Serve Robotics Inc.
Q4 2015 Earnings Call Transcript

Published: 26 Feb 2016

[Operator:]

Ladies and gentlemen, welcome to ServiceMaster's Fourth Quarter and Full Year 2015 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 will begin today's call. Please go ahead, Mr. Shields.

[Jim Shields:]

Thank you, Nikki. Good morning and thank you for joining our fourth-quarter and full-year 2015 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 February 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, highlighting our fourth-quarter and full-year 2015 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:]

Okay, great. Thanks, Jim, and thanks to you all for joining us this morning in our 2015 earnings call. Before I get into the full-year results, I'd like to talk about an announcement we made last month of ServiceMaster's new corporate identity and its alignment with our serve smart business model. For many years service companies have focused on their efficiency and route density to drive productivity and business results. We recognize the need to be efficient and are very good at driving productivity, but we also recognize that the on-demand economy and mobile technology have changed customer expectations. At ServiceMaster we know that the world has changed, and we see that as an opportunity. We all have experienced waiting for a repairman or service professional to arrive at our home or business and the frustration that comes from the inconvenience of working around someone else's schedule to get what we need done. Whether it is a broken dishwasher, mice in the attic, or a broken pipe flooding your basement suddenly everything gets reduced to who can fix it, how do I find them, can I trust them in my home, and can I trust them to do what is needed. Home and business owners want dependable experts who they can trust and rely on to fix their problem. They want convenient access to trusted professionals, and they want to buy and schedule services where, when, and how they want. With over 80 years of experience, we have the scale to provide service in a high-quality way, and we are going to use technology to give customers the access and experience they demand. Many companies are trying to disrupt the home services industry with technology or crowdsourcing because they see it as a significant business opportunity in improving the customer's experience. But fixing an appliance or an air-conditioning system or solving a pest infestation problem is not something that can be done digitally. Our years of experience, skilled employees, and partners can solve these problems, and we want to enable them to do so through technology. ServSmart is our approach to efficiently provide a great customer experience and differentiate ourselves from competition. Our new brand identity is designed to convey this message and is much more than a logo. It reflects our vision of being a leading provider of essential services powered by trusted experts and convenience. We will utilize uniform brand standards to increase awareness of our Company and all of the services we offer. It will define how we engage with our franchisees, suppliers, and most importantly our customers. Our brand tells the story of a Company that is energized, agile, and thinking digital first. We are excited about the way the Company is headed and the opportunity we have to reinvent the way customers buy home services. Turning to Slide 4, you can see ServiceMaster had a great year. We had a couple of important milestones in 2015, with American Home Shield achieving double-digit revenue growth and Terminix new services revenue surpassing $100 million in sales. Our investment in new products and channels is paying off, and we delivered strong top and bottom line growth. As for the Company results, revenue increased $137 million, or 6% versus prior year. At Terminix, the increase was driven by the growth of new services, organic growth in our pest business, and several tuck-in acquisitions. At American Home Shield, the increase is attributable to the continued growth in the direct-to-consumer channel where we are the industry leader. Our EBITDA growth demonstrates the operating leverage we have in our businesses, as 50% of revenue growth dropped to the bottom line. In 2015, our EBITDA improved $65 million, or 12% compared to the prior year. Cost-reduction efforts, supply chain, and sales and marketing efficiencies also contributed to our EBITDA improvement. We continue to see a significant leverage in the business, enabling us to invest in marketing and technology to fuel future growth. Full-year adjusted net income was $245 million, improved $79 million or 48% compared to prior year. In 2015 we paid down $340 million of debt and reduced our interest expense $52 million compared to 2014. Improved operating performance combined with debt pay down over the past year has greatly improved our capital structure. As a result, we are now in a position to return capital to our shareholders. Alan will speak more about our capital allocation plans in a couple of minutes. Full-year adjusted diluted earnings per share of $1.80 increased $0.34, or 23% versus prior year. As you can see from our results, our businesses remained strong, resilient, and consistent financial performers. We continued to invest while keeping our commitments to investors, customers, employees, and business partners. We are looking forward to doing the same in 2016. Turning to Slide 5 and our quarter results, we had another strong quarter despite the impact of approximately $10 million in revenue decline from the divestiture of our owned Merry Maids branches. Revenue grew 4% led by American Home Shield with a 7% increase and a number of home warranty customers we have, and in Terminix with the acquisition of Alterra Pest Control and continued growth of our commercial business. Despite significantly higher claims costs in American Home Shield, ServiceMaster's EBITDA grew by $10 million, or 9% versus prior year, with a conversion of 41% of each incremental revenue dollar to EBITDA. The claims cost at AHS was driven by our investment in the improvement of customer service. We decided to forgo the use of some of our in-network contractors who could not meet our service levels or lead times. In their place we use the independent contractors who could meet our service level commitment, which resulted in a much higher cost. As a result of the efforts, our consumer affairs satisfaction survey results improved from 3.8 stars in the second quarter to 4.7 stars in Q4. We believe the short-term costs are well worth the long-term gains in reputation and improved customer satisfaction and retention. Turning to Slide 5, earlier I spoke about ServSmart, our new brand identity and our digital mobile strategy. Entire industries like retail, travel, insurance, and real estate have been forever changed by technology that puts more control in the hands of consumers. American Home Shield has been a leader for us in this digital mobile transformation. Our strategy is about making it easier for consumers to purchase home a warranty, obtain service, or help them solve their home maintenance problems. Building a robust social media presence has been one key to our success. Through social media we've been able to greatly increase customer touch points and engagement. As a result our reputation has improved, and in turn increased loyalty, retention, and leads for our sales team. By applying the learnings and experience we gained at American Home Shield to the rest of the organization, we hope to do the same for Terminix and our franchise services group. In October of last year we took our first steps in implementing a social media program at Terminix. On Slide 5 you can see the dramatic increase in Terminix' presence across all social media platforms. Facebook likes nearly doubled, Twitter followers increased 111%, interest followers increased 172%, YouTube subscriptions tripled, and most importantly Terminix rating at ConsumerAffairs went from 2.5 stars to 4.6 stars in just four months. Terminix has unparalleled brand recognition in the pest control industry. By expanding our ServSmart platform to Terminix, we expect to build on this recognition and increase customer loyalty, sales, and profitability. ServSmart is more than just customer engagement in social media. We operate in large fragmented markets with few national competitors. By standardizing our processes across business units and developing flexible technologies, we are capitalizing on the scale and breadth of our operations. To the extent we build and leverage the right consumer-centric technology, it puts us in a position to capture a greater share of these markets and accelerate growth. Over the past year at America Home Shield we've been rolling out an automated scheduling system that has significantly improved customer service and operating efficiency. Beginning in March, we will be piloting the system at Terminix. Now turning to Slide 6 and our 2016 outlook. In 2016 we will continue to meet our commitment by delivering solid returns to shareholders. We project revenue to be more than $2.75 billion, or 6% growth over 2015, and EBITDA of more than $685 million, or 10% over 2015. We expect revenue growth of approximately 10% at America Home Shield and in 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 1 point to approximately 25%. Our business model remains resilient. We have the number one position in large fragmented markets, we offer essential services that customers value resulting in high retention and recurring revenues. We have an active acquisition program with a strong pipeline to complement our organic growth, and by capitalizing on these attributes we have significantly delivered over the past 18 months. As a result, in 2016 we will generate free cash flow in excess of $300 million. We continue to position the Company for growth by investing in technology and marketing. 2016 should be another good year. Now I would like to turn it over to Alan to discuss our financial results in more detail. Alan?

[Alan Haughie:]

Thanks, Rob, and good morning, everyone. I'll begin by discussing the Terminix segment shown on Slide 8. Starting with the fourth-quarter performance on the left-hand side, Terminix revenue increased by $19 million, or 6% year over year, comprising about $13 million or 4 points of growth from acquisitions, and $6 million or 2 points of organic growth. This organic growth reflects about a 1% net price increase and 1% from increased volume. More specifically, pest control revenue of $207 million reflects an increase of 10%, or $18 million over the prior year, comprising 11% of growth in residential pest revenue, 8 points of which is the result of acquisitions, the largest being Alterra, and 6% growth in commercial pest revenue. The increase in overall pest revenue does actually include about a 35% increase in bed bug revenue. Now we're particularly pleased with the acquisitions we made this quarter. Historically acquisitions have played an integral role in our growth, and Alterra complements our existing business well. It has significant scale, is all residential pest, is geographically dispersed but well aligned with our footprint, and as a result has significant synergy opportunities. With our breadth, scale, and residential footprint this acquisition was an excellent fit, which demonstrates the value of smart, strategic acquisitions in our growth plans. With regard to termites and other services, revenue of $115 million increased 1%, or $1 million, with completion revenue grown by 3%, or $1 million, to $59 million. And renewals remained basically flat at $56 million. Also, our revenue increase of about 15% from other services, exclusion, encapsulation, insulation, offset a 2% decline in core termite revenue. However, we are pleased with some of the recent developments in our core termite business, with both November and December, albeit being a low base month, showing an increase in the year-over-year number of core treatments sold. EBITDA increased by $14 million, a conversion rate of 74% of each incremental dollar of revenue. Gross margin for the fourth quarter increased year over year by about 1.1 points largely due to the efficient absorption of Alterra, and SG&A improved by 2 points of revenue benefiting slightly from lower incentive compensation. And so EBITDA as a percent of revenue improved by 3 points to 22%. We will of course continue to make investments that we feel are important for future top line growth. However, as far as 2015 is concerned, Terminix ended the year with revenue and EBITDA growth of 5% and 12% respectively, a conversion of 51% of each dollar of revenue into EBITDA. So each incremental dollar of revenue to EBITDA. So turning to Slide 9, let's discuss American Home Shield's fourth-quarter performance. First, and as predicted, the strong revenue growth in America Home Shield continues with 8% or $15 million of year-over-year organic revenue growth, $6 million of which was from pricing. Claims costs in the quarter were $19 million higher than last year. Now about $5 million of this increase was due to normal inflation and growth in direct consumer customers, and about $4 million related to out-of-period air conditioning claims recognized in the fourth quarter. So the remaining $10 million of the increase reflects higher average cost per service request driven by greater use of more expensive out-of-network contractors. This was necessary in order to improve service levels, particularly in the appliance trades. And as Rob mentioned, we believe the short-term costs are well worth the long-term gains we will realized in reputation, customer satisfaction, retention, and ultimately profitability. And this is particularly the case as our mix shifts towards direct consumer customers that tend to favor appliance coverage and more immediate service. So as part of our growth strategy we will continue to maintain high service levels, as we expand our preferred contractor network to include those that are willing and able to meet these more demanding service criteria. As the dominant player in the home warranty space, we continue to gain insights into customer preferences and are becoming more surgical in the pricing of appliance and other options within our contracts. Now, marketing spend any fourth quarter was actually $5 million lower than 2014, as we shifted some of the traditional holiday mail drops to January of 2016. As we continue to accelerate our direct-to-consumer business, we are getting better at refining our marketing spend and reducing our customer acquisition costs. By shifting marketing spend to January and avoiding the clutter of holiday cards and retail promotions, we hope to achieve higher sales conversion rates and increased sales. And yes, shifting marketing expense to the first quarter also helped to partly mitigate the impact of the higher close costs. But as a result of this shift we will however see a significant increase in marketing spend in the first quarter of 2016 compared to 2015. However, notwithstanding these points, American Home Shield's full-year revenue increased 11% and EBITDA by 15%, providing a conversion of 29% of each incremental revenue dollar into EBITDA. Slide 10 shows FSG's performance. The revenue decline of $10 million, or 16%, 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. And as of now we've divested or have commitments to sell over 80% of the branches. And once again we largely maintained our EBITDA by driving cost reductions on pace with the branch disposals, which has the impact of raising the EBITDA margin of FSG for the quarter by 4 points year over year to 35%. Turning to the folpeen hour count on page 11, the year-over-year revenue increase of 4%, or $24 million, includes $19 million, about 3 points of organic growth. And the remaining $5 million of revenue increase includes $13 million due to acquisitions within Terminix, with $8 million roughly coming from Alterra Pest Control acquired last November, partly offset by about $8 million of revenue divested as we convert our Merry Maids branches to franchises. Of this organic revenue increase of $19 million, Terminix contributed $6 million, an organic growth rate of about 2%. American Home Shield contributed $15 million on an organic growth rate of about 8%, and FSG as I said contracted by about $2 million. Gross margin as a percentage of revenue fell by 2 points to 43.4%, the principle driver being the additional claims costs in American Home Shield discussed a moment ago. Selling, general, and administrative expenses decreased year over year by $10 million, about half of which is the lower marketing spend in American Home Shield, and therefore SG&A fell as a percentage of revenue by 2.8 points. And as described on prior calls, amortization expense has followed by $7 million this quarter, as the definite live intangibles created when the Company was taken private in July 2007 have become almost fully amortized. Now we've taken a $23 million charge in the quarter for an item described as a 401(k) plan corrective contribution. Back in 2008 the Company amended its 401(k) plan with the result that all employees needed to be auto enrolled in the plan unless they notified us that they wished to opt out. Now, anyone that joined the Company after that 2008 date was properly auto enrolled, and that actually covers the vast majority of current employees. But unfortunately we have a small number of current and a large number of former employees that were never properly auto enrolled. Consequently, we're making what is called a voluntary correction proposal, or VCP, which in essence means that we open individual 401(k) accounts for each impacted person, fund the payroll deferrals that were never made, and also improve - provide a Company match and a reasonable rate of return up to the present day. We're proposing to make this VCP for $23 million in the next few months. Now this contribution is not a penalty, but a retrospective make-whole payment. And so it is fully tax deductible at 40% of the amount we eventually contribute. Now on a more pleasing but familiar note, as a result of the post acqui year elimination of high-yield debt, our fourth-quarter interest expense is $10 million lower than last year, and we've now achieved the $38 million of quarterly interest expense referenced on the third-quarter call. Other expense of $9 million includes legal and other charges relating to the USVI incident. Now, even though the matter remains open, we believe that given our discussions with the DOJ at this stage a charge for penalties and fines of $8 million is appropriate. So as result of all this, our pretax income of $33 million compares to $36 million over the same period last year. Our effective tax rate for the quarter is about 48%. It's a little higher than the run rate earlier in the year due to the non-deductibility of certain fourth-quarter items, most notably the other expense noted a moment ago. And of course to rate comparability we also report adjusted net income, which I'll reconcile in a moment, and this increased by $40 million, or 45% to $45 million. So Slide 12 provides our standard 2 reconciliations. First, we walk our segment performance measure adjusted EBITDA down to income from continuing operations, and then walk the reconciliation back up to adjusted net income. As a reminder, we exclude all amortization expense from adjusted net income; $6 million this quarter compared to $13 million in the fourth quarter of 2014. As already discussed, this is because I reported US GAAP net income gets a boost from this amortization as it falls, and so in the interest of highlighting underlying operating performance we exclude this improvement from adjusted net income. Other reconciling actions worthy of note are the 401(k) plan corrective contribution of $23 million. And although this is expected to result in an eventual post-tax cash outflow of about $40 million, there is no impact on future operating performance or sustainable cash flows, and so we've excluded this charge from EBITDA. And the same is true of the other non-operating expenses of $9 million. Turning to Slide 13, the fourth-quarter and full-year simplified cash flow statements are provided to better explain our sources and uses of cash. In the fourth quarter we generated $137 million of pretax, unlevered free cash flow, a $1 million reduction from last year. As can be seen, the improvement in EBITDA over last year was partly offset by $4 million in increased capital investment, largely IT related, and $7 million less in working capital inflows. And please note that as normal the fourth quarter is a source of cash from working capital. Overall, we continue to generate working capital as we grow, as evidenced by a net working capital inflow of $18 million for the full year, an improvement of some $15 million over 2014. So given the working capital inflow the quarter, pretax unlevered free cash flow represents 110% conversion of EBITDA, down 11 points versus prior year. And for the full year pretax unlevered free cash flow represents an exceptional 96% of EBITDA, up 2 points compared to last year. Now interest payments of $28 million are $7 million higher than last year. This simply reflects the fact that we fully redeemed our 7% and 8% notes, interest on which was paid semiannually in February and August, and partly replaced them with significantly cheaper term debt interest on which is paid monthly. So for 2015 we've paid about $42 million less cash interest than in 2014. Now as mentioned on prior calls, we have become a federal taxpayer, given that our NOLs have largely been exhausted and we are a profitable U.S. Company. Payments of $6 million this quarter reflect various tax initiatives that helped reduce the burden for 2015, bringing our total 2015 cash tax payments to $44 million. Henceforth we will be paying taxes at a rate close to our effective tax rate in the profit and loss account. And given our leverage is reaching more civilized levels let's say, is probably time to shift our focus away from measuring pretax unlevered free cash flow to more normal free cash flow. And first, our free cash flow for the fourth quarter was $98 million, which is $18 million lower than the fourth quarter of 2014 largely due to the shift in timing of interest payments and the increase in cash taxes. And our full-year free cash flow was $358 million, an increase of $84 million over 2014. Please note that formal reconciliations from the US GAAP cash flow statement to both free cash flow and pretax unlevered free cash flow are provided in the appendix and in the press release. Slide 14 provides a brief history of our free cash flow from 2011 to 2015. As you can see the combination of revenue growth, EBITDA growth at roughly twice the rate of revenue growth, and a business that uniquely produces cash from working capital as it grows and the significant reductions in debt have brought us to a point where our free cash flow has crossed the $300 million mark. Now in 2016, even though our tax cash taxes will significantly increase, the combination of at lease 10% EBITDA growth and the full-year benefit of reduced interest payments, will almost offset the higher tax payments. And all other things being equal, we anticipate free cash flow will again comfortably exceed $300 million. Now at the time of the IPO we signaled that we would articulated a capital allocation strategy when our net leverage reached the 3.5 to 4 times level. And given that we ended the year leverage of 4.2, and our outlook for 2016 is for at least 10% EBITDA growth, our net leverage is likely to fall within the 3.5 to 4 times range during 2016. Therefore, I'm pleased to repeat the announcement that our Board has approved an initial share repurchase program of $300 million over three years. We also feel that a longer-term net leverage target of 2.5 to 3 times is appropriate, and that's the level at which we intend to stabilize our leverage. Now before I turn the call back over to Rob for closing comments, we think it appropriate to signal that as of the first quarter 2016 we intend to stop reporting customer account and retention rate data as part of our public filings. As we continue to grow and diversify our customer base product offering and strategy, this customer count metric has become a demonstrably less relevant and even confusing metric. However, we do intend to continue to separate as meaningfully as we can revenue growth between organic and acquired, as shown in the tables that accompany the fourth-quarter press release. And following on from Rob's comments with respect to full-year guidance, our 2016 outlook includes a strong revenue growth in Terminix and an American Home Shield performance that for the full year will look very much like a repeat of 2015. And given our intention to keep investing in growth, whether for improvements in customer service, marketing, or sales, we are targeting a conversion of a little over 35% of each incremental dollar of revenue into EBITDA and another year with at least 100 basis points of EBITDA margin improvement. And on that note, I'll turn the call back over to Rob for closing comments.

[Rob Gillette:]

Thanks, Alan. We had a really strong 2015. Through our new brand identity in ServSmart, we are positioning the Company to provide easy access to services that are dependable, convenient, and on time. We need to meet our customers' increasing demands for quality service by delivering effective access across all of our businesses. We have accomplished a lot this year, and we expect to continue the success we've had in 2015 into 2016 and deliver on our commitments. We're very excited about the future of ServiceMaster, and we'd like to thank you for your time and support. I'll turn the call over to Jim for Q&A. Jim?

[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 guidance is limited to the outlook we provided in our press release and webcast presentation. Additionally, since the queue is long this morning, please limit yourself to one follow-up question so that we can get everyone in the allotted time. Nikki, let's open it up to the line for questions.

[Operator:]

[Operator Instructions] And our first question comes from the line of Samuel Eisner with Goldman Sachs. Please go ahead.

[Samuel Eisner:]

Yeah. Good morning, everyone.

[Rob Gillette:]

Good morning.

[Samuel Eisner:]

So on the $10 million of additional or higher uses of out-of-network contractors for the appliances coverage, can you talk a little bit about how your pricing is going to be used to offset this? Maybe just diving into that item a little bit further would be great.

[Alan Haughie:]

Certainly, I'm happy to. It's interesting, as we've grown in the direct-to-consumer channel, as I said in my prepared remarks; we're seeing that direct-to-consumer customers do actually favor this. They do demand rapid service, and we believe we can actually price for that. As of 2016, we have actually improved or increased our pricing on new contracts that are coming in, but, and this is a tiny subset of the population, but we have some appliance-only contracts and we've been able to increase the pricing on those contracts by about 35%. And I think that what we're going to see is a changing demographic. Bear in mind, we're the largest home warranty provider in the country. And so what we do essentially leads the changing behavior of customers. So we're basically at the front line. So I think we have a lot of opportunities, in any instance like this, to deliver excellent service, to make our customers again as we've often said wedded to our product, and then as we renew those customers to price accordingly. I think the opportunity is very strong in that respect

[Samuel Eisner:]

That's helpful. And maybe just talking a little bit broader about AHS. I'm sure we all like CNBC, we've definitely seen from your competitors starting to advertise on the TV. Can you talk a little bit about competition within the home warranty market? Have you seen any change in the way that some of your competitors are going to the market, and how has that impacted your business?

[Rob Gillette:]

There's a whole lot of interest in the direct-to-consumer market, and so competition I would say has increased and that's why we balance our investment in terms of marketing and growth and then service, as Alan mentioned. So we want to continue to differentiate ourselves on the basis of the quality of service and coverages that we provide. So I think our success in the direct to consumer market is piqued a number of people's interest to evaluate and look at it, and I would say competitively we're still very well positioned because of our scale and the opportunity to build on the success of the last couple of years. So I think there is increasing competition because of the growth opportunity that's there, but I think we're well-positioned and doing the right things to maintain our leadership.

[Samuel Eisner:]

That's helpful. If I could sneak one more in there on the USVI charge, is that a settlement that you have with the DOJ or is that just a reserve that you're taking? And is that in excess to the deductible that you have already exhausted or at least taken the reserve for? Thanks.

[Alan Haughie:]

I can't say a great deal on this. The charge that we reflected is our estimate, current estimate of the levels of the penalties and fines that we believe will be levied through the current state of our discussions with the DOJ. So it's the non-civil side technically

[Samuel Eisner:]

I'll get back in queue, thanks.

[Rob Gillette:]

Thank you.

[Operator:]

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

[Anj Singh:]

Good morning, thanks for taking my questions. One for Alan, could you just give your thoughts on capital allocation priorities? Are you planning on aggressively paying down debt in 2016? Just trying to get a sense of how you will prioritize that versus - debt pay down versus share repo and M&A. And also is there any reason you're not considering a dividend at this point?

[Alan Haughie:]

Great questions, thank you. The long-term leverage target of 2.5 to 3 times is exactly that, a long-term target. So we have no intentions to pay down any debt in 2016 other than regularly scheduled payments. So by signaling 2.5 to 3 times we're basically saying that as we move toward that point, that's the point at which we would consider introducing let's say something a little less flexible than share repurchase, such as a dividend payment. We're not ruling dividend payments out at any point, but we're just not ready yet to commit to that.

[Anj Singh:]

Okay, got it. And with regards to the new services that you have had a lot of success with, appreciate the color on how much revenue that they're producing now. I think that implies about 25% growth based on my notes. Could you just discuss what your sense is for the outlook for growth for these services in the addressable market? Just trying to get a sense of how long you think these types of tailwinds from the new products can continue. Thanks.

[Alan Haughie:]

Thanks. We remain optimistic. The growth rate naturally has slowed a little from - compared to 2014 and the early part of 2015 simply because we were rising from a very slow base. As Rob said, we've crested $100 million now in new and innovation services. The pipeline remains strong, the issue is how we basically divide the time and efforts of our sales force in terms of attacking core termite, selling these innovation services, and in some instances bundling the products. So in essence what this has done is broaden the range of products that we offer, and we will continue and are continuing to add additional products to that portfolio. Things like bird control, which hasn't yet taken off, but again we're optimistic about things like that. So we do continue to try and essentially be the comprehensive pest provider to homeowners.

[Anj Singh:]

One other quick one on the out of network contractors at American Home Shield, are these now in network? Just want to get thoughts on why the drag seems to be a 4Q effect only. Is it the increase pricing that's offsetting it? And what is your assessment of the contractors now? Is there any risk of having to shift away from some of the contractors currently that are still in the network?

[Rob Gillette:]

It's Rob. We always every year evaluate the contractors we have and recruit and hire new ones and break relations with others if we're not satisfied with where we are in terms of price and performance. And I think in the case of Q4 we focused on the service level. So at the time out-of-network service providers and the higher costs we mentioned, and then this time of year we're always negotiating to add new suppliers and build the business and our contracts for the new year. So it's something we do every year, and will continue to do. So I think we're pretty well positioned to build the base and have more people that are certified as part of our supply base.

[Operator:]

[Operator Instructions] And our next question comes from the line of Jeff Volshteyn with JPMorgan. Please go ahead.

[Jeff Volshteyn:]

Good morning and thank you for taking my question. I actually wanted to follow up on AHS service cost questions, and really understand how much of it could be driven by new markets that you are entering and not having your in network contracted technicians in there versus - and using some of the out of network versus actually replacing somebody you already have. And also whether there was a contribution of the weather that had to do with air-conditioning cost repairs.

[Alan Haughie:]

Great questions. Basically I think the weather was the principal driver for the air conditioning costs that we actually booked. So those $4 million of costs that I referenced on the call are basically weather related. A little bit of that is due to our expansion I think, in the sense that we've added new contractors naturally in the air conditioning arena as well who aren't quite as familiar with our systems and so their invoicing dragged a little as they learn our systems. So that caused those process - claims to come in a little later. With regard to the contractors, some of what we're seeing is due to direct consumer growth. As I said, it's more a question that the direct to consumer - the customers that we bring in through that channel do favor appliance repairs more. And in essence what it gives us is a challenging contractor density. You have to bear in mind that occasionally we needed to both call our contractors where they're not performing. When I talked about that $19 million, I divided it between $4 million for AC claims, $5 million of inflation direct to consumer growth. And that - those are the most discrete buckets that we can break it into. All of that $5 million of direct to consumer growth, that's where we are adding contractors in new areas. And as you can imagine, when we move we have to grow faster than we can grow our contractor network. It's inevitable because the way we add contractors is by having the contract - the customers in place to be able to guarantee volumes. Once we can guarantee volumes we can negotiate and manage rates and delivery performance, and rolling contractors at a very efficient level. When we're adding contractors we are doing - or customers, sorry, in new areas we basically reach out to these contractors in some instances for the first time, get them to bring in service, and once they see how we operate we can then guarantee contracts to them. So growth in this instance will always precede let's call it efficient acquisition of contractors into the network.

[Jeff Volshteyn:]

So it sounds like as you expand in DTC we might see some of that impact in the first and second quarter?

[Alan Haughie:]

I think we'll see a little bit more of it particularly as it relates to appliance, because as I said yes that factor will be there as we grow. And it's particularly become evidence in the appliance trade as an area where we need to add more contractors at a greater rate to have the right density, yes. And we'll see some of that in the first quarter

[Operator:]

And our next question comes from the line of Andrew Whitman with Robert W. Baird. Please go ahead.

[Andrew Whitman:]

Hi and thanks for taking my question. I wanted to talk about Terminix' customer accounts. It looks like the rate at which the termite is substantially unchanged at minus 2, but it looks like on an organic basis the pest customer account did dip a little bit here in the quarter. I was wondering, Rob, if you could give us an update on your thoughts around the customer loss there and the initiatives that you've had in place? You've talked about these in the past, and I think an update here at the end of the year would be helpful.

[Rob Gillette:]

Okay, sure. I think that as Alan said we continue to focus on all of the services we provide in pest control being part of it. And during the year we offered to new customers a service that supported a number of visits increase versus four in standard, anywhere from 5 to 6 in visits. So as a product offering that was a change that we made, and we found people accepted it and were really positive about it. And we are continuing to focus on our on-time delivery and ability to serve customers proactively and grow the base. So I would say we're pretty happy with where we ended up in the quarter and the year, and the team is really focused on continuing to expand our customer base in the future. So I think on an organic level it was a slightly lower in Q4 than we were in prior years. I think we did really well on the commercial side. So commercial effort and energy continues. So that's part of this equation that we didn't call out specifically in this call but have in the past. I think the team is doing all the right things to continue to provide service to customers and grow the business. So we're pretty happy with where we are.

[Andrew Whitman:]

Got you. I guess my follow up is on the American Home Shield side of the business, and there I just wanted to get a sense about the relative growth rates between the historical real estate channel and the direct to consumer. You have talked a lot about the direct to consumer as being the growth avenue. How much of the growth in, maybe not even just this quarter but over the last year or two, how much of the growth rate of American Home Shield is just due to a healthier real estate channel? Can you give us a breakdown of where the growth is coming from today in that segment?

[Alan Haughie:]

We don't disclose much about this, but the vast majority of the growth rate has come from the direct-to-consumer channel, not necessarily real estate despite the performance of the home resale market. We've seen a modest increase in our real estate business. But nowhere near the magnitude of direct to consumer.

[Operator:]

[Operator Instructions] And our next question comes from the line of George Tong with Piper Jaffray. Please go ahead.

[George Tong:]

Thanks, good morning.

[Rob Gillette:]

Good morning.

[George Tong:]

I'd like to further explore American Home Shield margins. As you continue to penetrate the direct-to-consumer channel and improve service levels, would you expect margins to be structurally lower than prior quarters? Or do you think pricing and better contractor management can largely offset the higher service requirements of this channel?

[Alan Haughie:]

Well we very much believe, George, that over the longer term that pricing will certainly offset the increased cost. I mean that's the whole purpose. We're, as I tried to say in my prepared comments or in the Q&A, I can't remember now, we are basically leading the charge on this. So there's no other source of let's say demographic. There is nowhere we can go to gain the demographic information or the behavioral information about how consumers are going to behave or what products they value. We see it ourselves in the way they react. So yes, over the long term and for let's say 2016 as a whole, we will see the pricing I believe largely offset the impact of this, changing both consumer behavior and contractor behavior.

[George Tong:]

Got it. That's helpful. And then follow up also on American Home Shield, growth this quarter remained strong at 8% but did step down a bit from 12% from 3Q. Can you talk about factors, including appetite for M&A, that could drive potential upside to growth levels seen during this quarter?

[Alan Haughie:]

Sorry, the 8% and 12% question, was AHS related?

[George Tong:]

Yes.

[Alan Haughie:]

I was just checking because I recognized the numbers. That was actually the point that I never like to talk about, which is you remember on the third quarter call I referenced that a little bit of the growth that you saw in Q3, 12% revenue growth compared to roughly 7% customer account growth. And those 2 points that was basically transferred from Q4 to Q3 of revenue just because the way the curve changed slightly. That's why the growth rate looks lower in American Home Shield's fourth-quarter revenue. It isn't really. It is just the way the curve for recognition of revenue shifted very slightly. I'm trying to continue to minimize those impacts in the hope that I never have to mention it again, but that's essentially what happened. The underlying growth rate I'm sure remains extremely healthy.

[Rob Gillette:]

You mentioned acquisitions I think too, George. We have a pretty healthy pipeline that we're evaluating today and we'll continue to do so. We balanced as we indicated what we would do in returning capital to shareholders with the opportunities as they present themselves in acquisition. So we'll continue to do both. We're always looking for those opportunities.

[Operator:]

And our next question comes from the line of Sara Gubins with Bank of America Merrill Lynch. Please go ahead.

[Sara Gubins:]

Thanks, good morning. Could you talk a bit about price in Terminix and price increases? There's been some discussion in prior calls about experimenting with pricing in preventative, because that's become a more price competitive market. I'm wondering what's happening there?

[Rob Gillette:]

I think we continue to focus on how to meet customers' needs and grow the business with both price and service. So we think we did that pretty successfully in 2015, and we'll continue to do that in 2016. So I think that as a business we've learned a lot about how to do that and how to capture price in different regions of the country and provide value to customers as they see fit. So we always talk in a range of the 5% or so that Alan mentioned in growth expectations or the high to mid-single digits for 2016. It's a balance of about one-third price and one-third in acquisitions and one-third in core market growth. So we would expect that to continue into 2016.

[Sara Gubins:]

Great, okay. And then just a couple of numbers questions. Could you help us with your expectations for the tax rate CapEx and interest expense in 2016?

[Alan Haughie:]

Gosh. The tax rate on the P&L will be, all things being equal, close to the 39% tax rate on pretax income. The cash tax payments will roughly run in line with that. Meaning bear in mind that the cash tax - what you see in 2015 for cash tax payments and tax expense they don't correlate. Obviously we'll be paying roughly at that expense rate going forward. So the tax rate in the P&L account will, all things being equal, look very close to our normal run rate of about 39%. That's 34%, 35% federal tax for state taxes; and that is broadly the rate we'll be paying on pretax income. The interest expense will be lower than last year largely because of the impacts of timing, but I don't think they've come out with that figure yet. But our intention is to - we'll run very close to that fourth-quarter $38 million rate that we hit in the fourth quarter. Because as I said in answer to an earlier question, I have no intentions to significantly pay down any debt other than normal mandatory payments.

[Operator:]

And our next question comes from the line of Denny Galindo with Morgan Stanley. Please go ahead.

[Denny Galindo:]

Hi there, good morning. Couple more questions on America Home Shield. First of all, what percent of the claims now are served by out-of-network contractors? And where would you like that to go? And then maybe if you could talk a minute about what's the timeline for when you realize we need to find a new contractor, you search, you find them, you sign them up to the network, and then he becomes similar to all the other contractors in the network?

[Rob Gillette:]

Denny, it's Rob. I will answer that. We don't disclose those numbers, and it varies by trade. So there's a lot of differences when you start looking at individual pieces of the service side. And in a market that has been growing like it has, I think that as part of our approach is in balance to invest in growth but also to invest in the service side. So I think with the growth we need to continue to look at how we do that. And that's part of what we're explaining in Q4 and part of what we'll carry somewhat into Q1. But we think we are pretty good positioned to add contractors to the base and keep the level at a balance that allows us to predictably forecast costs and manage the business. So I think we're in a good position.

[Denny Galindo:]

Okay, that helps. And then a second one on America Home Shield, we had recently done a survey of the industry and found roughly 40% of the customers are getting their contracts through the internet; 15% by phone, 35% by real estate agents. Is that in line with what you see at America Home Shield? Are you more heavy on one of these categories versus another category?

[Rob Gillette:]

When you talk about that, for us we talk about it in terms of DTC. So if that's what you're referring to, it's close. We did see an increase I think in the second half of the year. We usually talk about 35% or so coming through the internet, and I think it was increased a couple of points. So we're seeing an increase in that, which as you know we want to drive that self-service model and that relationship with the customer. So it's been great progress and we'll continue to drive that penetration in how we acquire customers.

[Operator:]

[Operator Instructions] And our next question comes from the line of Gary Bisbee with RBC Capital Markets. Please go ahead.

[Gary Bisbee:]

Hi, good morning. Question on Terminix, I think last quarter you alluded to maybe some incremental sales and marketing investments and you talked about trying to leverage some of the - both the technology but also marketing success you've had at America Home Shield to improve performance elsewhere in the company. I guess I'm surprised by how strong Terminix' margins were in light of an expectation for maybe some incremental spending. Did you do that, and how should we think about the phasing of your spending investment and what benefit you might have from those initiatives to take success at AHS over to Terminix? Thanks.

[Rob Gillette:]

I think initially we talked about and mentioned the focus on social media starting in October of last year. And so a lot of that does not require investment as much as it does translating the systems and approach we have in other parts of the business to Terminix. So we made great progress jumping close to 1.5 points or 2 points in the consumer assessment. So five-star rating, that's pretty phenomenal in a short amount of time, which is really just focus by the team. We allocated more emphasis in getting Terminix kick-started in that area. So it will be - the benefit of having the marketing organization as one group is we get a little bit of leverage across that, which we mentioned. And that we can take platforms that we have in one business and develop and execute them elsewhere. I didn't mention in my prepared remarks, but it's also an opportunity to add value to our franchisees and sell more franchises. So we can basically - my IT people would laugh at me, but kind of copy, control copy what we've got and drop it into different parts of the business. That was the major emphasis initially, and then as we move forward we'll be able to look at where we are in balance of margin expansion and growth, and then where we place that investment for the Company and where the returns are. So we're pretty excited about it and I think we made huge progress in just four months or so with time, and we're translating what we've done elsewhere to Terminix core, and we'll continue to roll out, as I mentioned, the ability to schedule services to customers which had a significant impact for our AHS contractors. Both the contractors and the customers really appreciated it. Our net promoter scores went up. And Terminix has really great net promoter scores now, but I think once we roll that out in March and start to validate it, it's going to be a significant impact to the service we provide and then our ability to grow. So I think it's more about getting started not about investment initially, and then over time we'll be able to do it more as one organization versus seven individual brands, which is the idea.

[Gary Bisbee:]

Great, thanks. And then just a quick follow up on as you broaden out the capital allocation strategy with leverage coming down, what are the prospects for accelerated M&A at Terminix? Historically you've talked about $40 million or so. You obviously did more with the bigger deal this past fall. But does it make sense, can you operationally - is there enough targets to spend more than that on a go-forward basis pretty consistently? Or is $40 million still a good number to think about? Thank you.

[Rob Gillette:]

Sure. It's kind of the number that we use as a rule of thumb, as you know. And dollars are allocated at least in our mind what to do. And it's been our strategy for many, many years. We have a really good pipeline now. I think it's a balance of what the price is to acquire versus the quality of the business and how it relates for instance to our coverage in specific geographies versus where we might not have as much density. So there's a lot of things that go into it, but I would tell you that right now our pipeline is pretty solid and strong for going into 2016. So we'll continue to do it, and as those opportunities arise that give access to more commercial business and business processes related to commercial, but also regional expansion where maybe our penetration isn't as high as it could be in other places. So that's the plan.

[Operator:]

Our next question comes from the line of Jonathan Pines with Gates Capital. Please go ahead.

[Jeff Gates:]

This is actually Jeff Gates. Can you give us the sales and EBITDA contribution you expect from the Alterra acquisition?

[Alan Haughie:]

No, we haven't disclosed that. We've disclosed the revenue at least that we enjoyed in Q4. But other than that we haven't disclosed publicly what revenue to expect in 2016 from Alterra.

[Jeff Gates:]

Can you tell us what it was in 2015?

[Alan Haughie:]

The revenue was $8 million.

[Jeff Gates:]

No, for - can you doll on it for the whole year?

[Alan Haughie:]

No, sorry.

[Jeff Gates:]

Is it fair to say that - I think that the CEO there was quoted at saying it was $75 million revenues. Would that be a substantially lower margin than the existing Terminix business?

[Alan Haughie:]

In the structure that they had yes, it probably would've been. For them. Bear in mind what we took on, we took on a set of customers, an operating structure, and technicians. We didn't take on the sales force or the SG&A infrastructure.

[Jeff Gates:]

Okay. And then the second question is I think you referenced the 35% incremental EBITDA margin. But I think if you look at your guidance it's much higher than that. So I'm trying to reconcile the two.

[Alan Haughie:]

Yes, it's a little higher than that, it's around about 40% isn't it. I'd say I'm using that as a simple - I use that as a simple long-term average. So you're quite right, the guidance has slightly higher than that. I think I said over 30%, a little over 35% when you look at the two core businesses. You're quite right.

[Operator:]

Our next question is a follow-up from Jeff Volshteyn with JPMorgan. Please proceed with your question.

[Jeff Volshteyn:]

Thank you for taking a follow up. Just quickly on Merry Maids, I think the original target for selling the corporate-owned locations, franchises was the end of the year. It seems there are still at locations that are on your books. What is the date on the sale?

[Rob Gillette:]

It's Rob. I would say that actually the progress we made in 2015 we felt really good about and the balance and trade off on revenue and then getting the margin that we had. So I would say the team has done a phenomenal job at managing that. And we have just a handful of branches to go. So I would guess the first half will be majorly done with that process completely, and we've been happy with how it's going. So you could see in the detailed financials that Alan walked through what the contribution is on some of the sales of the specific branches. And then pretty proud of the team as to how they went about it and how we managed the margin throughout the year. We are in good shape for 2016.

[Jeff Volshteyn:]

Great. And as a quick follow up on new products included in your 2016 guidance, is there a way to quantify it, particularly in mosquito services? And is there like a possible positive impact from Zika virus treatments?

[Rob Gillette:]

I would tell you this because of what we talked about on the digital marketing side, the translation of the process is from AHS into Terminix. Part of what we've done has been very proactive in digital marketing for the position of the product with customers existing and new over the early part of the year here. So the season starts, depending on where you live, in April timeframe, so I think we're well-positioned on the mosquito side. Really tough to judge what the Zika virus has any impact for us at all. So I think we're going to see a benefit from the pre-marketing efforts we've had and awareness created through what we've done in YouTube and some of the other social media spaces that we talked about. So I think I'll be a good year for mosquito in 2016.

[Jeff Volshteyn:]

Thank you.

[Operator:]

Our final question comes from the line of Denny Galindo with Morgan Stanley. Please go ahead.

[Denny Galindo:]

Hi there. Just one more question on American Home Shield. In terms of the margin expansion in that product, do you see it being in line with the overall margin expansion of the Company, or should that come in a little bit lower due to some of these issues with the contract - the out-of-network contractors?

[Alan Haughie:]

I think for 2016 we'll see a year that looks very like 2015, which means maybe a little bit lower, maybe 30% conversion, something like that. Still above it's base margins today. But certainly through the first half, and given the increase in marketing spend we're going to see in 2016, it will be a little more modest than the overall EBITDA conversion for the Company.

[Operator:]

Mr. Shields, I'll turn it back to you.

[Jim Shields:]

Okay. Thank you for your participation in today's conference call and webcast. As a reminder, a replay of the call will be available on our website in about one hour from now. We look forward to speaking with you. Thank you, everybody.

[Operator:]

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