently filed. Our third quarter performance held up fairly well, despite these economic challenges. Our year-over-year operating revenues were up slightly by 0.5% and operating performance is up nearly 7%.

In a few minutes our CFO, Steve Martin, will provide you with more analysis about our third quarter financial performance, and an overview of the effect that the economy is having on our business. But first let me give you a brief summary. In the third quarter, the Company reported operating revenues of $948 million, which is slightly ahead of 2007, even after taking into account our planned reductions at TruGreen LandCare. Like many Company's we've been keeping an eye on the economy for its effects on the customers, franchisees and suppliers. We've been watching the slowdown in consumer spending as significant drop in the real estate market and housing prices, tightening credit and fluctuations in material cost. In the face of all of these economic forces we've been carefully managing our businesses from both the short-term and long term.

Despite the challenges, the number of customer counts and lawn care grew in the third quarter over the same period in 2007, as a result of some late season sales initiatives we've been testing. With the departure in September of Dennis Hutton as TruGreen LawnCare's President, I've taken over as President on an interim basis while we conduct a national search for his replacement. And I'll look forward to sharing an announcement some time after the first of the year. Meanwhile, during this interim period we're putting heavy emphasis on standardization process with excellence in TruGeen to achieve the best possible customer experience, regardless of which of our 200 plus branches is providing the service.

Overall, despite some of the toughest economic conditions we've seen in years through September 30th, customer retention rates remain on par with 2007. That's an early indication of the investments we've made in improving service and the overall customer experience. The housing market continues to show weakness and is impacting our sales to the real estate channel at American Home Shield. However, our relationship with Realogy has continued to provide a buffer, and fortunately our exposure to the home sales process and termite business is less than 3% of Terminix's total revenues.

Mother Nature actually boosted our performance in the third quarter. Air-conditioning work orders, the largest part of our home warranty business fell in the third quarter, due to cooler than usual weather. The succession of severe summer hurricanes, Fay, Gustav and Ike, coupled with strong partnerships with major insurance company's, generates some additional business opportunities at ServiceMaster Cleans disaster restoration business.

One of the positive effects of the economy for us, is that it's opened the door for additional tuck-in acquisitions. We found a number of smaller local and regional players in lawn care, pest, and termite who are now more willing to sell their businesses. For competitive reasons, we won't discuss the details around those acquisitions but the pipeline of transactions continues to be strong. Our strong cash position and our ability to generate positive cash flows, give us the ability to pursue these tuck- in acquisitions and expand our footprint in key regions of the country. However, the current economic environment has lead us to carefully manage our liquidity and review each potential acquisition to insure its smart use of our capital.

While the revenue side has been somewhat slowed by the economy, particularly as it relates to new customers, we can help top line growth by simply retaining more of our existing customers. We also continue to make significant progress on our cost structure. We're on track to deliver at least $60 million in annualized savings by the end of 2009. This is being achieved through consolidation of some functions and the simplification, standardization and outsourcing of internal processes. We believe these initiatives provide a solid platform on which to create the new ServiceMaster, a Company that's built to perform for the long term.

We're nearing the conclusion of some key decisions regarding business process outsourcing and re-engineering of our information technology function, including defining the scope of work and defining contract specific terms and conditions. Moving toward a common IT infrastructure and standardized procurement practices, for example, are just common sense approaches for a Company of our size and reach. We hope to make a more definitive announcement on these efforts before the end of the year.

Last, we've identified significant potential savings through improvements in our strategic sourcing practices and negotiations with key suppliers. We've brought on board a new sourcing leader, Dell Crouse, to help evaluate these opportunities and execute a company-wide procurement strategy that leverages our size and volume. The slowing economy should give us negotiated window to sign multi-year agreements with suppliers and like and more favorable prices.

While the pace of our growth has been slowed somewhat by the economy, we're vigorously working toward the vision of the new ServiceMaster, a great Company made up of many great brands. To achieve that vision, we'll be relying on the continued support and dedication of our associates, and their committment to our one Company strategy. Part of that one Company promise is to operate more efficiently and cost effectively than ever before, while preserving the strength and integrity of each brand. Our new Senior Vice President of continuous improvement, Reggie Crenshaw will head up our efforts to maximize operational efficiencies across the Company.

As I said before, we're going to add to the value of the Company through standardization and consolidation wherever we can. We're going to leverage technology, our people and our processes as much as possible. We're going to identify ways of our businesses and our people to work more effectively together, across the different brands, always in the best interest of the total ServiceMaster Company. At the core of our business strategy is our committment to our corporate objectives, help people develop, excel with customers and grow profitably, while remaining rooted in our foundation to honor God in all that we do. Especially in a tough economy, it's critical that all of our associates understand that our Company success comes only by remaining faithful to our values, and doing the right thing for our customers and our associates.

We're in a strong position to succeed in the future, and I'm looking forward to sharing our 2008 year-end results with you when we get together again in 2009. And now I'll turn the call over to Steve Martin who will discuss our financial and operational results in great detail.

Thanks, Pat, and hello, everyone. I too am very pleased with all of the progress we have made to date, and I'm optimistic about the future at ServiceMaster. As Marty mentioned at the beginning of the call, earlier this month, we filed our third quarter 10-Q and associated 8-K, which furnishes reconciliations of our reported GAAP numbers to non-GAAP figures. We believe these non-GAAP measures will help you better understand the operating performance and trends of the Company. And our comments today will primarily focus on these non-GAAP performance measures. And let me turn to our results.

For the third quarter, operating revenues totaled $948 million compared to $943 million a year ago. Now last year's third quarter results included $31 million of non-cash adjustments, resulting from recording deferred revenue at its fair value, in connection with purchase accounting versus a $1 million impact in 2008. Excluding this purchase accounting adjustment, revenues in the third quarter of 2008 decreased 2.5% or approximately $25 million when compared to the third quarter levels of 2007.

Third quarter operating performance as set fourth in the 8-K, increased 6.8% to $169 million compared to $158 million a year ago. Improved segment results including continued increases in customer retention and improved price realization helped to partially offset the adverse effects of rising fuel costs, fertilizer, and other factor costs throughout the Company. I'll have additional comments on segment results in just a moment. Cash flow provided by operating activities from continuing operations was $52 million in the first nine months of 2008, compared to $229 million a year ago. This decrease in cash flows was primarily attributable to higher interest payments, restructuring payments and changing control severance payments related to the merger.

As we reported in an 8-K, as well as our recently filed 10-Q , we borrowed $165 million under our revolving credit facility, as well as $10 million under our accounts receivable facility to increase the companies cash position to preserve our financial flexibility, given the uncertainty in the credit Markets. Although there was no need to draw the funds from an operating cash flow perspective, and these funds continue to be fully invested in short-term US government securities in similar investment vehicles, we felt this was a prudent step considering the uncertainty surrounding many banks and financial institutions. Our intention is to pay down the revolver when the financial and credit markets return to more normalized conditions. However, no specific timetable has been set for the repayment of either borrowing at this point.

Moving now to third quarter segment results. At TruGreen LawnCare, revenues grew slightly to $364 million compared to $362 million in 2007, primarily due to improved price realization and higher customer counts. New sales increased 34% during the quarter and the rolling retention rate increased by 70 basis points, resulting in a 1.3% increase in customer counts compared to 2007. New sales at LawnCare have been positively impacted by an increased focus on selling full lawn programs during the quarter, while in previous years our focus has been on selling partial programs, as well as expanded services during our non-peak season. And we are very pleased with the results we have seen so far.

Customer retention and the quality of our service delivery continued to be the major strategic initiatives at LawnCare to insure we improve our customer service and communication every time we make contact with our customers. Operating performance increased 2.6% to $83.8 million compared to $81.7 million a year ago. These improved results are due to higher revenues and lower overhead spending in the quarter, partially offset by increased fuel and fertilizer costs.

Turning to TruGreen LandCare, operating revenues decreased 24% to $78.4 million, while operating performance improved slightly to $2.3 million compared to $1.4 million a year ago. As we have discussed for the past several quarters, the decline in LandCare revenues, includes planned changes such as the closing or consolidation of certain branches in 2007, and the pruning of less profitable and unprofitable customers. Additionally, we've had to make some changes to our salesforce as we are now targeting larger commercial accounts. On a positive note, we are now seeing consistently improved profit margins, despite the lower revenues due to the restructuring of this segments cost structure and the shift to a more profitable customer base.

At Terminix, operating revenues were $273 million consistent with third quarter of 2007. These results reflect growth of 1.4% in pest control revenues offset by a combined 3.3% decline in termite completion and renewal revenues, due to reduced demand for completion and a 10 basis point decline in customer retention. Operating performance grew nearly 29% to $45.4 million compared to $35.3 million in 2007, reflecting among other things a provision for legal matters in 2007 that did not recur in 2008, as well as lower termite material costs, sales in production labor, vehicle fleet counts, and overhead costs. This was partially offset by higher fuel costs. Retention rates continued to be strong at Terminix. Pest retention rates held steady at 78.8%. Termite retention rates decreased slightly by 10 basis points to 87.5%.

At American Home Shield, third quarter operating revenue increased nearly 19% to $177.3 million. Excluding purchase accounting adjustments, operating revenue was in line with third quarter 2007 results. Total new contract sales and renewal units declined by 1.6%, while sales from customer renewals increased 4.5%, reflecting a comparable base of renewable customers and improved customer retention. Customer retention grew to 61.5%, an increase of 40 basis points over last years results. Unit sales to the real estate channel declined 15.6% year-over-year, reflecting continued softness in the home resale market throughout most of the country.

Although our Realogy relationship for the negative impact of the current housing market we continue to see a slowing in unit sales from our Real Estate channel. Operating performance for the quarter declined 6% to $34.6 million compared to $36.9 million a year ago, in part due to a $2 million decrease in investment and interest income from the investment portfolio as compared to 2007. Now as we mentioned last quarter, higher claims activity experienced in the second quarter of 2008 resulted in the recognition of an incremental $15 million of revenue being recognized in the second quarter, with approximately $10 million of that amount being accelerated from the second half of 2008 and approximately $7 million of that from the third quarter. Reduced claim trends and resultant revenues recognized in the third quarter, were consistent with our expectations contributing to flat overall year-over-year.

We continue to make progress on reducing the exposure to the market volatility in American Home Shield investment portfolio as we identify excess reserves of over statutory reserve requirements, or determine that we could satisfy reserve requirements through alternative financial vehicles. Despite the turbulent market, during the quarter we realized $1.2 million in interest and dividend income and gains on the sale of securities while we took an impairment charge of $ 0.9 million.

While the current economic conditions, including the credit and housing Markets, continue to be challenging, we delivered solid results during the quarter. Although we have seen some relief recently in fuel and commodity prices, consumer sentiment and consumer spending are at historically low numbers, indicating that the environment will remain a challenging one for us. Our management team and all associates at ServiceMaster will remain focused on our strategies and initiatives that create and deliver long term value, while at the same time being prudent in our management of expenses and capital during the current economic downturn. I look forward to providing you an update of our fourth quarter and full year 2008 results during our next earnings call. This concludes my prepared remarks and at this time we would be happy to answer any questions you may

Thank you.

(OPERATOR INSTRUCTIONS)

Our first question comes from the line of Yoma Abibi of JP Morgan. Please proceed.

Thank you. Looking at the LandCare in a business, your customer retention was good and your full program growth was also fairly good. Can you give us a little bit more detail what's behind that? Has more marketing dollars gone into that segment? Are there more salespeople this quarter versus last year?

I think you're referring to LawnCare as opposed to LandCare.

Yes.

Right. The biggest change that we've put in this year is we've always had the thought that we can sell beyond our normal sales period which is roughly February through May 15th on into the end of June. We started this year what we call Summer Sales Program, where we've actually extended the sales period from June into October and it was very successful for us. We've proven that in fact we can sell both full program, as well as expanded services during this period of time that's normally been dead for us from a sales perspective. Very excited about what that holds for the future.

How about the customer mix? Has the customer mix changed over the last couple quarters?

No. Not at all. Not at all. We're doing the same things that we typically do to sell to the types of customers that we sold. We just simply expanded the selling season.

Can you tell us on average, what's the household income you target in this business?

Well, the median household income is in the range of $75 thousand to $85 thousand. We go from $55 thousand up to $150 thousand. We consider that to be our sweet spot and that's pretty consistent amongst all of our brands within the Company.

And what is the cost, I know cost for programs for a customer?

If we did a full program, and we have seven applications out there, we would probably be somewhere in the range of 275 to 350 depending upon where we are over the course of a year.

Great. That's it for me, thank you.

And our next question comes from the line of Max Saffian of Fortress. Please proceed.

Hi. Just two questions. The first is you mentioned that you should achieve the $60 million of savings in 2008. Just curious what future savings plans you guys kind of had on the docket. And then the second one, was how the investment portfolio fared in October, which was a difficult month in both credit and equity. Thanks so much.

Yes, let me just mention on the second part of the question, the October performance will be reported on in connection with our fourth quarter results, and as far as your first part of your question, was that on --

Just on that, can you give your split on equity versus credit, or anything like that?

Max, this is Marty. It's actually disclosed in our 10-Q, if you look at that, I think under the marketable securities there's a split between debt and equity securities.

Great.

Yeah, obviously, the market has been difficult here of late but we'll be talking about that next quarter. The first question was on the $60 million cost savings? That's the question? We are continuing with the programs we started last year ,and we're on track to exceed that $60 million of savings. And the next thing that you'll be seeing us announce pretty soon is related to the outsourcing and re-engineering efforts that we're pursuing. But we do not have any new information to report at this time on it, but it is progressing.

Our next question comes from the line of Oliver Corlett of RW Pressprich. Please proceed.

Good morning. The amount of cash that you had looked up at AHS, or you have cash in marketable securities went down a fair amount during the quarter. And I guess as a result, your unrestricted cash went up quite a lot. Is that, can you explain why it was such a large swing and whether that kind volatility is likely to continue in the future?

Yeah, let me just touch on it briefly. It's really part of our efforts to focus on our balance sheet and our cash liquidity. And addressing our reserve requirements at American Home Shield and where we have excess reserves. We are focusing on extracting that cash out of those restricted subsidiaries into a unrestricted cash position. We did make good progress on that during the second and third quarter, but and we'll continue to focus on it. But I would say the progress you saw in this most recent quarter was larger than typically we would see in given quarters. It is a focus that we have made a higher priority here in the last year or so.

Okay. So there's no sort of seasonal event that might cause that reverse itself in the coming quarters or anything like that?

Nope.

Okay. And you mentioned while you were on that, and the years of alternative vehicles to increase your liquidity in terms of those excess reserves. What do you mean by that exactly?

Well, for example, we are looking at performance bonds as a way to meet certain state regulatory requirements for reserves. We're looking at corporate guarantees or parental guarantees is other ways to meet those obligations, so we're exploring all options to improve the liquidity or free up some of the liquidity that's trapped in American Home Shield.

Right, and those, but those alternative vehicles, are they in a sense added risk that you're assuming it isn't so visible? I mean it seems like you're getting something for nothing.

Well first, let me say that we've not yet put any of those alternative vehicles in place, but we are evaluating our options at alternative vehicles. I'm not really sure, if I understood your question fully about getting something for nothing.

Well, to the extent that you're getting liquidity without apparently giving anything up. But it's not a material issue. I just thought I'd throw it in. As far as the, the LawnCare and the Terminix business. One of the difficulties I've had in doing an analysis of how resistant that might be to recession, is there aren't really apples-to-apples numbers going back far enough to see how they've behaved in previous recessions. Can you discuss that particularly with respect to LawnCare and the Terminix business?

Each business has its own foundation of how the consumer looks at it. When you look at Terminix and the termite piece of that, although we wouldn't say any of our businesses is recession proof, it's very hard to walk away from not protecting your house from something that could totally destroy your house. So the termite business is going to do better than most company's would do, regardless of the service that they provide. Pest, not quite as strong in that position as the termite is but I'm sure, at your own home when something shows up you'll want to eradicate it so that business has held pretty steady as well.

LawnCare care is probably the more discretionary of the three that you brought up. But yet, as we just talked about through the third quarter,r and in the third quarter we actually had the sales lift or the revenue lift because of the service sales program. But the economy is going to impact that discretionary business more, than it would the termite business. But we'll see how we roll in at the next year with that, but through the third quarter it looked pretty good.

Great. But as far as the actual numbers go from previous downturns, I mean I know we haven't had very many of them in the last 20 years. But in the last one in 2001 and in the 1990 period, how did the revenues and the operating performance behave in those downturns for those two segments?

We have looked at that, and there's really nothing that says any downturn in the economy has a significant impact. Again it's different by Company. We have ups and downs but the Company in total has weathered those pretty neutral, pretty flatly.

And as far as on the cost side, in a recession, do you have a lot more, I mean do you have a lot more variable cost ? Is it heavily variable cost to the extent that you can cushion the impact of a volume downturn, by having corresponding downturn in the

We're highly variable in our cost structure at the field level, yes.

Okay. That's all I have, thank you.

Our next question comes from the line of Kevin Minker of Serengeti Asset Management. Please proceed.

Hi, guys. Thanks, actually I had a couple things. I was wondering if maybe you could first comment in the Q, I was looking at some of your non-cash working capital, and in particular the accrued liabilities line. Just looked like it went into a negative number from the positive number last year. Just was wondering what went on there?

Yes, that one is pretty straightforward. Last year, we accrued a significant amount of severance payments, change of control payments that paid out in 2008. So we accrued them in '07, paid them out in '08 and that was the single largest component of that increase in working capital this year.

Okay. And then in terms of, I know in the past, you guys talked about I guess it was about $50 million in fleet purchases that you were going to do. Correct me if I'm wrong but I think that was going to get done in the third quarter. I'm just curious, did we see that this quarter?

Yes, we did.

Okay, and then going forward you mentioned that you may have a requirement there again in 2009, is that right?

Well, not necessarily to the point of a requirement at this point. It is something though that we are addressing, and it's unrelated to the requirement to purchase the $50 million of assets. That was with one provider and existing facility that they had the ability to terminate, pursuant to the change in control which they did. This is our leasing provider for new purchases has elected not to renew the -- that facility. So we're evaluating other options, including other possible leasing arrangements, or financing arrangements for future purchases of new equipment -- of new vehicles.

Okay, but can you just help me understand like can that lead to? I guess what I'm really trying to understand is -- I know it's early for 2009. But I'm just trying to understand what your capital requirements may be for 2009, just very broadly. I know in the past you guys kind of guided to around sort of $40 million to $50 million of CapEx, and I'm just wondering if should we expect to be in that similar range? And would anything related to the fleet be in addition to that? Or maybe you could just give broad guidelines there?

Yeah, and we talk about that a little bit in the Q. If we were to have to purchase the vehicles, it would be, it has ranged from $30 million to $50 million a year in vehicle purchases.

Okay.

That would be incremental.

Okay, incremental to the sort of $40 million or $50 million of normal CapEx?

That's right. That's right.

Okay. And then is that, all just tie into the residuals that you guys have for both your buildings and your fleet as well? I'm just curious in terms of the guarantees that you mention in there, is that the same type of analysis, the same costs?

It's the same underlying cost in that the residuals on the vehicles that we disclose are the vehicle leases that we have residual guarantees for. So in the future, if we were to end up, I'm not saying this is necessarily the answer ,but if we were to end up buying them, then as we pay off the existing leases that residual guarantee would come down as we pay those down.

Okay. And then can you just comment in terms of your revolver what sort of limitations would you guys have on your ability to draw on the revolver?

I think I'll let our Treasurer, Mark Peterson comment on that. Mark?

We don't have any limitations on drawing on the revolver itself. Am I hearing your question correct?

Yes. I'm just curious if there's anything that could happen to your business that would limit your ability to draw on the revolver?

No. There's nothing that we could foresee. The revolver is structured to be able to provide working capital necessary to run the business.

Okay. And then do you have any limitations in terms of your ability to buy in debt?

Yes. There are limitations in the revolving credit facility, or in the term credit facility on buying in debt. There's a restricted payments provisions in the agreement that would restrict our ability to buy in debt and you can read those in the document itself.

Okay, and then just on the business itself, in terms of just you guys kind of typical seasonality, can you just talk a little bit about how Q1 versus Q2 versus Q3 and Q4, what's the typical seasonality like X percent of our business, Q2 and Q3 type stuff?

Yes .. well. I can pull something up, historicals on that and give that to you.

Okay, just roughly, that's fine. And then just my last question is I know you guys don't give guidance, but can you just talk a little bit about the trends you've seen over the last six weeks, since we're already into November, just how are things going basically?

We're not, our disclosure policy is not to comment. We'll be happy to discuss next time we report our earnings, what happened in the fourth quarter but we're not going to disclose anything that would be forward-looking at this point.

Is it forward-looking if it's the past six weeks?

Yeah, we haven't reported on it through September 30th, so it would be forward-looking.

Okay. All right, thanks a lot, guys. Appreciate it.

Okay, thank you.

And Mr. Ketelaar, there are no questions at this time. I will now turn the call back to you. Please continue with your presentation or closing remarks.

Again, we thank you all for your interest and look forward to talking to you again with the fourth quarter results next year. Thank you.

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.