Serve Robotics Inc.
Q1 2016 Earnings Call Transcript

Published: 5 May 2016

[Operator:]

Ladies and gentlemen, welcome to ServiceMaster's First Quarter 2016 Earnings Conference Call. Today's call is being recorded and broadcasted on the internet. Today is May 4, 2016. 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 will begin today's call. Please go ahead, Mr. Shields.

[Jim Shields:]

Thank you, Melody. Good morning and thank you for joining our First 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 website, 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 fourth-quarter and full-year consolidated financial results. Rob will then provide 2016 full-year guidance. Alan will then review our performance by segment and 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 May 4, 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, highlighting our first quarter and full-year 2016 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 are available on our website. We have also included reconciliations of the relevant 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 in the figures labeled as such therein. I'll now turn the call over to ServiceMaster's CEO, Rob Gillette for opening comments. Rob?

[Rob Gillette:]

Thanks, Jim, and welcome to our Q1 2016 Earnings Call. This is another strong quarter of top-line revenue growth as we continue to benefit from our past investments in people, marketing and customer service. Through these investments, we are making great drive in transforming our business to be the leader in the way people buy home services. As we move forward, we will continue to invest in our people, technology and brands to transform our company. We are establishing a nimble, agile and winning culture and we are arming our employees and partners with the right technology to act decisively to improve customer service and drive profitability. Our results in the quarter reflect these efforts. ServiceMaster grew 6% compared to the prior year and 8% if we excluded the conversion of Merry Maids' own branches to franchises. Revenue growth at both American Home Shield and Terminix accelerated compared to the fourth quarter of 2015. American Home Shield led the way with 11% growth in revenue and its 7% increase in a number of customers we serve. American Home Shield's growth was strong in both the direct-to-consumer and real estate channels. Terminix revenue grew 8% compared to prior year with organic pest growth accelerating from last quarter. Acquisitions contributed 5% growth this quarter and particular, the Alterra contributed approximately $15 million in revenue. Historically acquisitions have played an important role in our growth and had complemented our marketing and sales strategy to acquire new customers. As we mentioned last quarter, the Alterra acquisitions fit well with our existing business. It has significant scale with all residential pests, is geographically dispersed and yet have managed well with our footprint. We have significant synergy opportunities as we convert these new customers to our technology platform and we are pleased with our integration efforts to-date and the financial contribution of Alterra to Terminix bottom line. Furthermore, we just announced the acquisition of Catseye Pest Controls, northeast operations. A $10 million company with a reputation for premium customer service and experience in exclusion product services. With this acquisition, we are acquiring a value brand and a very experience and capable work force. Catseye is a great addition to our Terminix business. Our acquisition pipeline is healthy and we will continue to be an important part of our overall growth plans. New products are also important to our long-term growth. For example, 18 months ago, we rolled out our successful mosquito service. With the Zika virus in the news, this is a service which is highly valued by our Terminix customers. With the spread of the virus, we have seen an increase in the number of customer inquiries on social media, call centers and through online search traffic just as we are entering the mosquito season in most of our markets. We can't say whether the Zika conversation will directly impact sales, but we do believe our education and awareness efforts around the potential dangers will encourage our customers to protect their homes and families with mosquito treatments. Terminix is focusing our marketing effort on responsible education about eliminating mosquito breathing sites, personal protection at home and while traveling and the different options that are available for reducing mosquito populations in customer's homes and yards. During this time, we are especially grateful to have Dr. Stan Cope on our staff. Dr. Cope leads our entomology and regulatory services team and is a resident mosquito expert. With deep knowledge of pest control as it relates to public health, Dr. Cope is an asset and resource for our team. He is also the current president of the American Mosquito Control Association. He recently attended the White House Zika Action Plan Summit in Atlanta Georgia. He will continue to be an expert resource for our team as the conversation around mosquito-borne illnesses increases. As I mentioned on last quarter's call, at ServiceMaster, we know that the world has changed and we see that as an opportunity. ServSmart is our approach to capitalize on that opportunity. Customers want dependable experts who they can trust to fix their problems and they want convenient access to be able to buy and schedule services where, when and how they want. Many companies are trying to disrupt the home services industry as we see a significant opportunity to improve the customer experience. But [ph] system or solving a pest infestation problem is not something that can be done digitally. With over 80 years of experience, we have the scale to provide high quality service and we are using technology to give customers the access and experience they expect. The on-demand economy and mobile technology have changed people's expectations. Through our years of experience, skilled employees and partners, we have a legacy of solving our customer's problems and now we're on a path to enabled them to do so through technology. Our investments in marketing and ServSmart technology this quarter reflect our commitment to transform and grow. For the quarter, EBITDA was $6 million lower than last year, largely because we increased marketing spend by $10 million and incurred approximately $6 million in additional technology costs associated with our ServSmart initiative. In addition, there was the $5 million increase in our contractor claim cost at American Home Shield, associated with the residual effects of greater use of more expensive, out of network contractors. As of the end of the first quarter, our use of in-network contractors has returned to historical levels. As we've mentioned in the past, the investment in people, technology and marketing are important to grow our business. We make investments when and where appropriate. Our ServSmart methodology enables our IT teams to develop and quickly deploy smart solutions. The result is a more agile, nimble approach to technology development with a quicker payback. Business development process returns on the first quarter investments will be realized faster and benefit the bottom line more quickly than in the past. Both adjusted net income and adjusted diluted earnings per share improved this quarter, largely driven by lower interest rate expense. First quarter adjusted net income was $47 million, an improvement of $2 million compared to prior year. First quarter adjusted, diluted earnings per share of $0.34 increased $0.01 versus prior year. Now turning to Slide 5 in our 2016 outlook. As I mentioned previously, we have invested in the future by spending more money on marketing and investing more in technology. As we move through this year, we will continue to invest. In addition, the effectiveness of our marketing spend is somewhat dependent on timing. Last year we shifted some of our marketing spending from the fourth quarter of 2015, to the first quarter this year. The goal is to avoid the holiday season mail clutter on specific mail drops. We are still analyzing the effectiveness of this shift, but as we progressed through the year, we may accelerate some of our marketing expense in the beginning of 2017 into the end of 2016. In addition, we have noted a greater percentage of our spend is being devoted to digital and online marketing. Specifically at Terminix, we have seen our online sales grow. Although that it is still early, we may spend more in Terminix' digital and e-commerce efforts if we continue to see progress and realize the current returns on our investment. As such for 2016, we are refining our outlook. We now project revenues to be between $2.75 billion to $2.78 billion or 6% to 7% growth over 2015 and an EBITDA of between $675 million to $690 million or 8% to 11% over 2015. As I mentioned previously, we do not manage our investments or marketing spend on a quarter-by-quarter basis. We time our spend and investments to optimize the return we get on the spend. As such in the first quarter, we had significantly higher marketing spend and investment. We continue to expect revenue growth of approximately 10% at American Home Shield and the middle to high single digits at Terminix. We will continue to see operating leverage as we grow the top line and we expect margin expansion of 50 to 100 basis points. Our business has remained resilient and we are investing for the future and are confident in our outlook and growth potential. Before I turn it over to Alan, I would like to mention that we will be holding an Investor Day in New York City on May 17. I will be joined by the rest of our ServiceMaster's executive team and we will share our strategic plan and more about our ServSmart initiative. We are excited about the event and the opportunity to present our plan to reinvent the way customers buy home services. I hope you have the opportunity to join us. You can register for the event on our website under the “investor relations” section. Now let me turn it over to Alan to discuss the financial results. Alan?

[Alan Haughie:]

Thanks, Rob, and good morning, everyone. I'll begin the cost by discussing the Terminix segment shown on Slide 6. Terminix revenue increased by $28 million or 8% year-over-year comprising $18 million or five points of growth from acquisitions and $10 million or three points of organic growth. This organic growth reflects roughly equal split between increases in price and the volume of services. More specifically, pest control revenue of $206 million reflects an increase of 12% or $22 million over the prior year, comprising 16% growth in residential pest revenue and 5% growth in commercial pest revenue. The majority of this growth in residential pest resulted from acquisitions, the largest being Alterra with organic residential pest growth of 3% for the quarter. And the 5% growth in commercial pest revenue was substantially organic. We continue to experience strong bed bug growth as well with a 35% increase in revenue this quarter, splits fairly evenly between residential and commercial. Revenue for the termite and other services of $143 million increased 1% or $2 million with completion revenue itself falling by 2% or $1 million to $61 million. However, the number of core termite completions actually rose year-over-year, continuing the trend that began in the fourth quarter of 2015. This is a positive development, given that these customers having the highest lifetime values in the ServiceMaster portfolio and which should therefore increase renewal revenue in 2017. This quarter, core termite renewable revenue itself rose by 4% or $3 million to $82 million, although this is primarily due to pricing. The low demand for our insulation services caused by the unusually warm weather throughout the nation during the first quarter and our recent dedication of more sales and marketing resource to the repositioning of core termite did result in a flattening sales of those services, but despite this, exclusion and encapsulation revenue actually grew by 7%. Although new services represent about $100 million of our revenue in 2015, so therefore a small part of our portfolio services, they remain key to our growth story going forward. Turning at EBITDA, increased by $5 million this quarter. The $28 million of additional year-over-year revenue directly produced $15 million of incremental EBITDA. However, this was a step by $4 million in additional technology costs, associated with the developments of the ServSmart platform Rob mentioned earlier, a $1 million increase in sales and marketing costs and about $5 million increases in a variety of other costs including $1 million in additional insurance premium. The gross profit actually remained flat at 46% compared to the same quarter in 2015. Now, all revenue increase of $28 million, the $5 million increase in EBITDA also represents an incremental flow through of 18% with each dollar of incremental revenue. If we notably add that with $4 million in addition on investments and technology, Terminix would have converted 32% per $1 of incremental revenue into EBITDA. Historically, I think it's fair to say that we've tended to invest roughly in-line with revenue growth. But given the returns we expect from the developments and implementation of our digital platform, we are at rate of investments in 2016. Now let's turn to Slide 7 and discuss American Home Shield's first quarter performance. The strong revenue growth in American Home Shield continues with 11% or $19 million of year-over-year organic revenue growth, about $7 million of which was impressing. Claims cost in the quarter were $10 million higher than last year. About $4 million of this increase was due to inflation [ph] on about $1 million reflects the impact of extra claims in first year direct-to-consumer customers. The remaining $5 million related to the excess cost of servicing the appliance trade is compared to the last year. As a point of reference, when discussing our fourth quarter results a couple of months ago, we explained that the use of more expensive outer network contractors drove about $10 million of additional claims cost, and at that time, we estimated that our mitigating actions would take hold in the first quarter, but signaled that there would be some continuing impact in the first quarter results. In fact, as Rob mentioned that as of March 2016, our use of preferred contractors has returned to the previous high levels. So the first quarter impact was very much as anticipated, about half of that experience in the fourth quarter. In other words, the use of outer network contractors cost us about $5 million this quarter, compared to $10 million in the fourth quarter of 2015. So as a result, the first quarter gross margin percentage for Home Shield are 45.9%, is 2 points higher than that of the fourth quarter last year; and if we were to normalize this year's first quarter gross margin for the $5 million with exceptional clients claims costs, then the growth margin percentage will be descending for the first quarter of 2015. Now, sales and marketing spend increased by $10 million over the first quarter of 2015 and this increase is largely the result of the shift and increase in size of a mail job that was originally planned for the 2015 holiday season. I've mentioned and also avoid the holiday mail clutter in an effort to enhance the effectiveness of the mail drop, we shifted it to the first quarter of 2016. And in order to further enhance the effectiveness of the mail drop, we put forward some digital and broadcast spend, roughly another million dollars. Coupling these traditional marketing and digital initiatives greatly improves the effectiveness of the campaigns and in addition, in order to handle the demand associated with the initiatives, we incurred about $2 million in cost associated with X for selling agents and contact center staff. Now over the past three years, we have substantially increased our marketing spend, which I think in an acceleration of customer acquisition and so revenue growth. Our acquisition costs remain flat on a per-customer basis and the return on our marketing dollars remains compelling, and therefore so did the case for continuing to invest in marketing. In addition to an increase in marketing spend this quarter, we increased the investments in our first month technology platform by about $2 million. So given these investments, we now anticipate the full-year American Home Shield EBITDA margin will be similar to those of 2015. Slide 8 shows FSG's performance. The revenue decline of $10 million or 17% is almost entirely related to the Merry Maids' business – the vast majority of which is due to the ongoing conversion of the branches into franchises. As of now, we have divested all our commitments to sell out of 94% of the branches. Once again, we've largely maintained our EBITDA by driving cost reductions on pace with the branch disposal, which has the impact of raising the gross margin of this segment by 6% each points year-over-year to 59% and the EBITDA margin by five percentage points to fairly 7%. Turning to the full P&L account on Page 9 and looking at the business in its entirety, the year-over-year revenue increase of over 6% or $37 million includes $26 million or five points of organic growth. The remaining $11 million of revenue increase includes $18 million due to acquisitions of Terminix, partly also $7 million of revenue divested as we convert our Merry Maids branches into franchises. Gross margin as a percentage revenue, so by just two-tenths of a point to 46.7%, the principal driver being the $5 million of additional claims in American Home Shield discussed a moment ago. Now, the year-over-year SG&A increase is $21 million and it's primarily the result of $11 million of additional selling and marketing cost of which $10 million is on American Home Shield and $6 million of high technology costs. Now as described on prior call, the amortization expense has fallen by $4 million this quarter as the definite live intangibles created when the company was taken private in 2007 and became fully amortized. With respect to interest expense, we're now running at the $38 million of quarterly interest expense reference on the third and fourth quarter call. Furthermore in the absence of any debt redemption this quarter, there's no repeat of the loss of debt of $13 million regarding the first quarter of last year. Other expense of $3 million includes a further $2 million of legal and other charges relating to the USVI incident to supplement the $8 million recorded in the fourth quarter of 2015. And even though the matter remains open, we continue to believe that the reserve of $10 million for penalty was related to this incident as appropriate. So this results in pre-tax income of $62 million compared to $45 million over the same period last year. And our effective tax rate in the quarter is about 37% and so the net income for the quarter is $39 million compared to $28 million last year. Of course, to a comparability, we also reported adjusted net income which I'll reconcile briefly in a moment and this increased by $2 million to $47 million. So, Slide 10 provides our sSandard 2 reconciliations, first we work our segment performance measure, adjusted EBITDA down to income from continuing operations and then the reconciliation back up to adjusted net income. However, I think the explanatory or immaterial so we shall move on. Slide 11 provides the first quarter simplified cash flow statement. In the first quarter, we generated $89 million of free cash flow, an $18 million improvement over last year. We continue to demonstrate the incredible fundamental cash flow characteristics of this business with working capital generating $26 million of inflow, an increase of $5 million over the last year – largely upsetting the reduction in EBITDA. Now, our investments in is the principal source of higher capital spending on the quarter and as a result, we expect about $60 million of capital spending this year. Interest payments of $42 million are $25 million low over the last year, largely to reflect in the carry of the savings from the redemption of our high-yield note, interest on which was paid semi-annually in February and August. And as mentioned on prior call, we've become a federal tax payer given that we have largely been exhausted on the [ph] company, so payments of $3 million this quarter merely reflects favorable timing of payments. For the year, we still expect to pay cash taxes somewhere in the $140 million to $150 million range. Notwithstanding that, we still expect to comfortably exceed $300 million in free cash flow for the year. At a high level, this free cash flow projection is divided as follows

[Rob Gillette:]

All right, great. Thanks, Alan. We continue to reap the benefits of our investments with strong top-line revenue growth this quarter. We will continue to make investments in marketing and technology to drive both growth and productivity. We have the number one position in large fragmented markets and we offer services that are essential through our customers and that result in high retention rates and recurring revenue. Through our ServSmart initiative, we are positioning the company to capitalize on these attributes and become the provider of simple, easy to access services that are dependable, convenient and on-time. We hope to share some of the progress we've made with you at our Investor Day on May 17 in New York. Now I'll turn it over to Jim Shields for Q&A.

[Jim Shields:]

Thanks Rob. As a reminder, during the question-and-answer session, we encourage you to ask questions that you may have, but please note the guidance is limited to outlook that we provided in the press release and webcast presentation. Additionally, just the queue is long this morning, please limit yourself to one follow-up question so that we can get everyone in the allotted time. Melody, let's open up the line for questions. Thank you.

[Operator:]

Thank you. [Operator instructions]. One moment please for the first question. And our first question comes from the line of Jeff Volshteyn with JPMorgan. Please proceed with your question.

[Jeff Volshteyn:]

Good morning and thank you for taking my questions. Let me start with Terminix. I wanted to get a little more color on termite side of the business. Can you just help us understand what are some of the trends maybe by geography or by type of customers that you see there?

[Alan Haughie:]

Well, we're still seeing the trend that we discussed a few quarters ago and has been a similar of a constant theme, the acquisition or the purchase of additional services by our customers I think as I mentioned, organic growth is not exactly particularly strong in the past at 2%, but it's an improvement over the fourth quarter and we still see an underlying increase in the volume of services that are being purchased by our pest customer. Mosquito are still small at the moment, but that's showing very positive sign. So there's still that on-demand behavior of our core pest customers and that's progressing very well. Within the termite segment, as I've said, we're actually seeing increased number of completions. We're doing some bundling and couponing and bringing in more customers again throughout the first quarter than we get in the first quarter of last year, 2015. We're actually seeing a very positive development in the way core termite is behaving and they're not fully reflected yet as I said in the revenue. That will come through later in the year as well as in terms of renewals in 2017. But the underlying development in both markets are quite strong.

[Rob Gillette:]

The other thing I would add to what Alan said, Jeff, is that because of the weather and the warm weather that we've had the insulation side has been kind of softer year-over-year than what we'd normally experience which is logical. But then given that, hopefully activity will continue to be there for termite going into the spring season.

[Jeff Volshteyn:]

That's helpful. As a follow-up, quick question on AHS. I'm glad to see the cost issue with some of the contractors have been resolved through – Alan, I think you mentioned – $4 million of inflationary increases in cost. What does it relate to and how should we think about it for the rest of the year.

[Alan Haughie:]

We will see. If you look at the dynamics of American Home Shield business, we have our $7 million in pricing. We'll always be able to offset cost increases or inflationary cost increases with pricing. That's something close to our gross margin. In other words, if we have let's say $7 million of pricing year-over-year, it's reasonable to anticipate maybe half that dollar value in inflation in contract to cost. As we talked before, we have to be flexible and make sure that we manage the contractor base appropriately particularly as we grow. I believe we have that on the good control as we exit the first quarter and enter the second quarter. But that will be a few million dollars per quarter in underlying installation I would say. But never more than the price increases that we're passing through because we get ratio of pricing to inflationary cost given that our contract to cost base is roughly 50% of our revenue.

[Operator:]

Our next question comes from the line of Denny Galindo with Morgan Stanley. Please proceed.

[Denny Galindo:]

Hi there. Good morning.

[Alan Haughie:]

Good morning.

[Denny Galindo:]

This time of the year, as we move into May, we start to get a better sense of a swarm. What are you seeing right now? This is the year where the weather has been warmer and it seems like it should be good environment for termites. Do you have any quote on how the year will progress and at this big termite year, is it going to be this year or maybe we wait another year for it?

[Rob Gillette:]

Alan and I have been waiting for three years now, but we think actually the conditions are positive to support activity and we've seen some of that and on the core termite side of our business and we think we're making good progress. Had a backlog that we're executing on today. So in general, I'd say it should be a good termite season.

[Denny Galindo:]

Okay. And then one question on American Home Shield. The top-line accelerated pretty nicely here, but the customer account was a little bit slower than we have thought. So maybe more of it came from pricing. In conjunction with the higher marketing that you've spent this quarter, I want to get a feeling for was this increase marketing cost kind of needed to keep the growth at this level? Or was it something that maybe will cause further acceleration in the future?

[Rob Gillette:]

I'll take that and maybe Alan can jump in. Remember, the biggest part of what we do is the renewals year-over-year. So in part, the price comes from some of the renewals, but also some of the new business. You see the variants in price into our product mix different product solutions and things like that. Most of the cost that we mentioned that we carried over from Q4 2015 to 2016 was direct mail. And direct mail tends to lag a little bit. It's not tied to the current period. As you know, we sign one year contract that we renew so it tends to pay out over a number of months. So it really isn't tied to the current period. Don't connect the two together. We just decided to try a different approach to the direct mail side.

[Alan Haughie:]

Yes.

[Operator:]

Thank you. Our next question comes from the line of George Tong with Piper Jaffray. Please proceed with your question.

[George Tong:]

Hi. Thanks. Good morning.

[Alan Haughie:]

Hi, George.

[George Tong:]

There was a $1 million increase in AHS claims cost in the quarter because of extra claims. More broadly, can you talk about changes you've seen in AHS claims frequency, severity and actions you may be taking to manage any of the increases?

[Alan Haughie:]

If you think about the theme we developed, we've discussed when we brought out the fourth quarter results that it is a slight great tendency of the new customers we're bringing on whether through real estates or direct-to-consumer to favor the appliance coverage that we offer and various ways in our contracts. As we've said, when we looked at last year, the fourth quarter made a 7% increase in the number of customers and 8% increase in the number of appliance claims – not a massive inquiry. With $1.6 million customers overall and growing in Home Shield, there's a reasonably robust portfolio. So there aren't many small factors that cause that portfolio to change. I think the most important aspect of this business to bear in mind is that we can and do continually redefine and redevelop our product to add new services, to remove things – and we'll cover some of this on Investor Day – the nature of the products is being continually refined and piloted in given areas and that will continue to happen as we go forward. The beauty of this product is that I believe, however our customers behave, we fundamentally will have a product that will sort of match that general need and you see us going through one of those development phases right now.

[Operator:]

Thank you for your question. Our next question comes from the line of Anj Singh with Credit Suisse. Please proceed with your question.

[Anj Singh:]

Hi. Thanks for taking my questions. My first one and a couple-part question on American Home Shield. I guess if you could help us with what is baked in from marketing expenses for American Home Shield for the full year versus last year? And it seems like the marketing expenses are taking up, so should there be any change to the 10-ish percentage top-line growth outlook that you've talked about previously? And if not, then when should we expect that growth profile to start improving?

[Alan Haughie:]

Yes, good question. I'm probably too conservative to come out here right now and say that the amount of spend that we're plowing into 2016 will show any revenue benefits in 2016, but yes, the fact that we are accelerating and continuing to invest more dollars in marketing, we should see benefit in 2017 of that growth rate.

[Anj Singh:]

Okay. Would you still say your customer acquisition cost are flat in American Home Shield?

[Alan Haughie:]

Yes. I tried to make the point. That's the issue. We often talked about as not seeing what I'll call the inefficient frontier of this investment and that continues to be the case. Therefore, the argument for investing sooner is still compelling.

[Anj Singh:]

Okay, got it. And my second question, with regards to the technology investments, it seems like you ramped up the pace of investments and sizes of investments. Could you talk about what has changed in your outlook or plans to ramp these up as it relates to your guidance for this year?

[Rob Gillette:]

Yes, I think it's more about timing. What we talked about is we don't really pay some by quarter, we pay some in terms of return and we make the investments including that investment in technology. So both right. Two things I would say; it's focusing on rolling out service mobility application or Terminix in large part; two is translating a lot of our E business and digital marketing learnings from AHS to Terminix. So we put a lot of energy and effort into that in the quarter. And then we also rolled out a new sales mobility tool with iPads and support with applications which actually the guys are deploying this week. So I've seen a number of emails and excitement about using the tool and it gives us the ability to update, provide information too and current knowledge to our salespeople in the field to provide the customers. Really those three areas, the digital investment in Terminix, continued direct mail largely and AHS was a big part of the investment in marketing, but then the technology was largely deploying these two tools in mobility for Terminix.

[Anj Singh:]

Okay, got it. Appreciate the color. Thank you so much.

[Alan Haughie:]

Sure.

[Rob Gillette:]

Thanks, Anj.

[Operator:]

Thank you. Our next question comes from the line of Gary Bisbee with RBC Capital Management. Please proceed with your question.

[Gary Bisbee:]

Hey, guys. Good morning. Let me start by following up on that IT spend. So the $6 million I think was a higher number than any of us expected. Can you help us understand the phasing of the spend through the rest of this year and what's the timing, this sort of incremental spend in these initiatives is going to persist for?

[Alan Haughie:]

Well, at least we reported $6 million additional cost year-over-year. I would say that we're going to see that at least every quarter for the rest of the year. We are trying to build in quite obviously the flexibility to accelerate that, should the benefits be obvious to us. We're working what we call “agile.” The idea is to bring in minimally viable product as soon and as early as possible that will benefit the customer experience. We're enjoying great success in that and therefore there is little benefits in the like. There's really no point in going slowly with this initiative because it's transformative. So we will see as I said, about roughly $6 million per quarter of increase year-over-year for this at least.

[Gary Bisbee:]

And do you think that persists beyond this year or are these three things that Rob just mentioned, you get them done and get through the bulk of it and you're back to a normal phase of growth with revenue?

[Alan Haughie:]

Closer to the way you said it, yes.

[Gary Bisbee:]

Okay, all right.

[Alan Haughie:]

We will not see continual rates of increase like this at all going into…

[Gary Bisbee:]

And then the follow up question, just on the marketing spend, the incremental $11 million this quarter, I understand how you frame that and you told us to expect some of that last quarter. But was there pulling forward from later in this year as well? Any thoughts on year-over-year timing through the rest of 2016 in terms of marketing spend? In other words is it down or less?

[Alan Haughie:]

It's going to be up in Q2, it will be up to a lesser extent than it was in Q1 – but it will be up in Q2. And as yet we are undecided and this is the truth, we're undecided on Q3 and Q4. That depends on the effectiveness in the rate of which we're acquiring customers as we modulate growth on the investments. But again, we're trying to make sure we're building the flexibility for higher marketing in the second half should we hear that as appropriate. That was something that Rob covered in his prepared remarks.

[Gary Bisbee:]

Thank you.

[Alan Haughie:]

But we will see. To clarify that, higher marketing cost year-over-year in the second quarter in Home Shield.

[Rob Gillette:]

As Alan said, moderated by our cost to require balance in that return which we mentioned during the call.

[Operator:]

Thank you. Our next question comes from the line of Sara Gubins with Bank of America. Please proceed with your question.

[Sara Gubins:]

Hi. Thanks. Could you give us an update on the pricing environment that you're seeing in termite and pest?

[Alan Haughie:]

Well, it doesn't change much. I think as you said, in test, this is an essential service, customers largely expect and absorb couple of points price a year. If you are a Terminix customer, you will receive a notification -- flight [ph] notification as I did for my services indicating that the price has gone up and most likely, happy when that happens like most customers – and in termite completion, as I mentioned, we're actually doing some escort bundling, coupon discounting of termite services. The termite completion, that is, that's the initial thing that brings in the customer. So with some modest discounting and I say modest, we've seen this acceleration in the number of completions and of course, all that means is the real benefit is that we have an increased number of customers that will therefore when you pay the ongoing annual premium in the out years. So the environment remains certain types. It can absorb the standard levels of pricing we've been putting in and the termite market at least in certain aspects and certain geography, it's actually quite responsive [ph], so we'll see for the initial treatment. When it comes to a termite renewal, very absorbent to price increases as you saw. The reason for the termite renewal revenue going up wasn't the price. Once customers are let's say hooked on a product, they generally – yet again, just like the pest customer, they absorb the price increases. The environment may stay healthy.

[Rob Gillette:]

Yes. Remember the conditions too, are favorable in terms of price activity. So the warm for the weather and start of the spring, the more activity that occurs and much activity in terms of pests is customers calling us for the problem and that gives us an opportunity to sell these bundled products that Alan talked about, too. I think Alan mentioned too, bed bug was up quite a bit. Although small, but it indicates that there's activity out there. Customers tend to call us when they have a pest issue and it gives us an opportunity to sell then on mosquito and other things like that.

[Sara Gubins:]

Okay, great. Thanks. And then sorry if I missed this. But within NHS, you now backed in network utilization levels, are you paying those contractors more that are in network? Are you paying them more per job than you were before, or does that go back to historical levels as well?

[Rob Gillette:]

I think as Alan mentioned, it varies by region and specific contractor and then we mentioned some of the inflation that we can anticipate for the balance of the year – combination of price of both labor, but also materials.

[Sara Gubins:]

Okay, thank you.

[Rob Gillette:]

Yes.

[Operator:]

Thank you. Our next question comes from the line of Andy Whitman with Robert W. Baird. Please proceed with your question.

[Andrew Whitman:]

Hey, guys. I guess I wanted to build on that last question about AHS contractors and just ask specifically what actions have you taken to address the contractor claims? Is the network bigger now? I don't know, maybe you guys can give a little bit of detail?

[Rob Gillette:]

I'll start. I think we added some in the neighborhood of 150 or so contractors or net between adds, and deletions and new. So it's increasing so we've added more contractors and then as our density grows in a specific geographic region is evolving, we add new contractors to that as well. So we're up in the contractor base.

[Andrew Whitman:]

Got it. And then I guess on the balance sheet, the notable jump in prepaid expenses and other assets as well as your self-insurance, liability, I was wondering if you tell us what was driving that sequential change?

[Alan Haughie:]

Yes. The principal element is the fact that we're on the USVI matter. We are, as we said, covered by insurance, but as the claims develop, we have to gross up our balance sheet to reflect both a payable out for the potential settlement of the claim as well as an asset to recognize the equal and opposite recovery from the insurance on that principal. That's the largest element to that increase.

[Andrew Whitman:]

Got it. Okay, thanks. I'll hold it there.

[Rob Gillette:]

Thank you.

[Operator:]

Thank you. Our next question comes from the line of Dan Stool [ph]. Please proceed with your question.

[Unidentified Analyst:]

Hey, guys.

[Alan Haughie:]

Dan.

[Unidentified Analyst:]

Hey, I'm back.

[Rob Gillette:]

Yes.

[Unidentified Analyst:]

I just can't get my head around it. You're growing low single digits in pest control. If you look at the first quarter of rolling, it's up 7%, [indiscernible] 6%, equal lab -- which I'm not a big fan -- about 9%. What is going on? Are you using share? Are you in a different market? Can you shed some color on these things?

[Rob Gillette:]

Well, we're clearly in different markets than the companies you mentioned. So I think that's part of the equation and I think part of that is what we've done to focus on and transforming the business and how we approach selling. That's why I mentioned some of the tools that we put together in investment and technologies for mobility tools and things. Right now we feel pretty good about where we're headed in our ability to grow in Terminix. There's a differences of course between all the individual companies in the mix and acquisitions and everything else is recorded.

[Unidentified Analyst:]

Got it. And then a follow up on AHS. On those out of network contractors and customers, if I make customer today and I make a claim, am I still getting the contractor at the same time that I got it maybe three or four months ago? Or have you changed the time it takes to fix the problem?

[Rob Gillette:]

In service levels in general?

[Unidentified Analyst:]

Yes. Are you providing the same service levels with just better cost structure?

[Rob Gillette:]

Part of the investment that we mentioned in the quarter was the investment in the ability to speedy answer calls and the service capability that we have. So we've increased both the number of contractors we have, but also increased the number of people that we have on the phones, demanding the phone and setting up and scheduling appointment. I would say it's equal in terms of equality.

[Alan Haughie:]

Agree.

[Unidentified Analyst:]

Got it. All right. Thanks, guys.

[Alan Haughie:]

Thank you.

[Operator:]

Thank you. Our next question comes from the line of Sam Eisner with Goldman Sachs. Please proceed with your question.

[Nick Stuart:]

Yes. Hey, guys, this is Nick Stuart on for Sam. Thanks for taking my questions.

[Rob Gillette:]

Sure.

[Alan Haughie:]

Hey, Nick.

[Nick Stuart:]

If you're going back to the formula in insurance cost in Terminix, is that a run rate quarterly cost that continues from here, or is that just a one-time charge?

[Alan Haughie:]

I may have mangled my words. The $5 million charge for a bunch of other stuff, $1 million of that is insurance premium.

[Nick Stuart:]

Got it. So of the $5 million, other costs, what are those specifically and do those continue?

[Alan Haughie:]

Too many small things to break down. No, there's no reason to expect them to continue. I could really break it down in so many small items, none of which were in any sense or anything like that.

[Nick Stuart:]

Okay, that's helpful. And then with respect to the Cat's Eye acquisition, when did that close and what can you tell us about how many customers you acquired or how much revenue that acquisition should contribute?

[Rob Gillette:]

The revenue I mentioned is $10 million in general and then the rest, we don't disclose typically.

[Nick Stuart:]

Got it. Okay. And then just lastly on the DOJ investigation, can you just update us on what's the rejection that you called out? Means?

[Rob Gillette:]

You mean the procedures?

[Nick Stuart:]

Yes, right.

[Rob Gillette:]

Part of the process in resolving and coming to agreement finalizing everything with DOJ, there is another scheduled date in August. So no change of significance to that.

[Operator:]

Thank you. [Operator instructions] Our next question comes from the line of Denny Galindo, Morgan Stanley. Please proceed.

[Denny Galindo:]

Hi, there. I had a couple of other follow ups.

[Rob Gillette:]

Yes.

[Alan Haughie:]

Hi, Denny. Back at you already.

[Denny Galindo:]

Yes, I'm back. The acquisition that you announced, it sounded like it was a little different than what you typically do because you're not using your brands. Were you typically bringing them under the Terminix brand? Maybe you could give a little bit more background on that structure and is this something that would become more common as you kind of become more of a technology and marketing company and you improve those capabilities, it might be more useful to mom and pop brand to kind of tap into some of the investments that you're doing there? Maybe talk about that a little bit.

[Rob Gillette:]

Yes, sure. I think it varies by specific supplier that we acquire and really how well they've executed in terms of both brand, but also service. I've mentioned that in terms of Catseye, we're pretty excited about actually knowing from some of the things that they've done in premium service and how they provided services in exclusion, but also really high quality service and that's how they're recognized. So we want to make sure that we learn from that and apply it in different places and also take advantage of much of the investment that they've made in their brand name. It varies from business to business. I think in the case of Alterra, it's a similar circumstance and the number of customers that we work with gives us the opportunity to provide alternative services to them. So we've over time will integrate some of these things back into the one brand approach, but given the business of where it is and quite honestly what we can learn, we take advantage of the investment that we made.

[Denny Galindo:]

And then secondly, it does sound like the claims issues are pretty much past now, but is this something that will reoccur during every slow season in AHS where if you're going to grow 10% every December, you'll have a battle with the contractors and you'll have to divert some claims to lower to your contractors to while you're negotiating and you'll have higher claim cost in Q4, in Q1 and then it will be fine for the rest of the year, or was this truly a one-time occurrence?

[Alan Haughie:]

Let me answer in between those two aspects of the question. We're obviously working hard to make sure that the structure of our relationships with our contractors is designed to prevent something like this happening again in terms of design and negotiation. It may at some point in some area happen again. In no way would I assume that it's a regular fourth quarter assurance. Certainly not.

[Rob Gillette:]

It's something that happens throughout the year continuously. Right?

[Alan Haughie:]

Yes.

[Rob Gillette:]

So it's not something that you could say will happen on a recurring basis as Alan said.

[Denny Galindo:]

Do the contracts come up at different times during the year?

[Alan Haughie:]

Yes.

[Denny Galindo:]

Okay. They're evenly spread throughout the year.

[Alan Haughie:]

Yes. It's the contractor anniversary, not calendar year.

[Denny Galindo:]

Okay. That's it for me.

[Rob Gillette:]

All right. Thanks, Denny.

[Operator:]

We have no further questions at this time. I'll turn it back to you, Mr. Shields for our closing remarks.

[Jim Shields:]

Thank you for your participation in today's conference call and webcast. As a reminder, we will be holding an Investor Day in New York on May 17. You can register for the event on our website under the investor relations section. A replay of today's call will be available on our website also in about an hour. Thanks again and we look forward to seeing you in New York on May 17.

[Rob Gillette:]

Yes, thank you.

[Operator:]

Ladies and gentlemen that does conclude today's conference call. We thank you for your participation and ask that you please disconnect your lines.