Terminix Global Holdings Inc (TMX) 2010 Q3 法說會逐字稿

Ladies and gentlemen, welcome to The ServiceMaster Company's third quarter 2010 earnings conference call. Today's call is being recorded and broadcast onto 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 engine. At this time, we will begin today's call. Please go ahead, Mr. Ketelaar.

Good morning and thanks for joining our third quarter 2010 earnings conference call. Joining me for today's call is ServiceMaster's Chief Executive Officer, Pat Spainhour; Chief Financial Officer, Steve Martin; Treasurer, Mark Peterson; and Comptroller, David Martin. We will make some prepared remarks and then 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 legends 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.

Information discussed on today's call speaks only as of November 18, 2010, and any rebroadcast or distribution of information presented on today's call after such date is not intended and will not be construed as updating or confirming such information. The ServiceMaster Company undertakes no obligation to update any information discussed on today's call.

ServiceMaster recently filed its 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. We may reference throughout today's call non-GAAP financial measures, such as adjusted EBITDA, comparable operating performance and operating performance, which factor in adjustments related to such things as restructuring expenses and non-cash option and stock-based compensation expense, among others.

We have included in our 10-Q and Form 8-K, available on our website, definitions of these terms, as well as relevant reconciliations to the most appropriate GAAP financial measure in order to better assist you in understanding our financial performance.

During the question-and-answer session, we encourage you to ask any questions that you may have. Due to our disclosure policy and legal requirements, 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 questions during this public forum.

I will now turn the call over to Pat Spainhour for opening comments. Pat?

Good morning, everyone, and thanks for joining today's call. Overall, we are pleased with our third-quarter results, with operating revenues up 6.2% compared to the third quarter of 2009. Operating performance was up 1.4%.

Like everyone, we are still carefully watching for signs of an economic recovery. We are still focused on the key initiatives that will drive our future growth, particularly customer retention.

Our focus this year on revenue growth has delivered positive results, and that trend continued in the third quarter. Five of our six business units grew revenues in the third quarter. Despite the tough economy and the stagnant consumer and commercial spending, we've been able to show year-to-date revenue growth.

Another key metric for us is customer counts, which are being driven both by new sales and our strong focus on retention. As of the end of the third quarter, new sales, excluding acquisitions, are up almost 4% overall, with strong growth coming from Terminix in both pest and termites.

In TruGreen, our neighborhood sales efforts continued to produce excellent results, with a 24% jump in the sales channel year-to-date. This more than offset the decline in our other channels, primarily the telephone and inquiry sales, and we continue to do neighborhood selling as a key element of our overall residential sales strategy in TruGreen.

At the same time, customer retention is playing an important role in our growth plans. Retention rates in TruGreen, Terminix and American Home Shield were all up in the third quarter compared to the same period a year ago. Terminix remains committed to growing both organically and through acquisition, and we recently took steps to bolster our efforts in both areas.

In August, we acquired the assets of Antimite Termite and Pest Control and its affiliate, SOS Exterminating. This acquisition, which is reflected in our third-quarter performance, expands the Terminix footprint on the West Coast with the addition of 12 branch locations and more than 37,000 customers across Southern California and Arizona.

Overall, Terminix revenues in the third quarter were up 8.3% over a year ago, driven by improvements in termite, pest control, commercial and strong product sales. Operating performance was up 18%. Customer accounts in our pest control segment grew 500 basis points over the third quarter of 2009. Customer retention was up 250 basis points in pest and up slightly in our termite business.

We also took steps to enhance future product growth opportunities in Terminix by assigning a new seven-year product development and supply agreement with TyraTech, a leading innovator in the field of eco-conscious pesticide and the current supplier of Terminix SafeShield, a natural product. This continued alliance provides access to TyraTech's advanced technology, which helps us meet the growing demand for powerful, environmentally-focused pest solutions.

In addition to the sluggish economy, weather continued to create challenges for us in the third quarter, which affected our operating performance. This was especially true in American Home Shield, where we saw another quarter of high claims activity, resulting from the unusually hot weather across the country that lasted late into the summer. Total year-to-date claims expense has increased $22.4 million, or 12.2%, over 2009.

With the prospects for a rebound in the real estate market still unclear, American Home Shield is aggressively pursuing other sales channels to drive growth. Enhanced marketing efforts, particularly in direct-to-consumer and third-party sales, are being developed to add new customers. Retention in those other channels tends to be higher than in real estate sales, and this mix helped boost retention in the third quarter up 300 basis points over 2009.

At TruGreen, revenues were up 5.5% in the third quarter. That was driven in part by catching up with production that was delayed by weather earlier in the year, and by less discounting compared to 2009. Unfortunately, the full benefit of the higher revenues wasn't reflected in TruGreen's operating performance. They were offset by higher sales and marketing costs and higher-than-expected costs associated with our transformation of TruGreen.

On our last earnings call, we told you we were evaluating TruGreen LandCare to determine how best to drive sustainable growth and profitability. Since then, we made a decision to explore strategic options that will help the business achieve its fullest potential. As this process evolves, we will continue to make investments in the business to ensure we are serving our existing customers.

I want to emphasize that this decision does not indicate a change in our strategic growth plan for our core commercial operations. In fact, we feel the commercial space represents a major growth opportunity for us. We will continue to pursue these opportunities in the future.

As I've said before, our priority is to preserve the strength and integrity of each brand. I am pleased by the way our teams have responded, particularly in such uncertain economic times, while working together across our different brands in the best interest of the total ServiceMaster Company. While we are committed to a strong finish in 2010, we are not going to change our basic game plan. Our business priorities remain the same, led by keeping a laser-like focus on the experience our customers have with our brands every day.

We are adding to the value of the Company through standardization and consolidation wherever we can. We are going to continue to leverage technology, our people and our processes across ServiceMaster brands as much as possible. This is the one Company strategy I have spoken about before, and we continue to communicate this approach to our associates as a strategic advantage in our relationship with customers, suppliers, communities and each other.

As you know, I've announced my plans to retire from the Company, targeted for the end of the year. At the Board's request, I've agreed to stay on as CEO until a new CEO is hired. While my time at ServiceMaster is winding down, we still have a lot of work ahead of us. We are not slowing down and waiting for a new CEO to be hired to make the decisions our company must make to stay competitive and keep growing.

ServiceMaster is still transforming, and despite all the economic headwinds we've faced in the past two years, we are better-positioned today than we were five years ago to meet the needs of our customers and grow our company.

Since becoming CEO in 2006, I've worked with many extraordinary people here, and I've had the chance to meet incredibly talented associates in all of our businesses, who are fiercely proud of their brands and the service they deliver to their customers each day. I am excited about the company we are building. I believe in ServiceMaster. And I hope you feel as strongly as we do that the best of ServiceMaster is yet to come.

I will now turn the call over to Steve Martin for more details on our quarterly financial performance. Steve?

Thanks, Pat. Third-quarter results were solid for ServiceMaster, even with the continued higher claims activity at AHS and economic and operational challenges at TruGreen LandCare. Let me quickly recap our consolidated results, and then I will review the segments.

Revenues in the third quarter of 2010 increased $57 million to $977 million, up 6.2% compared to the third quarter of 2009, with operating performance as set forth in the 8-K increasing 1.4% to $176 million. Our results reflect strong performance at Terminix and American Home Shield, despite AHS's higher claims experience. This performance offset some of the challenges Pat discussed at TruGreen lawn care, and, in particular, TruGreen LandCare.

Cost of services rendered and products sold in the third quarter was $561 million or 57.4% of revenue compared to 57.3% a year ago. The 10 basis point decline in gross margin was driven principally by the higher claims experience at AHS, partially offset by lower factor costs and other direct expenses.

Selling and administrative expense as a percentage of revenue for the third quarter of 2010 was 27.3% compared to 27.1% a year ago. The increase in SG&A primarily reflects increased investments in sales and marketing efforts and increased spending in our headquarters functions to enhance capabilities in our centers of excellence and on initiatives designed to improve the performance of our operating units.

For the first nine months of the year, revenues were up 3.8% over 2009, with five of our six operating segments showing growth. Operating performance for the first nine months of the year was down 0.5%, as growth in Terminix, TruGreen lawn care, American Home Shield and ServiceMaster Clean was more than offset by decline at TruGreen LandCare and the higher expenses in the other operations in headquarters' segment.

Cash flow provided by operating activities was $119.2 million in the first nine months of 2010, up from $69.2 million a year ago, and was comprised of $209.1 million in earnings, as adjusted for non-cash charges, offset in part by a $79.7 million increase in cash required for working capital and $10.2 million in cash payments related to restructuring charges.

The increase in working capital, which reflects normal seasonal needs, was $45.8 million less than during the first nine months of 2009. This favorability was driven by the timing of accounts payable interest and payroll-related payments, offset by growth in accounts receivable balances. This growth in accounts receivable was due to growth in certain service lines with longer than average collection terms, as well as some negative collection trends in TruGreen lawn care.

CapEx was $105.3 million through September 30, and included $32.8 million in new vehicle purchases. We continue to expect 2010 capital expenditures, excluding vehicles, to range from $55 million to $65 million, and total capital expenditures for vehicle needs to range from $50 million to $60 million.

Our liquidity remains strong, with $500 million available under the revolver and $40 million available under the Accounts Receivable securitization facility. Additionally, we have approximately $40 million of unrestricted cash and marketable securities.

Moving now to third-quarter segment results. At TruGreen law care, revenues grew 5.5% to $371 million, reflecting in part the continuation of catching up on production that was delayed due to the late spring start, as well as a 1.3% increase in customer accounts, lower discounting and improved price realization. The increase in customer accounts was driven primarily by new unit sales from our neighborhood selling program and the benefit of acquisitions.

As of September 30, the rolling 12 month retention rate at TruGreen stood at 69.5%, although we saw retention improvement trends taper off during the quarter. This was due to a combination of the impact of high summer temperatures on the appearance of lawns across the country, as well as some negative customer impact associated with our ongoing transformation efforts at TruGreen.

Operating performance was essentially flat at $81 million. While we benefited from lower fuel and fertilizer costs, these were offset by higher investments in sales and marketing and increased costs related to initiatives to transform branch operations and improve customer service.

At Terminix, third-quarter revenues improved 8.3% to $295 million compared to $273 million a year ago. These results reflect solid growth of 7.2% in pest control revenues, a 4.8% growth in termite revenue and $6.2 million of additional product sales. Revenues were helped by the acquisition of Antimite Termite and Pest Control, which closed during the quarter.

The growth in pest revenues was related to a 5% growth in customer accounts due to an increase in new unit sales, the contribution of acquisitions and a 250 basis point improvement in customer retention rates. As of September 30, the rolling 12 month retention rate in pest stood at 80.4%.

Termite revenues improved due to an increase in new unit sales, the contribution of acquisitions and a 20 basis point improvement in customer retention. The rolling 12 month termite retention rate grew to 86%. Operating performance grew more than 18% to $63.4 million, reflecting the operating leverage from the increased revenues, reduced fuel and vehicle-related costs and favorable termite damage claim trends, partially offset by higher investments in sales and marketing and higher provision for incentive compensation.

At American Home Shield, revenues grew 9.6% to $197 million compared to $180 million a year ago. The increase in revenue reflected an increase of 3.4% in customer accounts and improved price realization. This increase in customer accounts was helped by an increase in new unit sales and a 300 basis point improvement in its rolling 12 month customer retention rate as of September 30, which stood at 66.3%.

Revenue growth in the third quarter was also positively impacted by a difference between years in the timing of revenue recognition. In 2009, we recognized a higher percentage of revenue in the second quarter versus the third quarter due to the timing of contract claims. As we've discussed in the past, AHS recognizes revenue over the contract period in proportion to the expected direct costs.

Operating performance grew to $41.3 million compared to $37.5 million a year ago, reflecting the favorable impact of increased revenue and the favorable impact of incurring sales and marketing spend early in the year as compared to prior year. This was partially offset by a 15.9% increase in contract claim costs related to an increase in the number of seasonal air-conditioning claims.

Turning to TruGreen LandCare, operating revenues decreased 7.9% to $58.3 million, while operating performance declined $5.2 million to a loss of $2.3 million. The lower revenue amount included a 9% decline in the base contract maintenance and an 8% decline in enhancement revenue, reflecting contract cancellations and price concessions granted in 2009 and 2010 in response to increased competition in the commercial landscaping space and the difficult economic environment.

Operating performance during the quarter was hurt by the revenue declines and labor inefficiencies related to higher technician turnover. This was partially offset by reduced fuel costs. As Pat mentioned earlier, we've made a decision to explore our strategic options with LandCare, including the possible sale of the business. However, it is premature to speculate on the ultimate outcome of this process.

In the Other Operations Segment, which includes the results of Merry Maids and the Company's headquarters' functions, revenues were slightly higher at $21.6 million. Operating performance for the segment was a loss of $22.9 million compared to a loss of $16.8 million last year. The larger loss was primarily due to a $4.3 million charge related to Pat's pending retirement and higher spending in the headquarters' functions designed to enhance capabilities in our centers of excellence and on initiatives designed to improve the performance of our operating units. This was partially offset by an improvement in Merry Maids' performance, primarily related to reduced overhead spending.

In summary, we continued to make progress during the third quarter as we executed our strategies despite the difficult economic climate. We are taking a cautious and conservative approach to the economic recovery, and will continue to focus on our core strategies of improving retention and making improvements in our cost structure and the efficiency of our operations. We believe that doing so will position us for longer-term growth as the economy rebounds.

We look forward to providing you with our next update when we report our full-year financial results. That concludes our prepared remarks and at this time we would be happy to take your questions. Operator?

(Operator Instructions) Yilma Abebe, JPMorgan.

Thank you. Good morning. My first question has to do with LandCare. As you look at strategic options in this business, is there an opportunity to reduce costs to decrease the operating performance loss in the segment?

We have certainly been doing that in a way to run all of our businesses more efficiently, but now that we are looking at it from a strategic perspective, we certainly want to make sure that we can serve our current customers and grow the business during this period of time, not knowing what the outcome is going to be.

So yes, we've looked at, now that we are in a different ballgame with LandCare, how to make sure we are as efficient as we can be in what we spend and what we invest in there, knowing that we do need to spend and invest to maintain a good-performing company out there.

And I guess this may be difficult to answer, but as you look forward, are there any sort of cash costs that we should be modeling in as the Company looks at these strategic options?

At this point, I think there is nothing specific that I would say needs to be modeled in from a cash cost standpoint related to this.

Okay. All right. And my other question has to do with TruGreen lawn care. Revenues are up, but margins are obviously off year-over-year for the cost that was just discussed. And the two buckets that I caught were higher sales and marketing efforts and the ongoing transformation of these branch operations. Of these two buckets, which one is higher in terms of a higher level of cost recognized in the quarter?

I think it is about the same; when we looked at it, it is really about the same in each bucket.

Okay. And I guess the transformation of branch operations, that bucket, where are we in that process? Should we expect the costs related to that to decline in the next several quarters?

This transformation actually began in September of last year, as we've discussed with you guys about the change in the organization. The transformation includes the whole Company. One of the key things that we are continuing to work on and will work on for the next several months and quarters is branch standardization, to make sure we have 200 branches operating as a brand, meaning that we are consistent in everything that we do out there.

Some of the things we've been working on will phase out. The rebranding part of the transformation is just about over. But certain things have a longer life. This branch standardization and doing those type things will continue, and other things will fall off as we go through time here.

But we will be in transformation for the next several quarters here, but probably on a lesser degree than what the startup was back in September of last year.

Thank you. That's all I had.

[Emily Shanks], Barclays Capital.

Hi. This is [Mike Perez] on behalf of Emily Shanks. You touched a bit on the effect of warm weather on 3Q results. What sort of impact will the unseasonably warm October weather have on your 4Q results?

It has been warmer in October, and that does help, and so we are off to a good start. But we really need to wait for the full quarter to play out and the full season to play out before we can really comment on what the impact will be for the quarter.

Okay. It seems like you've done a good job improving service levels and customer retention. What is the next step in your execution plan heading into 2011?

In total retention, it is just about in every company. AHS and TruGreen and Merry Maids are probably the biggest three in terms of themes that we've got in play and issues in play to grow it. Terminix, both pest and termite, will continue doing the types of things they are doing to create that customer experience that the customers expect.

But it is different by company. American Home Shield is really working on the fundamental core customer service strategies, and some of that will be systems-oriented and some of that is how we work with the customers. And that is underway.

TruGreen is a continuation of the great success that we've had over the last three years of further penetrating EasyPay, PrePay into the business. The new thing that we started this last year -- or this year, our service technicians that we've brought from being people who were in the tech -- I'm sorry -- in the technology side, driving -- delivering the service, we're pulling them in to help train and work with all levels of service in the Company.

And that has made a tremendous impact in retention rates. Where in fact that we've had those folks located in the brands, we are going to expand that better into 2011, and eventually have full coverage with that STC function out there to really help drive customer retention. TruGreen continues to expand the LQA, the lawn quality audit, theme that is really driving tremendous opportunities for us.

Merry Maids is some of the same things that these other companies are doing, but it is all about getting closer to the customer and that intimate relationship, and have more follow-up from the people who sell in, who come back and give the customer the -- it's kind of like an LQA -- the opportunity to talk about how we are doing and so on.

There are other things that we are doing with comp plans for associate retention that will help improve retention as well.

But as you can imagine, each business kind of stands on its own for the most part. Each has their own unique strategies, each is at a different place relative to executing against those strategies. But we see great progress and look forward to what it is going to do for the Company going forward.

Okay. That's very helpful. Thanks. Good luck.

Marianne Manzolillo, Angelo, Gordon.

I had some questions regarding the American Home Shield business. So you were saying revenues are up due to higher customer counts. Was that a 3% increase in your customer count?

Yes, customer accounts in American Home Shield are up 3% as of September 30 versus September 30 a year ago.

Right. And then can you remind us as far as kind of the source of the revenues, kind of the breakdown -- how much of the business comes from when a home is a sold, home sales? Because you did mention that you are trying to perhaps change how you go about getting new customers.

There are really three basic channels that we operate in in American Home Shield -- the real estate channel, the consumer channel and then third party, which is more about having marketing inserts in various institutions that get mailed out that drive leads that we follow up on.

The real estate channel is roughly about 25% of the business, and the other two channels, the consumer is the largest of the other two channels. And third party is something that just has been out there and it grows and we are trying to figure out how to take advantage of that and make that be more a part of the process going forward, but at the same time, looking to grow the consumer piece at a faster pace than the other channels as well.

And when you say consumer, what do you mean by that?

That is direct mail and digital marketing.

It's all the inquiry-type leads that we generate through direct mail and other vehicles that we have out there, the inserts as well.

Internet sales.

Internet, yes.

And has that been the source of the increased customer count, the consumer part of the business, or the consumer leads generated through that channel?

Yes, yes.

Okay. So then with -- have you also -- you said increased prices as well.

Yes, we've had a price increase that has been factored in for 2010.

Right. Okay, great. But you also did have higher claims this quarter as well, right, because of the warm weather? So that would impact your EBITDA in that segment.

Exactly, contract costs would be up because of the excessive claims.

But it's interesting, your EBITDA year-over-year was up. So how do we kind of think of that? Though you had higher claims, your EBITDA was still up.

Yes, the way to think about that is -- there are two things going on. Last year, we had a difference in the timing of claims for the summer, and we -- our accounting policy is to recognize the revenue at the time that the claims occur, so in proportion to the claims.

And last year, we had a larger portion happen in the second quarter, the first half of the summer and a less -- a lower portion in the second half of the summer, which is in the third quarter. But this year, we had a bump of that revenue recognition in the third quarter versus last year, strictly from a timing standpoint.

That incremental gross profit from that helped cover the higher claims experience we had in the quarter, along with other cost reductions or differences in cost for the quarter; in particular, the timing of our spending on sales and marketing costs, which last year was -- we had more in the third quarter. This year we moved that up to more in the second quarter.

Even year-to-date, though, through the nine months, your EBITDA is still above last year's EBITDA.

Yes, that is correct. And that is the overall growth in the volume of accounts and the price increase that Pat mentioned, as well as the lower costs that we have been able to control our costs. And that combination has more than offset the higher claims experience from the summer claims.

That's great. How much of the decline have you seen from the real estate channel? Because you say it is 25%. Has that changed at all, and are you seeing some changes there now that the tax credit or so is over for home purchases?

The tax credit was over officially in April, but any transactions that were in the stage of closing went through for a couple months. And each month after April, we've seen the significant falloff to that 25%, 26% run rate. And that is the only thing that has changed out there of any consequence. So right now, we are looking at a 25% run rate decline for the balance of the year in real estate, as the industry would have in general with that change.

And one thing to keep in mind about that home tax credit is it was implemented in the fourth quarter of 2009, and it continued on through April of 2010. And you had closings from those sales occurring all the way up to June of 2010.

So we are now in the fourth quarter of 2010, where we did not have the benefit of the tax credit that we had at this time last year.

And you had it last year at this time, obviously.

That's correct.

And you said you are seeing how much of a decline in that -- a 25% decline in that channel?

Right around 25%, yes.

Okay. All right, great. Thank you very much.

Operator, are there any further questions? Operator? Well, I guess there are no further questions at this point, so I want to thank everybody for joining us on today's call.

We appreciate your continued interest in ServiceMaster and we will look forward to giving you an update at our year-end call in 2011. Thanks very much.

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 at this time.