Serve Robotics Inc.
Q3 2016 Earnings Call Transcript

Published: 25 Oct 2016

[Operator:]

Ladies and gentlemen, welcome to ServiceMaster's Third Quarter 2016 Earnings Conference Call. Today's call is being recorded and broadcasted on the Internet. Beginning today's call is Jim Shields, 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. Shields.

[Jim Shields:]

Thank you, Cathy. Good morning and thank you for joining our third quarter 2016 earnings conference call. Today, you will hear from ServiceMaster's Chief Executive Officer, Rob Gillette, and Chief Financial Officer, Alan Haughie. For those of you who haven't had a chance to download the investor presentation from our Web site, I’ll walk you through the agenda items shown on Slide 2. Rob will lead off by providing some opening remarks and then provide a summary of our third quarter consolidated financial results. Alan will then review our performance by segment, provide more details of our consolidated results. Rob will then provide summary comments before opening the call to your questions. Before we begin, 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 3, 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 25, 2016. 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, highlighted our third quarter 2016 financial results. And we have posted a related presentation, both of which can be found on the Investor Relations section of our web site. We will reference certain non-GAAP financial measures throughout today’s call, we have included definitions of these terms in our press release, which is available on our web site. 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 are to adjusted EBITDA as defined in our press release. I’ll now turn the call over to ServiceMaster’s CEO, Rob Gillette for opening comments. Rob?

[Rob Gillette:]

All right. Thanks Jim. And thanks to all of you for joining our today. Before I get into the financials and results for the quarter I want to speak to you about some of the recent changes we’ve made at Terminix. On August 15 I assumed responsibility for leading the Terminix business. As I mentioned in the past, our efforts are focused on improving the customers’ experience, from the time they began the search for a service provider to the time they take for those services. By assuming leadership of Terminix, my goal is to better align our overall resources to accomplish its objectives. Over the past several years Terminix has embarked upon numerous operational initiatives, including the consolidation of branches in some geographies, establishing shared service centers, streamlining processes and implementing a centralized call center operation. As a result of theses efforts, we have greatly improved our profitability and expanded on our industry-leading margins. As we move forward we want to capitalize on each accomplishment by accelerating our top line growth. During my first two months as the leader of Terminix, I have focused most of my time and effort on how best to accomplish this task and have had the opportunity to spend time in the field talking with our technicians, and sales and branch leadership. Terminix is a great brand, it has a tremendous history and has highly motivated and dedicated employees who take great pride in what they do to serve our customers. As we move forward we’ll capitalize on these strength to position the company to acquire more customers, continuously improve our service quality and communication, and attain higher retention rates in growth in the business. The goal is to improve while simultaneously leveraging the economies of scale inherent with a Terminix business model. The first step in positioning Terminix for growth has already taken place in our Terminix Segment. Despite the headwinds resulting from a decrease in termite activity in the recent years, we see significant opportunity to enhance our focus in a preventive termite space. This segment includes customers who do not have an infestation problem, but see value in purchasing the termite solution to protect their own home against possible future damage. In most instances, a customer’s tone is the most valuable asset and protecting it from termite damage is considered to be an essential service. By using target marketing and innovative product offerings, we are capturing an increase in share based customers. As a result, this is the fourth straight quarter in which we have experienced a year-over-year increase in sales in our core termite services and have begun to see our efforts show in our financial results. We will continue to invest and grow our termite business in the market segment. As we’ve mentioned in the past termite customers have among the highest lifetime value in the ServiceMaster portfolio with high renewal rates and strong margins. We are the industrial leader and plan to continue to grow in this market. With regard to pest control, as that mentioned last quarter, organic pest control growth in Terminix has been less than satisfactory. Terminix is a great brand with great employees and the organic growth rate we have realized over the past several quarters does not meet with our expectations. Over the past two months, I’ve had the opportunity to meet with hundreds of employees to listen and learn about our issues, challenges and opportunities. The level of commitment and energy we have throughout the businesses is both humbling and inspiring. I spent time with the management team and evaluated staffing levels, pay and pricing plans, product offerings, retention metrics, net scores, role definitions and people’s accountability, I reviewed various customer surveys and received numerous customer comments and feedback. I am very pleased to report that this experience reaffirms my believe that Terminix is a great business with great people and all our efforts, with regard to ServSmart are yielding results. Our sales engine is performing well, regeneration is strong, growth rates are steady and we have high positive brand recognition. Our e-commerce channel continues to grow and our social media presence continues to improve. Our long-tenured customers appreciate doing business with us, as demonstrated by their loyalty and our retention rate. But we really need to do a better job of retaining our first year pest customers. I’ve met with many industry leaders and most recently attended the annual Pest Manufacturers Association meeting in Seattle, where I learned a great deal from people who have been in the industry for many years. We are assessing differentiated product offerings that meet the specific needs of customers in various regions throughout the United States. By offering different service intervals and solutions we can provide more choice for customers and tailor our service protocols to meet their needs. Although there are many issues affecting customer retention, the solutions are not complex. We have already laid out plans and have begun to implement them. This includes reducing the administrative workload on branch leaders by adding service specialists back into the branches ahead of scheduling and service workload. This allows managers to be in the field selling and servicing customers and leading through example with our team members. We need to be on time to advise the first time and engage with customers. We are adding discipline to our schedule adherence and execution and measuring and rewarding people on their on-time delivery to customer request. We are in the service business and need to ensure we are staffed with people, who have a great attitude and train them how to deliver a great customer experience. Many of the changes needed at Terminix are basic and fundamental. By simplifying priorities and holding people accountable, we can drive results for both customers and shareholders. Although not a panacea, technology will help improve sales, technician effectiveness, and service and retention. ServSmart will play an important role and complement some of the operational changes we are making at Terminix. These tools will enable our people to serve customers more efficiently and enable customers to communicate their needs to our team. As of today all 1,200 sales professionals have an iPad. With these devices they can now access driving directions, view and schedule visits, create a new sales call, see and update customer information and see nearby prospects. In the future, we will be enhancing the software to allow sales people to digitally map each home to assist them in their inspections. The software will provide the ability to create sales proposals, close sales via online and take payments through their devices. We are now beginning to rollout our service mobility platform to all 5,000 service technicians. By the end of this year, all technicians will have a new iPhone that is equipped with the initial service mobility platform and will have an upgraded, fully functional mobile platform by the end of 2017. This platform will allow us to more easily communicate with customers and then with us. We will be able to send online – notices to customers, so they know when we will arrive and they can more effectively manage their own time and busy lives. I’m excited about future of Terminix. Many of the changes are well underway, while some of them still need to be more fully developed. Change will not come overnight, but we have a clear path on how to improve service, retention and topline growth. With regard to the cost of these initiatives, many of these changes involve just a shift in resources or a change in the incentive structure from voyage. In some cases additional expense will be incurred to increase our service quality, in particular in hiring and training of the right people. Historically, we have had directed our investors to anticipate about a 35% incremental EBITDA margin at Terminix. We now anticipate that over the next 18 months investors should expect flat margins at Terminix, with most of the investment coming over the next six months. Over the long run, we anticipate recouping these costs to higher retention rate and topline growth returning to incremental margins of 35%. Terminix is in a great position, we have the size, scale and infrastructure that is unique to the industry. To capitalize on these assets, we need to improve our service quality. We have identified the issues, developed the finance and we are now executing. Now turning to results. ServiceMaster revenue grew over 7%, compared to the prior year and 9% if you exclude the conversion of Merry Maids’ branches that are franchises. Revenue growth was driven at American Home Shield by the increase in the number of our direct-to-consumer and real estate customers, and at Terminix by the acquisition of Alterra, which occurred in November of last year. At the end of the second quarter, American Home Shield acquired OneGuard Home Warranties. As I mentioned last quarter, the acquisition is important to our growth strategy, it expands American Home Shield’s footprint in three highly competitive and important states, Texas, Arizona and Nevada. In terms of pricing for our services, both Terminix pest control business and American Home Shield continue to realize prize increases in the quarter. We are pleased with the performance of our Alterra acquisition. Acquisitions have been a key growth driver for Terminix in the past and will continue to be in the future. Generally, acquisitions for Terminix fall into two categories, a tuck-in or a strategic acquisition. Historically we have acquired about $40 million in tuck-in acquisitions annually. With these acquisitions we typically retain the customers and a portion of the technicians and quickly integrate the operations into our infrastructure and systems. These have a high synergy value because we take out the administrative cost and sales functions from day one. Customers may require or acquire are very profitable and provide us an opportunity to cross sell. Alterra was a large tuck-in acquisition, it is very profitable and its performance has the key to our expectations. Adjusted EBITDA increased $18 million or 10% this quarter, compared to the prior year. This includes $5 million of weather-related claims that we had previously disclosed in our pre-earnings announcement. Adjusted EBITDA increased by 13% if you add the $5 million back to normalize for the effective extreme temperatures and weather. Adjusted EBITDA includes approximately $5 million in technology cost related to the ServSmart initiative. As we discussed last quarter the increase in technology investment this year is a step change. We expect our investment in technology to remain at approximately the same dollar level in 2017. Our adjusted net income improved this quarter, largely driven by the increase in adjusted EBITDA. Third quarter adjusted net income was $81 million, an improvement of $7 million, compared to prior year. Third quarter adjusted diluted earnings per share of $0.59 increased $0.05 versus prior year. This was driven by an increase in adjusted net income, partially offset by higher weighted average, diluted common shares outstanding. As approved under our share repurchase program, during the quarter the company used $36 million in cash to purchase 960,000 shares, at an average price of $0.37 and $0.19. Before I turn it over to Alan, I want to mention that this morning we announced the refinancing of our Term Loan B. Since going public in 2014, we have made steady progress in reducing our leverage. Through this refinancing, we anticipate extending the maturities on our debt and reducing our weighted average cost of debt. Now let me turn it over to Alan to discuss more about the refinancing and detailed segment results. Alan?

[Alan Haughie:]

Thanks Rob, good morning everybody. Let us turn now to Slide 5. As Rob mentioned, this morning we announced the refinancing of our $2.4 billion Term Loan B due 2021 and our $300 revolving credit facility. We are seeking to refinance our Term Loan B with a new $1.5 billion Term Loan B, due 2023 and $1 billion of unsecured debt, expected to mature in 2024. Our existing $300 million revolving credit facility will be refinanced with a similar sized revolving facility during 2021. By refinancing our current loan and facility this time, we anticipate reducing our weighted average cost of debt, extending our maturities on average by post of three years, diversifying the maturity schedule of our debt and increasing our flexibility to raise capital in the future. In addition to extending our maturities, through this transaction we plan to increase the ratio of our fix to debt to our floating rate debt from approximately 40% to close to 75%, thereby protecting us from our potential future rate and interest rates. And we have to close the transaction in early November. Turning now to Slide 6, on Terminix’s third quarter performance. Terminix revenue increased year-over-year by $24 million, or 6%, roughly $8 million or 2.2% which was organic and $16 million or 4.2% which was driven by acquisitions mostly Alterra. Conversion of revenue to profit was very healthy, with $10 million of additional gross profit generated from this $24 million of additional revenue. Terminix EBITDA increased by $10 million this quarter, but as we can plainly see the improvement came from the $10 million of increased gross profit with a net $3 million reduction in SG&A, offset by $3 million of additional year-over-year technology costs. Since our first quarter we are reporting very healthy 42% conversion of incremental revenue into EBITDA. Now before moving on to a more detailed breakdown of Terminix’s revenue on the next slide, I’m going to say a word or two about the Alterra acquisition. I was very pleased with the performance of this acquisition which closed almost a year ago. It has exceeded our expectations and yielded a return above our headwind. And as we mentioned we consider Alterra to be the large tuck-in acquisition. And in such acquisitions we immediately strip out the administrative costs and sales functions and achieve the upfront synergies of greater profitability and wider margins than would otherwise be realized in a more traditional acquisition. And this is true in the case of Alterra, where we retain the customers in a portion of the technicians, but not the sales and administrative functions. But unlike most tuck-in acquisitions, we delayed the integration of the back-up office operations on to our operating systems because of Alterra's sheer size, the geographic breadth of its franchise and to ensure a seamless transition to our customers and personnel. And in the first quarter 2017 we will begin to integrate Alterra’s back office operation, as we begin to rollout Alterra’s branches on to our systems, we will have an increased opportunity to cross sell Terminix other services, such as termite and mosquito to Alterra’s customers which to date has been limited. We are excited about the opportunity of taking the next step with Alterra and focus our sales efforts to grow our relationship with our legacy Alterra customer. And from a financial perspective obviously Alterra has contributed significantly to Terminix’s growth. Turning to Slide 7, on Terminix’s revenue drivers for the third quarter. Revenue from termite and other services of $140 million, increased by $6 million or 4% year-over-year with completion revenue up $3 million or 5% to $69 million and renewal revenue up $3 million or 4% to $71 million. Now the majority of the completion revenue of $69 million is derived from core termite completion. Revenue for which was essentially flat year-over-year with the increase in revenue of $3 million largely coming from the new services exclusion, insulation and so forth. And although core termite completion revenues was flat we continued the unbroken trend established during the fourth quarter of 2015 of the year-over-year increase in the number of core termite completions. As I’ve mentioned termite services is one of our most comfortable services with high retention, wide margins and high lifetime value. And to the extent of first year sales of termite completions are increasing that is a good signs of future renewal revenue growth and a long-term profitability of this segment. In addition to the increased volume of core termite completions renewal revenue increased by 4% and this increase was driven by an increase in prices and a gradual mix shift to investor retaining based product another good sign of a long-term prospects of our termite business. Pest control revenue of $234 million increased by 8% or $17 million over the prior year with organic pest control growing at about 1%. Rob spoke previously about our disappointment in our organic growth at Terminix and the steps we’re taking to improve service quality, retention and growth. Although we continue to be pleased with the performance of certain service lines, such mosquito, which increased by 27%, year-over-year, we believe the actions we’re now putting in place will result in improved customer service and ultimately faster growth. And so overall for Terminix, continued healthy gross margin, good operating leverage, strong total revenue growth, driven by acquisitions, new services and termite renewals were continuing challenges with organic pest growth. Now let’s turn to Slide 8, and discuss American Home Shield’s third quarter performance. Home Shield had a strong quarter, with good topline revenue growth and strong gross margin, even though claims are impacted by the record high temperature. Home Shield revenue grew organically by $24 million or 9%, comprised in points of pricing [indiscernible] points of customer account growth. When we include the $10 million of revenue impact from OneGuard, acquired at very end of June revenue increased by 12%. Volume contributed to $19 million of increase and pricing contributed about $5 million. A very strong quarter. Gross margins increased by $9 million and decreased as a percentage of revenue from 51.9% to 49.1%. The decrease was largely driven by the $5 million attributable to the warmer weather partially offset by the flow through of volume and price and the addition of the OneGuard. In addition to the weather related claims costs, gross margin includes a $3 million increase in claims attributed to normal inflation and almost $1 million of increased claims costs due to the impact of the growth in the first year direct consumer customers. Now there are three points I want to make about American Home Shield’s gross margins here. The first is really the blue dots to the $3 million increase in claims attributed to normal inflation. We historically maintain our gross margin percentage close to 50%, largely due to our ability to pass increases in contractor costs and to our customers’ [indiscernible] that is through this quarter, that’s about $3 million in normal inflation of contractor costs was offset by about $5 million of increases in price. The second point is really to the dollar to the $5 million increase in weather related claims costs, these claims were entirely due to the record temperatures in July and August, increasing the number of air conditioning system right now and associated repair. The cost per work order was well within our expectations. And following the elevated claims that occurred due to higher out-of-network usage in the fourth quarter of 2015, and carried over into the first quarter of 2016, we have implemented a number of changes that give us better visibility into contractor costs and enhance our ability to align growth of supply of contractor. And the third point relates to the $1 million increase in claim costs related to our first year direct to consumer customer. As discussed previously, these customers tend to make one extra claim in their first year, after which they are revert to the average of claims a year. First year direct to consumer customers’ record is at about 15% of our annual revenue. Because these first year direct to consumer customers represent such a small proportion of our overall revenue base, the impact of one additional claim per year by these customers has a minimal impact on claims cost in a quarter. And as you can see, this quarter we continue to grow the topline and expand our direct to consumer customer base about with just $1 million of increased claim’s costs related to this first year direct to consumer customers. Now shifting to EBITDA, which increased $5 million or 7% this quarter compared to last year. The higher gross profit contribution is $9 million was partly offset by the SG&A acquired, so to speak with OneGuard at $3 million and higher year-over-year technology cost of $2 million, as we maintained our investment in ServSmart at roughly the same levels of the first and second quarters. Excluding the weather-related claims, EBITDA would have grown close to 14%. And as mentioned on prior calls, incremental selling and marketing costs were largely front loaded this year. In the first half of the year we incurred $9 million more marketing than in 2015. For this third quarter our marketing cost at HomeShield were $1 million lower than the third quarter of last year and we would anticipate a similar year-over-year pattern for the fourth quarter and the third. Now, Slide 9 shows FSG’s performance. Revenue declined by $7 million or 12% of which $9 million is due to the carry over impact of the now completed conversion of Merry Maids branches in different franchises. And this $9 million reduction was partly by $2 million of increased disaster restoration revenue largely from the Fort McMurray fire in Canada earlier this year. But looked again we have largely mitigated the impact on EBITDA of the Merry Maids’ conversions through cost reductions and this in with the increased fee revenue has raised FSG’s gross margin by six percentage points year-over-year to 61%, and raised the EBITDA margin by 7.41%. Turning now to the full P&L account on Page 10 and looking at the business in its entirety, the year-over-year revenue increase of over 7% or $52 million includes $35 million or five points of net organic growth. The remaining $17 million of revenue increase comprises $16 million due to acquisitions within Terminix, $10 million from the OneGuard acquisition in Home Shield partly offset by $9 million of revenue divested, each converting the Merry Maids branches to franchises at FSG. Gross margin as a percentage of revenue decreased by seven tenth of a point to 47.2%, largely as result of the $5 million of weather related claims at Home Shield. And year-over-year SG&A increase to $7 million reflects the high technology costs of $5 million, the OneGuard SG&A of $3 million, combined with general overhead efficiency. But with 4% increase in SG&A on a 7% increase in revenue, we naturally have SG&A as a percentage of revenue improving by eight tenth of a point to 24.4%. So for the third quarter, we generated pretax income of $116 million, compared to $83 million over the same period last year and with an effective tax rate vary on 39%. Net income for the quarter is $70 million, compared to $49 million last year. Of course, to age comparability, we also report adjusted net income, which I will reconcile in a moment, and this increased by $7 million to $81 million. Slide 11 provides our standard to reconciliations. First, we work our segment performance measure, adjusted EBITDA down to net income and then what the reconciliation back up to the adjusted net income. Nothing surprise in this. So that we will move on to Slide 12, which provides the third quarter in year-to-date simplified cash flow. In the third quarter, we consumed $43 million of fee cash flow from inflow of $36 million over the same period last year. This reduction of $79 million for two primary components

[Rob Gillette:]

Okay thanks Alan, we had a good quarter and have identified significant opportunity to improve our Terminix business and focus the team on the critical few priorities that will make us successful. By simplifying our focus to delivering for customers being on time, right the first time with a great attitude, I am confident we can drive growth in the future. Our continued growth of American Home Shield demonstrates that customers see significant value in the services we provide. We continue to build around it and grow the market for home warranty products and services. We have made a successful transition in the Franchise Services Group, by moving to a franchise-only model in Merry Maid, while simultaneously improving our EBITDA margins. We have the free cash flow to continue to invest in technology and to acquire companies that expand our product offerings and customer base, which provides new sales opportunities for all of our businesses. We feel good about the progress, we’ve made and the opportunity we have going forward. Thank you for investing our company, I look forward to sharing our progress with you in the future. I will now turn it over to Jim for a question and answer session. Jim?

[Jim Shields:]

Thanks Rob, as a reminder during the question-and-answer session, we encourage you to have any questions that you may have, but please note that guidance is limited to the outlook that we have provided in our press release and in the webcast presentation. Cathy I would like to open it up to questions now.

[Operator:]

[Operator Instructions] One moment for the first question. And our first question comes from the line of Toni Kaplan with Morgan Stanley. Please proceed with your question.

[Toni Kaplan:]

Hi, good morning.

[Rob Gillette:]

Good morning Toni.

[Toni Kaplan:]

You mentioned the increased investment in Terminex in the fourth quarter to help drive the customer experience, just wondering how long, these investments should last? Will it only be fourth quarter or would you expect to continue to invest in 2017, as well?

[Alan Haughie:]

I think from my perspective, we said investments will occur over the next six months or so. So really into the first quarter with the overall go forward means you have flattish margins over the next 18 months. So we carry over a lot of it’s training a lot of it is I'd mentioned putting people in the field we want to make sure they are all trained and are able to help and assist the filed and get them out and working with our technicians and customers. So expect it to continue for the next six months or so and then will maintain kind of the level margin.

[Toni Kaplan:]

Terrific. And then can you talk about pricing in the Terminix business? How did that trend this quarter and did you see similar trends across termite and pests and pricing?

[Alan Haughie:]

I’ll say this one no the behavior of our pricing strategy is actually different in fact in Terminix past yes, has good pricing, expect the majority of the organic increase is price in the pest side. With termite particularly the core termite completions partner is driving an increased flow of potential future when your customers we have a modest price increase which is proving highly effective and bringing in customers that we would otherwise simply knowhow given that a completion event is a one-time event.

[Toni Kaplan:]

Thanks a lot.

[Operator:]

And the next question comes from the line of Andy Wittmann with Robert W. Baird & Company. Please proceed with your question.

[Andy Wittmann:]

Thanks. Alan, for you, in American HomeShield, you talked about some of the systems that you've recently put in place to give you little bit better visibility, I think you called it, into contractor costs. I was hoping you can give us just a little bit more detail on some of those initiatives and how they will help you manage those contracts or costs better.

[Rob Gillette:]

Yes, sure. I mean, the most important thing is to make sure that as we have grow it into new areas, new regions that we have, let’s say a pipeline. And so, it’s like a normal supply management exercise of constantly ensuring that you have an adequate supply of new contractors that were ensuring have adequate insurance that are – adequately qualified. So, the most important point is making sure that the pipeline is full and that we have constantly trying to promote contractors help from, let’s call it the less preferred funnel through to the ultimate, which is the most preferred contractors, again the closest volume of work. So that the real changes for us has been more, more closely monitoring this on a daily and weekly basis as opposed to monthly and making sure that we don’t have any, let’s call it, supply gas. And it’s really is the case because there are pockets and regions, as you can image, around the nation that move at different rates and establishing a closer relationship between our growth pattern in a given municipality and linking that with our ability to add and promote contractors as well as manage the volumes we expect give to those contractors. So, it’s essentially linking our revenue growth on a far more micro level by municipality with contractor capacity.

[Andy Wittmann:]

Thank you. That’s a helpful color. And then I wanted to ask my follow up on your refinancing activities. Can you give us a sense, I know obviously it hasn’t been the price, but clearly you’ve got a vision for what this is going to be. Can you give us may be a minimum saving that you expect or may be a range of savings that you expect from all the refinancing that you will be conducting here?

[Rob Gillette:]

No, it’s a bit early. It’s a good question, Andy, and I wish I could answer it, but I think it’s a bit too early.

[Andy Wittmann:]

Okay, thank you.

[Operator:]

And our next question comes from the line of George Tong with Piper Jaffray. Please proceed with your question.

[George Tong:]

Hi, thanks. Good morning.

[Rob Gillette:]

Good morning.

[George Tong:]

You have discussed the role of ServSmart and technology in improving service quality in Terminix. Can you elaborate on additional actions we’re taking to drive improved organic revenue growth trend in the segment?

[Rob Gillette:]

Hi, George, it’s Rob. Really it’s more about focusing on fundamentals in general. So adding back people who can help deal with scheduling changes locally and have a point of contact in the individual branches in general truly focusing on on-time delivery and ensuring that we have discipline in meeting customer commitments. So I think we will help significantly and then I think most importantly how we respond when things don’t go as planned and how we can address customers’ concerns. And that will help by having someone in the field and then the authority to communicate. So one of the things that the iPhone give the team the feel, there’s the ability to communicate easily, directly with the customers and our branch, people and personnel, which is not something that it really have today. So there is an ability to digitally link and communicate customer to tech customer to our inside service people and then our inside service people to the tech. So all those things will contribute to our growth and retention and then doing a great job for customers, so there’s no real replacement for that.

[George Tong:]

Got it. You have indicated you now expect flat margins in Terminix over the next 18 months, elevated investment spending over the next six months. Can you elaborate on what that implies for the cadence of margin performance over the next several quarters and longer term why you believe incremental margin to return the 35%?

[Rob Gillette:]

I mean, we’re not giving out 2017 guidance yet, George, but the implication – question is a fair one that I will deal with. Yes, so we will see lower – at this point in time, I expect we will see lower margins in Terminix that the prior year for first half of 2017, but for the full year I expect to see margins at this point in time flat to 2016 in total. That’s our current expectation. We are still developing our funds obviously, but that’s how we see it evolving at the moment.

[George Tong:]

Great. And then longer-term confidence around the 35% target?

[Rob Gillette:]

Yeah, I mean, remember the business still remains very, very scalable and the underlying business model is highly effective with very high variable margins I think as Rob addressed. We need to go to a period of investment, which is essentially reallocating resource in training. So the majority of that expense, we expect to be temporary.

[George Tong:]

All right, and then lastly, could you discuss what you're incremental margin targets are for American Home Shield and if you anticipate making any increased marketing investments in order to sustain high single-digit organic revenue growth?

[Rob Gillette:]

Good question. Again, moving on to 2017, at this point in time, I expect to see an increase in overall margin for American Home Shield. We have a number of tailwinds that I hope will come through in Q1 and Q3 in 2017. But at this point in time, thanks for the question; it’s a bit too early for me to comment on the marketing trends. We have Marvin Davis, our new CMO, and so until we have finalized our plans for 2017, it’s too early for me to say what the specific marketing expectation.

[George Tong:]

Very helpful thank you.

[Operator:]

And our next question comes from the line of Anj Singh from Credit Suisse. Please proceed with your question.

[Anj Singh:]

Hi this Anj Singh from Credit Suisse, Rob I wanted to follow up on some of your commentary on Terminix, I guess could you help us size what is the amount of incremental investment you are baking into that business over the next 18 months and do you have any perspective on perhaps when you may see the results in organic growth for that segment. Perhaps what is your aspiration for organic growth once these initiatives or improvements have taken hold. And lastly how long do you plan to have to direct responsibilities for Terminix.

[Rob Gillette:]

Good question lot of them there, but in terms of the longer term and total costs I mean I am not in a position to address that. I think it is more incremental and as I said specific to training and making sure that we do a good job of hiring and recruiting the right people. So I mean a big part of growing Terminix is that we need the people in place to both sell and service the business. So without having that right kind of challenge and attitude in place and fully staffed its hard to grow. So I think that's one right, that's one of the thing, if we want to truly focus on. So to do that, we may add some incremental numbers of people and then invest in training to ensure the effectiveness of those people, but also make sure that we don't end up behind the curve in terms of total ability to serve customers whether it’s with technicians in total or with the sales people in general. So that's another investment that we're making in the business. But I think many of the other things that we talked about are really kind of changing priorities and focus I think we might have gotten a little bit distracted by all the multiple number of things that were being asked especially administratively. So by reducing that workload and allowing the guys to focus on the core products and services that we provide I think it will help them immensely and then having the marketing team as well as the people in the field truly focused on improving the service levels and specifically retention on the first year pest customers, because that's the kind of what its all about in terms of sustaining that position in one-year, two years and beyond or after the second year then they renew incredibly well, right. So that is kind of our focus as a business and I will expect we could equal the growth of the industry and now hopefully on the longer term do better than that based on the services that we provide.

[Anj Singh:]

Okay, got it. And as a follow-up for Alan, I just want to go over the commentary on Alterra and make sure I understood that correctly. What is the impact that we should be anticipating in 1Q, 2017 as you integrate Alterra's backend, should there be a margin improvement there or is that better growth through more confident cost sell, I just want to make sure I got what you were trying to tell?

[Alan Haughie:]

Oh yes. The objective of talking about that was that we are hoping to have an opportunity to cross sell, which is something that we have to see in the numbers right now. We do mind Alterra is a mega tuck-in so fundamentally we’ve gone through this first year and we have a new set of many first year customers. And we will see a tail off in the number of customers in 2017 versus 2016 and we’re hopping to offset that with cross-selling opportunity to those same customers. Now I wasn’t implying that there was going to be a cost of integration I think there.

[Unidentified Analyst:]

Okay, appreciate it, thank you.

[Alan Haughie:]

Thank you.

[Operator:]

We have time for one more question and it comes from the line of Gary Bisbee with RBC. Please proceed with your question.

[Jay Hanna:]

This is Jay Hanna on for Gary this morning. I was hoping can you give a little more color on the balance in organic revenue in termite? And may be a little bit more to identify the deceleration in organic revenue of pest?

[Rob Gillette:]

Yes sure. From a termite perspective so I was talking about completion revenue of $69 million paid. As I said termite revenue piece of that dollar revenue which is core termite completions of slight year-over-year. So we actually had virtually all of the increase this quarter, driven by the innovation services. So that’s pretty good. It’s been a while since we actually reported a meaningful increase in the innovation services year-over-year. Some of the core termite completion revenue is flat is entirely in keeping with the strategy in the key business and discussing for the last three quarters in terms of increased volume, lower price generating an increased base of yield customers. That’s the fundamental point there. Our organic pest growth of 1%, as I said on the call it’s mostly pricing. The core was a slight drop in let’s call it a core contracted pest services has been our trend with good performance on lot of the one off services that we provide.

[Jay Hanna:]

Okay got it.

[Rob Gillette:]

Yes the pest revenue organic growth is mainly priced.

[Jay Hanna:]

So there was no bounce from any weather related issues?

[Rob Gillette:]

No, those were [indiscernible] now, no.

[Jay Hanna:]

Okay, thank you.

[Rob Gillette:]

Thank you.

[Rob Gillette:]

Thanks everybody for your participation in today’s conference call and webcast. As a reminder, a replay of the call will be available on our Web site in about one hour from now. Again thank you. We look forward to speaking with you. Take care.

[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 lines. Have a great day.