Terminix Global Holdings Inc (TMX) 2020 Q4 法說會逐字稿

Ladies and gentlemen, welcome to the Terminix Fourth Quarter and Full Year 2020 Earnings Call. Today's call is being recorded and broadcast on the Internet. Beginning today's call is Jesse Jenkins, Terminix's Vice President of Investor Relations, FP&A and Treasurer.

I will now turn it over to Mr. Jenkins, who will introduce the other speakers on the call.

Thank you. Good morning and welcome. 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 2, all forward-looking statements are subject to the forward-looking statements 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, 2021. The company undertakes no obligations to update any information discussed on today's call.

This morning, Terminix issued a press release filed with the SEC on Form 8-K, including our unaudited fourth quarter and full year 2020 financial results. The press release, 8-K and the related presentation can be found on our Investor Relations website at investors.terminix.com.

We will reference certain non-GAAP financial measures throughout today's call, and we have included definitions of these terms in our press release. We have also included reconciliations of these non-GAAP financial measures to the most comparable GAAP financial measures in our press release and the appendix of this 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.

Joining me on today's call are Terminix' CEO, Brett Ponton; current CFO, Tony DiLucente; and Executive Vice President and incoming CFO, Bob Riesbeck. Slide 3 of the presentation posted on the Investor Relations section of our website shows the agenda we will cover today.

I'll now turn it over to Brett Ponton. Brett?

Thanks, Jesse. The fourth quarter saw a continuation of the strong operating momentum generated in the second and third quarters driven primarily by the residential service lines. We delivered top line revenue of $460 million with growth of 4%. Our termite service line grew 6%, including 5% organically, driven by strong sales in both core termite units and home services.

We continue to gain traction with our subscription-based monthly pay termite offering launched during 2020. We are encouraged by the positive customer reaction and are optimistic the new model will lead to higher retention in the future. 4% organic growth in residential pest was highlighted by retention gains, volume growth and pricing realization that continued to be partially offset by lower summer sales units and onetime bed bug services. Excluding these impacts, organic growth would have been over 6% in residential pest.

In commercial pest, we continue to see sequential improvement, and the business was down only 1% organically year-over-year in the fourth quarter compared to 3% last quarter. We are optimistic about the outlook in this service line as we move forward in the year and begin to lap COVID impacts in late March.

We also saw strong gains in our European Pest business, delivering double-digit organic growth when excluding the benefits of foreign currency translation. Strong gains in Norway and Sweden were driven by growth in the insurance channel in the fourth quarter. And despite more severe pandemic restrictions in the quarter, we continued to add customers to build density in our Terminix UK business.

Fourth quarter adjusted EBITDA grew 24% or $13 million year-over-year to $68 million. Adjusted EBITDA margins of 14.8% increased 240 basis points. Strong adjusted EBITDA growth was highlighted by improved employee retention and better labor management as well as vehicle efficiencies and better indirect cost containment.

Double-digit revenue growth in our international businesses also yielded better EBITDA contributions that will continue to grow as we add customers in Terminix UK. These gains were partially offset by higher incentive compensation expense, including over $1 million for a onetime special bonus to all frontline employees. This bonus was given in appreciation for the hard work of our teammates during unprecedented circumstances in 2020. Their dedication and commitment to excellent customer service is to be commended, and I thank them for delivering a very strong year.

Strong incremental margins in the back half of the year are a positive sign, but we continue to see 30% incremental margins as the appropriate long-term target that balances short-term returns with investments in the long-term health and profitability of this business.

Another highlight of the year was the completion of the termite damage claim mitigation program in Mobile Bay. As planned at the beginning of the year, we have completed a rigorous inspection and applied additional treatments to every available customer in the area. The results of these efforts are apparent in the numbers, with over 30% reduction in both new litigated and nonlitigated claims year-over-year in the Mobile Bay Area. We plan to leverage the best practices we learned in Mobile Bay in the development of standard operating procedures and training protocols that will be shared across the organization as we make improvements to reduce termite damage claims expenses in the coming years.

The fourth quarter also saw the completion of the sale of ServiceMaster Brands and the subsequent debt reduction. Beyond the benefits created by lower leverage and a strong cash position, the sale allows us to focus 100% of our efforts and resources on improving the operational capabilities and consistency of the Terminix business, driving greater value for all of our stakeholders.

In an effort to better align our operations to support our teammates as well as reduce the cost structure of the remaining business, we recently announced the promotion of Kim Scott to COO, with added responsibilities for Terminix Commercial. With the majority of Terminix customers already serviced out of combination of residential and commercial branches, expanding Kim's responsibilities to include the other 25% of the revenue base she did not previously oversee will allow us to harmonize operations behind standard procedures and training protocols that will span the entire business.

Over the last year, as President of Terminix Residential, Kim has made great strides, improving residential operations, driving gains in both employee and customer retention and overseeing the successful launch of the monthly pay termite product. She also led the successful execution of the termite damage claims mitigation program in Mobile Bay.

This move does not alter our commitment to the attractive commercial sector. Recognizing the unique go-to-market commercial model, supporting Kim will be dedicated commercial selling and marketing teams. The Commercial business enjoys strong customer retention and lifetime value. And with the regulation on businesses expected to increase in the coming years, we expect this service line to be an important part of our growth story. By reducing costs and better aligning the business, we will generate the necessary savings to invest in the needed key operational capabilities that will drive future growth in all areas of the business.

I'm also excited to have Bob Riesbeck join us as CFO. Bob and I go back many years, and I have watched his career from a distance over the last several years as he has created value for investors under difficult circumstances in brick-and-mortar retail businesses. Bob brings a multiunit retail background and is experienced in driving consistency from branch to branch through operational consistency and standardized operating procedures.

In my short time in the business, I have learned that we have a unique operating model at Terminix, which is why I was excited to get Bob together with Tony for these last several months. The long transition period has certainly been helpful to assist with his onboarding to the business. You will hear from both Bob and Tony in a few minutes.

We have also taken other actions across the business to simplify and streamline the back office in line with the leaner, singly focused company we have become. Our streamlined structure will better position us to drive our 2021 strategies to improve consistency and results through improved execution, greater focus on standard operating procedures and investments in key operational competencies across all of Terminix.

Before I discuss these 2021 initiatives, let's turn to Slide 5 and review the progress made on the 2020 priorities. As you know, we had 4 strategic priorities in 2020. Employee turnover improved 20% in 2020 compared to prior year. As you will see when Tony goes through the EBITDA bridge, we continue to reap benefits of a more seasoned and tenured workforce with better customer retention as well as improved labor productivity.

In the fourth quarter, technician retention was flat to prior year. Maintaining and continuing to improve these metrics will be key as the job market shows signs of improvement following the pandemic. I will discuss our future plans to continue to make progress on teammate retention despite the larger macro headwinds when we discuss our 2021 priorities.

Customer retention also improved during 2020. In the residential pest service line, daily cancel rates were down 9% in the fourth quarter compared to prior year, while on the termite side, cancel rates were down 3%. This is the third straight quarter of daily cancel rate improvement in both service lines, and that consistent focus has led to improvement in trailing 12-month retention rates.

Residential pest retention improved 160 basis points, and termite improved 230 basis points compared to prior year. While the commercial pest service line has been severely impacted by COVID-19 cancellations and is down compared to prior year, when adjusted for cancellations related to those concerns, retention has remained relatively flat year-over-year. Despite the improvement in residential pest and termite, we continue to see room for improvement in our customer retention rates across all service lines, and this will remain a key opportunity of the business going forward.

As I discussed previously, these retention gains, coupled with our initiatives to improve productivity and our cost structure, drove margin expansion of 240 basis points year-over-year. Adjusting for incentive compensation, which was $10 million higher than the same period in 2019, the underlying margin improvement was over 450 basis points. Strong pricing realization, especially in commercial and growth in high-margin termite services in residential, were also key contributors to margin expansion.

And finally, 2020 was a resounding success in all phases of our termite business. Our new tiered product helped us grow core termite completions 14% in the fourth quarter and 10% on the full year. While the new monthly pay customers will create some headwinds for us in termite renewals in the first half of 2021, we are confident that the long-term consistency and predictability that will come from better retention more than outweighs the near-term timing impacts.

Success with core termite has also led to new cross-selling opportunities in our home services products, such as attic insulation and wildlife exclusion, which were up 13% in the fourth quarter and 9% for the full year.

We also had a good year with termite damage claims. As I mentioned earlier, we finished our mitigation program in the Mobile Bay Area as expected and believe the added protection for our remaining customers will help to improve claims in this higher-risk area of the country in the future. Including mitigation expense, we saw just over $70 million of total termite damage claims expense in 2020. While this is over $20 million higher than prior year and $45 million higher than our baseline of 4% of total termite revenue, it was in line with our communicated expectations for the year. We have seen continued improvement in damage claim trends over 2020 and saw a 16% reduction in new nonlitigated claims nationwide year-over-year.

As I mentioned earlier, we saw over 30% improvement in new litigated cases in the Mobile Bay Area. While litigated cases are difficult to predict quarter-to-quarter, the progress in both litigated and nonlitigated trends is encouraging. We have a long way to go to get to industry-leading rates, and we plan to leverage the best practices learned in the Mobile area during 2020 to other parts of the country in 2021.

Turning to Slide 6. I would like to discuss our strategies to drive improvement in the business in 2021 and beyond. Our goal at Terminix is to become the pest management provider of choice for teammates, customers and investors alike behind our industry-leading brand, and we have aligned our team to be singly focused with a commitment to this goal. Over 2021 and beyond, we will build world-class capabilities that will drive consistency across the business through focused investments in key operational areas. These specific 2021 initiatives reflect my firm view that we can create significant value in this business through a dedication to and focus on operational excellence in the core fundamentals of service delivery.

Building off the strong momentum generated in 2020 and with the right leadership pieces now in place, we will drive more consistent and better results for years to come, starting with the initiatives you see here. While these initiatives may sound simple on the service, driving consistency across over 11,000 teammates and over 50,000 customer touch points a day will require steadfast dedication and focus.

Improving the teammate experience is critical to our ongoing success. Our teammates are the most important part of our business. They are typically the first and often the only person from Terminix who directly interacts with our customers. The customer relationships they develop over many years during a long tenure with the company is a key driver of customer satisfaction. This is why we will be developing defined career paths for our teammates that will provide everyone an equal opportunity to grow both personally and professionally.

We have countless examples of homegrown talent, developing from route technicians to division leaders. And in our goal to become the employer of choice in the industry, the opportunity to turn Terminix from just the job into a fulfilling career is an important first step in improving the teammate experience.

The next step will be the development of standard operating procedures across the business that I mentioned earlier. Standard procedures are only as valuable as our ability to train against those procedures, which is why we will also be building out Terminix University this year as the platform to deliver enhanced training to our teammates to support their chosen career paths.

In addition to training enhancement, we will be prioritizing technology enhancements in order to improve our teammates' work-life and help them be more successful. Key to this will be the rollout of our customer experience platform or CXP. When I came on board, we paused on CXP so we could be sure we have the proper enhancements in scope to prioritize the teammate and customer experience. We are now planning on a rollout that begins in the coming months and rapidly expands once we move beyond the peak pest season into the fourth quarter.

In 2021, we will also be accelerating our efforts to improve our customer acquisition initiatives. We are planning to launch a state-of-the-art e-commerce platform in the back half of the year that will improve the way our customers interact with us online. This improvement will make it easier for customers to find us and buy from us online.

Search engines are a key driver of web traffic today, and our new site will start the process of optimizing this channel. While we are still in the early phases, we do have an update to terminix.com that will be coming in the next few months to begin this process. We also have plans to optimize our digital marketing processes. Alex Ho has brought a wealth of knowledge and sophistication from his background in digital marketing, and he is moving forward with a few initiatives designed to increase lead generation while improving our return on marketing investment.

Some of the savings from these actions will be used to develop and implement the new e-commerce platform. We also have several initiatives in Terminix Commercial to better leverage our industry-leading brand recognition and further develop commercial sales professionals, or CSPs, with state-of-the-art training. These actions will drive more inbound leads and improve our close rates at a time where the commercial market is set to rebound to historical norms.

Finally, we have new leadership in place to help develop and refine our M&A strategy and integration capabilities. While we are likely to be deliberate in our approach out of the gate while we enhance our integration capabilities, focus on operating improvements and the rollout of CXP, we'll remain active with both smaller tuck-in deals as well as Terminix franchisees. As we develop our capabilities, we will leverage our substantial cash and balance sheet flexibility to become more active in the M&A markets over time.

The next bucket of initiatives is a continuation of our journey to industry-leading customer retention. We made tremendous strides in customer retention in 2020 and have several initiatives that will help us maintain and improve these efforts this year.

We'll review the details of why our customers leave us. It is centered on 2 main themes: did you show up when you were scheduled? And did you solve my pest problem? While this sounds quite simple, the key is consistency from customer to customer, teammate to teammate and branch to branch. Our focus this year will be centered on improving our technical capabilities through standard operating procedures and protocols to ensure that we are solving our customer problems the first time every time.

We're also planning to develop greater consistency in our approach to routing and scheduling. We're in the early innings of optimizing routing and scheduling and are developing a better plan to improve our current efforts. While we won't wait for full development of CXP to begin this initiative, routing and scheduling will also be a key component of our new platform and will lead to even greater strides once fully implemented.

One area we are watching closely as we head into 2021 is cancellations related to customers moving. We saw a shift in customer behaviors late in 2020 as the housing markets rebounded, and this has continued into early 2021. While we have a robust action plan to engage with a new homebuyer and transfer services for the seller to a new property, we expect this to be a retention headwind we will have to overcome.

Commercial retention declined in 2020 due to customer cancellations related to COVID, and we are expecting a gradual return to norms in 2021 as the economy improves and we continue to improve our service delivery standards.

Finally, we are focused on expanding our adjusted EBITDA margins. As we have seen through 2020, improving customer and teammate retention has had a direct impact on profitability. In addition to the benefits of those initiatives, we have several initiatives on pricing plan for this year. Better segmentation of our customers will allow us to explore elasticity of our services. And early indications show, we have some opportunities to be more aggressive with pricing, both for new customers and as existing customers renew their services.

We're also planning for reductions in termite damage claims expense as we move past the mitigation plan and leverage best practices and lessons learned across the country. The reductions we are seeing in outstanding claims counts and improvements over 2020 give us confidence we are making the expected improvements to return to, and ultimately improve upon, industry levels in the coming years.

We have developed a strong customer-first culture in Terminix Nation, and our efforts in 2021 to provide the enhanced tools and training necessary through the CXP rollout will enable our teammates to deliver world-class service. Additionally, a newly aligned M&A leader with a focus on integration will allow us to build a scalable platform that we can leverage as our operational consistency and execution improve. While there is considerable work to do, we are in a very good position with the right leadership team and culture to make progress on these initiatives in 2020. I'm excited about the opportunities to drive continued growth and build greater long-term values.

And with that, I will turn it over to Tony to discuss the fourth quarter performance. And I will return with closing comments after Bob discusses 2021 guidance.

Thanks, Brett. Today, I'll cover Q4 performance, highlighted by strong organic revenue growth and substantial margin expansion. Overall, Terminix delivered revenue growth of $19 million or 4% with organic revenue growth of 3%.

Starting with the Termite and Home Services column on the left side of the chart. Revenue grew $7 million with 5% organic growth in the quarter. Breaking down the components of growth further, termite completions and home services were up 14% in the quarter, with core termite completion also up 14% and home services completions up 13% year-over-year. The continued strong performance in core termite is driven by sales of our new monthly pay tiered termite product, while the growth in home services is driven by better cross-selling due to more people working from home.

Renewals of core termite units made up approximately 42% of the total Termite and Home Services completion revenue in the quarter. Although customer retention did improve in the fourth quarter, termite renewals were down 3% driven by a lower volume of completions available for renewal from the prior year.

Residential pest grew 5% in the fourth quarter. Tuck-in M&A contributed 1% of the growth, while organic revenue growth was 4%. As Brett previously mentioned, we continue to see improvements in customer retention, with daily cancel rates in residential pest 9% lower versus prior year. Growth in residential pest was partially offset by our decision to limit summer sales activity in order to protect both our potential customers and our salespeople from COVID-19 as well as by lower bed bug demand due to travel declines. If you normalize for these 2 circumstances, our organic growth would have been approximately 6% in the quarter.

These items will continue to affect the first quarter of 2021 as the loss of revenue associated with the summer sales units carries over to future quarters, and travel is forecasted to be down for the foreseeable future. Despite these factors, demand remained strong for residential services, and we are planning for continuing organic growth in residential pest in the first quarter.

Commercial pest revenue was flat in the fourth quarter versus prior year, with M&A growth of 1% offsetting an organic decline of 1%. COVID-19-related work order postponements due to business closures continue to have an impact on organic growth but not as significantly as we saw early in the pandemic. We've seen improvement in business trends as the economy reopens, and organic growth rates were up 2% sequentially over the third quarter and continued to improve into January.

While we can't foresee when the commercial market will fully return to its historical growth rates, we are forecasting growth in 2021, particularly as we lap prior year COVID impacts by the second quarter.

European pest revenue was up 29% in the fourth quarter, including 24% organically. Approximately 10% of the organic growth was related to favorable currency translation. The remaining 14% organic growth was driven by strong double-digit growth in Sweden, Norway and Terminix UK. Sweden and Norway saw growth in insurance contract work driven by an uptick in rodent infestations, while growth in Terminix UK continues to come from both national and nonnational accounts added since the acquisition in the fourth quarter of 2019. Starting in 2021, we plan to include European pest revenue in the commercial revenue service line given that the vast majority of its revenue is commercial.

In the other revenue service line, product sales were down approximately $1 million from prior year due to declines in sales through distributors to small pest management providers and tighter inventory management by larger distributors in response to COVID-19. Although organic growth is down this quarter, the significant purchasing leverage this bed provides with our vendors continues to provide benefits in lower chemicals costs. Overall, the fourth quarter delivered solid revenue growth in residential pest, termite and European pest, while trends continue to slowly improve in commercial pest.

Turning to Slide 8. You can see the finance summary in detail on the adjusted EBITDA drivers for the quarter. Before we turn to the specifics, you'll notice that we have combined our business into a single segment for external reporting. We believe this presentation better represents how we manage the business as a focused pest management company and simplify some back-end processes without sacrificing the details our investors need to fully understand our business operations.

Turning to the P&L box on the left of the page. You can see the 4% revenue growth I covered on the previous slide led to a 24% increase in EBITDA driven by revenue conversion and strong productivity gains. Adjusted EBITDA growth and lower interest expense after the debt payoff using proceeds from sale of ServiceMaster Brands drove an $18 million increase in adjusted net income and a $0.14 per share increase in adjusted earnings per share.

Across the bottom of the slide, you can see the adjusted EBITDA drivers for the quarter. Revenue growth, almost all of which is organic, added $8 million in the quarter. Direct cost productivity generated $9 million of higher adjusted EBITDA in the quarter. $7 million in labor productivity was primarily the result of improved labor and overtime management and better employee retention. We also saw vehicle and fuel costs decline $2 million year-over-year through actions to improve the fleet management process and lower fuel prices.

Indirect and G&A cost productivity generated $9 million of higher adjusted EBITDA year-over-year primarily from the flow-through of back-office cost productivity and lower travel expenses. Partially offsetting the year-over-year net increase in adjusted EBITDA was $10 million of higher incentive compensation costs due to improved financial performance in 2020. This includes the special onetime bonus to our frontline teammates that Brett discussed earlier.

We also saw a $3 million increase in expenses from higher termite damage claims costs. Termite damage claims expense was $18 million in the quarter, which was approximately $13 million above the historical norms or 4% of total termite revenue. The increase in the quarter was primarily related to the completion of the mitigation program in Mobile Bay, while damage claims expense was roughly flat to the prior year. For the full year, damage claims expense was just over $70 million for a $21 million increase over prior year and a $45 million over the historical baseline.

In total, adjusted EBITDA margins of 14.8% expanded by 240 basis points when compared to the fourth quarter of 2019. Excluding the onetime impact of $10 million in additional incentive compensation expense in the quarter, margins would have increased by 450 basis points.

And finally, with this being my last earnings call, I wanted to say thank you to the Board of Directors and executive leadership team of ServiceMaster and Terminix for allowing me the privilege of helping to lead this exciting company over the last 4 years. Also a special note of thanks to the Terminix Nation and our 11,000-plus employees who have great passion and energy to provide consistently outstanding service to our customers. I've enjoyed the transition with Brett and Bob. They're exceptional leaders, and I'm confident that Terminix will continue to enjoy great success going forward. Finally, I want to thank all of our investors and exceptional analysts that invest in and cover our company. I hope to cross paths with each of you down the road as I move on to my next adventure.

And with that, I'll turn it over to Bob to review the cash flow for the year and the 2021 guidance. Bob?

Thanks, Tony, and thank you for supporting my transition over the last couple of months. We thought it would be helpful to first walk through our cash flow on Slide 9 to help get a better understanding of headwinds and tailwinds as we transition to 2021.

Working capital was a benefit to us in 2020, with approximately $30 million of favorability driven by a onetime payroll tax deferral as part of the CARES Act. In 2021, we expect working capital to be the use of cash as we paid 50% of that payroll deferral back, with the other 50% to be repaid in 2022. We are also expecting the working capital use from increased termite damage claims payments as we proceed through the litigation process and reduce the number of litigated cases on the balance sheet in 2021.

CapEx in 2021 is expected to remain between 1.5% and 2% of total revenue or approximately $30 million to $40 million at the midpoint of guidance. Cash interest of $83 million in 2020 is expected to be reduced by a little less than $40 million after following the November 15 paydown of $75 million in high-yield bonds and $51 million advanced payment on the term loan.

2020 cash taxes of only $4 million saw the benefit of a onetime net operating loss refund from 2015 that will not repeat. In 2021, we expect the cash tax rate to be between 20% and 22%. You can also see the $49 million in payments we made in connection with the Alabama Attorney General settlement in December. Excluding the impact of this onetime payment, our free cash flow to adjusted EBITDA conversion in 2020 would have been 64%.

As for the uses of free cash flow in 2021, we do not have any near-term maturities on our public debt. However, we do have an approximately $50 million deferred acquisition payment related to the 2018 Copesan purchase that we will pay in the second quarter. And we will continue to be active with our share repurchase program early in the year.

While the onetime leverage ratio is below our ultimate long-term target range, the flexibility of a large cash position and strong balance sheet was important to us during the pandemic. You can expect us to use our cash responsibly through 2021 with opportunistic and systematic share repurchases as well as accretive, easy-to-integrate bolt-on acquisitions. While we certainly have ample capacity to explore large strategic transactions should they become available, we are focused in the near term on executing on the 2021 initiatives that Brett laid out earlier. These will ultimately drive operational consistency, leading to improved financial results.

Moving to 2021 outlook on Slide 10. We expect revenue to grow to between $2.025 billion and $2.050 billion with organic growth between 3% and 4%. We expect adjusted EBITDA between $365 million and $380 million and margins between 18% and 18.5%. For revenue, the outlook assumes commercial pest will continue the gradual positive trends we have seen over the last several months as the economy continues to reopen, with the back half of the year picking up as we lap prior year COVID impact. Growth in commercial pest will be aided by continued strong growth from penetration of Terminix UK into the London area and a continuation of the historical growth patterns in Sweden and Norway.

We expect continued growth in residential pest to be partially offset by lower year-over-year summer sales revenue in the first quarter from fewer units sold in 2020 and the continued lower trends in bed bug services due to the reduced travel during the pandemic. We also expect continued demand in termite completions due to the new monthly pay product and strong growth in home services.

The unprecedented winter weather over the last week has also impacting our business. At one point, we closed over 100 branches nationwide due to deteriorated road conditions from ice and snow. I'm pleased to say our teammates are well, and we have been able to get back to work this week to service our customers. We are still evaluating the full impact, but this will certainly have an effect on demand for pest services in the first quarter. Early indications are the impacts will be nominal, and we have included our current expectations in this guidance.

As Brett mentioned briefly, we do expect between $8 million and $10 million of termite renewal revenue to be pushed into 2022 due to revenue recognition on our new monthly pay product. Historically, revenue was typically recognized on or around the annual renewal date, while the new monthly pay product will be recognized evenly over 12 months due to the subscription-based model. We believe the affordability of the monthly payments and the shift towards this model will improve our retention rates as we move forward and will smooth out termite renewal revenue over time as we lap the timing impact of 2021.

Due to the seasonality of termite swarm season, this change will impact us more severely early in the year. Using prior revenue recognition as our baseline, we expect revenue in the first quarter to be $5 million lower, the second quarter to also be $5 million lower, third quarter to be roughly $2 million lower, and the fourth quarter $2 million higher due to the change in revenue recognition.

Adjusted EBITDA will see the flow-through of organic revenue growth and reduced termite damage claims expense as we lap the completion of $10 million termite mitigation plan in the Mobile Bay Area. We expect to see cost headwinds during the year related to increased training and lost productivity from the rollout of CXP and as well as increased travel and the lapping of strong employee retention performance.

We expect the cost of our 2020 initiatives and investments in operational capabilities to be funded through cost structure simplification as we evolve to a leaner, singularly focused pest company. In addition, we expect our effective tax rate to be approximately 28% and depreciation and amortization to be approximately $95 million.

And with that, I will now turn it over to Brett for closing comments.

Thanks, Bob and Tony. Before I start on my closing statements, I want to thank Tony for his contributions to Terminix and the preceding ServiceMaster businesses. Tony was instrumental in a number of strategic initiatives that culminated with the company ultimately becoming Terminix and solely focused on pest management. He is leaving us with a strong finance team, a pristine balance sheet and cash position and some very large shoes to fill. I'm glad we have been able to support Tony in his decision to move on to the next phase in his life, and I wish him and his wife, Anita, well going forward.

I'm excited about the opportunities that lay ahead of us in 2021. Our strong leadership team is focused on the fundamentals of customer service in both the commercial and residential markets. Our strategy, collectively known as the [Terminix Way], is designed to build key operational capabilities in the business through enhanced standard operating procedures that will improve consistency from branch to branch and teammate to teammate.

2021 will be focused on building the capabilities needed to drive sustainable, long-term profitable growth. Over the course of this upcoming year, we'll be rolling out a number of initiatives that will move us forward with a better teammate experience, improved customer retention, streamlined customer acquisition and expanded profit margins. These initiatives will require dedication and incremental improvements every day, and we are committed to driving them forward step by step. We are confident building these fundamentals during 2021 will lead to considerable shareholder value as we progress towards our goal to become the pest management provider of choice.

As Terminix turns the page on a strong 2020 and continues our efforts into 2021, I want to again thank our many teammates who have sacrificed and delivered under considerable pressure during the COVID-19 pandemic. I am proud to serve with you and be a member of Terminix Nation, and I'm excited about what we are going to accomplish together in 2021 and beyond.

And with that, I will hand it over to Jesse to lead us through the Q&A.

Thanks, Brett. With the queue being long this morning, please limit yourself to a single question so we can get to everyone in the allotted time.

Operator, let's open the line for questions.

(Operator Instructions) Our first question comes from Ian Zaffino with Oppenheimer.

Very comprehensive prepared remarks, really appreciate that. Question would be -- maybe, Brett, you've been here for a little while now. What are your targets for -- let's say, retention targets for ultimate pricing? And how do you balance retention with pricing? And then also maybe touch upon commercial as well. I know you talked about the harmonization that came out leading both areas. But like what should we anticipate as far as the change on the commercial side? Or what's kind of going on there? Sorry about all the questions, but I appreciate it.

Thanks, Ian. I thought maybe I'll take the second part of the question first. It's a bit more strategic, then I'll cover off on your question around retention versus price. First of all, let me give you a little context for the changes that we made to the organization. As you said, I've been here now for just over 5 months in the role. And there's really 5 objectives I had for myself and the team in my first 6 months here in the role.

Number one, I wanted to go out and learn this industry and learn our organization. So I spent a considerable time out in the field. Objective there, of course, is to really understand how the model works, how our team operates, understand strengths and opportunities in our field organization, in particular.

Number two, of course, we had a complete spin-out of the sale of ServiceMaster Brands and deleveraged. And that left us with a business here, of course, that's now 100% focused on pest control.

And to that end, that was my third priority for 6 months here was really developing the Terminix near-term strategy for the company. As you heard in my prepared remarks, we set a vision, our objective here to be the preferred brand in our industry, preferred by customers, employees as well as investors.

And the fourth priority was to align the Terminix leadership team structure to be able to enable the execution of that strategy. And within that, there were a few priorities that I had from a structure point view. Number one, I knew I'd have to develop a succession plan for Tony, who wanted to exit the organization as he had planned on doing. We named Kim Scott, as we said, in the COO role. And the reason why I did that, just to comment on that, it felt like there was a significant opportunity to bring residential and our commercial businesses together. There's certainly uniqueness in the sales portion of the model, sales and marketing that requires distinct, unique capabilities there, and we're going to maintain differentiation there.

But in our service organization, as I've traveled out in the field and saw the opportunities, there is significant opportunity to bring those parts of our organization together between residential and commercial. And under Kim's leadership, I felt like we have a really strong leader to do that. Over the past year here at Terminix, Kim has been very instrumental, as I said, in driving retention improvements and our teammate performance there. Certainly, customer retention was really, really strong as well. We had successful launch of our termite monthly pay package.

And then finally, just strong execution, as we talked about, with the termite damage claims project in the Mobile Bay. So I feel really good about the strength of our operational capability. I believe there's best practices that we can quickly scale to our commercial side of our organization.

And then lastly, we named Christie Grumbos into our M&A role with a real focus early on, on building our stronger integration capabilities of the company and to focus on tuck-in acquisitions. Christie comes to us -- he's previously the CFO of our residential business, which he's got deep insights into operations, and he's a really strong leader to help us develop the integration capabilities required to effectively integrate tuck-in deals going forward.

Then lastly, as you heard us share today, number five is really establishing our priorities for the year. And the emphasis there is to build off our 2020 momentum. The team did an outstanding job of building, I think, really strong momentum exiting Q4. End of the year, we're going to build on that momentum in the business. We've laid out our key strategic priorities for the year. CXP is a critical one, strengthening our marketing capabilities I talked about and also really set the table in the year on our future capabilities that sets up growth in '22 and beyond.

And then the last thing I'll comment on is we simplify our organizational structure here at the company. Now that we're singly focused on pest, it gives us an opportunity to reinvest some of that in operational support and marketing to drive future growth going forward. So long answer to your question around structure, but I wanted to give some context to the changes that we made there.

As it relates to retention goals for the company, as we talked about, really strong year that we're coming off of in 2020. With 230 bps improvement in our termite service line and 160 bps in pest, really strong performance on the year, again, well led by Kim and her leadership team in executing that. But I also believe there's plenty of runway here to get the best in class, and that's really where we're set in our marks is industry-leading performance in those metrics.

A couple of reasons to believe there is, as we look across our branch portfolio of 360 branches, we certainly have branches in our company today that are delivering industry-leading customer satisfaction, and ultimately, retention. The opportunity we have here is to learn from those branches. The best practices they're using to deliver that, package those best practices up in playbooks and then use those to scale across our organization, supported with the right training systems and enabled through the CXP technology to bring this together.

So we certainly have to invest in the capability here to ensure that we get to industry-leading levels, but I feel good about the progress we've made, the initiatives that we have on board to help us achieve those longer-term goals for the business.

Our next question comes from George Tong with Goldman Sachs.

Termite and Home Services grew 5% organically in the quarter, lifted by 14% growth in new completion from the sales of the monthly pay tiered product. How sustainable do you think double-digit growth in new completions is? And what range of organic growth in Termite and Home Services is embedded in your full year guidance?

Yes. So we obviously, on Slide 10, provided some guidance on our revenue for the year. And then obviously, that guidance is 3% to 4% organic growth overall. We've actually done -- our breakdown on that is really half of it's price and half of it's volume across all product lines. We obviously have not gotten into providing individual guidance by product category.

Maybe just to add a little color on that, George. First of all, I think with the success of the monthly pay tiered package certainly was a tremendous success this year. And I think there's still a significant runway here to build upon that growth going next year. And of course, given the fact we've now migrated to a monthly pay subscription-based model, we would expect that to translate well into higher retention on our termite business going forward in terms of renewals in the out-years. So I feel like we've built significant momentum here in 2020 but still runway for us to grow off of the baseline we've established there.

Our next question comes from Michael Hoffman with Stifel.

Tony, it was a blast traveling with you and meeting investors. Good luck.

Thank you, Michael. I enjoyed too.

So can we walk through the cash flow bridge again? Just trying to write everything down and core processes at the same time. So in the middle of your EBITDA, you're at $372 million. And I think what I have is headwinds known are -- or the -- go to your Page 8 and follow that chart. We're going to have $35 million of CapEx, $42 million of cash interest, implies about $51 million of cash taxes. So I think the treatment charge, there's no incremental there. So the only 2 numbers I really don't have a good handle on are Other and working capital. Can you help us zone in around that?

Yes. So we did give you a little bit of guidance on that as far as the working capital and has given back a piece of that tax deferral from the prior year. So you do have about a $15 million impact from a use of cash standpoint related to that onetime deferral of payroll taxes under the CARES Act. And then obviously, CapEx guidance between $30 million and $40 million. And you're right on top of the interest number of roughly $40 million and then cash tax guidance of 20% to 22%.

So I think we've given enough there from that perspective. And then I think the only other thing is termite damage claims also with those being roughly $10 million less based on the mitigation payment of the current year.

Okay. So following that Page 8 chart, the working capital line is going to be a positive 15. And you're not assuming any working capital for organic growth. You'll be sort of neutral. It's just the CARES act. And then I got a 10 instead of a 49 as a positive instead of a negative?

That's correct.

Our next question comes from Tim Mulrooney with William Blair.

Tony, congrats on your tenure at Terminix, and wishing you all the best on your next adventure.

Thanks, Tim. Enjoyed our working together. It's fun.

Yes, me too. So my question is on M&A. You've got a very healthy balance sheet now, and all indications are that there's still a lot of transaction activity across the U.S. pest control market. Would you anticipate getting more involved in a more serious way over the next several quarters? And if so, can you talk about the type of assets that you'd be particularly focused on? Because I mean you've done a lot of large commercial transactions over the last couple of years, but the residential market also appears to be a good place to be right now. So I just would be interested to get any of your thoughts here.

Sure. Yes, certainly, I think as we've shared, a couple of times now, our first and foremost focus is going to be on organic growth here at the company and building the capability here to drive sustainable, consistent organic growth from quarter-to-quarter, as we talked about. Certainly, inorganic growth is going to be part of our growth algorithm here going forward. As I mentioned, part of us -- strategy are adding Christie Grumbos to the M&A team. We are going to be very focused, I think, on building out our pipeline, more robust pipeline certainly, but also this year, intense emphasis and focus on how we integrate those acquisitions going forward. And certainly, CXP is going to be a huge enabler to help us integrate deals more efficiently going forward.

So having said that, from an M&A priority point of view, I think, as we've said before, too, our initial priority is going to be on tuck-in deals that drive density in existing markets here, recognizing how important density is to our business model. And those tuck-in acquisitions are still relatively easy for us to integrate.

Beyond that, we'll certainly continue to look at adding geographic presence to our business. We have over 20 franchisees left that some of which have an interest in exiting, and we certainly would be interested in taking over that brand in those respective geographies.

We certainly -- as you said, the balance sheet capacity to contemplate something a bit more strategic and certainly will if that comes along for us. But I think it's fair to say our immediate focus here as a team is focused on organic growth and density acquisition plays for us in the near term.

Our next question comes from Andy Wittmann with Baird.

I just -- I guess I want to understand a little bit more about the termite segment in particular. You've had these great completions in the last couple of quarters. And that seems like it should be a great leading indicator for eventually converting that into renewal revenues that, I think, potentially could or maybe should accelerate maybe even beyond this low single-digit kind of rate that you're talking about in your guidance for all segments. So I was just hoping you could explain a little bit about some of the dynamics as to why that would not be the case or -- and if maybe that's just because the base of renewals is so large. Or what are the things that are holding you back from posting better growth on the renewal side of termite?

So I think one of the impacts that we have is that headwind related to the change in our payment plan and that program because it's been very successful so far, and we think it will continue to be successful from a retention standpoint and from a growth standpoint. But we do have that headwind for the first 3 quarters of the year of roughly $12 million, and we get a little bit back in Q4. So we do believe the program will help us grow and grow the business, obviously, it's new to the company here recently. And so very -- feel good about where we're heading.

Yes. Just to add a little bit more color on that. Certainly, as you said, Andy, clearly success this year in 2020 with the Evolution project -- or product that we launched there, really positioned well with the consumer to make sure we got an affordable option for them. You said, we expect that to translate well into strong renewal rates going forward.

But keep in mind, Andy, too, I think historically here, our growth rate here has been around 3% to 4%. So we're kind of in line with that. We're optimistic. We're building off a strong base and a very strong go-to-market platform here. And also with the advent of new technology tools and online selling of cross-selling opportunities to improve, we hope to accelerate upon that. But at this stage, we're comfortable with the guidance we're providing.

Our next question comes from Judah Sokel with JPMorgan.

I also wanted to just begin by thanking Tony, wishing him well wishes and welcoming Bob to the team.

Thanks, Judah. Enjoyed working with you.

I wanted to ask about the Customer Xperience Platform. It's clear that customer retention is an important initiative in the company's drive to improve customer overall organic revenue growth. I'm trying to understand, after a year where customer retention did improve so much and really has been the focus of the company and investments for a number of years now, trying to understand what exactly is different about the CXP. Maybe you could just help us give a little more color on what this new initiative involves, what capabilities this will bring to help bridge the gap to peers and reach those industry-leading retention levels.

Thanks, Judah, for the question. First of all, I would like to dissect what you said. The team has done a great job in 2020 with intense focus and strong execution on retention today. Having said that, as I traveled out in the field and spent time riding with technicians and spending time with our branch leaders and talking to our call center team and understanding better our back-office systems here, it was pretty clear to me to see how challenging the limitations are with our current system today and really providing timely information that's consistent across all those stakeholders that touch our customers today.

So first and foremost, I think the technology that we're investing here is going to give us a 360-degree view of the customer with real-time information that flows between key departments in our business. That should allow for a much better experience and transparent experience going forward. So I feel pretty confident about that.

As we said, it's a major initiative for the company. Both Bob and I have had experience in launching initiatives like this one. We have a pretty aggressive rollout plan this year. We intend to start with our commercial selling team to get on the platform. And as we talked about in the prepared remarks, we'd expect in the second half of the year to start to roll out to our service organization going forward.

So you couple the enabling technology with CXP, with the work we intend to do this year around developing stronger standards for execution, supported with the right training, we feel like as we head into 2022, we're going to have a really strong package of standard operating procedures, great training through Terminix University, supported with a good solid CXP platform to enable that, provide our team with the tools that they need to do their job.

Yes. The other area it's also going to help us is with M&A. And definitely with tuck-in acquisitions, getting them integrated much faster and getting them up on basically our platform and being able to basically monitor consistency across the company from an SOP standpoint with all the branches, and it's just going to basically make us a much more integrated operating business.

Maybe one last thing that I'd add to, as I learned more about this industry and the route-based model and the experience we're delivering to customers, you realize quickly how important those customer relationships are between our techs, in particular, and the households or the customers that they serve. And that's another major advantage here is we want to free up their time to spend as much time as they can in building those relationships. And certainly, that becomes enabled with tighter SOPs and stronger execution through the technology.

Yes. And it's also important to understand that most of that investment has been made. And then any ongoing investment is already included in our guidance, both from a CapEx standpoint and from an operating standpoint.

Our next question comes from Toni Kaplan with Morgan Stanley.

Also wanted to add my congrats to Tony and look forward to working with Brett and Robert. Wanted to ask about your long-term view on the right level of EBITDA margins. I guess there was a time when margins were in the mid-20s, but I think many people would view that as potentially a period of underinvestment. Now you're at sort of mid- to high teens but maybe in an elevated damage claims period. So I guess, what are you viewing as a normal margin level for the business long term? And how are you thinking about investing for growth versus margin expansion within that context?

Yes. Thanks for the question, Toni. Just maybe a couple of overarching comments, and Bob can add some color here. Certainly, I think we see a significant opportunity here to improve upon our margin base in 2020 that we've established here. The team has done a great job this last year of expanding margins, and we certainly expect to expand margins going forward. And I think that's a guiding principle here going forward as well as we expect to expand margins while we're making some of the operating expense investments that we need to make in this business.

I think it's fair to say our long-term target of 30% incremental margins is still an appropriate target for us. And certainly, as we exceed those targets, it's going to drive our overarching margins up going forward. So at this stage, we're comfortable with the guidance we're providing for next year. Again, 30% incremental margins is the appropriate target here. That frees up, I think, enough operating expense here for us to reinvest back in the business, but we're comfortable with the 30% incremental target we've established.

Yes. And I also think that we did provide you some guidance on the headwinds that we have both from a training and some lost productivity as we launched the CXP experiment, I guess, and then experience. And then also increased travel, we got to get back on the road. We've got to start seeing our branches more and understanding what's going on in the field. That obviously has not happened in the past year.

And then we had some great experience from an employee retention standpoint due to COVID. So we've got concerns that some of that may be a headwind also. So I think in the short term, we've got some headwinds, and that's why we've kind of got steady improvement going from early 17.2% in the prior year to 17.6%. We're guiding in the 18% to 18.5% range on a go-forward basis for the next 12 months, I think. We do have some challenges short term, but we think that they do go away long term.

Maybe the second part of the question there was how do we balance margins and growth. And I think as we demonstrate in our plans for 2021, we are going to strike a balance here between showing margin expansion, but also we feel like we're making the necessary investments, the appropriate responsible investments at this point in our journey. That's going to develop capability that unlocks, I think, more accelerated growth in our out-years, '22, '23 and beyond, given the investments we're making in SOPs, training and development through the Terminix University as well as some of the investments in marketing and the e-commerce platform.

Our next question comes from Gary Bisbee with Bank of America Securities.

Good luck, Tony. it's been a pleasure.

Thanks, Gary.

So I guess, thinking about 2020 and your commentary today and really over the last couple of quarters, there certainly were several areas where there was some real momentum evident on the back of a multiyear turnaround effort here. And I guess I just wanted to ask, do you feel like you have a good sense for how much of those benefits in a couple of categories may well have been a byproduct of the pandemic and where you could see some of that turn into a modest headwind? I think you acknowledged on employee retention being up. That may well have been somewhat impacted by the job markets. But are there other categories that -- those improvements in retention? Are margins sort of perversely benefiting from not having had the summer sales program? And if you reinstitute that at some point, does that become a headwind? And I'm not trying to suggest that there wasn't a lot of progress. I just wonder if some of that was pandemic-related and creates some headwinds over the next 12 to 18 months we should be thinking about.

Yes. I mean we've provided that in the guidance. I mean I think that we do have a travel headwind. Again, as we mentioned that we got to get back on the road. We had a labor productivity headwind because of that retention. And then we also have -- the commercial pest business was a challenge this past year, where we've lost roughly 5% of volume and -- but we still have 4% in price increase. So there's still a lot of things that are impacting us related to COVID that we've got to shore up here in the long term. And we've reflected that in this guidance and -- but we do feel like it's an opportunity longer term.

Yes. I think it's -- just going back to the point to around -- certainly, I think we commented that our employee retention certainly benefited this year from maybe a less mobile work environment. So we've got some work to do as we lap that. But having said that, I think the investments that we're going to make, improving teammate experience, better training strengthens our employer value props. And we feel like there's a nice offset to maybe some of the tailwinds that we enjoyed through COVID.

But I think also from a consumer behavior point of view, some structural changes long-term that COVID's created, certainly stronger awareness around safety and health in both service lines, residential and commercial, that certainly is going to benefit us going forward as well as a work-from-home dynamic that's likely going to persist post-COVID as well. It sets up a nice backdrop, I think, for our Residential business.

Our next question comes from Mario Cortellacci with Jefferies.

I'll reiterate the same as everybody else, good luck to both Tony and Bob.

Thank you.

On the new e-commerce platform, could you just help size up any cost or investment that is going to be involved there? And then similar to the question on CXP, how is that going to be different or even differentiated from the competition? And does the launch in the back half of '21, is that just like an initial phase? Or is that something that will continue into 2022 and potentially helping ramp organic growth in '22 or would have a benefit from that into '22?

Yes. So the first part of the question around e-commerce, as we made the comment in our prepared remarks, we're self-funding the investments in both the modern website -- the modernized website as well as stronger e-commerce capability. And that's coming from stronger return on investment and other channels that we're using to help self-fund that. So no incremental investment this year being made in that enhanced capability.

As it relates to CXP, I think the real opportunity we have to differentiate our services versus the competition, again, are the relationships that our techs enjoy. All the touch points that we have between our brand and our customers become a real strong part of our differentiation. That's in line and consistent with our industry-leading brands. I think our opportunity here has been how do we unlock the capability and empower our team on the frontline to enhance those relationships by having access to real-time information that's timely and provides that 360-degree view of the customer that's been missing here. So unlocking our team's ability to extract value there, I think, is at the epicenter of what CXP is all about.

As it relates to timing, you characterized it right. We're going to start to roll out after the pest season from -- starting in Q3 into Q4. Of course, we would expect that to roll through the calendar year into Q1, Q2. How long it's going to take us is all going to be dependent upon how well the initial rollouts go beyond pilot. The team's developed a very robust plan that we're working through today. And at least right now, we're expecting a roll over the calendar year into Q1 to complete that.

Yes. And from a capital perspective, again, it's within the guidance that we provided as a $30 million to $40 million of CapEx and then also within the margins that we provided from an EBITDA perspective. So all of that's captured in here. And as Brett mentioned, it will go into 2022, but the majority of it should get done in 2021.

Mr. Jenkins, there are no further questions at this time.

Yes. That concludes our call today. Thanks, everyone, for your continued interest in the company. And we look forward to talking to you again on our next earnings call tentatively scheduled March -- excuse me, May 6.

That does conclude the conference call for today. We thank you for your participation and ask that you please disconnect your line. Have a great day, everyone.