Terminix Global Holdings Inc (TMX) 2013 Q2 法說會逐字稿

Ladies and gentlemen, welcome to the ServiceMaster Company's second quarter 2013 earnings conference call. Today's call is being recorded and broadcast on the Internet. Beginning today's call is Brian Turcotte, ServiceMaster's Vice President of Investor Relations. Mr. Turcotte 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'll begin today's call, please go ahead, Mr. Turcotte.

Thank you, Chris. Good morning. Thanks for joining our second quarter 2013 earnings conference call. Today you will hear from ServiceMaster's Chief Executive Officer Rob Gillette; our Interim Chief Financial Officer David Martin; and TruGreen's President David Alexander. We will make some prepared remarks this morning and then address your questions.

Before we begin, 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 public filings with the Securities and Exchange Commission. These forward-looking statements are not guarantees of performance and are subject to the 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 today, August 14, 2013, 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.

Earlier this morning, ServiceMaster issued a press release that was also filed with the SEC on form 8-K, highlighting are second quarter 2013 financial results. Additionally, a handout summarizing our second quarter results and key performance indicators can be found next to the webcast icon on the Investor Relations website section of our website. Included in our press release and handout are additional disclosures that we believe will enhance your understanding of our financial and operating results. We may reference non-GAAP financial measures throughout today's call, such as adjusted EBITDA and operating performance, which factor in adjustments related to such things as restructuring expenses, non-cash goodwill and trade name impairments, and non-cash stock-based compensation expenses among others. We have included definitions of these terms in our press release, which is available on our website. We have also included relevant reconciliations of these non-GAAP financial measures to the most comparable GAAP financial measures in our press release and handout in order to better assist you in understanding our financial performance.

During the question-and-answer portion of the call, we encourage you to ask any questions that you may have, but please note that we don't provide any guidance, so please limit your questions accordingly. I'll now turn the call over to our CEO, Rob Gillette, for opening comments. Rob?

Great, thanks, Brian, and good morning to everyone. Thanks for joining us today. I'm excited to be here and to be part of the ServiceMaster team. I been busy since joining the Company about nine weeks ago and have visited branches, call centers, met with franchise owners and have been getting to know our people and businesses. What I've found so far confirms John Krenicki's earlier observations that we have market and category leading brands, we have approximately 8 million customers who use our services every year, and we have a very passionate and dedicated team of people. All these things translate into significant opportunity for growth and improved performance of our business. I plan to work closely with the team and we'll focus specifically on a few key areas in the near-term.

First, filling the key leadership positions which are open all my staff. These searches are ongoing and we're going to make sure we get the right people in the right roles. In the interim, we're fortunate to have knowledgeable and committed leaders in place who have taken greater responsibility during this transition and we have a lot of confidence in them. We are focused on driving service and operational improvements at the customer level and ultimately growing customer counts. This work is underway in all of our businesses. As we said on the last call we need to reestablish ServiceMaster's credibility by delivering reliable and predictable financial results. We know we have to improve and we will.

We are also taking actions to improve productivity and accelerate results by driving more accountability throughout the organization. For example, I now have the leader of Supplier Management reporting directly to me. This will create greater visibility and accountability for all aspects of our supply chain. I am confident Mary Kay Runyan, our supply chain leader, can apply the same discipline she's used to find cost improvements in Fleet Management and Direct Mail and apply them to our other spend categories.

Finally, we're focused on stabilizing TruGreen and returning it to growth and profitability. TruGreen is facing some challenges and they are largely self inflicted. Unfortunately, we did this to ourselves. But, we all take ownership for executing the TruGreen turnaround and that starts with me. I will be focusing a great deal of time and energy with David in TruGreen.

As you know, David Alexander and his team have already identified the key issues within TruGreen and have been working on solutions. But as we said in our last call, there is no overnight fix. It took us a while to get into this situation and it is going to take us a while to get out of it.

David will give you an update in just a few minutes. Overall our second quarter results did meet our expectations. The decline in revenue and operating performance versus prior year was largely attributable to TruGreen, while the other ServiceMaster businesses performed as we expected. Total Company operating revenue in the second quarter decreased approximately 2% and our operating performance decreased about 30% when compared to the second quarter of 2012. If we exclude TruGreen results, the Company revenue and operating performance were both up over 3% versus the second quarter of 2012. Our interim CFO, David Martin, will review the consolidated and segment results later in the call, but now I'll ask David Alexander, the President of TruGreen, to update you on his business. David?

Thank you, Rob, and good morning, everyone. Since I last spoke with you in May, the TruGreen team has been working on the initiatives I shared on that call. And this morning I'll update you on our progress. As we discussed, TruGreen entered 2013 with three very significant challenges. First, we had a product offering that was not getting the job done from a sales standpoint. Second, we began 2013 with a customer base that was over 10% lower than where we began 2012. And third, we were in the early days of a system implementation involving all three of our core technology systems. And we're dealing with real integration and optimization challenges.

To respond to our product offering challenge, we created tiered product offering intended to address the needs and desires of three different types of consumers. And also rolled out extensive new training for both our sales reps and our lawn technicians. Based on results to date, our efforts to improve the product offering in sales process are paying off, as these changes drove a significant increase in new, full program sales in the second quarter over the prior year. Despite the improvement in sales, the impact of our other two key issues, lower customer count and challenges with implementation of our new operating systems, continue to have a material negative impact on the business. Further, the prolonged nature of the operating system issues has resulted in new challenges and now leads us to believe that fixing the issues will take us longer than previously expected.

Let me be more specific. In the second quarter revenue was down due to a 6.3% lower average customer count. And due to service delivery inefficiencies related to systems issues. These systems issues impacted our ability to provide efficient and timely service to our customers. In addition to hurting the top line, they also negatively impacted production, vehicle cost and our chemical expense.

Increases in chemical expense primarily resulted from the service delays we experienced at the start of the season, due to both systems issues and the cold wet spring limiting our ability to apply pre-emergent treatments at the optimal time of the year. As a result, we've had to retreat many lawns later in the season and those re-service rates have driven higher than historical chemical spend to ensure that our customers receive the results on their lawns that they expect. In addition, higher call volume associated with service delivery issues also impacted our administrative labor costs. The collective impact of these issues resulted in lower than expected revenue and operating performance in the second quarter.

The other reality of our service delivery issue is that over time it affects customer satisfaction. While our trailing 12 month retention rate is up 320 basis points through the end of the second quarter, as we moved through the quarter we began to see unseasonably high cancel rates, which we believe will have an impact on revenue for the balance of this year and on our customer count going forward. We realize that the systemic impact on our business from these issues is unsustainable. And we took actions in the second quarter to ensure that we address them in a way that lays the foundation for improved profitability in 2014. These steps included -- rolling out multiple improvements to our operating system; reevaluating changes that were made in the business structure in 2012; establishing clear, more direct accountability to the areas of improvement that are most important, most notably our system challenges; refining our branch operating standards; and finally, making a number of key changes to our leadership team.

In closing, we began this year in a very challenging position. Progress certainly has not come easily. But, I believe that we are doing the right things to return TruGreen to success. I remain confident that we can and will get TruGreen back on track, but it will take some time. And the results of our efforts will not come quickly enough to have a meaningful impact on our 2013 performance. I look forward to updating you again on our progress in the coming quarters. David Martin will now review ServiceMaster's consolidated and business segment results. David?

Thank you, David, and good morning, everyone. Let me briefly cover our consolidated results and then I'll move onto the segments. Second quarter consolidated revenue decreased 2.4% to $939 million compared to a year ago. And second quarter operating performance decreased 28.9% to $151 million. Second quarter operating performance margin declined 600 basis points to 16.1% compared to the second quarter of 2012. The decrease in revenue and operating performance for the quarter was principally driven by TruGreen's performance.

Cost of goods sold as a percentage of revenue increased 330 basis points to 58.7% compared to a year ago. The increase primarily reflects reduced leverage due to the decline in revenue and lower labor, chemical and vehicle efficiency at TruGreen. SG&A expense as a percentage of revenue increased 300 basis points to 28.1% compared to the second quarter of 2012. The increase primarily reflects reduced leverage due to the decline in revenue, an increase in key executive transition charges, higher sales labor, increased investments in sales tools, and higher costs associated with leadership changes at TruGreen.

As David discussed earlier, we continue to face challenges in the TruGreen segment. These issues have impacted the timing of its recovery. As a result, we have revised our long-term projections for TruGreen, which are used as the basis for valuing both goodwill and trade names. As we noted in our press release, TruGreen's second quarter operating income was negatively impacted by a $673 million non-cash impairment charge to reduce the carrying value of TruGreen's goodwill and trade name assets to their estimated fair values. The impairment charge was based on the revenue and operating results of TruGreen in the first six months of 2013 and the outlook for the remainder of 2013 and future years. As you may recall, TruGreen's operating income for the second quarter of 2012 was negatively impacted by a $68 million non-cash impairment charge related to the trade name asset.

Moving on to the balance sheet. Our cash balance decreased from $423 million to $385 million during the first six months of the year. Net cash provided from operating activities for the six months ended June 30 of $79 million was driven by $90 million in earnings adjusted for non-cash charges partially offset by a $5 million increase in working capital needs and $6 million in restructuring payments. The increase in working capital requirements primarily resulted from normal seasonal activity partially offset by increased accruals for compensation and insurance related payments. For the six months ended June 30, net cash used for investing activities of approximately $72 million primarily reflects purchases of technology and property improvements of $39 million, purchases of investments and securities of $18 million, $10 million outstanding under a revolving promissory note between ServiceMaster and its parent Company, ServiceMaster Global Holdings, and $6 million used for tuck-in acquisitions. Net cash used for financing activities was $44 million for the six months ended June 30, which primarily consisted of debt repayments of $27 million, a discount of $12 million paid on issuance of debt, and payments of debt issuance costs of $6 million.

Our liquidity profile remains strong. Cash and short and long-term securities totaled $545 million, of which $278 million is associated with regulatory requirements at American Home Shield and other working capital requirements. We currently have $324 million of capacity under our revolving credit facility and there were no borrowings on the facility during the second quarter of 2013. We also have $36 million of remaining capacity available under an accounts receivable securitization arrangement.

Now, let's talk about the segment results. At Terminix, revenue for the second quarter of 2013 was $365 million, up about 5% compared to the second quarter of 2012, reflecting growth in both pest and termite revenue. Pest control revenue increased nearly 4%, reflecting improved price realization partially offset by a decrease in customer counts. Termite revenue, including revenue from new and renewing customers, increased 6.7%, reflecting improved price realization and the favorable timing of renewal revenue. Terminix's operating performance for the second quarter of 2013 was $98 million, an increase of approximately 10% compared to the second quarter of 2012. This increase in operating performance of $9 million reflects the impact of higher revenue and a reduction in incentive compensation expense partially offset by higher bad debt expense.

At TruGreen revenue for the second quarter of 2013 was $308 million, down 12.4% compared to the second quarter of 2012 primarily driven by fewer full program customers, a result of lower sales volume in 2012, and inefficiencies in service delivery caused, in large part, by integration issues with newly implemented technology. TruGreen's operating performance for the second quarter of 2013, which excludes the goodwill and trade name impairment charges, was $22 million, a decline of $66 million compared to the second quarter of 2012. This decline in operating performance mainly reflects the impact of lower revenue, lower labor, chemical and vehicle efficiency, higher bad debt expense, higher sales staffing levels, increased investments in sales tools and costs associated with leadership changes.

At American Home Shield revenue for the second quarter of 2013 was $206 million, down about 1% compared to the second quarter of 2012. This decline reflects the impact on revenue of a change in the expected timing of contract claims, partially offset by improved price realization and an increase in customer counts. American Home Shield's operating performance for the second quarter of 2013 was $47 million, an increase of 6.6% compared to the second quarter of 2012. This $3 million increase in operating performance primarily reflects the impact of a $5.4 million increase in tax related reserves in 2012, which did not recur in 2013, partially offset by the impact of lower revenue, investments to drive improvements in service delivery, and higher sales and marketing costs.

The ServiceMaster Clean segment, which also includes the Furniture Medic and AmeriSpec brands, reported revenue for the second quarter of 2013 of $36 million, up 12% compared to the second quarter of 2012. This increase was driven by a 7.4% increase in domestic royalty fees, primarily from an increase in disaster restoration services; a 29% increase in janitorial national account revenue, driven by strong sales activity; and a 23% increase in sales of products to franchisees, driven by higher demand. ServiceMaster Clean's operating performance for the second quarter of 2013 was $17 million up 37.3% compared to the second quarter of 2012. This increase of $5 million reflects the impact of higher revenue and lower key executive transition charges.

The Other Operations and Headquarters segment, which includes our Merry Maids operations, ServiceMaster Acceptance Company and our business support functions, reported revenue for the second quarter of 2013 of $24 million, an increase of 4.5% compared to the second quarter of 2012. Merry Maids revenue for the second quarter of 2013 was $22 million, an increase of 3.3% compared to the second quarter of 2012 and primarily reflects a 4.4% increase in revenue from Company-owned branches. This increase was driven by an increase in customer counts and improved price realization, partially offset by a decline in the frequency of services provided to existing customers. Merry Maids operating performance for the second quarter of 2013 was $6 million, which was comparable to the second quarter of 2012 and included the impact of higher revenue offset by higher technology cost related to a new operating system.

The operating performance of the Company 's Headquarters functions and ServiceMaster Acceptance Company declined approximately $12 million in the second quarter of 2013 compared to the second quarter of 2012. This decline was driven by -- $2 million of higher expenses related to our automobile, general liability and workers compensation insurance programs; a $4 million reversal of reserves related to our medical plan recorded in 2012, which did not recur in this segment in 2013; and a $6 million increase in key executive transition charges. That concludes my comments on ServiceMaster's consolidated and business segment results. Now I'll turn the call back over to Rob for closing comments. Rob?

Good, thanks, David. Before we open up the call for questions I just want to again say how excited I am to be here at ServiceMaster and to be part of this team. We're committed to turning TruGreen around and taking the steps necessary to drive both top and bottom line growth in all of our businesses. We have to grow and we have to build an organization of people that are accountable and find a way to win. I'm looking forward to sharing our progress with you as we take the next steps on our path forward. I'll turn it back over to Brian to get into the Q&A.

Thanks, Rob. As a reminder during the question-and-answer session please limit yourself to one follow-up question so we can get to everyone in the queue in the allotted time. Operator, let's open up the lines for questions.

(Operator Instructions)

Karru Martinson, Deutsche Bank.

Good morning. Looking at TruGreen, when you talk about laying the foundation for 2014 improved profitability, it certainly seems like we're going to be entering 2014 with a lower customer count and seeing a lot of the same issues that we saw coming into 2013. And what gives you the confidence that the business can be turned around in that timeframe?

Well first of all, thanks for your question. First of all regarding your comment that we are going to be challenged from a customer count coming into '14. I think that's an appropriate comment. If you looked at 2012 we had a very steep decline in customers. If you look at what's happened this year, particular second quarter, we had good sales. We've seen higher retention than last year. So, we've taken what was a very rapid downward spiral from a customer count standpoint that's leveled off. We're not to a point we're really rebuilding our customer base, but we're not hemorrhaging customers either. We began the year down over 11% from a customer count standpoint. Right now we're down 5% year-over-year from a customer count standpoint. So, it's not going to be the impact '14 over '13 that it was, the big places that we have an opportunity to impact '14 are getting our productivity back to where it's been historically.

Being able to start work for customers as we should, being able to complete work for customers as we should, and to accomplish that we put a tremendous amount of focus on getting the systems right. Our systems, today, are still not where they need to be in terms of our ability to start or complete work. They're still not where they need to be in terms of productivity. As we get those things resolved, we'll be in a much better position in '14. And our ability to retain customers will improve as we continue to address our ability to serve them well. So, we believe by the end of '13 we will have addressed a lot of things that will put us in a much better position for '14. But, again, this has been a tough year and we're trying to be very realistic about where we are and where we will be able to get to by the end of this year.

Okay and just to follow-up, in a technical sense what needs to change in your systems? When you said that you're having issues with starting or completing work and you are not where you need to be in productivity, what in the systems needs to change to fix that problem?

Without sort of boring you to tears with granularity, there are three distinct systems. We have an operating system that has every account's information. It has your address, it has the type of program you're on, it has your start dates, your end dates, it has the windows between applications, it has building information. We have issues with that system. We've made a lot of progress, there are still things to be resolved.

Secondly and critically important, we have a routing and scheduling system. In this business to be effective and to be efficient, you've got to be very, very good at how you route your work. So, if you look at all of our customers, we'll probably do somewhere around 15 million applications in a year. And to the extent that we can be dense in our routing to the extent that when I come into your neighborhood I can treat all your neighbors in one trip and make one trip into your neighborhood a week, not come every day. To the extent we can route at that level we become much, much more efficient. As we become more efficient, it also means I have the capacity to do more work. As I have the capacity to do more work when I sell a new sale, I can get them started sooner. As I have the capacity to do more work I can get things done on time. So, I get to a point that if I have a new customer I start them promptly. If I have an existing customer I get their work done in the window I should and I'm able to complete work as I get through a season.

So, those are the things that we're trying to tackle from a routing and scheduling standpoint. So, there's a very, very close connection between efficiency and actual ability to produce revenue. If I have dense routes, I'm efficient from a fuel, vehicle, maintenance and labor standpoint, but I'm also much more productive from a revenue standpoint, because I'm able to complete the work. Those are the things we've been tackling from a routing and scheduling system standpoint.

The third tool we use is the handheld technology that the tech communicates back to the branch with. So, we know where they are in their day, we know what work they've gotten done and what's still ahead of them, we know if we need to reroute them. We have had issues with that tool. We've had sync issues, synchronization issues. We have had tissues with the tool going down too often. We have had communication issues between those tools and the branch. Again, we've made a lot of progress there, but each of those tools still have work to be done. We're in a much better position than we were three months ago, two months ago, even a month ago. And while you don't see these numbers, if you look at our revenue miss to last year, May was better than April, June was better than May. So, we are making progress, but realistically we're not where we need to be yet.

Thank you very much guys, appreciate it.

Yilma Abebe, JPMorgan.

My first question is on terms of the customer count. You started the year with customer counts down by 11% and I think I caught a comment that right now you're down 5%. Is that in a snapshot as of today? What I'm trying to get out is and I think at this point this season is likely over from a customer add perspective, would this down 5% be the number that you be going into 2014?

It will be in that neighborhood. We're still actually fairly productive from a sales standpoint right now. But, my comment -- I made a comment in my prepared remarks that we are up 320 basis points on retention. If we were able to retain that, the number would be better than that. But we've seen some trends in the last few weeks where cancels have been higher then -- the last few weeks of the quarter where cancels were higher than what we expected and the trends did not look as favorable as we expected. So, that's one of the reasons we've taken a little more conservative view of the rest of this year. But the 5% down in terms of where we'll start '14 is -- I think that's probably within the ballpark of where we will be. Again, we don't give guidance, but that's in the ballpark I think.

Okay, that's fair. And in terms of the cancels that you're just have seen that are above your expectations what was the reason for that? Or is it several reasons? What's driving that?

Well, I think it's two or three things. Again, let me begin by saying our retention rates year-to-date are the best they've ever been in the history of the Company. It's not that looking backward over the last few months we have a retention problem. If anything, we have, again, we have record high retention. What we've seen in the last few months is more cancels and a lot of those cancels have come from new customers where because of our systems issues we did not get on their lawns in a timely manner and therefore they lost confidence in us because we sold them and instead of being there three or four days later we were there two weeks later.

We've also had some issues where, again, because of routing and scheduling issues and capacity issues related to that, if I should've been on your lawn last week, maybe I'm not on your lawn til this week, and after that has happened a couple of times your frustration level begins to climbs and you are more quick to cancel. So, that's where we've seen some tick up in cancellation and that's why we've been -- that's why we are being conservative in terms of how we think about the rest of this year.

Thank you. I'll jump back in queue.

Thanks, Yilma.

Sam McGovern, Credit Suisse.

Hey, guys, thanks for taking my questions. When you look at your expenses year-over-year, such as investment in sales, fuel expense, overtime labor, chemicals, et cetera, can you bridge the year-over-year change on those sorts of line items?

Is this a TruGreen question, Sam?

Yes.

Okay, so, let's kind of talk about each of them. Again, I'm trying to think of a great way to explain this. If I am serving you, the way that we would set up the year I would say, okay, our first treatment of Sam's lawn should be on February 1, our last treatment of Sam's lawn should be October 1 and we want to come every 35 days in between. And around each of those 35 days we'll have a window that we can still be effective. And then I would take everybody else's lawns around you, look at when they bought, when they started, when they would end, what their spacing dates would be. I'd have windows around each of those. And then you have fairly complex systems that look at all those application dates, look at the tolerance windows and then attempt to combine those stops into the most efficient routes possible.

To the extent your routes are inefficient, your drivers spend a lot more time driving rather than producing revenue. Because they spend a lot more time driving, we spend a lot more in fuel. Because we spend a lot more in fuel and they are driving more, we have higher vehicle maintenance expenses. So, all of those things are affected by how dense our routing is and how well, literally from the beginning of the year, we're able to establish good routes and consistent dates, particularly in tight geographic areas.

In terms of the chemical spend, it's been a couple of things. Number one, as we talked about in our first call, we had a very cold wet spring. Because we had a cold wet spring and we were not getting out like we should have due to systems issues, we didn't get ahead of weeds this year. The best way to control weeds is before they sprout. Pre-emergent control of weeds keeps you from chasing weeds the entire year. If you are not effective early on weeds, you end up having to re-service all summer long on weeds. And that's what we found this year. That's created a lot of trips that we're not compensated for, we're simply honoring our commitment to the customer. And secondly, it has created a lot of chemical spend that we never planned for. So, a bad start to a year, you tend to pay for for a long time and that's what we've seen this year.

Got it. And sort of a follow-up on the TruGreen segment. When you look at winning customers back, do you guys think that you need to discount on price to get those guys back or what are you guys looking at as sort of the factor that's going to draw people back in?

I think the thing that is going to draw people back in is just delivering on our commitments. If you look at our longer-term customers, we are still running very good retention rates. So, the customers who've been with us more than a year or two are being very gracious. They know that our product works. They tend to know their lawn techs and they are showing us a lot of goodwill. Sorry, David, probably shouldn't use that term. They are showing us a lot of goodwill in terms of how they're looking at our service right now.

But, customers who are newer, customers who we've just started and we've made a commitment to them and now it's been two weeks and we haven't shown up, we are seeing high cancels. Customers who we've just started and two or three works into it, we're not showing up, they're canceling. Customers who have been with us six months and we miss a treatment, they are cancelling. So, I think we can absolutely win back customers and we're retaining a lot of our -- we are retaining the majority of our core customers. We actually have historically high retention rates on those customers.

In terms of discounting, our discounting is not so much used to win back customers, that will be a decision based on competition. When we go into the spring we'll look at what key competitors are doing from a discounting and pricing standpoint. We do market research around every major market. We know where we need to be price-wise and we'll use discounting as a mechanism to close sales where needed. But, for example, we're not discounting anywhere right now and we're still seeing fairly good sales.

Got it, thanks.

Bobby Jones, Highland Capital Management.

Yes, just to maybe follow-up on one of Sam's questions real quick. David, I didn't hear you actually bucket out the kind of north of $60 million year-over-year delta. I mean, even in orders of magnitude what each of those buckets cost. I mean, are you guys tracking that or can you just help us bridge as we think about it on our own end?

Sure. So, let me try to put it in at least order of magnitude for you. So, the $65 million decline in operating performance, the largest impact came from the $44 million of lower revenue. That was far and away the biggest impact. The secondary impacts, lower labor, vehicle and fuel efficiency would be sort of the next big bucket. Higher chemical costs, higher bad debt expense, higher sales staffing level, those are sort of the rest of how you would waterfall it. Again, it is the revenue missed, first, big piece. Second big bucket relates to labor, vehicle and fuel efficiency and then the other things to a lesser extent that I just mentioned.

Okay. And then on the labor route density, are there KPIs that you guys track? I mean What is it, gallons of fuel per customer?

Yes. We track stops per hour. We track revenue per hour. We track revenue per customer. We track labor as a percent of revenue. We track miles. We track time -- we're beginning to track time in branch in the morning, time in branch end of day, time from departure of branch to first stop. So, we have -- we actually -- one of the things -- I mentioned some organizational changes. One of the things that we did about three months ago is we brought in a VP of Process Improvement, who is a 20 year UPS guy, and we've really been developing out all of our key KPIs as it relates to productivity and how we can measure those at a very low level. How we can create consistent processes across 200 branches. We have a test branch in Columbus, Ohio that we measure everything and that's also where we test any changes. We've already made -- I will give you a very simple change, but a change we've already made.

One of the things that we found in our test branch is that our drivers typically all leave first thing in the morning and go fuel up. But because they are all dispatched in about a 30 minute time window, in some branches that as many as 50 or 60 drivers, and they all leave at once. They all go to the same service station to fuel up. They all queue up, they all drink coffee, they all talk, they all wait to get their fuel and then they all leave. Well, something as simple as saying there can be no morning fueling. Fueling has to be done end of day. Because they tend to come back at different times, we eliminated the queuing. Now, that doesn't sound like a lot, but we think we're going to save about seven or eight minutes per tech across the entire chain per day with something that small. So, we are looking at every process from the time an employee walks into the branch to the time they leave at the end of the day to look at how do we create consistent and efficient processes.

Okay, that's helpful. And then have you all, just out of curiosity, looked into anything like converting fleets in certain markets to nat gas or anything like that? Down in Texas we hear a lot of Boone Pickens.

We have a very, very strong fleet department at ServiceMaster. That department looks at a lot of different scenarios for us. They evaluate equipment for us. And I do know they have looked at those things. I can't give you a lot of color into it, but I do know that's been evaluated.

One last, if you let me ask.

Sure.

On Terminix, Rob, can you maybe help us think this time last year we started increasing prices on TruGreen and, obviously, the customer attrition followed a number of operational issues, obviously, but today we're kind of looking at a inflection point in the Terminix business. Customer counts are starting to drop off, as we're increasing pricing. Can you maybe address any perceived similarities and perhaps what you're doing to ensure that retention rates stay high and perhaps going after lost customers?

I think, as we said in the comments, the focus is really on customer count and growing customer count. And if you look year-over-year there is some decline but it's roughly flat. The commercial side of what Terminix does is year-over-year about the same and we had some slight declines, but the team is really focused on growing it. I'm not sure I would draw an analogy between the issues related to TruGreen and Terminix, in large part because we don't have the execution issues and other things. So, the team is really focused on growing the business and that will be my major focus going forward.

Well, certainly appreciate the Q&A.

Thanks, Bobby.

Kevin Coyne, Goldman Sachs.

Hi, you have Celeste Everett on for Kevin, how are you?

Good, how are you?

First with the unseasonably high cancellation rate and the impact on revenue that you expect for the remainder of the year, you've talked about it a bit, but can you quantify the impact to your total customer base that you saw in the last few weeks of the second quarter, just to help us assess the impact?

It's not so much that the impact on the customer count was that material. It was more that we saw some trend changes and then we basically extrapolated those trends changes over the rest of the year and that was a somewhat conservative way of thinking. We had actually run better through probably mid- May in terms of cancellation rates. We saw, again, some trend changes that really began mid-May and sort of lasted through the end of the quarter. Based on those, we said we believe we think these are the things causing them.

And when I say that, we get fairly granular detail on why people cancel. When people cancel we route those through our customer service reps. We route those through save desk. We code reasons for cancellation. And as we look through all that, we said we think we have an uptick in cancellations and we think it's going to be a challenge for a while and based on that we changed our forecast. But I can't -- I'm sure David probably show those details from a numbers standpoint, but I would tell you the number that changes from a number standpoint are not material, but the trend changes are what have caused us to take a more conservative view of the rest of '13.

Okay, that's helpful thank you. And then looking at your three systems, where do you think you've made the most progress since we've last spoken? And then looking specifically on the routing and scheduling, has this stabilized or deteriorated from the first quarter or is the issue just as large as it was?

No, it's not as large as it was. I think we've made a lot of progress. In terms of places we made progress, if you went back 60, 90 days, we were still having significant integration issues between the three systems. So, for example, the routing and scheduling system has probably 200 different parameter settings in it, very complex algorithm. And the way it would interact with our operating system, which had its own set of rules and parameters, and the way they would interact then with the handheld system, there were basically clashes between those three systems.

From an integration issue standpoint, the three systems are now working well together. We're not seeing that type issue. So, the movement over the last 90 days has been much more to optimization. So, taking each of them, the handheld's our biggest optimization issue is related to synchronization. We were losing time every day because of how long it to synchronize, both while the tech was out in the field and also when they would come in in the morning, when they start in the morning and when they end the day.

So, we brought in -- one of the other changes, we have a new CIO that came onboard about 30 days ago, with a very, very strong background in this type of business. This type of business meaning large fleets. He had been CIO for United Rentals. He has done a tremendous job helping us identify where things were breaking down from a handheld standpoint. We've decided to upgrade a number of our handhelds. We have upgraded Wi-Fi hotspots in a number of branches. We've changed service providers. We've gone through and done audits around which were the strongest service providers in each branch and we've made changes where that was appropriate. So, we're seeing fewer issues with the handhelds.

From routing and scheduling standpoint, from our last call to the day, there've been over 20 releases in our routing and scheduling software to address issues. It is producing much tighter routes then what -- where we were 90 days ago. We are seeing ourselves go into a neighborhood once in a week, not five times a week. We're seeing much more productivity out of the techs. We're seeing higher completion rates. There's still work to be done. But it is most definitely better than it was.

One of the other challenges we have is when you start a year bad and you get customers on different timelines and cycles and then you have tight windows around the dates of the next applications, it's hard to pull those together and make them cohesive again within a year. So, there's only so far we can get this year. Starting clean next year we will see a lot of benefits from things we're doing right now.

Okay, great, thank you.

Thank you.

[Matt Dratch], Reef Road Capital. Mr. Dratch, your line is open. Please go ahead.

Matt, you may be on mute.

Hi, guys, thanks. Most of my questions have been answered, so I will save you the time. Thanks a lot.

Okay, thanks, Matt.

Jeff Kobylarz, Stone Harbor Investments.

Hi. Just curious, wanted to follow-up on Celeste's question about the inefficiencies. Is there any way to roughly quantify or just give some kind of window just about the inefficiencies that you're experiencing right now? Are they 10%, 20% of where they were relative to three months ago? Anything you can quantify to give us an idea about the magnitude of how far you are away from getting to a normal kind of run rate?

At the worst point, if you look at -- and I'm not trying to create a new thing to report on here -- but at the worst point, our labor as a percent of revenue was about 400 basis points worse than last year. It's now running between 100 and 130 basis points worse than last year, labor's percent of revenue. So, the impact of that has obviously improved a lot and that's probably the most significant productivity metric I pay attention to.

Okay. And as far as these operating systems, labor, scheduling, routing, I believe they are currently in place at Terminix. Is that right?

It is.

And so, what is the difference here? Why did they run well at Terminix and not well here at TruGreen?

A couple of points I would make first of all, while on the surface they may look similar, TruGreen and Terminix are very, very different Companies. So, let me give you one example from a routing standpoint. When Terminix does a route, it tends to stay fairly stable. You're serving a customer within their home and as long as the customer is there, there's really no reason you can't do that service. So, once you create a relatively good route, you're able to stay fairly close to that route, probably a 90%, 95% ability to run the route you planned. If you look at TruGreen, our work is outside. So, we can be affected by anything from rain to thunderstorms to wind. We can't apply chemicals if the wind is above a certain number of miles an hour under federal regulations. So, a windy day we just had to change our plans. A rainy day, we have to change our plans. We call, the customer says I can't be there to put my dog up. We have to change our plans. Or the customer says they are mowing, please don't come while they are mowing. Or the customer says we are having a party on our lawn. Please don't come while we are having our party.

So, if you think about, since we are moving into football season, when Terminix calls a play they tend to run the play. When our system calls a play, we audible about 30% of the time. The system is very good, the system is relatively good at calling plays. It does not work well when you have to audiible. And that is where our challenges have been. The big challenge, though, is if we had just left the system alone and said okay here is Terminix system we are going to run it just like it is, it would have worked fine. We've had to make a lot of changes and the reality is as we made those changes it brought a lot of new complexity in terms of how the three systems work together and it created a lot of the problems that we've gone through over the last few months. The changes had to take place, but in many cases when you change one thing in a system, it affects other things in the system and that's what we've seen.

Can I just ask one little follow-up and that's about -- if the operating system and the EBITDA percentage, if you just can't get back to where you were like 19% a couple years ago, would you just then bail on this current system that you have now and just go back to whatever system was working that generated 19% EBITDA margins?

The answer is I would love to do that.

Jeff is asking a lot of questions that we've discussed internally.

Exactly. So, one of the first things that I asked after I came here is okay, I'm looking at numbers that don't look very good, can we not just pull this out and put back in what we had? And the answer was yes, if you want to spend millions of dollars and spend about 12 to 18 months doing it. The problem is the old system there were issues with PCI compliance. It was an old system and was most definitely aging. And while you didn't see a lot of those impacts yet, they were coming, quick. So, the decision to replace the system was a needed decision.

Now, I have some concerns with how it was implemented from a testing and piloting and design and everything else standpoint, but going back to the old system is not an option. Now, in terms of if we can't ever get productive with this system will we just stay with it, no. I mean, we've looked at six other options. We've done fairly deep dives on half a dozen other systems. The conclusion we've come to, though, is that we're making progress on the system. It is getting better literally every week. And from a risk to our customers and a risk to our associates and a risk to our business, the best thing we can do right now is to go full speed on getting this as productive and effective as we can, but at the same time have a separate team who is looking at other options and in the background saying if we need to go a different direction, what does that look like? How would we do it intelligently, how much time would we spend on as is, to be, external design, gap analysis, piloting, testing, how would we roll it? So, we have a parallel path that if we ever needed to go down we're not wasting time on. We are setting up other alternatives, but based on what we've seen we believe we can get there with what we have and that that presents the lowest risk to all of our constituencies, our Associates, our customers, our owners, everyone.

All right, thanks for that explanation. I appreciate it.

Thank you.

[Lieng Chin], MetLife.

Hi, I was just curious, I mean, I recently called TruGreen for an application and I had -- I didn't have any issues in terms of scheduling or timing or anything. So, I was just wondering are the systems issues are they national or local by franchisee? Or I mean how exactly what's the scope of the problem?

No, its national, but what you're also seeing is -- the key term, I believe, was when you said recently. We are much better today at getting service scheduled and getting service completed. We are much better today at starting on time and we're hearing much better things. The customer issues are -- have declined significantly from where they were 30, 60, 90 days ago. But we're not where we need to be, yet, and there are things that, hopefully, you as a customer won't see, but are still affecting us from a route density and efficiency standpoint. I think we're doing a much better job for our customers than we were 30, 60, 90 days ago. But, again, we're not where we need to be from an efficiency standpoint yet.

Okay. And if I could just ask one follow-up. You were recently downgraded by Moody's and I'm just curious do ratings downgrades trigger anything for you, in terms of your capital structure or interest costs?

There would be no triggers under our term loans or our notes. There would be a trigger under our revolving credit facility, but we don't presently have any borrowings under that revolver.

And what happens to your revolver in the event of a downgrade? If you did have drawings?

It would be rate based and the revolver test is really the secured leverage ratio, that's what's used.

Okay, thank you.

Thank you.

Jamie Russell, Onex Credit Partners.

Hi, this is Andy Scheffer for Jamie. I had a question. You mentioned that labor as a percentage of revenue was 400 basis points worse than normal at the worst period in time. When did that happen and then where did you start the quarter and where did you finish the quarter and I assume now you're at the 100 to 130 basis point difference?

I think David told me I kind of went overboard with detail anyway, but I think the answer is what I would tell you is the run rate as we ended the quarter was more in the 100 to 130 basis point range and as you go back in the year the number was higher.

Right. Think of it as a stair step across the year.

Yes, that's probably the best way to explain it.

So, sort of a steady slope starting from the beginning of year?

It was sort of a unsteady slope. It was fits and starts. We'd do something, it would get a little better. We'd start working on something else, it would break. It would get bad again. But over the last -- let's say over the last couple of months anyway particularly, it's been much more of a steady progress.

And, so, second quarter was probably a little bit better than the first quarter?

I don't have those numbers in front of me, but I think that's a fair comment.

Okay. Thank you.

Thank you.

Yilma Abebe, JPMorgan.

Thank you. A couple quick ones. When a customer typically cancels, do you have visibility in terms of where they go? What I'm trying to get out is is it incrementally easier to get back those lost customers as opposed to trying to get new customers?

The answer to that is yes. One of the things we always start a year with is calling last year's cancels. Obviously, we have the highest answer rate on those, because those are real people with real numbers. But number two, we have the highest close rates in terms of resales on those customers. So, the answer to your question about are they easier to recapture than just someone we've never done business with, the answer is yes. Those are our highest likelihood to re-sign -- to sign up are people who've been customers who've canceled within the last 12 months or so.

And cancellations can be anything from -- cancellations don't occur just due to service. We'll have customers who we do a very good job for and they'll say, okay, my yard looks great now, I don't need you anymore. And then 12 month later they'll come back. We have customers who may have financial issues from their own personal finances that need to cancel and then six or 12 months later will come back. So, those type cancels happen all the time. What we've had more of are service related cancels.

If you do have a service related cancel, though, what does the typical customer do? Would the customer go to another competitor or would they just not do anything?

Don't really have that information. It really kind of depends on who the customer is. We have customers who use us more just for fertilization and weed control and they may just say, okay, I'll do it myself. We have other customers who rely on us both for that and insect control. We have other customers who use us for those things and aeration and over-seeding. So, I'd say the more the customer depends on us, if they don't use us, the more likely they are to go to a competitor. The more the customer uses us just for basic services, a lot of those may just do it themselves for a while.

Thank you, that's helpful. And one last one and I apologize we can come back to the same IT systems related issues, but one question I did want to ask is, in terms of the issues being taking longer than expected, more difficult than expected, this quarter versus what was telegraphed in the first quarter, what exactly happened? Were there technical issues that surfaced or it is just taking more and more time and labor?

The one thing I would ask you to do is if you go back and listen to or think about what I said in the first quarter. I signaled that this was not going to be solved quickly. So, in terms of what we communicated this is pretty much exactly the path we communicated. In terms of our internal expectations and, obviously, internally I expected things to get done quickly in terms of what I expected of my team.

The challenges have been that when you have systems issues that cover the waterfront. When you have three different systems and you begin with integration issues. And it is almost like peeling back an onion. You get past the integration issues. You can't see the optimization issues until you get past the integration issues. As you begin to fix the big optimization issues and you think, okay, if I fix this it will solve 90% of the problem. Instead it solves 70%. And then you see underlying issues that were not visible. And that is a process with major systems and that's the process we've been going through.

I see. So, I guess maybe I misunderstood. So, in the June quarter it's not like the systems were, relative to your internal expectations, turned out to be more difficult than your initially anticipated, is just a process you're going through and making steady progress? Is that right?

It's a combination of, again, every time you fix an issue when you're talking about systems this complex, you have expectations and you have hopes about what that will do. A lot of times it will not -- you assume it is going to get you 90% of the way there, it may get you 70% of the way there or you find underlying issues you then have to tackle. You solve those you find there are underlying issues to those.

These are being run by very complex algorithms and again hundreds of parameters, and something as small as a minor parameter setting within one of those systems can create big inefficiency. So, I'll give you an example and it's embarrassing example. One of the things we found out just recently is that in our handhelds in a preference setting someone had set them up to prefer right-hand turns. Well, right hand turns are safer and that preference is good, but in a lot of cases it was causing us to go way out of route just because someone had set a field in a handheld to do a certain thing. Again, that's a fairly granular comment, but that's how low-level as can be. There are hundreds of parameter settings in each of these, there are preference settings in each of these.

And, so, you get past the immigration issues, you begin to attack the big optimization challenges, the core algorithms in the systems, and then you begin to say, okay, let's look at preference settings. Let's look at parameters. Let's look at how the three systems are communicating and you keep peeling off layers. And you get -- each time you do you get a little more productive. And then you find something else and that's the process we've been going through.

Thank you and we have no further questions at this time. I'll turn the call back over to you.

Thanks, Chris. Thank you again for participating in today's call. We look forward to speaking with you again when we announce our third-quarter earnings in the fall. Goodbye.

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