Serve Robotics Inc.
Q1 2017 Earnings Call Transcript

Published: 27 Apr 2017

[Operator:]

Welcome to ServiceMaster's First 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'll begin today's call. Please go ahead, Mr. Turcotte.

[Brian Turcotte:]

Thank you, Julie. Good morning and thank you for joining our first 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, April 27, 2017. The company undertakes no obligation to update any information discussed on today's call. This morning, ServiceMaster issued a press release filed with the SEC on Form 8-K highlighting our first 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. Today, we will reference certain non-GAAP financial measures throughout the 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 reconciliations 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 or to adjusted EBITDA as defined in our press release. Turning to the agenda. Joining me on today's call are ServiceMaster's Chief Executive Officer, Rob Gillette; 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 item shown on Slide 3. Rob will lead off by summarizing our first quarter 2017 consolidated net results, discuss some of our key business initiatives and then review the Terminix results. Tony will follow with the review of the performances of American Home Shield and Franchise Services Group, provide more details on our consolidated results and then speak to the 2017 full year outlook. Rob will then provide summary comments after he and Tony take your questions. I'll now turn the call over to Rob. Rob?

[Robert Gillette:]

Okay, thanks, Brian. Good morning and thank you all for joining us for our first quarter 2017 earnings call. Before I begin, I would like to thank Jim Shields for all his efforts leading our Investor Relations and treasury function for the past 2.5 years. He's done a great job in the role and I know quite he'll be doing a great job in Terminix as well. And he's going to become the CFO of our Terminix business, so congratulations to Jim. Brian Turcotte has returned to lead our Investor Relations and Treasury team. Brian led our Investor Relations team when we took the company public in June of 2014. He had served in a number of important finance roles within the company and I would like to welcome Bryan back and he will be your point of contact for Investor Relations. Turning to our consolidated results shown on Slide 4. ServiceMaster had another good quarter driven by solid revenue and EBITDA growth. Revenue grew $35 million or 6% 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 acquisitions of OneGuard Home Warranties and Landmark Home Warranty last year. Terminix and the Franchise Services Group each produced modest revenue growth versus prior year. Adjusted EBITDA for the first quarter increased $7 million or 6% compared to the prior year. The increase in EBITDA was primarily the result of the conversion of higher revenue, driven by organic growth at American Home Shield and the Franchise Services Group and the acquisitions in American Home Shield. The plant's strategic reinvestment in our field operations, sales force and higher commissions drove margin compression at Terminix versus prior year. What's encouraging is that we began to see the benefits of these investments and I believe that we're on a clear path to organic growth and improve customer retention. I'll cover the Terminix first quarter performance in more detail in just a moment. Our adjusted net income for the first quarter was $46 million, a $1 million decrease versus prior year. This slight decline in adjusted net income was largely driven by increased depreciation which Tony will cover in his remarks. Adjusted diluted earnings per share of $0.34 was flat versus prior year. Turning to Slide 5, I'd now like to take a few minutes to discuss some of the investments we're making to drive profitable growth at Terminix. As I mentioned during our fourth quarter earnings call, I was participating in a week-long Terminix branch Manager Summit here in Memphis. It was the first time we have brought the entire field and home office team together in a number of years. We did this to outline our plans to improve growth, listen to the feedback from the field and renew our focus on customer service. We took the opportunity to train the team on the new tools we're deploying and how they can help drive service quality and customer satisfaction. Our Terminix culture has always been sales driven. We emphasize the need to continue to drive sales growth while simultaneously improving customer service, engagement and retention. It was a fantastic meeting and great energy. Marty Wick, Terminix's Chief Operating Officer and I had one-on-one meetings with every one of our 350 branch managers and I believe that they left the summit better able to lead the changes we're making and were extremely motivated to make it happen. I'm happy to report that our customer retention improved in the first quarter and the team continues to deploy the new tools and processes we have developed. Marty and his team will continue to monitor our progress, but the true measure of our success will be improved customer satisfaction, retention and increased organic growth. The right side of Slide 5 is an image taken from one of the Terminix television commercials. In February, we launched our new TV advertising campaign featuring Rick, a category's first action hero. Rick embodies Terminix. He's determined and relentless, yet confident and approachable. The campaign is distinctive, entertaining and shows our willingness to do whatever it takes to protect customer's homes from pests and termite damage. We're pleased with the early results of the new campaign. For the month of the March, our cost per call and direct response to television declined by 18% and we've seen an 11% increase in people searching for Terminix online compared to this time last year. Turning to Slide 6, we've mentioned our ServSmart initiative at our Analyst Day in May and in recent earnings calls. Today, I'd like to update you on how ServSmart is improving customer service and efficiency at Terminix. Terminix is currently deploying its ServSmart field service platform to all branches nationwide. The system also allows real time customer engagement through text messaging, on-my-way notifications and instant post-service 5-star feedback to ensure customers are satisfied. Additionally, the use of the iPhone platform, combined with optimized routing and scheduling, helps our technicians effectively meet customer requests and efficiently deliver service at scale. The platform also gives leadership visibility into each and every interaction as they happen, ensuring successful outcomes and allowing them to address issues real time. We have introduced and are rolling out a new approach to routing and scheduling we call multi-day planning or MDP. This new process will enable us to improve our route efficiency and service by stabilizing our production schedules and improving on-time delivery. Early returns are showing much improved net promoter scores and reduced cancel rates for customers served to the new platform. As we complete the nationwide rollout in early May, we expect to see continued evidence that the ServSmart strategy is helping us win the magic moments in every customer journey and increase returns to the bottom line through improved efficiency and customer retention. Turning to Slide 7, we're focused on improving customer service and growth at American Home Shield as well. Yesterday, American Home Shield announced the opening of the new customer care center in Phoenix, Arizona. The 25,000 square foot facility will employ 250 customer service representatives, who will handle inbound customer calls and manage customer repairs through the company's network of professional contractors. The new facility is on the same floor as the recently acquired OneGuard Home Warranties which operates a 100-person call center there. This new facility was built in response to growing demand for our Home Warranty products. The increased staffing will mean in more access and greater convenience for our customers. The right side of Slide 7 illustrates our new marketing message at American Home Shield. Over the past 6 years, we focused our marketing message on lifestyle imagery that reinforces the "Worry Less. Live More." value proposition for purchasing Home Warranty. This makes it easy for the competition to follow suit, copying both what we say and how we look as a brand. So we're transitioning to a more aggressive and more memorable tagline specific to American Home Shield, Be sure with the Shield. This new tagline comes with a new set of brand visuals that helps consumers remember our name, remember our value proposition and ultimately, understand why they should choose American Home Shield over the competition. Not all Home Warranties are created equal. American Home Shield's superior reputation will continue to be a point of differentiation, creating increased awareness and growth. Turning to Slide 8 and the performance of Terminix. Revenue increased $1 million versus prior year to $365 million. The increase in core termite, wildlife exclusion and insulation sales was mostly offset by the expected decline in revenue from Alterra, a pest-control company we acquired in November of 2015. Excluding the impact of Alterra, revenue would have grown nearly 1%. Adjusted EBITDA for the first quarter declined by $13 million from $94 million in 2016 to $81 million in 2017. Looking at the waterfall chart on the bottom of Slide 8, you'll see that we incurred about $5 million in additional labor cost, driven by the addition of technicians, service supervisors and training to improve safety, customer service and retention. We experienced the $4 million increase in damage claims which reflects an unusual number of large settlements in the first quarter of 2017. We believe we will return to historical levels over the balance of the year. The $7 million increase in sales and marketing cost was driven by investments to grow and train our sales force, higher commissions attributable to the growth in the core termite, exclusion and insulation sales and incremental investments in marketing. These additional costs were partially offset by the conversion of higher revenue and lower fuel costs. Turning to Slide 9 and the Terminix revenue. Termite revenue including renewals increased 4% versus prior year, while organic termite revenue increased 3%. Starting on the left side of the chart, revenue from termite completions or new termite sales and other services of $70 million, is an increase of $9 million or 15% versus prior year. Termite renewal revenue was down $3 million or 4% to $79 million. During the quarter, over 60% of the $70 million in termite completion and other services revenue was derived from the sale of core termite completions. Core termite revenue increased about 14% year-over-year, continuing the trend established throughout 2016 of a year-over-year increases in core termite growth. As we mentioned on our call last quarter, Termite Services is one of our most profitable offerings with high retention, margins and lifetime value. Increases in first year sales or termite completions are a good sign for future renewal revenue growth and a long term profitability of the segment. The remainder of the $70 million of termite completion and other services revenue comes from services we provide like exclusion and insulation. This revenue stream increased by about 18% year-over-year. The termite renewal revenue decreased by 4% compared to Q1 of 2016 due to timing of promotions and other marketing initiatives to our customer base. Pest control revenue of $202 million in the first quarter decreased by $4 million or 2% versus prior year. As previously mentioned, the organic pest control revenue decreased 3%, significantly impacted by an expected $6 million organic revenue decline associated with Alterra. Excluding Alterra organic pest control decreased by $1 million or less than 1%. While we have been disappointed with the organic pest control growth, we believe that we have taken the right steps to improve service quality and retention. We still expect organic growth revenue growth at Terminix to range from 1% to 2% for the full year. I will now turn the call over to Tony to review the performance of American Home Shield and the Franchise Services Group. He will also provide more details on our consolidated results and the 2017 full year outlook. Tony?

[Anthony DiLucente:]

Okay. Thanks, Rob and good morning, everyone. Let's turn to Slide 10 and discuss the American Home Shield's first quarter performance. As Rob mentioned, American Home Shield or AHS, had a strong quarter with solid top line growth, bottom line growth and almost 4 percentage points of margin expansion. Revenue increased from $194 million to $227 million or 17%, with the organic growth contributing half of that growth and acquisitions driving the other half. The organic revenue growth was mostly driven by growth in customer count which accounted for almost 7% of AHS' 8% organic growth. Higher prices accounted for about 1.5% of the organic growth in AHS. The OneGuard and Landmark acquisitions contributed about $17 million or 8.5% of growth. EBITDA increased year-over-year by $12 million or 63% and margins expanded 390 basis points from 9.8% to 13.7%. The largest contributor to the increase in EBITDA and margin expansion was $7 million, a flow-through from organic revenue growth and $3 million of flow-through from the inorganic growth generated by the OneGuard and Landmark acquisitions. Price, net of inflation on claims cost provided an additional $1 million of EBITDA benefit in the quarter. Revenue growth was solid in our 2 key channels to market. Year-over-year organic growth in the direct-to-consumer channel was 12% and 7% in the real-estate channel. Our key focus areas to sustain our strong growth rates center around optimizing our advertising, promotion and direct mail campaigns to drive new sales units as well as improving service quality to improve retention rates. AHS continues to upgrade their contractor base. A key initiative is to proactively build and improve the contractor network, both with respect to total capacity as well as quality. These efforts are critical to our ability to sustain the ongoing growth of the business, both with respect to having available contractor capacity as well as driving higher contractor retention. As you know, we manage over 14,000 contractors and we believe that this provides us with the necessary scale, competitive advantages and capacity to continue to grow going forward. In Q1, we continue to make solid progress with respect to continuous improvement of our contractor base and in terms of both total capacity and quality. In total, our contractor base as of the end of March was 7% higher than it was at the same time in 2016 and our preferred contractor account improved by 11% during this time frame as well. Regarding quality in the contractor base, AHS is driving several initiatives to continually upgrade contractor performance which in turn will drive higher customer retention. These initiatives include a focus on scheduling, problem resolution cycle time, contractor professionalism and communications with the customer. The results have been impressive as overall contractor quality ratings have improved significantly in Q1 versus the previous quarter. So moving on to Slide 11, let's cover the Franchise Services Group's Q1 performance. Revenue increased $1 million year-over-year or 2%. But factoring out the conversion of the Merry Maids branches to franchises in 2016, revenue was actually 8% higher year-over-year. Adjusted EBITDA for the quarter was $21 million which is $3 million or 17% higher than the previous year. This improvement in EBITDA was driven primarily by ServiceMaster restore fee revenue related to extreme weather and other disaster events and higher franchise development licenses sales. The branch to franchise conversion for Merry Maids had a negligible impact on adjusted EBITDA. Although weather and other disaster events often drive the results in the Franchise Services Group, it's important to note that we continue to work on key initiatives to drive results in the areas we can control. Our Franchise Services Group has a strong focus on helping our franchisees drive customer level revenue growth which in turn will drive higher fee revenue back to ServiceMaster. Key initiatives include further developing insurance carrier relationships, improving Merry Maids customer retention and landing new national accounts for ServiceMaster Clean. Results in Q1 were good, ServiceMaster Restore insurance program customer level revenue was up 14% in the quarter. Merry Maids' net promoter scores improved 9 percentage points and janitorial national account revenue was up 8% in ServiceMaster Clean. So turning to the consolidated P&L on Page 12 and looking at ServiceMaster and its entirety. The year-over-year revenue increase of almost 6% or $35 million, includes $18 million or 3 points of net organic growth. The remaining $17 million of revenue increase comprises $4 million due to acquisitions within Terminix and $17 million from the acquisitions in AHS, partly offset by the $4 million of revenue decline - or revenue divested due to the conversion of the Merry Maids branches to franchises. Gross margins are roughly in line year-over-year. The decline in Terminix margins, driven by our investment and improving customer service, was essentially offset by higher margins in AHS in the Franchise Services Group with strong year-over-year revenue growth expanded gross margins. The year-over-year SG&A increase of $13 million primarily reflects $7 million of Terminix sales and marketing costs and $6 million of cost from the OneGuard and Landmark acquisitions in AHS. As a result, SG&A as a percentage of revenue increased 0.4 point to 28.9%. Net income of $39 million for the quarter is flat year-over-year and adjusted net income for the quarter is $46 million which is down $1 million from the same period in 2016. Moving on to Slide 13, let me cover the bridge from adjusted EBITDA to adjusted net income to help explain the slight decline in adjusted net income. As previously noted, adjusted EBITDA for the first quarter of 2017 was $134 million which is $7 million or 6% higher than the same period in 2016. However, depreciation expense in the first quarter was $5 million higher than it was in the same period in 2016. Additionally, the effect of tax rate in 2017 was slightly higher. The increase in depreciation and the effective tax rate offset the year-over-year increase in adjusted EBITDA, resulting in essentially flat net income and adjusted net income versus the prior year. The depreciation expense was driven by prior year investments in technology, as we discussed in this call and prior call, as well as from acquiring company vehicles for our Terminix outside sales professionals. With respect to cash flow, as shown on Slide 14, free cash flow was $109 million in the quarter which was $20 million or 22% higher than the same period in 2016. The increase in cash flow was driven by the higher year-over-year EBITDA and the higher decrease in working capital in the first quarter of '17 versus the same period in '16. The $109 million of free cash flow generated in the first quarter was used to buy back $51 million of ServiceMaster common stock, pay down $14 million of debt and fund $11 million of acquisitions. The remaining cash flow generated in the quarter increased our cash balances by $37 million since the end of 2016. So regarding the $51 million of share repurchases made in the first quarter, 1.3 million shares were acquired at an average price of $38.04 per share. As of March 31, 2017, we have now reacquired 3 million shares of common stock at an average price of $37.27 which totals $111 million or 37% of the approved program to date. We're on track to complete our 3-year $300 million share buyback program by 2018. Finally, moving to Slide 15. We're reaffirming our full year outlook for 2017. We expect full year 2017 revenue to range from $2.885 billion to $2.915 billion or an increase of between 5% to 6% compared to 2016. Full year 2017 adjusted EBITDA is anticipated to range from $700 million to $715 million or an increase of 5% to 7% compared to 2016. 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 that we can move into the Q&A portion of the call. Brian?

[Brian Turcotte:]

Thanks, Tony. [Operator Instructions]. Julie, let's open up the line for questions.

[Operator:]

[Operator Instructions]. Our first question comes from the line of George Tong with Piper Jaffray.

[George Tong:]

We saw margin compression in the quarter in Terminix because of investments back into the business. Rob, can you discuss your anticipated required investments over the next several quarters in Terminix in order to achieve your growth objectives for the segment?

[Robert Gillette:]

Well, not specifically going forward, but we made a lot of investments as you can tell in the first quarter and actually in Q4 as well, relative to training and hiring, recruiting and staffing. So you - that was the majority of the increases and then some of the other incidents that occurred as the claims cost and the investment in sales as well impacted the margin. So I wouldn't anticipate that the majority of the investments that we need to make have been made in the year. Now we need to focus on growing the business and converting that investment into growth.

[George Tong:]

Got it. And Tony, in the American Home Shield segment, can you elaborate on trends you're seeing with claims, frequency and severity as well as what you're seeing with in-network and out-of-network contractor costs?

[Anthony DiLucente:]

Sure. Well, first off, we - our preferred contractors are around 80% of the network. The in-network contractors are definitely trending up. What we're trying to do is stay ahead of the curve, if you will. So I think it's important - or we think it's important, every - continuously to build that network. So we're constantly evaluating the contractors we have. If we don't see good quality, we'll move them on and we'll bring in new contractors. It takes a while to get new contractors into the preferred status, but that's an investment so to speak that we're going to continually make each quarter so we have the capacity to grow. So things are trending up overall in that regard.

[Operator:]

Our next question comes from the line of Gary Bisbee with RBC.

[Jay Hanna:]

This is actually Jay Hanna on for Gary today. I was hoping you guys can give a little more insight on the situation with Alterra in terms of that. Those revenue losses in collecting.

[Robert Gillette:]

Well, the only insight, as you remember, it's primarily all of the majority of the customers of Alterra were first-year customers which is the lower renewal rate that we experienced, I just think that we described it in Q4 as well. So year-over-year, this is - the impact that you've seen or we discussed was that we had the entirety of all the new customers in the first quarter and then we had attrition over the year and then into Q1 of this year. So it's just the comparison of the initial investment being late in fourth quarter of '15 and then the customer account differences between Q1 of '16 and Q1 of '17.

[Operator:]

Our next question comes from the line of Anj Singh with Credit Suisse.

[Anjaneya Singh:]

The first question on Terminix, realizing it's small dollars. But can you give us some more insight on what those damage claims are and what's driving those? It seems like it's been a few years since you've incurred those. Just trying to get a sense of how we should be thinking about those going forward.

[Robert Gillette:]

Yes, as we said, we incurred more sizable claims than normal and more of them in the quarter than we typically have. So it varies from quarter-to quarter in the business and they're termite claims, specifically, right? So it just varies and we track them closely. But when it comes to settlement time, it's a little lumpy and less predictable. So that's just the variance we believe that for the balance of the year, scrubbing what we know about the market and our customer base that will return to normal levels for the balance of '17.

[Anjaneya Singh:]

Okay, got it. And a follow-up on American Home Shield. Last quarter, you guys had referenced some attrition you'd expected related to your financial institution customer. How is that tracking? Any color on the retention of those customers versus what your expectations were?

[Anthony DiLucente:]

Well, I would say that it's happening, but it's happening in a slower rate than we had planned. But certainly that move is still intact and it's going to happen over time.

[Robert Gillette:]

So pretty much on track to right thought.

[Operator:]

Our next question comes from the line of Judah Sokel with JP Morgan.

[Judah Sokel:]

I was wondering if I could ask about the reduction in revenues from termite renewals. Maybe you could explain as what's going on there. Last quarter, I saw that it was up a little bit, now it's down a few million. I would have thought that maybe a shift to the big product could help in that renewal. And then maybe you could just explain what you're seeing in trends going on there.

[Robert Gillette:]

Yes. One of the things I mentioned in the call in my script was the change between '16 and '17 and - related to marketing initiatives and customer communications. So there was - one effect is the billings year-over-year. So there was a movement '15 to '16 versus '16 to '17, so that's part of it. And then the balance is just a normal attrition of the core customer base that we have. So we're happy about the new sales increase in termite overall. But on the base, that's the difference.

[Judah Sokel:]

And maybe just one more question to follow up on a previous question about seeing improvement in Terminix as the year progresses. Are you expecting that to be very much back-half loaded versus the first half? Are we going to see some steady progression as we go through the quarters?

[Robert Gillette:]

Yes. It will be steady and we're focused on it now. As I said, I feel like we've made the investments necessary, put a lot of the energy effort and dollars into people processes and training and now it's down to the execution phase of going out and getting the business and continuing to drive the retention improvements that we saw in the first quarter.

[Operator:]

Our next question comes from the line of Toni Kaplan with Morgan Stanley.

[Jeffrey Goldstein:]

This is actually Jeff Goldstein on for Tony. Just to provide a little bit more color around commercial growth within Terminix and how that's been trending recently. And should we expect any of the labor initiatives that you've been undertaking at Terminix to provide? Any type of lift to commercial as well?

[Robert Gillette:]

Yes. In terms of the total resource commitment, it's across the board, right? So it's really the addition of technicians and supervisors, whether it's commercial or residential to ensure that we have the right ratios and the right kind of people in place, in training the - provide service to customers. New - we didn't call out specifically, but new commercial pest grew about 8%. So pretty good in terms of the growth rate. We had some movement in core customers in terms of total units and national accounts up and down that cost an impact on the customer base. So that happens in commercial, where you got one national account that would have many, many locations across the U.S. So in general, I - we felt pretty good about the new sales and we're focused the resources on commercial as well as residential.

[Jeffrey Goldstein:]

Okay, that's helpful. And then can you just talk a little bit what you've seen so far in the second quarter as it relates to termites and if you'd expect this year's mild winter to have any type of noticeable impact on termite activity?

[Robert Gillette:]

Yes, we've said it before, we can't give you - we can't think of anything you can truly correlate to get you something just definitive demand or tomorrow or other things. So what we've said that we had an increase in terms of customer contact through the web or searches for Terminix online of 11% and a majority of those were termite as well as pest. So I think in terms of activity, it's about normal to what we would expect, nothing exceptional. Some believe that it may be somewhat delayed because of where the temperature patterns played out. But I - it's difficult to say. We just know that if we get the team out there and train and we start selling, that's when we convert the business. So I'm not sure I could tell you much more than that.

[Operator:]

Our next question comes from the line of Andrew Wittmann with Robert W. Baird.

[Andrew Wittmann:]

I guess, Rob, I wanted to just clarify in an earlier answer you had about the termite renewals, I didn't understand portion how marketing affects - are you referring to the fact that - I guess, maybe the question is, last year, you guys talked about discounting and bundling to build the annuity on the termite business. Are you saying that the discounted customer that maybe signed a year ago doesn't renew it quite the same rate as you would have expected? Or how does the marketing that you talked about affect the renewal rate?

[Robert Gillette:]

It's complicated. But it was driven also by payment notification from year-to-year which should have been mailed to certain group of renewal customers, but did not go out as planned, right? So a notification instead went out in January of '16. So it moves quarter-over quarter. It moves kind of a disproportionate or call it another month of renewals into Q1 of '16 versus '17. So that seems a little tricky to respond to and that - but that's what happened. So basically, we said marketing communication is just a billing movement from Q4 of '15 in the Q1 of '16 and so we call it timing collectively.

[Andrew Wittmann:]

Okay, that make sense. And then, I guess, maybe, Tony, can you talk a little bit about what the out-of-network costs were year-over-year? I believe, as we think about the year-ago period, certainly 4Q '15 was the one where we had probably the most impact negatively last year. But once you still had, what I would call, what should have been in the easy comp this year or an easier comp. Can you quantify what the out-of-network claims cost impact was on a year-over-year basis for us?

[Anthony DiLucente:]

Well, probably the easiest thing to do with - the out-of-network or the most expensive contractor account is declining and it's declined by 4%. So that - so the issue that we had in Q4 of 2015 and the spilled over into the first quarter of 2016 to some degree, that issue is gone. I mean, we don't have - we're really working hard to manage this contractor base and it's going very well. What we're doing is attempting to continuously grow this contractor base. And as we do that, we bring on new contractors, we move on contractors that aren't performing. When we bring on new contractors, there's a ramp-up that occurs to bring them from an out-of-network or in-network to preferred contractor status. A little bit of costs in that process, but we think it's an important thing to do because we do see the growth in this segment. And if we have a strong contractor base that we grow quarter-in quarter-out every year, every quarter, we'll be able to take advantage of that growth. So that's basically the impact there as far as the claims cost year-over-year.

[Operator:]

Our next question comes from the line of Robert Davis with Oak Hill.

[Robert Davis:]

If you remember going back to Q4 2016, there were some increased onetime costs in AHS that were being lapsed. And then I think there were some idea that these costs were going to also be favorable going to Q1 2017. I just wanted you guys to comment. Obviously, the AHS performance is very strong, but I just wanted to hear what the impact of that easier comp was from some of those claim costs in AHS for Q1?

[Anthony DiLucente:]

So hopefully, I understand the question. But in Q1, of '17, we - again, we're continually working to increase our capacity, the number of contractors that we have. So in order to do that, we have to bring in new contractors. Those new contractors then become preferred contractors over time. So there's a little bit of cost increase associated with that. But we're maintaining strong level preferred network contractors at 80%. And like I said before, we're declining the - what I would call, the out-of-network contractors and we've seen a 4% decline there. But again, there's going to be a little bit of an increase in Q1 of 2017 associated with developing new contractors over time. So I don't know, hopefully, that addressed your question. If not, let me know.

[Operator:]

Our next question is a follow-up question from the line of Anj Singh with Credit Suisse.

[Anjaneya Singh:]

A quick follow-up on American Home Shield, not sure if I missed it. But the organic growth of 8%, it looks like it was primarily driven by the warranty growth at 7%. So could you just update us on price increases at American Home Shield? What's driving what seems to be slightly lower pricing in 1Q?

[Robert Gillette:]

Well, comparatively, year-over-year, there's a lot of mix changes and other things between real estate and DTC and other things. We still kind of pursue a normal pricing increases on renewals in the 1% to 2% range, depending on where they are. So maybe a little bit of price impact in the quarter, but nothing major, right?

[Anthony DiLucente:]

And there's still 150 basis points of price in the growth.

[Robert Gillette:]

Yes. Right.

[Operator:]

There are no further questions at this time. And so Mr. Gillette, I will now turn the call back to you.

[Robert Gillette:]

Okay, great. Thanks for joining the call today. Listen, we're focused on growth throughout the company and you can see that. American Home Shield and the Franchise Services Group had strong top and bottom line growth in the first quarter. In Terminix, we're taking the right steps to improve the organic growth by investing people and improved processes that are making an early impact. We're doing the right things for the future and are beginning the execution stage of our improvement plans. Thank you for joining our call today and we look forward to reporting on our progress at the next earnings call.

[Brian Turcotte:]

Thanks, Rob. Thank you again for your participation. As a reminder, a replay of the call will be available on our website in about an hour from now. We look forward to speaking with you again on our second quarter earnings call at a date to be announced in July. Goodbye.

[Operator:]

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