Serve Robotics Inc.
Q2 2017 Earnings Call Transcript

Published: 31 Oct 2017

[Operator:]

Ladies and gentlemen, welcome to the ServiceMaster’s Third Quarter 2017 Earnings 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 and Treasurer, and he will introduce the other speakers on the call. At this time we will begin today's call. Please go ahead, Mr. Turcotte.

[Brian Turcotte:]

Thank you, Chris. Good morning and thank you for joining our third quarter 2017 earnings conference call. Before I review the agenda and introduce the other speakers, 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. As stated on Slide 2, 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, October 31, 2017. The Company undertakes no obligation to update any information discussed on today’s call. This morning, ServiceMaster issued press release filed with the SEC on Form 8-K highlighting our third quarter 2017 financial results, and we have posted a related presentation, both of which can be found on the Investor Relations section of our website. We will reference certain non-GAAP financial measures throughout today’s call, and we have included definitions of these terms in our press release, which is available on our website at www.servicemaster.com. We have also included reconciliation of these non-GAAP financial measures to the most comparable GAAP financial measures in our press release and presentation in order to better assist you in understanding our financial performance. All references on the call to EBITDA today are to adjust EBITDA as defined in our press release. Joining me on today’s call are ServiceMaster’s Chief Executive Officer, Nik Varty; and Chief Financial Officer, Tony DiLucente. For those of you who haven’t had a chance to download the investor presentation from our website, I’ll walk through the agenda items shown on Slide 3. Nik will lead off with some opening remarks regarding his key activities and observations during his first 100 days as CEO of ServiceMaster and then provide an update on the Terminix business transformation and the company's strategic growth priorities. Tony will follow and summarize our consolidated third quarter financial results, review the integral business unit results, provide more details in regard to our financial statements and then speak to the updated full year outlook. We will then open up the call to your questions. I’ll now turn the call over to Nik. Nik?

[Nikhil Varty:]

Thanks, Brian. Good morning and thank you all for joining us today for our third quarter 2017 earnings call. During the quarter, we saw a good revenue and EBITDA growth across American Home Shield and Franchise Services Group. And also [indiscernible] we have normalized for hurricane Irma and Harvey and excluding Alterra customer attrition. Tony will provide details on the financial results later. We also launched a disciplined approach toward improving performance of Terminix, building on some of the investments we described earlier in the year. We are making good progress on the spinoff of American Home Shield and have embarked on developing and establishing a strategy to set up two highly successful listed companies. I'll start with Slide 4. Having now spent a 100 days with the company, I'm very confident that there is a significant opportunity to unlock value at ServiceMaster by sharpening our focus on our results and operational excellence. ServiceMaster has powerful and well-recognized brands that reach into more than 5 million homes annually nationwide. First and foremost, we see tremendous potential at Teminix through improved performance and drive long-term profitable growth through our strategic transformation plan. Terminix operates in markets with strong future growth potential and has significant opportunity to leverage its core strength to grow rapidly in the commercial business space with the right level of focus, leadership and implementation of key growth strategies. American Home Shield, or AHS, continues to be a strong and consistent performer, delivering high single-digit organic annually for the past five years. We're continuing to drive profitable growth at AHS in this vastly underpenetrated market and see significant potential in adjacent markets through the use of our industry-leading contractor network. We will continue to drive shareholder value through appliance to spin off AHS, which is on schedule for the third quarter of 2018. We're building a strong leadership team that can capitalize on the high growth potential of this business and deliver sustainable long-term value for our shareholders. As one of the nation's largest franchisers of home and commercial services through a highly profitable franchise services group, we are continuing to expand that business by growing our national accounts and broadening our service capabilities in the new areas. We have increased our customer-level revenue in the business to $2.5 billion annually and we see significant further growth potential as we account for only a small fraction of the very large and fragmented home and commercial services market. Over the past 100 days, I've had the opportunity to meet with hundreds of our employees across all the three businesses and corporate support centers, and I have been impressed by their professionalism and commitment to improving the customer experience. I visited Terminix and American Home Shield call centers in Dallas and Lorraine, Georgia, met with employees and have listened to numerous customer calls. At so many of the branches in Massachusetts, California and Ohio, I had the opportunity to learn from our tech and outside sales professionals and our banks and service managers and also accompany live technicians on service calls. I had an excellent experience meeting with our largest franchisee of Terminix in South Carolina as well. I also travelled to Houston a few days after hurricane Harvey devastated South Texas to thank our employees and franchisees for their incredible dedication to getting people back in the homes and back to their jobs. We’ve mobilized more than a 1,000 people to help out with the recovery efforts, and I am very proud of how our people rallied on our customers, both personally and professionally, to support them during this critical time of their needs. This response demonstrated how well prepared we are at all times to help our customers when they face disaster-related events. And although I didn’t have an opportunity to travel to Florida or the Caribbean following hurricanes Irma and Maria, I also want to recognize our employees and franchisees in those areas. In all of the locations affected by these storms, I could not be more proud of our teams. Although I've been in the CEO role a very short time, a relatively short time, I have also had an opportunity to meet with sell-side analysts that follow ServiceMaster and many of our valued shareholders and debtholders. I value your opinions and the opportunity to demonstrate our commitment to driving long-term value for our owners. Tony and I have conducted monthly operating reviews and deep dives for all three of our businesses as well as functional reviews over the past three months. This process has allowed me to better understand both the opportunities and challenges facing our business and also provides me with the forms to appraise our talent throughout the organization. I can tell you that I have been very impressed with the people throughout our businesses and I've identified areas where we can further enhance our teams to drive the improved performance. As I mentioned on the second quarter earnings call, the decision to separate the AHS business from ServiceMaster is the right and necessary step at this point in time. The plant spin-off is expected to better position both AHS and ServiceMaster for the feature as more highly focused companies that are able to pursue their distinct strategies and growth opportunities. It will allow the companies to fully focus on this transformation activities while allowing the AHS to pursue its high growth opportunities. I was pleased to announce on October 2nd that we have hired Dion Persson to Head of Spin-Management Office and manage the overall strategy for the company. Dion will be responsible for developing and executing a well-structured process with spinning off ASH and will be responsible to identifying and advancing all business development activities for the company. This includes directing and evaluating new marketplace opportunities such as strategic partnerships mergers and acquisitions that support ServiceMaster’s strategic growth and development plan with the goal of positioning two successful publicly traded companies in 2018 off-spin [ph]. Prior to joining ServiceMaster Dion served as Vice President of Strategy and Analytics for Ingersoll Rand and also served as Senior Vice President and General Counsel and Head of Human Resources at Johns Manville as well as Senior Vice President of their largest business the Engineering Product Group. He previously worked for the law firm of Skadden Arps as well. We are extremely pleased to have him on our team. We are committed to keeping you informed as the spin process move forward. We recently named Matt Stevenson as President, Terminix Residential. Terminix Residential will become a separate P&L with full accountability for driving improvements in the residential business and delivering results. This new business unit focus will enable us to better understand our residential customers and their needs to accelerate growth and introduce new products and services. In this new role, Matt will report directly to me and have full P&L responsibility for Permanents Residential business and will be focused on driving growth and profitability in the $5 billion residential pest control and termite market. We believe that having a dedicated focus on the residential market will allows us to leverage our understanding of the home owners’ specific pest and termite control needs is the unique offerings to attract and retain customers and accelerate growth. Prior to joining ServiceMaster, Matt served as President and General Manager at Meritor WABCO, where he significantly improved performance in many areas, including sales, operations and marketing, and reposition the business for greater profitability, growth and long-term success. Prior to WABCO, Matt held a variety of executive sales, marketing and operations roles at Bridgestone Americas and Daimler Trucks North America. We are excited to have Matt joining our Terminix team. Before I turn the call over to Tony to review our third quarter results and full year 2017 outlook, I'd like to update you on our Terminix business transformation. Please turn to Slide 5. At Terminix, we are taking a disciplined approach to executing on a series of systematic transformational activities the significantly upgrade the customer experience, improve our customer attention rates and profitably, grow our market share. We are building a strong leadership team with significant experience and delivering results and driving profitable growth to lead the tremendous individuals we have throughout the business. At the same time, we are creating an organizational structure that enhances personal accountability and supports a high performance culture. We are empowering our route technicians to deliver an exceptional customer experience by giving them the tools they need to improve customer engagement while providing them with timely customer feedback. We’re beginning to see results from our past technological investments in improving pre- and post-service engagement and our ability to receive the direct customer feedback. We will develop a strong commercial business to better able to focus on and serve commercial customers, which represents a significant opportunity for us. We will implement a disciplined Lean Six Sigma approach to enhance efficiency to significantly improve customer levels, strengthen our investment discipline and drive profitable growth. We are enhancing our ability to consistently deliver on our commitments by increasing our transparency, improving operational cadence and measurement systems, and strengthening business processes with a goal of creating long-term sustainable value. We recognized change will not happen overnight and that it will take time for us to demonstrate the benefit of steps rotating to drive improved performance. But I am confident we are headed in the right direction to deliver consistently strong revenue and earnings growth. Turing to Slide 6. I'll share some of our strategic growth priorities for each of our businesses. At Terminix, we will continue to execute on the business transformation I just reviewed. Our initiatives are design to achieve world-class customer service to improve customer satisfaction and increase customer retention levels. And we will seek to expand our commercial pest control and termite business. Today, our commercial revenue represents about 20% of our global Terminix revenue and I'm confident that we can grow that profitably. At AHS, we will also seek to increase market penetration by providing world-class service to our valued customers. As we have mentioned on the past few earnings calls, we have increased call center investments to improve response time as well as upgrading contractor capacity and quality. We also plan to expand product offerings and expand into adjacent markets. I don’t want to provide too much detail today about our plans for competitive reasons, but we will updating you in the future. And at the Franchise Services Group, or FSG, we will continue to leverage relationships with insurance companies that currently provide us with disaster restoration leads as well as form new relationships to grow that business. The ServiceMaster Clean business will work to both increased share with existing national accounts as well as add new accounts to drive higher revenue growth. FSG is also exploring opportunities to expand their current reach beyond its core area to drive growth. I'm very excited about our growth opportunities across all of our businesses and plan to share our progress as we move forward. I'll now turn the call over to Tony.

[Tony DiLucente:]

Thanks, Nik, and good morning, everyone. Turning to our consolidated results we have shown on Slide 7. ServiceMaster produced solid revenue and EBITDA growth in the third quarter. Total company revenue grew $39 million or 5% compared to the prior year. Our results were primarily driven by organic growth at American Home Shield, where we continue to see strong demand for our products in both the real estate and direct-to-consumer channels, coupled with the favorable impact of our acquisition of Landmark Home Warranty last year. Terminix delivered 1% organic revenue growth versus prior year, excluding the impact of temporary branch closures related to the hurricane and expected Alterra customer attrition, and we continue to believe that we're on a clear path to improved customer retention and organic growth. The franchise services grew organically by 7%, excluding the impact of the converted Merry Maids branches to franchises and the Master distributor acquisition in January. Adjusted EBITDA for the third quarter increased $8 million or 4% compared to the prior year. The increase in EBITDA was primarily the result of a conversion of higher revenue driven by organic growth, acquisitions and lower claims cost at AHS. The ongoing business transformation initiative and hurricanes drove margin compression at Terminix versus prior year. I'll cover the third quarter performance with Terminix in more detail in a moment. Our adjusted net income for the third quarter was $99 million, an $18 million increase versus prior year, and adjusted diluted earnings per share of $0.73 was up $0.14 versus prior year. This 22% increase in adjusted net income was primarily driven by higher adjusted EBITDA and a lower provision for income taxes related to stock option exercises. Turning to Slide 8. In the third quarter performance of Terminix, revenue was relatively flat at $395 million. The increase in core termite control, termite renewal, wildlife exclusion, mosquitoes and insulation was offset by the decline in core pest control due to the temporary closure of 53 Terminix branches primarily in Texas and Florida due to hurricanes Harvey and Irma and expected customer attrition associated with Alterra. Adjusted EBITDA for the third quarter declined by $10 million from $92 million in 2016 to $82 million in 2017. If you view the waterfall chart on the bottom of Slide 7 it’s starting on the left side, you'll see that higher revenue conversion was about $1 million favorable in the third quarter, including the unfavorable impact of Alterra customer attrition. The impact from the 53 temporary branch closures related to the hurricanes in the third quarter and favorably impacted EBITDA by $3 million. There should be no significant carry over impact on the fourth quarter. Moving to the right. We incurred about $1 million in additional production labor costs primarily from having more supervisors, also as I’ve mentioned last quarter, we found that to meet our customer service expectations at the outset of this efforts that we need to allow for more time for service visits. However, we do anticipate optimizing the process going forward, which should reduce the labor cost. The $3 million increase in termite damage claims reflects increased warranty claims and reserve requirements in the third quarter of 2017. Large claims increased in the third quarter compared to our historical norms, primarily in the Gulf Coast. We are continuously evaluating how we estimate future claims, but as of now we are expecting $1 million unfavorable EBITDA impact from termite damage claims in the fourth quarter versus prior year. A $2 million increase in our insurance program was principally driven by an increase in the number of company owned sales vehicle versus prior year. As we discussed earlier in the year, we decided to lease company vehicles for our field service, field sales personnel. We estimate that the vehicle insurance will be $1 million higher year-over-year in the fourth quarter. And finally, the $2 million increase in sales and marketing cost was driven by higher commissions as impact sales to the third quarter were higher than the same period in 2016. Please note that we are planning to spend about $4 million more in both sales and marketing in the fourth quarter versus the same period in the prior year to drive organic growth. In summary, regarding the additional costs, we are investing in growth and we’re committed to finding efficiencies that it will improve margins. However, we believe that the full year 2017 EBITDA margins will be between 200 to 300 basis points lower than prior year due to the ongoing business transformation initiatives in the third quarter of Hurricanes impact. Turning to Slide 9 and the Terminix revenue drivers for the third quarter. Terminix organic revenue growth versus prior year was 1%, excluding temporary branch closures impact from hurricanes Harvey and Irma. If we also exclude the impact of our impairment and customers attrition on the third quarter. Terminix revenue growth would have been 2%. Starting on the left side of the chart. Revenue from termite completions, which includes new termite sales and other services, was $72 million, which is an increase of $3 million or 5% over prior year. Termite renewal revenue increased $1 million or 1% to $72 million. During the third quarter, about 70% of this $72 million in termite completions and other services revenue was derived from the sale of core termite completion, meaning a first-time termite service. Core revenue increased about 3% year-over-year, continuing the trend established in the fourth quarter 2015 of year-over-year increases in the number of core termite completions. The remainder of the $72 million of termite completions and other services revenue comes from services such as exclusion and installation, and this revenue stream increased by about 9% year-over-year. Termite renewal revenue increased by 1% compared to the prior year, driven by price and an initiative to upgrade our paid monitoring stations for a small subset of our customers. Pest control revenue of $228 million in the third quarter decreased by $6 million or 3% versus the prior year. As previously mentioned, organic pest control revenue growth was significantly impacted by an expected $5 million organic revenue decline associated with Alterra attrition. The unfavorable revenue impact from the 53 temporary branch closures related to hurricanes Harvey and Irma was about $4 million in the third quarter. As we've previously discussed, we have significantly invested in improving service levels and driving new growth in Terminix. Although we have much more to do, we have seen significant improvement in customer engagement and service as evidenced by the higher net promoter scores and it realized significant growth in new sales during 2017. We are increasingly confident that we have taken the right steps on our continuing journey to transform service quality, improve retention in growth and position the business for long term sustainable growth. For 2017, we expect organic revenue growth at Terminix, excluding the impact of hurricanes, to come in at 1% for the full year. Let’s turn to Slide 10 and discuss American Home Shield’s third quarter performance. AHS had another strong quarter with continued solid top line and bottom line growth versus the prior year. Revenue increased from $309 million to $346 million or 12% with organic growth contributing about two-thirds of that growth and acquisitions driving the remainder. The organic revenue growth was mostly driven by an increase in customer count, which accounted for 7% of AHS’s 8% organic growth. Higher prices accounted for 1% of the organic growth in AHS. The Landmark acquisitions contributed about $12 million or 4% of growth. Revenue growth continued to be solid in both of our key channels to market. Year-over-year organic growth in the direct-to-consumer channel was 7% and 9% in the real estate channel. We remain focused on sustaining our strong growth rates through optimizing our advertising, promotion and direct mail campaigns to drive new sales units as well as improving service quality to improve retention rates. Third quarter gross margin was up 230 basis points versus prior year at approximately 51%. EBITDA increased year-over-year by $70 million or 21% and with margins at 210 basis points to 27.8%. To understand the drivers of EBITDA growth, please turn your attention to the waterfall chart on the bottom of Slide 10. Starting on the left side, the largest contributor to the increase in EBITDA was $14 million of flow-through from organic revenue growth with $11 million EBIT related to volume and $3 million related to price. Lower claims costs provided an additional $3 million of EBITDA benefit in the quarter as favorable claim incidence rates more than offset inflation. The acquisition of Landmark contributed about $4 million in the third quarter. On a year-to-date basis the acquisitions of OneGuard and Landmark has contributed $12 million of incremental EBITDA and we expect a nominal impact in the fourth quarter as we will have lapped most of Landmark impact. A $4 million increase in sales and marketing cost reflects both the shift in a $2 million advertising campaign from the second to the third quarter as well as an additional spend of $2 million. And also we plan to increase our marketing spend by about $3 million in the fourth quarter as compared to the prior year to drive more units as we enter 2018. And finally, a $2 million increase in call center service cost was driven by higher labor cost resulting from both an overall increase in call center staffing level to improve response times and staffing levels that were too low in the third quarter of 2016. Call center costs should be approximately $1 million higher in the fourth quarter versus prior year. As we mentioned on recent earnings calls, the AHS team continues to upgrade their contractor base both with respect to total capacity as well as quality. We manage over 15,000 contractors and believe that this provides us with the necessary scale, competitive advantages, and capacity to grow going forward. In total, our contractor base, excluding acquisitions as of the end of September 2017, was 12% higher than was as of the end of September 2016 and our preferred contractor count improved by 7% during this time frame as well. Moving on to Slide 11, let’s now cover Franchise Service’s third quarter performance. Revenue increased $4 million year-over-year or 7%. The increase was driven by $3 million of higher domestic janitorial national account revenue, $2 million of higher royalty fees, primarily domestic disaster restoration fees and a $1 million increase in product sales, offset in part by lapping the favorable impact of the Canadian fire restoration fees of $2 million in 2016. Excluding the conversion of the Merry Maid branches to franchises and the Master distributor acquisition organic revenue was also 7% higher year over year. Adjusted EBITDA for the second quarter was $22 million, which is $1 million or 4% higher than the previous year. This improvement in EBITDA was driven primarily by higher revenue conversion, the favorable impact of converting the Merry Maid branches to franchises, at lower sales and marketing costs. The franchise services group experienced a 130 basis points of EBITDA margin compression in the third quarter versus the same period in prior year due to a revenue mix shift from high margin royalty fees to lower margin Janitorial National Account. Janitorial National Accounts had a lower EBITDA margin because we recognized all of the customer-level revenue in the margin calculation since we own the relationship with the customer. Conversely, we only use royalty fees as our revenue in the margin calculation for our other brands. Despite lower margin, we certainly like to increase the EBITDA that the Janitorial National Accounts contribute. In the first nine months of 2017, FSG EBITDA has grown 12% over the same period in 2016, thanks in large part to high fee revenue arriving from disaster restoration efforts. Although we cannot predict the royalty fees that we could receive from hurricane cleanup efforts over the next few months, we do expect lower year-over-year EBITDA in the fourth quarter due to the low revenue conversion, timing of marketing expenses and non-recurring G&A benefits in 2016. Turning to the consolidate P&L on Slide 12 and looking at ServiceMaster in its entirety, the year over year revenue increased to 5% or $39 million includes $25 million or 5 percentage points of net organic growth. The remaining $14 million of revenue increase comprises $2 million due to acquisitions within Terminix and $12 million from the acquisition in AHS. Gross margins are slightly higher versus prior year. The increase in AHS margins driven by lower claim spots more than offset lower margins in Terminix and the Franchise Services Group. The year over year SG&A increase of $14 million primarily reflects $5 million of cost from acquisitions in AHS, $2 million of higher call center service costs in AHS, $4 million of AHS and $2 million of increased Terminix sales and marketing costs and $3 million of higher depreciation expense primarily related to vehicles and the investment in technology to upgrade the mobile digital platform in Teminix. As a result, SG&A as a percentage of revenue increased by 50 basis points to 45%. Net income of $80 million for the third quarter is up $11 million. Adjusted net income for the second quarter is $99 million, which is up $18 million from the same period in 2016. Moving on to Slide 13, let me cover the bridge from adjusted EBITDA to adjusted net income. As previously noted, adjusted EBITDA for the third quarter was $200 million, $8 million higher than the same period in 2016, while adjusted net income was $99 million, $18 million higher than the prior year. The $18 million or 22% year-over-year increased and adjusted net income was driven by $8 million of higher EBITDA as well as $10 million to benefit from a lower effective tax rate in the third quarter of 2017 versus the same period in 2016. In the third quarter of 2017, the effective tax rate was only 29.6% versus 39.8% in the same period one year ago. This lower rate was driven by excess cash benefits for share-based awards. Lower stock-based compensation and interest expense were offset by higher depreciation expense in the third quarter 2017 versus the same period of 2016. The higher depreciation expense was driven by prior year investment in technology as well as acquiring company vehicles for our Terminix outside sales professionals. With respect to cash flow as shown on Slide 14, free cash flow was $67 million in the third quarter, which was $110 million higher than the same period in 2016. In the third quarter of 2016, we made payments of $88 million related to the U.S. Virgin Islands Fumigation Matter. This payment was partially offset by reduced tax payments in the third quarter of last year related to the Fumigation Matter, which is the primary driven of the change in our tax accounts year-over-year. Increases in net income of $10 million and a decreased seasonal working capital outflow of $15 million were the other large contributors to the cash flow improvement in the quarter. For the nine months ended September 30, 2017, free cash flow was $293 million in the year-to-date period, which was the $123 million higher than the same in 2016. In the year-to-date period 2016, we made payments of $90 million related to the USDI Fumigation Matter. We also had favorable timing of tax payments of $21 million and a decreased seasonal working capital outflow of $4 million as compared to the prior period. In the third quarter, we used $14 million for the purchase and cancellation of a portion of our 7.25% 2038 bond. We did not repurchase any shares of ServiceMaster stock in the third quarter of 2017. We currently have a $155 million remaining from the original $300 million share buyback program. Finally, moving to Slide 15, I'll cover our full year outlook for 2017. Full year 2017 revenue expectations remain in the range from $2.9 billion to $2.92 billion or an increase of 6% compared to 2016, primarily at AHS. We are revising our full year 2017 adjusted EBITDA expectations to a range from $670 million to $675 million or from flat to an increase of 1% compared to 2016, reflecting the impact of Hurricanes on third quarter results and ongoing business transformation initiatives at Terminix. As I explained last quarter, as we say setback to the rebuilding the core of our growth platforms to Terminix, we are investing an additional leadership, technology, resources and service capabilities to ultimately drive higher levels of organic growth of Terminix. Additionally, we have increased our spending on Terminix marketing to drive lead generation and increase our staffing of sales technicians to help spur new organic sales. Although these investments have a short-term impact on margin, we remain confident that they will generate strong organic growth. We also believe that the implementation of new operating processes and systems will lead the cost efficiencies that will allow us to claw back against margin erosion. Finally, in AHS, we expect to see more modest year-over-year adjusted EBITDA growth in the fourth quarter as we have faced more of our 2017 marketing spend towards the latter part of the year to drive momentum going into 2018. Additionally, we expect claims cost to be higher in the fourth quarter as the third quarter benefited from an unusually cold summer. Please note that our 2017 outlook excludes the impact of any potential acquisitions during the year. With that, I'll now turn the call back to Brian so we can move into the Q&A portion of the call.

[Brian Turcotte:]

Thanks, Tony. As a reminder, during the question-and-answer session, we encourage you to ask any questions you may have, but please note that guidance is limited to the outlook we provided in our press release and webcast presentation. Additionally, please limit yourselves to one follow-up question so we can get to everyone in the allotted time. Chris, let’s open up the line for questions.

[Operator:]

[Operator Instructions] Our first question comes from the line of Sam Eisner with Goldman Sachs. Please go ahead.

[Sam Eisner:]

So on the -- I think you applied guidance for the fourth quarter for EBITDA is about $129 million, net $50 million down year-on-year. I think you have highlighted about $10 million of that walk in the higher call center cost, the market, the sales and marketing in the Terminix. I think there is net kind of $5 million which yet to be identified. Can you maybe give us additional color on what else is in there in terms of kind of the year-over-year impact in the fourth quarter?

[Nikhil Varty:]

I think we have covered most of it. We talked about year-over-year marketing increases in the American Home Shield business, also higher marketing expenses in Terminix. We also are not going to assume that we are going to have favorable weather-related impact to our claims costs in the fourth quarter. I mean, that’s actually is the prudent way that we have to really stay focused on, a normal weather pattern and we did benefit to some extent in the third quarter from unusually cold summer. So, perhaps, the claims costs in particular are probably most of the gap that you are speaking up on.

[Sam Eisner:]

And then just maybe a second question here. You highlighted it in your opening kind of opening statements an opportunity to get into the commercial market and I think that was something that you highlight with the sell side during [indiscernible], if you can expand on that further and has that strategy being fully kind of avail at this point?

[Nikhil Varty:]

That’s an interesting question because, if you look at the strength of our business and the significant footprint we have across the country, we are in a great position to focus on some sweets pots in the commercial space, and right now we are in the final stages of developing and implementing our strategy. We recently parted ways with our current commercial business leader and we will close to finalizing announcing announcement of a leader of the commercial business. So I have you know great level of confidence in our ability to show some rapid increase, as we go forward delayed strategy with the right focus and the right leadership , we can definitely put a lot more focus than we have as a company in the past. And I see certain specific verticals that will spend much more easier for us to get into -- when I say easier, see now nothing's easy but we have to drive the level of service and customer expectations in that so it's a different focus than the residential but by creating a dedicated focus bringing in a leader with you know strong capabilities and growing national accounts we're confident that you know we can leverage this space that we have not really focused on over the past few years.

[Sam Eisner:]

That's helpful, I'll hop back in queue. Thanks.

[Nikhil Varty:]

And I'll definitely keep you guys updated throughout and as we have been since I started here on how we progress on that strategy.

[Operator:]

Our next question comes from the line of Anj Singh from Credit Suisse, please go ahead.

[Anj Singh:]

Hi, good morning. Thanks for taking my questions. Just wanted to revisit the EBITDA revision walk perhaps asked another way, could you parse out your estimate of the hurricane impact to EBITDA versus the increased investments into Terminix as we look at the $7.5 million change from your prior midpoints and the current midpoint?

[Nikhil Varty:]

Well the hurricane was $3 million of the change, and that is really you were asking else? Regarding asking, can we elaborate anything else regarding that's what we elaborate on.

[Anj Singh:]

I guess the way I was looking at is the hurricane impact at Q3, it seems like it was more than offset by the better contribution from AHS. Whats is the incremental or stepped up spend that's happening at Terminix is there increased investment at Terminix beyond what you're anticipating at Q2.

[Tony DiLucente:]

So we are increasing our spending in marketing year-over-year in Terminix, marketing expenses and sales expenses. So that's a big part of the increase as well. And I want to also if you're looking ahead to the fourth quarter, we're not going to forecast the same type of incident rates we saw in the American Home Shield with respect to claims cost. So that has some impact on the revision of times too. And finally, if you look at American Home Shield, remember that I have mentioned that we rephrase some marketing expenses from the second quarter into the third quarter, well we also have more marketing on a quarterly basis in the fourth quarter as well. So we really rephrase our marketing spending more backend loaded in the third and fourth quarter than we had in previous year.

[Anj Singh:]

Okay, okay, got it. And then a follow up on. If we look at your Terminix revenue adjusted for the hurricane impact, it seems like it still would have decelerated a little bit from the 2Q levels. Could you talk about what is driving the moderation and the performance and outlook adjusted for the hurricanes? Is the performance just weaker or are the translation effort is just taking a little bit longer? Just any color there. Thanks.

[Nikhil Varty:]

Anj, if you look at adjusting for hurricanes, we were flat to slightly above flat. And then we have already talked about the attrition this year. We've seen after the point that will be [indiscernible] clause expiration of the Alterra customers. So if you adjust for that our normalized revenue, Terminix is growing about 2% year-over-year in the quarter and 1% organic. So we still - and this is why we launched this systematic transformation approach to rebuild the core on our growth platforms. And we have been remaining set fast on building our ability to grow in this business because I see tremendous potential in how we approach that. Now we are at the same time and I have about being a Six Sigma Lean in force to identify or any duplication of efforts are raised in the system so this can not only help it avoiding unnecessary costs and providing a discipline investment, they will also simplify our business model significantly, which gives us an ability to unlock capacity to deliver on the growth opportunities that we were consistently able to raise the new sales or new accounts as we generate in pest business. We just have to make it simple and raise our customer engagement or customer experience level to best-in-class to continue to repaying at a higher level.

[Anj Singh:]

Okay, got it. Thank you.

[Operator:]

Our next question comes from the line of Toni Kaplan from Morgan Stanley. Please go ahead.

[Toni Kaplan:]

Could you share any statistics that you are tracking on employee turnover within the Terminix business? Just since you’ve sort of implemented new metrics and strategy, and I know it's still early, but just any sort of trends that you are seeing improve and maybe what sort of your goals are that we can measure you against in the future. Any sort of metrics we can sort of point to you going forward?

[Nikhil Varty:]

We in these last few months that I've been here, I have visited several of our branches and our touch base with plenty of our tax are outside sales professionals or branch managers and even went on rides along, could you see how they are running their share. How they interact with customers and help can we better help them. We definitely can do a significantly better drive and we are working on it July was I truly believe exemplary treatment of employees is explanation going to lead the exemplary treatment of our customers and improve the loyalty. From our attention basis on our tax we see on an average the industry rate of retentions is about 70% are well performing well above that probably also compared to a competition even it is slightly above what competition or retention rates are so. We definitely can continue to improve that also continue to improve, also continue to improve retention rates or [Indiscernible] on us so we are taking a very strong focus on how we are in this company how do we make our organization customer centric and with our tax upfront as the part of the impairment of our organization who ensure that were giving them the right tools and the right flexibility to serve our customers better. So well I'm not worried at right now but our retention rates what has demonstrated this year my goal is to help the company to take it through significantly higher levels from where it is because retention of employees does lead to have a direct correlation to how we retain our customers.

[Toni Kaplan:]

Okay, that's great. And then just one on the Hurricane. So your closest competitor mentioned cost for reacceleration post the 3Q Hurricanes, but it sounds like you are expecting there won't be an impact in the first quarter. Could you actually see a benefit as branches come back online and see sometime if it's from maybe the increased OpEx and are you being conservative when you no impact? How should be we inking about it? thinking about it?

[Tony DiLucente:]

First of all I must give a lot of high marks for the Terminix branches for how rapidly they were able to bring back business all the braches back up, how they were able to redeploy on the resources to help in areas that we are not as badly affected, and I also company's efforts to keep our employees as whole as possible and we continually provide them financial support in this typical times that even they face in the business areas. That’s going to be probably a strong hangover. I don’t think of that much of an effect getting over into Q4 but from a positive side we are driving a dedicated focus to obsess to the level of pest increase and how we can approach to that. So that is still on the pontification and how we can bring that capacity back up and build that into a capacity models to show these additional opportunities as we go forward. But then hurricane or any such event or -- definitely there is a longer-term trend. I don’t want to predict exactly what it will be in the Q4 versus next year but, we definitely is going to be positive in these areas, supporting the increased activity of pest. But we are systematically evaluating that at the stage, but also not just evaluating but building capability to support these kind of activities that we can actually fulfill the demand that could rise us from this.

[Operator:]

Our next question comes from the line of Andy Wittmann with Baird. Please go ahead.

[Andy Wittmann:]

I guess, I just wanted to ask for maybe a little bit more update on yours on spin process. Cnd certainly you guys made some progress on this one, and one that could maybe the two key questions of maybe what you are going to full time capital structure of each company and or the SG&A lowered that you might be angling on as you progress down this path?

[Nikhil Varty:]

Let me address the first part of your question, Andy. As we announced to spin three months ago and since then we made significant progress

[Tony DiLucente:]

Sure, more specifically on the timing of spin. We're still on track to complete the spin in the third quarter of 2018. We do expect to file an initial confidential Form 10 in the first quarter, this filing has to be confidential and nonpublic because the 2017 audited financial statements won't be completed by that time. We're required to do three years of audited financials, and so those become [indiscernible] at some later date. As far as, Andy, your questions on the capital structure, obviously we've already spent a lot of time looking at that and we have more time to spend going forward. We do have a general plan and structure, but we haven't made any final decisions on exactly how much leverage we're going to put on each company. I will say this our wonderful cash flow in both of the businesses gives us some flexibility but we want to take our time and do this the right way and we're working to it systematically with our advisors and in our teams appropriately. I think that was the majority of the question did I miss anything.

[Andy Wittmann:]

SG&A burden was the other portion of that.

[Nikhil Varty:]

That's nothing, Andy, one bad one to that, Andy. Obviously, again, and very methodical process. I mean the first step is to define how you want to operate both spend for both let's call it ServiceMaster and American Home Shield? And then after you define an operating model, then you build a cost model and then at that point we'll have what I would call -- an estimate that you know we could share when all that is done which is later on the process so we'll continue to keep you advised as we progress on this journey, but that's just a little bit too soon to really report that information.

[Tony DiLucente:]

I think to add on to that Andy you know obviously the clear strategy on both these is helping us develop a structure to support it the systems and cadence to drive it and the right people to deliver you know so we're very systematically working through that process and as you know we're going to be you know as the process goes by we'll be sharing additional information about the commitment that we made.

[Unidentified Analyst:]

Great thanks. And then I guess, Nick, I wanted to kind of follow up on the Terminix segment and the investment situating. Really highlighted a number of those units cost including sales and marketing, but as you look at other investments in the P&L you've talked a lot of people, systems, processes, how much more investment needs to come out? Or where are you on that journey is most of it outside of in place excluding maybe couple of key hires hire. I guess I'm just trying to get a sense about what the '18 outlook for Terminix margins could do without giving guidance just kind of thinking about where you are in a sequential basis with your P&L investment.

[Nikhil Varty:]

As I've shared with you earlier, the first part of my journey was to get a full assessment on where the gaps in the business are, what do we need to do to drive it, and that has given me a tremendous amount of confidence that there is no reason why we can build, rebuild the core of this business back to going at or above market level. So there's two things, one is significantly elevating the customer experience, which will allow us to you know retain or improve our customer retention significantly; and the second is you know product strategy that clearly allows us to differentiate ourselves as a leader going forward. So yeah, there are definitely investments in not just marketing but also in the right organization structure, creating a focus around commercial drive the leasing of necessary investments. Now on the other hand, it's not just about how much we invest and how much we spend but how we do it, and we are launching a very, very disciplined six sigma lean approach. It is for me and this is again my past experiences while coming from - checking to work left one of the companies has been where we find look really structured way. We first of all lean out the process and eliminate a lot of the steps in the way that actually make the business model much more simpler our ability to engage with customers much easier, our ability to get flexibility and the opportunity for techs much more easier and actually definitely helps in unlocking a lot of the while capacity to serve even with the existing tech to just give a better much and better service level to our customers. And so we have lot of work to do on the efficiency improvements and so it's a balance situation between how much we are investing and how we will pull back. But I want to make sure that we're not doing things just to deliver the next quarter or quarter after that, but really to stay step fast in our goal to rebuild this business to get it back to market plus or above market growth levels if we deserve to be, and I'm very confident that this focus having the key leaders on top. Now as an organization, I believe there is a tremendous amount of talent in business this business. And if you look at the continues growth that we've been able to demonstrate at American Home Shield over to last five years, high single digit have growth significantly in FSG, that just underscores the ability of tech ServiceMaster to know how to build business profitably. So I'm pretty confident with the right focus and leadership. And it's a little too premature for me to comment on 2018. Off course, we will be giving a lot more color to this on close of fourth quarter. When we close our fourth quarter in February definitely we’ll outline the guidance for 2018 and a give a lot more color on this initiative as we've learn more and we give you progress for that.

[Operator:]

Our next question comes from the line of Judah Sokel with JPMorgan. Please go ahead.

[Judah Sokel:]

I was hoping to ask a little bit about the commercial vertical within Terminix clearly that for strategy of your as you doesn’t expect you want to expand Terminix's exposure to and maybe if you could talk a little a bit about how that business has been trending for service demand ware and shown out what the opportunities are that you just deal exist in the commercial vertical and what are some of the challenges specially compared to residential?

[Nikhil Varty:]

In terms of our commercial business, which is about 20% of our total Terminix revenue till date, the trend in the business has been relatively flat to modest growth in the past few years and that comes with just clearly not making it one of the focus priorities and investing in the right way or approaching the right level of customers. Our strength in that business has been quite significant in the small medium-scale businesses and we are currently developing a national account strategy which we believe in certain verticals and certain specific markets were highly capable of delivering strong differentiation to capture those. My belief with the core strategy that we are putting in place bringing in a leader we -- as I mentioned earlier, we recently partnered ways with the commercial business leader who was in place for few years of bringing in really highly talented individuals ability to grow in national account, so of national accounts, creative business structure systems so that can support that will significantly upgrade our ability. This is a faster growing space in the market and I truly believe that for some of the very specific markets we have great opportunities that will probably pay off and definitely with that right level of focus and leadership.

[Judah Sokel:]

Maybe just a quick second question on AHS business. Once again, that required saw real estate channel growing at a really nice pace and addition for the DTP channel. I think investor perception was that over the years AHS transformed that business by moving more into the DTP channel way from the real estate channel because it was a more of growth opportunity, but we are seeing pretty fast growth at both. So maybe you could touch on what the opportunity is in real estate. Do you think that the real estate channel can continue to be a high single-digit organic grower? Where do the opportunity lie ahead for AHS?

[Nikhil Varty:]

I think as I mentioned earlier, it’s number one, what I really like about the AHS business is it’s an incredible platform that the one key solid differentiator where we have about 15,000 over the countries best contractors who we are able to level load their jobs and utilize them as partners across the country to deliver increasingly better service to our customers. So both in the DTC channel and real estate channel, I see quite a lot of potential to continue to add volume. What I like about this again also is it’s a vastly underpenetrated market. If you look at our market share today, which is north of 50%, considering the market size to be close to slightly above 4 million homes, between sustainable family homes and rental properties and apartments, that’s close to 100 million owned America that just told you that there is -- and their services are being performed. The key is how do we drive our business model beyond the current way we do business, if we go the market. So we are redefining that strategy and putting significantly higher focus. So on the current warranty-based or risk-based model we see increased DTC not only in penetration in the market business also significant opportunity in the type of services we can enhance too, same thing on the real estate model we see higher penetration. I'm not sure if you caught one of our announcements recently where we launched and afford in the real estate market, which we seen significantly helping retention going forward where we have full of the engagement, we launched our 18 service. When new home on a enters his home, we have a service now that will provide us part of whole package changing all the locks and keys on their home. That provides that initial touch point, which in many cases in the real estate deal somebody inherits of that the seller and we don’t show that customer [indiscernible] they had that problem, there is a -- there is a perception on part of the owner where they are getting real value for that which should maybe paying for it. This initial compact just starts with them off in the right way to understand the value of the contract. So we are working on additional such ideas and opportunities that can help to improve this market penetration as well and we still see significant space on DTC, but also on the non-risk-based model which as I mentioned earlier that we will share as time goes by, we consolidated our strategies and launched these new efforts.

[Operator:]

Our next question comes from the line of Gary Bisby with RBC Capital Markets. Please go ahead.

[Gary Bisby:]

Hey, good morning, guys. Nik, the first question for you. You talked a lot about the disciplined approach you want to put in place, the Lean Six Sigma opportunity, just more accountability throughout the Terminix organization, and I guess who really needs to drive that and who' is impacted by these changes. Is this is largely a corporate? Or is there a lot of work that needs to be done at the branch level? And as part of that, how much disruption does changing the cultural approach these processes likely have on the business and over what time period would it be reasonable to begin to see the benefits of these efforts? I assume there's a sort of long period of time where you put in all the changes before it really begins to benefit the business. Any color on that would be helpful, thanks.

[Nikhil Varty:]

The key to succeeding on such a journey is to have a clear structured approach that normally you can articulate to our shareowners and you guys on the analyst side, but it's our ability to articulate that right down the line to our text. So the key focus right now is how do we unclog some of the things we’ve done in the past that didn't serve us that well, but focusing on investments on the right thing where we enable the tech in this business is a fairly simple business. It's all about the customer experience that the tech leaves with the customer. It enhances retention significantly -- so we've demonstrated our ability to grow on new sales, the key is we have to work hard to improve that retention rate to get the next revenue growth you know moving significantly higher. So it will take time, but for me to drive a cultural change the first thing is have a clear strategy that gets a buy in, which we are fairly close to articulating across the board in the company in the next coming weeks. Driving that is the organization structure, as I mentioned, clearly we're driving the focused approach on residential and commercial, the residential leaders already in place, I mean managed to get that done within two months, which is pretty good and we got a real solid proven leader who has demonstrated in the past driving significant growth, working across hundreds of company-owned franchises and branches at Bridgestone, and also been able to demonstrate major turnarounds within a relatively short period of time. So to me this is a journey where we need to get back to the growth levels that we want, but also ultimately I think Gary the key focus for me is staying steadfast with an approach to drive at market or above market growth going forward not only with the customer levels but with the fully revamped product strategies that we are about to launch.

[Gary Bisby:]

Okay, great, and then just a follow-up. There've been some efforts begun last year to consolidate certain things like marketing and some of the digital efforts from Terminix into the AHS business effectively which was centralized. I know you're reversing all of that, but how much of that was done and how much either spend or disruption is there in pulling the Terminix marketing efforts and advertising efforts out from that central group? Is that already done or is that something that's going on now? Thank you.

[Nikhil Varty:]

Let me tell you probably the one -- the best return investment we've got is really taking our ability of our employees to significantly improve the interface with the customer by upgrading the technology. So giving iPhones and iPads to every employee to have tools in the hand when they approach a customer, so that improve the pre-engagement ability that improves their full service engagements make notified of their customers on our dispatch need app for the customers sees more like an mover like format where the tech is approaching the home, improved our on-time delivery with the customer versus previously doing this over this hang the yellow tag and leaving we have significantly enriched that. So that's the quite a lot of money. We invested in providing much better vehicle to both our tax and our outside sales professional that carries a lot of brand value with trucks driving around. It improves a lot of recall. It improves the morale of the people and how they approach the customers as well. So there is a lot of great things that were done. And yes, I'm not being critical about the marketing efforts and outlook, I think with our current strategy we are improving significantly our ability to segment those markets where we can see the biggest bank or above and refocusing on our marketing investments and in those areas and those treatments like certain specific type of pest in that area, just to get a maximum return on investment on how we approach these markets. It's a matter of -- it's not like I'm taking something and just completely turning it around but driving a systematic turnaround of what a world-class business should look like. Ultimately it's all about service. The real differentiator is the experience we leave with our customers and why they want to stay with us for the rest of their life, we just want to keep that life time cycle value and thinking that please that helps the very cost of acquisition in the future as well, which will definitely help us.

[Gary Bisby:]

Great, thank you.

[Operator:]

There are no questions on the phone lines at this time. Mr. Varty, I will turn the conference back to you.

[Nikhil Varty:]

Thank you. I want to close by affirming my earlier comments that we are focused on consistently delivering on our commitments and to improve operations and drive profitable growth. And wild change will not happen overnight. I'm very confident were taking the right steps to create long-term values for our shareholder and thank you all for joining our call today and we look forward to reporting on our continued progress in the future. Thank you.

[Tony DiLucente:]

Thanks Nik. Thank you again for your participation in today’s conference call and webcast. As a reminder, a replay of the webcast will be available on our website at www.servicemaster.com in about one hour from now. We look forward to speaking with you again on our fourth quarter and full-year 2017 earnings call at a date to be announced in February of 2018. Chris, please end the call and happy holiday everybody.

[Operator:]

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.