Serve Robotics Inc.
Q3 2015 Earnings Call Transcript

Published: 3 Nov 2015

[Operator:]

Ladies and gentlemen, welcome to ServiceMaster's Third Quarter 2015 Earnings Conference Call. Today's call is being recorded and broadcast 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, José. Good morning and thank you for joining our third quarter 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 Web site, I will walk through the agenda items shown on Slide 2. Rob will lead off by providing some opening remarks, and then provide a summary of our third quarter consolidated financial results. Alan will then review our performance by segments, 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 filing that may cause actual results to vary materially from those contemplated in the forward-looking statements. The information discussed on today's call speaks only as of today, November 3, 2015. 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 third quarter 2015 financial results. And we have posted the related presentations, both of which can be found on the Investor Relations section of our Web site. We will reference certain non-GAAP financial measures throughout today's call, and we have included definitions of these terms in our press release, which is available on our Web site. 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, and the figures labeled as such therein. I'll now turn the call over to ServiceMaster CEO, Rob Gillette for opening comments. Rob?

[Rob Gillette:]

All right, thanks Jim, and thanks to all of you for joining our Q3 2015 earnings call. Before I get into the third quarter results, I would like to talk about the organizational changes we announced earlier this month and the importance of these changes on the future direction, growth, and profitability of the company. On September 23rd, we announced that Mark Barry had been promoted to the newly created position as ServiceMaster's Chief Marketing and Strategy Officer. In his new role, Mark will oversee company strategy, including competitive intelligence, insights and analytics, as well as all marketing and business development. At American Home Shield, Mark has built a successful model for acquiring new and retaining existing customers. In particular, Mark has been instrumental in expanding direct-to-consumer sales. We think there's a significant opportunity to build on what Mark and team have done in American Home Shield, and to translate that success to all of our businesses. We've all seen how technology is putting more control in the hands of consumers. Companies such as Uber, Expedia, Apple, and many others are examples. They're changing the way consumers and companies buy and sell services. Technology is giving consumers the ability to interact with us when, where, and how they want. Marketing and IT are converging in this digital environment, and customers value ease of access, and convenience. AHS has been the leader for us in this digital and mobile transformation. For example, online sales now represent 35% of American Home Shield's direct-to-consumer sales, which are up 47% year-to-date over the prior year. Over half of our customer service requests for technicians are being completed through an automated process such as our Web site, mobile, or the IVR. Although these accomplishments are impressive, the America Home Shield digital model strategy -- mobile strategy is about more than just making it easier for consumers to purchase on warranty, or obtain a service. It's about building customer loyalty through increased engagement. This involves not just selling services, but also interacting with consumers in a convenient and easy way to help solve their home maintenance problems. Non-selling customer engagement could be as simple as providing home maintenance tips online, identifying useful or do-it-yourself resources, or quickly solving appliance problems through a click to chat. Our work in social media, search engine optimization, and mobile has greatly increased customer touch points, and accelerated our efforts to increase engagement. This has helped lift American Home Shield's reputation, and in turn built loyalty, increased retention, and driven more leads to our sales team. Consumers are increasingly making purchases online or through their mobile devices. But unlike some of the established names in the digital marketplace, we have the advantage of a vast network of trusted professionals who make 75,000 visits to homes and businesses each day, and actually diagnose problems and fix them. With over 13,000 employees, 11,000 contractors, and 5,400 franchise locations, our goal is to leverage this vast network by empowering our associates with mobile technology. This technology will add value to ServiceMaster, and to our contractors, franchisees, and suppliers. Our businesses remain strong. They are resilient and consistent financial performers. With the implementation of our digital mobile strategy, which we call ServeSmart, we are positioning the company for growth and performance in the future. The first step in our ServeSmart strategy is to apply the learnings and experience we gained from American Home Shield to Terminix, and to the Franchise Services Group. For example, today, American Home Shield has a 250,000 Facebook fans, 21,000 Twitter followers, and close to 10 million online video views. American Home Shield, which has 1.6 million customers, has significantly more customer touches than Terminix, which has 2.3 million customers. As we build customer engagement at Terminix, we will build loyalty, retention, and sales. Terminix has unparalleled brand recognition in the pest control industry. By expanding our ServeSmart digital platform to Terminix, we expect to build on this recognition, and increase customer loyalty, sales, and profitability. Now for the financial results, since 2010, annual revenue growth has exceeded 5%, and EBITDA growth has exceeded 10%. As our results on page four demonstrate, the third quarter was no exception to the story. We continue to see significant leverage in the business, and we are able to invest in a growth for the future. For the quarter, revenue increased 6%, and EBITDA grew to 11% compared to prior year. Both revenue and EBITDA were driven primarily by the growth of the direct-to-consumer channel at our American Home Shield business, and new services at Terminix. Adjusted net income improved $13 million, and adjusted diluted earnings per share increased $0.08 versus prior year. Pretax unlevered free cash flow of $125 million was an increase of $5 million, and represents a cash contribution rate of about 72% of EBITDA. Alan will speak more to cash flow later during our call. During the quarter, we completed the refinancing of all of our pre IPO high coupon high yield notes. Since going public, we have refinanced over $1.3 billion of high coupon debt. Combined with the debt pay down over the past year, our capital structure has greatly improved, and we have significant reduced our interest expense. Now turning to Slide 5, as I mentioned earlier, as technologies advance customers' expectations with regard to access, quality of service, and engagement is increasing. Through our ServeSmart platform we are focused on meeting those expectations across all of our businesses. We will continue to focus on retention and profitability by deploying the right technologies to increase customer engagement, and loyalty. We operate in large fragmented markets, with few national competitors. By standardizing our processes, and developing flexible digital and mobile technologies, we're capitalizing on the scale 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 top and bottom line growth. This means, for example, allowing real-time tracking of our texts by customers, providing real-time SMS and email notifications, and enabling customers to provide us instantaneous feedback through their mobile devices. Over the past year, in American Home Shield, we have been beta testing our new dispatch system that incorporates all of these features. We are now in the process of rolling out this system nationwide, and are currently using it in 10 states. We are excited about the prospect of the new system, and the benefit it brings to operations, and customer satisfaction. In the beta test, inbound phone calls per job were reduced by 30%, and net promoter scores improved by 105%. Our long term vision is to utilize this type of technology across all of our businesses. Now, let me turn it over to Alan, who will talk more about the financials. Alan?

[Alan Haughie:]

Thanks, Rob, and good morning everyone. I will now cover our third quarter results in more detail, starting with the Terminix segment, shown on Slide 6. Terminix revenue increased by $19 million or 5.4% year-over-year, comprising 1.9 points of growth from acquisitions, and 3.5 points of organic growth, about two points of which came from pricing. Pest control revenue of $2.17 million, increased by 7.4% or $15 million year-over-year, comprising 5.9% growth in residential pest, which represents about 70% of our pest revenue and 10.3% growth in commercial pest. The increase in residential pest includes a doubling of revenue from our highly successful mosquito service and a 25% increase in bedbug services. Now, our acquisition activity mainly focuses on the pest business, and so, the impact of Terminix acquisitions are almost entirely reflected here, and represented by 2.7 of the 7.4 points of pest revenue growth. Revenue from termite and other services of $135 million increased about 1.5 points or $2 million with both completions and renewables growing by about 1.5 points to $67 million and $66 million respectively. And as with most recent quarters, we have offset declines in core termite treatments with increased sales of other services, largely exclusion and insulation that are reported within termite revenue. We are very pleased with our progress in developing a range of services offered by Terminix and are investing in marketing, digital lead generation, sales staffing and sales training to continue our healthy growth. EBITDA increased by $5 million. A conversion of about 26% of each incremental dollar revenue will continue to position the company for long-term growth, and have stepped up our investments in both sales and service at Terminix, ranging from digital and mobile to feet on the street, and this impacted both gross margin and SG&A. Gross margin, which typically expands as we add volume and price, was essentially flat year-over-year at 44%, and SG&A increased by $3 million compared to 2014. These investments are very important for future top line growth and as we continue to expand our service offerings and make it easy and convenient to do business with Terminix, and this resulted in a very healthy 22% EBITDA margin, an increase of two tens of a point over the last year. Turning to Slide 7, very strong growth at American Home Shield continues with 12% or $30 million of year-over-year organic revenue growth. The conversion of the additional revenue to EBITDA was very strong with EBITDA increasing by $13 million or 21%. The gross margin from American Home Shield fell by about 1% of revenue from 53% to 52%, with slightly increased pricing of about $5 million offset by higher claims cost of about $7 million. And this increase in claims cost is partly result of slightly warmer summer and partly the impact of our growth in direct-to-consumer customers, who tend to make one extra claim in their first year, and of course, claims development for these customers is very much in line with our expectations. And as we have mentioned previously, these direct-to-consumer customers have an extremely high retention rate and lifetime value. So incurring these extra first year claims is a sensible long-term investment. And furthermore, these customers increasingly tend to transact online or use our interactive self-service technology, so our average cost to administer and transact with our customer is in fact falling. As a result, low SG&A as a percent of revenue more than offset with slight drop in gross margin percentage and resulted in a conversion of 43% of each incremental revenue dollar into EBITDA, and the third quarter EBITDA margin of 27% with an increase of two points over last year. Slide 8 shows FSG. The revenue decline of $6 million or 9% is almost entirely related to the Merry Maids business. The vast majority of which is due to ongoing conversion of the branches into franchises. As of the end of October, we have divested or have a commitment to sell over two thirds of the branches. However, as with prior quarters we've maintained, or improved EBITDA by driving cost reductions on pace with the branch disposals, as promised when we embarked on the Merry Maids conversion plan, and this also has the impact of raising the EBITDA margin of FSG by four points year-over-year to 34%. Slide 9 shows the consolidated results for the third quarter. The year-over-year revenue increase of 6% or $42 million is largely organic. About $7 million of the revenue growth is indeed due to acquisitions within Terminix, but this was partly offset by the $4 million reduction in revenue due to the ongoing Merry Maids branch conversions. Gross margin as a percentage of revenue fell very slightly by three tens of a point, 47.9% from 48.2%. The primary driver which is the additional claims in American Home Shield discussed a moment ago, largely offset by improved pricing across all segments and improved operating leverage. Selling, general, and administrative expenses increased year-over-year by just $2 million, largely due to sales investments in Terminix, and therefore, fell as a percentage of revenue by 1.3 points. As described on prior calls, amortization expense has fallen by $6 million this quarter as the definite life intangibles created when the company was taken private in July 2007, it became fully amortized. And this is also the quarter that reflects the one-year anniversary of our IPO. So, the 2014 results included a consulting agreement termination fee to our equity sponsors of $21 million with obviously no corresponding charge this year. And as a result of the post IPO debt reduction strategy, our interest expense is $8 million lower than last year, and this reflects two major changes in debt structure. On the 1st of April, we completed the redemption of $390 million of 8% notes. And in aggregate, we redeemed $215 of the notes for cash and upsized our term debt by $175 million and this reduces our quarterly interest expense by about $6 million compared to last year. And secondly on the 17th August, we completed the redemption of all $488 million of 7% notes, and in aggregate redeemed $88 million of notes for cash and upsized our term debt by $400 million, and this reduces interest expense for the quarter by further $2 million compared to last year. So, the loss on extinguishment of debt of $31 has two components, the 5.25% prepayment premium for the remaining $488 million of 7% notes and the write-off of $6 million of previously capitalized debt issuance cost. So, as a result of all this, our pretax income of $83 million compares to a pretax loss of $5 million last year. Our effective tax rate for the quarter continues at about 39%, and so, third quarter net income is $49 million compared to a loss of $4 million last year. And of course, to aide comparability, we also report adjusted net income, which I'll reconcile in a moment, and this increased by $13 million or 21% over the prior year to $74 million. EBITDA of $174 million is $17 million, or 11% higher than last year, the conversion of 40% of incremental revenue. And of course, the rate of adjusted net income improvement exceeds the rate of EBITDA improvement due to our debt reduction actions, lowering our interest expense by 16% year-over-year. So, Slide 10 provides our standard to reconciliations. First, we walk 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, $7 million this quarter, from adjusted net income. And as already discussed, this is because our reported U.S. GAAP net income gets a boost as this amortization falls, and so the interest of highlighting underlying operating performance, we exclude this improvement for adjusted net income. And for the same reason, we naturally exclude gains on sales of Merry Maids branches from adjusted net income. So, turning to cash flow, the third quarter and first nine months simplified cash flow statements are provided on Slide 11 to better explain our sources and usage of cash. In the third quarter, we generated $125 million of pretax unlevered cash flow; a $5 million improvement over last year. As can be seen, the $17 million improvement in EBITDA was partly offset by a modest $5 million in working capital and $7 million in increased capital investment. Now, the third quarter working capital change reflects perfectly normal seasonal movements. Overall, we continue to improve our working capital efficiency as evidenced by net working capital outflow of just $5 million for the first nine months of the year; an improvement of some $22 million over the first nine months of 2014. On the additional capital investments, mainly IT-related are largely due to the timing of project spend, and this can be seen we've invested at a similar level as last year over the first nine months of 2015. Going forward, we still anticipate annual capital spending ex-acquisitions to be in a $40 million to $50 million range. So, given the working capital movement, this quarter's pretax unlevered free cash flow represents a 72% conversion of EBITDA, down five points versus prior year with virtually all five points being used in the timing of the IT investments, and for the first nine months of the year, pretax unlevered free cash flow represents an exceptional 93% of EBITDA, up six points compared to last year. Now, interest payments, $56 million and $26 million lower than last year, and this largely reflects savings on high yield notes, interest on which was paid semi-annually in February and August, which are no fully redeemed. And as mentioned on prior calls, we have become a federal tax payer given that our NOLs have largely been exhausted, and we are a profitable U.S. company. Payments of $31 million this quarter reflect a level very similar to our U.S. GAAP income tax charge for the quarter. Now, for various tax initiatives, we currently expect to pay somewhere in the region of $10 million in the fourth quarter, bringing our total 2015 cash tax payments to less than $50 million; an improvement of $60 million predicted on the second quarter call. Combining these cash flow items, we still accumulated about $27 million of cash available for debt reduction in the third quarter, and that's generated $261 million in the first nine months of this year. The debt repayment of $125 million in the quarter reflects the $88 million of cash we contributed to the 7% note redemption plus the 5.25% prepayment premium of $25 million, and the balance is mainly regularly scheduled debt repayments. So we ended the quarter with $260 million of cash. And please note that a formal reconciliation from the US GAAP cash flow statement to pretax unlevered free cash flow is provided in the appendix and in the press release. Slide 12, provides an update on our net leverage and interest coverage as of the end of the quarter. Net leverage as of 30, September is equal to gross debt, with a face value of about $2.82 billion less unrestricted cash of about $170 million, some net debt of about $2.65 billion divided by trailing 12-month EBITDA of $612 million. This gives us net leverage of about 4.3 times EBTIDA, compared to 7.8 times at the end of 2013, and five times at the end of 2014. And when we annualize the impacts of redeeming the $488 million of 7% notes with $400 million of term debt at a rate of 4.25%, and our annualized interest expense is now $153 million, about $38 million per quarter. And if we use this annualized $38 million per quarter of prospective interest, our trailing 12-month EBITDA of $612 million, is now four times our go-forward interest expense. So, with respect to our fourth quarter and full year outlook on Slide 13, we are raising the low end of our previously reported range for revenue by $10 million, and raising our 2015 EBITDA guidance to $620 million. And as we've stressed every quarter, since the IPO, we project EBITDA numbers in which we have a high degree of confidence, while continuing to invest in both technology and marketing to drive future growth. As can been seen from the financial results this quarter and our increased guidance, the business remain strong. So I'll turn the call back over to Rob for closing comments.

[Rob Gillette:]

Great, thanks Alan. People increasingly value simple, easy to access services that are dependable, convenient, and on time. We need to meet those increased expectations by delivering access to our services across a variety of digital and mobile channels. We are moving forward by leveraging our scale, and developing the right customer-centric technologies. By centralizing marketing, we're in a better position to capitalize on our capabilities. We've accomplished a lot since we executed our IPO, but we're not stopping. ServeSmart is leading the way. We had a great quarter, and took another step in positioning ourselves as the leading provider of essential residential and commercial services. We are confident that our strategy will continue to drive both top and bottom line growth, and we're very excited about the future of ServiceMaster. I'd like to turn it over to Jim now, and get into the Q&A section of the call. Jim?

[Jim Shields:]

Thanks, Rob. As a reminder, during the question-and-answer session, we encourage you to ask any questions that you may have, but please note the 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 to everyone in the allotted time. Let's open it up for questions now. José?

[Operator:]

Thank you. [Operator Instructions] And our first question comes from the line of Anju Singh of Credit Suisse. Please proceed with your question.

[Zach Bakal:]

Thanks for taking my question. This is actually Zach Bakal in for Anju Singh. Just wondering, if the combined guidance for EBITDA and revenue implies incremental margins for the fourth quarter that are quite strong, about 53% by my [ph] numbers. Can you talk about some of the factors behind that flow through, and whether or not we should be expecting some support from harvesting any further gains on AHS securities in the fourth quarter?

[Alan Haughie:]

Well, thank you for that. I think the margin remains strong in the fourth quarter. I do think there's a bit of a law of small numbers in the calculation you're looking at. So -- but my number is actually something like a 40% conversion of revenue to EBITDA, very consistent with what we saw in Q3, and no, there's no anticipation of harvesting gains on securities in creating that EBITDA, but thank you.

[Zach Bakal:]

Great, and then just wondering, the acceleration in the AHS growth of 12% was pretty impressive. It was also supported by an easier comp. Just wondering how sustainable you view double-digit growth in AHS, and whether or not there are any factors in particular, such as the revenue recognition curve change you mentioned last quarter, which can be dragging or boosting that growth, given that customer growth remained at 7%.

[Alan Haughie:]

That's a great question. We basically had about 7.5% of customer growth, and about 2.5% from pricing and mix, and so you're right, there's a little bit of a boost in that 12% as a sort of catch up from the Q2. We've continued to invest very strongly in the marketing in American Home Shield, and we do see that helping to push us, I'd say, close to high single-digit or the 10% revenue growth in American Home Shield. So the marketing effort is going very well still.

[Zach Bakal:]

Got it. Thanks for taking my questions, and congrats on the quarter.

[Alan Haughie:]

Thank you.

[Operator:]

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

[George Tong:]

Hi, and thanks. Good morning.

[Rob Gillette:]

Hi, George. Good morning.

[George Tong:]

Can you discuss some of the catalysts that you have that can drive improved pest customer account growth performance over time, and how initiatives with penetrating the commercial channel are tracking?

[Rob Gillette:]

Yes, I'll take that George. It's Rob. I think we're continuing to improve our commercial business, and grow in a way that we'd expected, and similar to what we've done all year. So there's a good strong focus on that, so we would expect commercial to continue to grow faster than our residential business. So I think that's going well. The investments that we talked about in terms of digital support and interaction with customers, and the investments that Alan referenced in terms of additional sales and spend and support are going to help us to continue to drive growth in total, but also customer retention, and see them valuing what we do to serve them over time. So, all the investments we talked about on the call, plus the additional increase in the sales organization in Terminix we think will help us continue to do that.

[George Tong:]

That's helpful. And then as a follow-up, can you talk about the traction you're seeing with bundling termite preventative solutions with termite curative solutions, and how that may impact the growth outlook for termite?

[Rob Gillette:]

Well, I think that we continue to look at new and different ways to add value to customers, which includes offering multiple services, and in terms of what you refer to as bundling, but we think of it as offering services to customers that they need beyond the core that we present. And so we've been pretty successful at that with the innovative services that we both talked about during the call. So we feel good about that, and how we're positioning the business in the future, and building off the strong customer base that we have, and the growth we had in the quarter, but also into the future. So that's kind of the core of our focus.

[George Tong:]

Great, thank you.

[Operator:]

Our next question comes from the line of Jeff Volshteyn of JPMorgan. Please proceed with your question.

[Jeff Volshteyn:]

Good morning and thank you for taking my question. I wanted to ask about pest customers. So the customer count declined again, retention was a little bit weak, but it seems like the business is doing well, and new products and services are doing well. So there's this disconnect that we have discussed for a while, and I just wanted to understand your thinking on, first of all, how representative do you think this metric is of contracted customers? Maybe what percentage of total customers they represent? And really what are the trends in new sales versus cancels in pest customers?

[Alan Haughie:]

Well, it's a great question. I mean, customer preferences are changing, and that's the whole point. So we value customer loyalty, and we believe that's far more important driving growth and profitability than specific customer subscriptions. I would say about 85% of the revenue that we show in the pest segment is from contracted customers, but the whole point is, as we continue to grow our customer base, as we have done by providing excellent service, the metric is becoming less and less relevant. And so, you can see the divide now between our great growth of 7% in the quarter and that customer count metric. Yes, you're right, it's becoming less and less relevant because it clearly doesn't correlate well with the great performance we've had in the quarter.

[Jeff Volshteyn:]

And then can you comment on new sales versus cancels for pest customers?

[Alan Haughie:]

Well, we don't actually report that number externally, Jeff. So, no, I won't look at that.

[Jeff Volshteyn:]

Okay, no problem. As a follow-up, on the M&A environment for your pest segment, there was a sizable transaction in the space, and does that change the competitive dynamics in the group, and does it change the transaction multiples that the sellers are expecting?

[Alan Haughie:]

Yes, it's a good point. The transaction multiples are rising without that -- let's say, a little bit of additional competitive pressure in the M&A space, but we're not dissimilar to our major competitors when we say that we're not willing to overpay for our pest businesses, but we understand this business extremely well, and we are very well positioned to recognize which opportunities present the most value to us, and that's the ones that we pursue.

[Jeff Volshteyn:]

Okay. Thank you very much.

[Alan Haughie:]

Thanks.

[Operator:]

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

[Andy Whitman:]

Good morning. I wanted to ask some questions around the American Home Shield, and wanted to start with the marketing spend that's been driving the increase in the growth rates here recently. And specifically in -- on the prior call, I guess you mentioned that the cost to acquire new customers hadn't risen with your increased marketing spend. So, maybe Alan, if you could give us some detail about how the marketing spend was compared to the -- in this quarter compared to the prior year, and the relationship for the cost to acquire that incremental customer?

[Alan Haughie:]

Sure, yes. It's easier for me to describe it on a year-to-date basis because it is something of a continuum. On a year-to-date basis we spent about $4 million to $5 million more than we did last year on Home Shield marketing. For the quarter we're about flat with last year, which was a heavy quarter. I'm not going to disclose the number, but it was a heavy quarter, and we're about flat with that, and we are continuing to see the efficiency of this spend. And I'm a conservative guy, so the marketing guys show me data that implies the cost is going down, so I always say it's flat. So, no, it's still going very well.

[Andy Whitman:]

And then can you talk about the impact that you've had as you've been -- and maybe it's too early to say this, but you've gone towards focusing on direct-to-consumer. You talked about the impact on margins with the extra claim that you can get from that, but what about on the retention rate? Have you seen the overall retention in the -- channel by channel changing as you've gone more direct-to-consumer? Are you seeing that benefit that you expect for retention? And maybe just more broadly speaking, can you talk about what the retention rates are for direct-to-consumer real estate, and then the ongoing renewals? Just to give investors some context there.

[Alan Haughie:]

Certainly. I will do my best to keep this answer short. The real -- the metric is the first year retention rate for these two channels of customer acquisition. A real estate customer has a retention rate into the second year of about 25%. A direct-to-consumer has a retention rate into the second year of about 75%. So it's a 3

[Andy Whitman:]

Got it. If I can do a couple more here on American Home Shield, I guess, can you talk about, Rob maybe, the initiatives to drive technology? What that customer experience has gone from into, I think, a more tangible sense about what's going in that business might help investors think about the value add of this business.

[Rob Gillette:]

Okay. Now, it's a good question, and it's been pretty exciting for us to watch. I mean, a few years ago you wouldn't have seen any of these Facebook likes, you wouldn't have seen any of the orders being processed directly through the Internet, as I mentioned like 35% of the direct-to-consumer customers buy directly online, and over half are scheduling in some automated basis. So the trial that we talked about that we perform in AHS over the year is to provide the service, and coordinating service through our contractors, and through our customers. So they're able to communicate, coordinate, and facilitate the services, and schedule with the contractors directly, and we're in contact with it continuously. But it's the way people want to buy. So, we've talked many times, and you've probably heard us say that we want to sell to customers the way they want to buy, and not the way we choose to sell. And that's the way they want to buy. And we've validated this technology and its success in terms of growth and reducing our cost to serve as Alan mentioned. And it just makes logical sense to translate it across the rest of our portfolio. So, that's why we put the marketing team together, that's why we are focused on investing in this technology to differentiate ourselves with consumers but also to provide them access to us which is easy to use and continue to drive on-time delivery and the performance we have for them. So, it's changed our business and it will continue to change in the future. So, we are pretty excited about it and we've learned a lot in the last two years.

[Andy Whitman:]

Thanks.

[Operator:]

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

[Unidentified Analyst:]

Hi, this is Jay, and I am filling in for Gary for today. I was wondering if you guys can talk a bit more about the AHS claims cost, and should we expect this to be a more significant factor as the segment grows?

[Alan Haughie:]

Certainly, if we continue to grow indirect consumer, we'll see a slight increase in that -- let's call it the adverse selection in the first year, usually offset by increased pricing and volume growth in our opinion. So what you are looking at is in 2014 we started this growth trajectory by investing in marketing, and we have now added sufficient volume that the increase in volume essentially offsets or more than offset the impact of those increased claims. So, as you can see from the way the EBITDA margins performed, yes, we probably will see slight increased claims cost that will be more than offset with increased volume and pricing given this model.

[Unidentified Analyst:]

Okay. And going in a sort of different direction, we have been finding that some research is showing that overall termite populations are decreasing. Can you speak to this, and whether it should shrink growth for the Terminix sector in general?

[Alan Haughie:]

Yes. I think that we are all seeing that there is a decline in overall terminate demand, and that's one of the reasons why you see us reinventing a portion of our business in terms of the innovation services. We have such a vast network of technicians and sales professionals that every house -- every house has a set of pest-related problems and what we are doing is seizing on those opportunities to broaden our range of services. So, it's actually proving to be a phenomenal boost to our inventiveness in terms of the innovation services. So, yes, it's happening, and it's merely presented an opportunity for us to increase our share of customers' pest wallet, if you like.

[Unidentified Analyst:]

Okay. Thank you.

[Operator:]

Our next question comes from the line of Sara Gubins of Bank of America Merrill Lynch. Please proceed.

[Sara Gubins:]

Hi, good morning. The investments that you are planning to expand ServeSmart, could you talk about the magnitude that we should expect over the next year or so? How that breaks up between capital expenditures and operating expense? And do you think that you are behind the market on this, or you are trying to get ahead of it?

[Alan Haughie:]

I will certainly start with the first one. We don't -- because I thought this question might come up, so I mentioned that I don't see our range of capital investment rising outside of the $40 million to $50 million per year, which is actually little higher than our current run rate than we have mentioned in the past. In the past, we spent quite a lot on IT, and I would argue we probably don't have as much to share for, as I would like to think. So, there is a great deal of -- let's call it efficient investment and redesign that we are putting in place at the moment. And most of these enhancements are very genius and they are necessary, but they are not that expensive given the way technology has advanced.

[Rob Gillette:]

Yes, I would say just to answer your question further, I would say that we are leading. I don't think that many people in our services type of industries are thinking in this way. So, we clearly are going to try to keep our foot on the accelerator and differentiate ourselves in this space. So in large part, it's deciding what to present to the customer and how to facilitate the service and coordinate it for the delivery of that service. And for us, that takes the form of our own people, franchisees, and contractors. So, our ability to do that in a high quality way, on-time, and then customers provide us instantaneous feedbacks, we know immediately the quality of the interaction they had, so we can address any concerns or basically reward those that provide that quality of service, we think will lead us to the future and enable us to grow. So, I would say that we are leading in this space and we have a every intention to continue to.

[Sara Gubins:]

Great. And then, as we look at the fourth quarter guidance even when we back out the drag of Merry Maids, it looks like you are expecting slower growth in revenue and margin, and I certainly understand that you are investing, but I am wondering if fourth quarter is kind of how we should think about the future in 2016, or is there something maybe perhaps on the investment side that you would consider somewhat unusual there?

[Alan Haughie:]

No, I mean there is nothing unusual. I would point to the full year growth numbers as being indicative of our trajectory. We try to put this business on a course of achieving at least 5% revenue growth and 10% EBITDA growth. We are obviously going to exceed that for 2015, and we obviously target that for 2016 too. And there is no question of the business slowing down in any sense. The quarter is different. They differ slightly due to slight modest seasonal differences, but no trajectories just as else you're seeing year-to-date.

[Sara Gubins:]

Okay. Thanks a lot.

[Operator:]

[Operator Instructions] And our next question comes from the line of Denny Galindo of Morgan Stanley. Please proceed with your question.

[Denny Galindo:]

Hi, good morning. First for Rob, you've made -- how is it going? You made some moves to bring the business together. Now, Mark is now in a corporate strategy marketing role, and it seems like you are focusing on marketing to residential customer base with some of your technology initiatives. So with the multiples your competitors are paying for commercial businesses, would you ever consider selling the commercial business, so you could increase your residential focus further, and what are some of the factors you would weigh when thinking about something like that?

[Rob Gillette:]

I will take your question. I think that we wouldn't consider selling the business. We consider growing into it, and so, penetration commercial that is, our penetration is lower in that space because of our historical focus on residential. So, I would say a lot of the investments in technology and opportunities we have to provide service to customers are targeted to consumers, i.e. residential. And yes, we combine a lot of the commercial resources under one organization and one leader. So, we are focused on commercial and developing capabilities there as well. So, having Mark and team together focused on the marketing does a couple of things, one is it drives better yields and the spent that we have and what we get from it. The digital focus that we've used in American Home Shield has enabled us to get a significant exposure in terms of our product and brand at a reduced cost. So it's a way to proceed into the future. And we also are looking at the verticals that we serve, commercial being one of them. Another significant space is real estate, whether you talk about some of the smaller brands from AmeriSpec to Home Shield to many of our businesses, Terminix is involved in doing inspections for our existing company sales, and there is opportunity for us around that space. So, we look at that vertical as well. So, commercial, real estate, and then what we do to facilitate and sell disaster recovery services to insurance providers and helping home owners and facilitate getting them back in their home after a disaster of some kind, there is an opportunity to continue to sell services through that channel. So, we are looking at driving the digital strategy, but look at marketing collectively, but also at verticals and what opportunities they may present for us to build on a position we have with customer base and grow. So that's our strategy.

[Denny Galindo:]

Okay. That's helpful. Let me toss one over to Alan. I know people focused a lot on contracted customer, but are there better ways to measure recurring revenue? Are you able to measure anything like a same customer sales? And if you are, what would be the trends in pest and termite with that type of metric?

[Alan Haughie:]

It's a great question. And the value of same customer sales in rising, there is no question about that. And one of the things that we've talked about is having -- I would say a better CRM, Customer Relationship Management system, which we are working on to sort of give us that sense. I am not sure that we quite have the ability to -- we haven't quote out on that yet. What I would point to though, and I try to keep going back to this is the volume of services offered, whether it would be to contract it with customers or general recurring customers is rising. The volume of services is up, even when you back out acquisitions and pricing. And that's the fundamental metric that we focus on, essentially volume. Dollar equivalent, price equivalent, sales volume is up year-over-year by roughly three points.

[Denny Galindo:]

And then, one last one, as you approach your target leverage, have you given any more thought to capital structure, return of capital next year, and could you put a timeline on when you might feel comfortable kind of discussing this more in detail?

[Rob Gillette:]

Yes, thanks.

[Alan Haughie:]

Yes, we think about it all the time, and I think the most likely point, which given our leverage target of 3.5 to four times, the most likely point that will be more forthcoming on this is when we announce our full year earnings, and give 2016 guidance at the end of the February.

[Denny Galindo:]

Thanks. That's it from me.

[Rob Gillette:]

Thank you.

[Alan Haughie:]

Thank you.

[Operator:]

And our last question…

[Jim Shields:]

I think we have time -- I'm sorry. I think we have time for one more call.

[Operator:]

Okay. And our last question is a follow-up question from the line of Sara Gubins. Please proceed with your question.

[Sara Gubins:]

Hi. Thanks for taking this. You'd talked in the past about the preventative market being more price sensitive, and that you thought you might be losing some sort of local players in your experiment on pricing. Could you give us an update on what you're finding there?

[Rob Gillette:]

I think we did talk about it, and I think the team is continuing to look at different ways, and we talked about selling additional services in an answer to a question that was asked before. So, I think that we feel good about the direction that we have, and how we're positioning the product and services with the core and new customers. So, I think it's going well.

[Sara Gubins:]

Okay, thanks.

[Rob Gillette:]

Thank you. Jim Shields Thank you. Everybody thank you again for participating in today's conference call and webcast. I want to remind you a replay of the call will be available on our Web site in about an hour from now. So, we look forward to speaking with you. Thanks, everybody. I appreciate it.

[Rob Gillette:]

Yes, thanks.

[Alan Haughie:]

Thank you.