Terminix Global Holdings Inc (TMX) 2020 Q3 法說會逐字稿

Ladies and gentlemen, welcome to the Terminix Third Quarter 2020 Earnings Call. Today's call is being recorded and broadcast on the Internet.

Beginning today's call is Jesse Jenkins, Terminix' Vice President of Investor Relations 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 statement legends contained in our public filings with the Securities and Exchange Commission. These forward-looking statements are not guarantees of performance and are subject to the risk factors contained in our public filings that may cause actual results to vary materially from those contemplated in the forward-looking statements.

Information discussed on today's call speaks only as of today, November 5, 2020. The company undertakes no obligation to update any information discussed on today's call.

This morning, Terminix issued a press release filed with the SEC on Form 8-K, highlighting our unaudited third quarter 2020 financial results. We also issued a press release this morning announcing a settlement with the Alabama Attorney General regarding our Mobile Bay Formosan termite business practices. These press releases, 8-Ks and the related presentation can be found on our new 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 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; and Chief Financial Officer, Tony DiLucente. Slide 3 of the presentation posted on the Investor Relations section of our website shows the agenda we will cover today.

I will now turn it over to Brett Ponton. Brett?

Thanks, Jesse, and thank you all for joining our call today. Before I get into the performance of the quarter, I'd like to begin by recapping a few observations from an eventful first 50 days. My first 1.5 months on the job has been spent working closely with both the senior leadership team here in Memphis and directly with the front line.

I would like to thank the technicians and management teams in Dallas, Orlando and Mobile for taking the time to meet with me as I get up to speed. Over the next few months, I look forward to visits with other teammates across the country as I continue to educate myself on the finer intricacies of the pest control business.

As I spend time with teammates in all levels of the organization, one of the things that becomes immediately clear is the organizational focus on the customer experience. The passion of the team to deliver excellent customer service is evident in every interaction I have had in my short time at the helm.

The team has done a good job of understanding and tracking the metrics around the customer experience that will drive improved business results. I've always felt that employee retention is a critical component of success, and it has been a real driver of improvement for Terminix over the course of 2020.

Engaged experienced teammates delivering valuable services to our customers in their time of need are improving Net Promoter Scores, which are a clear leading indicator to customer retention. Something unique in our business is the opportunity to consistently engage with our customers over multiple touch points in a year. Our ability to understand what makes those touch points stand out to people will drive better customer satisfaction and, ultimately, better customer retention.

When I'm in our branches and offices, I can see the clear focus on a customer-first culture. I have spent much of my career helping companies in need of a turnaround, so it is nice to inherit a company that already has such strong operating momentum and clearly defined organizational objectives, supported by substantial industry tailwinds.

I look forward to putting my own stamp on some of the finer points as I lay out my strategy in the coming months. But I feel encouraged about the current direction and momentum already evident in the business.

During my travels and initial meetings, I've identified a few opportunities that we will dig into over the next few months. One clear objective will be improving the consistency of our operations.

Today's settlement underscores the importance of consistent operating standards, training and quality assurance in the business. By enhancing our focus on the fundamental operating procedures, branch by branch and technician by technician across the country, we can limit the volatility in earnings we have experienced over the last several years.

There is considerable knowledge in the business at the local level, and we have the opportunity to [still] that knowledge down and leverage best practices across the organization through robust training procedures and quality assurance. We also have the ability to create a more clearly defined teammate experience, complete with development opportunities and career paths.

And finally, with the sale of ServiceMaster Brands behind us, we need to realign our support structure around a leaner organization, 100% focused on equipping our passionate frontline with the enhanced tools, technology, training and development opportunities to deliver excellent customer experiences. I am encouraged by what I have seen in the first few weeks.

The core business is on a stable foundation and already making progress on a powerful set of initiatives. Improved execution, supported by strong underlying industry dynamics, has the company positioned well for future profitable growth.

And with that, I will turn to Slide 5 to discuss recent performance. In the third quarter, the company delivered top line revenue of $512 million, with growth of 10%. Our termite service line saw retention gains and strong new unit sales in both core termite units and home services, delivering 4% organic growth, which would have been 6% if not for the $3 million onetime impact of the Mobile Bay Formosan termite settlement, which I will discuss in more detail in a moment.

4% organic growth in Residential Pest Control was highlighted by retention gains, volume growth and pricing realization, partially offset by lower summer sales units and onetime bed bug services. And although our commercial pest business was down organically year-over-year, we saw a strong sequential improvement from last quarter and are cautiously optimistic about the trends in October.

Third quarter adjusted EBITDA was $98 million, with a margin of 19.2%, a year-over-year expansion of 370 basis points. Strong EBITDA margin expansion was driven by improvements in employee and customer retention.

One of the most impressive aspects of this business is free cash flow generation, and year-to-date, we have generated $232 million. And as Tony will cover in more detail in a moment, The ServiceMaster Brands sales significantly improved our capital structure and provides us ample flexibility to pursue attractive tuck-in M&A deals and the capacity to support larger strategic targets as they become available.

And finally, we were able to negotiate a favorable settlement with the Alabama Attorney General regarding our Formosan termite business practices in the Mobile Bay Area, the impact of which falls within our previously disclosed ring-fence estimates. Tony will spend considerably more time on this settlement, but we were happy to resolve a large portion of this lingering liability in the quarter.

As we exit the third quarter and look into the fourth quarter and beyond, I am encouraged by the positive results and strong momentum. Turning to Slide 6, I will give a brief update on our progress on strategic priorities for the year.

When I joined the company in September, I was encouraged by the focus on a manageable number of key priorities in order to accelerate solid performance. We continue to make meaningful progress on each of these strategic priorities, and this is driving the improvements in both growth and profitability over the last few quarters.

Employee turnover improved 18% in the third quarter compared to the prior year. By focusing on better hiring assessment, onboarding and training and development practices, we were able to continue to drive service-level and customer retention improvements, not to mention $7 million of labor productivity in the quarter.

While the impacts of COVID on the job markets are likely aiding the impressive performance, we believe the actions we are taking are sustainable and will continue to aid turnover and efficiency gains into future periods. With more seasoned and experienced technicians on the job, customer satisfaction continues to improve, as seen in Net Promoter Scores and customer retention.

On the residential side of the business, combined termite and residential pest daily cancel rates are down 18% year-over-year in the third quarter. Consistent improvement in daily cancel rates over the last several quarters are starting to drive trailing 12-month retention rates in the right direction.

We continue to see meaningfully better retention and first-year customers as new customer additions during the pandemic are responding well to more frequent communication designed to clearly explain employee and customer safety measures. With first-year customers moving into the base and Net Promoter Scores remaining at elevated levels, we feel confident we have runway to continue to make meaningful retention improvements as we progress towards the top end of the industry-level customer retention.

As I discussed previously, these retention gains, coupled with our initiatives to improve productivity and our cost structure, drove margin expansion 370 basis points year-over-year. Strong pricing realization, especially in commercial and growth in high-margin termite services in residential, were also contributors to our margin expansion.

And finally, We are making meaningful progress on revitalizing our termite business. With a heightened focus on this service line, we were able to deliver strong termite organic growth through sales of our new monthly pay tiered product offering. New core termite units were up 17% in the quarter and, combined with the strong first year retention rates I mentioned earlier, will set us up for customer account growth into 2021.

On my trip last week to visit our team in the Mobile Bay Area, I saw firsthand our commitment to serving our customers and the significant progress made on our ongoing supplemental treatment plan. To date, we have completed approximately 9,000 supplemental treatments and dual-defend conversions.

Net of cancellations, we have less than 2,000 supplemental treatments remaining to perform, and we are on pace to complete the mitigation plan within the calendar year. These supplemental treatments are helping to drive outstanding nonlitigated claims in the Mobile area, down 27% year-over-year, and new nonlitigated claims filed in the third quarter are down 42% compared to the same period in the prior year.

And Tony will go through the details in a few minutes, but there are many favorable factors of this settlement that have me optimistic we are trending in the right direction as we work to put these issues behind us. I will now hand it over to Tony to discuss the third quarter results, the Mobile Bay settlement and fourth quarter guidance. I will return with some closing comments before our Q&A session. Tony?

Thanks, Brett. Today, I'll cover Q3 performance, highlighting improving organic revenue growth trends and continued margin expansion.

Turning to Slide 7. Let's start with the continuing operations financial summary. I'm going to talk about the Terminix segment in more detail later, so let me first cover European Pest Control and Other operations.

Our European Pest and Other operations contributed $21 million of revenue and $4 million of EBITDA in the period, highlighted by strong results for Nomor in Sweden and Norway, which delivered over 20% margins. Additionally, Terminix U.K. made significant progress adding scale in their start-up and broke even in the third quarter, thanks to recovering volumes and cost improvement actions.

Although we're mindful that COVID infection rates are increasing in the U.K., the impact of the third quarter was minimal. The recent U.K. announcement regarding business shutdown to combat the rise in infection rates is being evaluated. But currently, we do not expect the overall impact to be material to consolidated Q4 financial results.

It's important to note that Q3 is the strongest seasonal quarter in Europe. Additionally, there was a favorable out-of-period adjustment for Norway in Q3, which won't repeat. For this reason, we expect to see European margins return to more normalized and seasonal levels in the fourth quarter. With that said, we're excited about the progress we made in Q3, especially in the U.K., and look forward to continuing improvements in the future periods.

Adjusted EBITDA was also impacted by our move of ServiceMaster Brands to discontinued operations. There was $3 million of back-office support function costs that were previously allocated to this segment that accounting standards requires us to classify within continuing operations.

With the completion of the ServiceMaster Brands sale on October 1, we will no longer separately break out these cost allocations, and we'll absorb them in the Terminix segment going forward. We continue to make progress reducing our cost structure, in line with becoming a pure-play pest control company.

Including Terminix, which we will discuss in detail in a moment, adjusted EBITDA of $98 million improved $26 million or 37% year-over-year, for a margin of 19.2% in the quarter, 370 basis points better than the same period in 2019. Adjusted net income and adjusted earnings per share, up 47% and 52%, respectively, reflect the flow-through of higher EBITDA in the period as well as the impact of the Q1 share buyback.

Turning to Slide 8. You can see the Terminix revenue growth by channel. Overall, Terminix delivered revenue growth of $30 million or 6%, with organic revenue growth of 2%. Excluding the price increase refunds as part of the Mobile Bay Formosan termite settlement, which I will discuss in more detail in a moment, total revenue and organic growth would have been 7% and 2%, respectively.

Starting with the Termite and Home Services column on the left side of the chart, revenue grew $7 million, with 4% organic growth in the quarter. If you adjust for the price refunds from the Mobile Bay Formosan termite settlement, organic growth in this service line would have been 6%. Breaking down the components of growth further, termite renewals were down 4% to prior year, but would have been flat without the price refunds from the Mobile settlement.

We continue to see strong retention improvement in the termite service line, especially in first-year customers. Termite completions and home services were up 13% in the quarter, with core termite completions up 17% and home services completions up 9% year-over-year. The continuing strong performance in core termite is driven by sales of our new monthly tiered termite product and active swarm season, while the growth in home services is driven by cross-selling opportunity that core termite sales present, coupled with more people working from home.

The sale of renewable core termite units made up approximately 53% of the total Termite and Home Services completion revenue in the quarter. The strong growth in renewable units, combined with better retention rates, bode well for 2021. As we look to Q4, we continue to see growth in our termite business, but at a seasonably lower level as seasonal termite demand wanes.

Residential Pest Control grew 5% in the quarter. Tuck-in M&A contributed 1% of the growth, while organic revenue growth was 4% and approximately 500 basis point sequential improvement over the second quarter. As Brett previously mentioned, we continue to see improvements in customer retention, with daily cancel rates in residential pest down 16% versus prior year.

Growth in Residential Pest Control was partially offset by our decision to limit summer sales activity in order to protect 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 8% in the quarter.

These items will continue to affect the rest of the year as the loss of revenue associated with summer sales units carried 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're planning for continuing organic growth in residential pest in the fourth quarter.

Commercial Pest Control revenue was up 8% in the third quarter versus prior year, with M&A growth of 11% more than offsetting an organic decline of 3%. Acquisitions continue to provide significant growth as the onboarding of Gregory and the Cloud provided new commercial capabilities and experienced management teams to our portfolio. As a reminder, these acquisitions will move into the organic growth line starting in the fourth quarter.

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 sequentially over the second quarter and continue to improve in October. We continue to monitor increasing infection rates across the country, but remain cautiously optimistic that improving trends will continue.

In the Other revenue service line, product sales saw considerable growth from the McCloud acquisition, but organically, Other revenue declined by 14% from lower sales through our master distributorship channel. Sales to distributors were negatively impacted by inventory level adjustments in response to COVID as well as lower demand from smaller pest control companies that serve commercial customers.

Although organic growth is down this quarter, we continue to see great value from this business due to the significant purchasing leverage that it creates with our vendors. Overall, the third quarter delivered solid revenue growth in residential pest and termite and improving trends in commercial pest off April lows as the economy continues to recover.

Moving on to Slide 9. You can see the EBITDA drivers for the quarter. Revenue growth added $14 million in the quarter, with $9 million generated by organic growth and $5 million from M&A, as margins from acquisitions improved sequentially as we realize synergies from previous deals.

Direct cost productivity generated $10 million of higher EBITDA in the quarter year-over-year. $7 million in labor productivity was primarily the result of improved labor management and better employee retention. We also saw vehicle maintenance costs decline $3 million year-over-year through the onboarding of a new vehicle maintenance provider, lower fuel prices and fewer vehicles on the road.

Indirect and G&A cost productivity generated $7 million of higher EBITDA year-over-year in Q3, primarily from the previously announced $18 million of 2020 cost actions taken in the second quarter. We expect continued savings in the future periods from these actions and are on track to grow these to a run rate of $30 million on a full year basis in 2021.

We also continue to enjoy lower travel expenses due to COVID and saw improvement in collections in the residential business. We also saw a $2 million decrease in sales and marketing expenses in the third quarter. These savings are primarily timing-related and, for the full year, sales and marketing are tracking roughly flat to 2019.

Partially offsetting the year-over-year net increase in EBITDA is $5 million of higher incentive compensation costs due to improved financial performance in 2020. As a reminder, in the fourth quarter, we're lapping a $9 million favorable incentive compensation adjustment that will impact year-over-year margin comparisons.

We also saw $4 million of higher termite damage claims costs, primarily related to our efforts in the Mobile Bay Area. Total termite damage claims and mitigation expense was approximately $19 million in the quarter. Our mitigation efforts remain on track, and we are making good progress on our supplemental treatment plans in the Mobile Bay Area.

Expenses for the mitigation program were approximately $3 million in the period. Underlying termite damage claims increased $1 million in the quarter as we saw reductions in both nonlitigated and litigated file claims counts year-over-year. In total, adjusted EBITDA margins of 19.9% at Terminix, expanded by 420 basis points when compared to the third quarter of 2019.

Moving to Slide 10, you can see the projected capital structure and leverage after the sale of ServiceMaster Brands. In addition to the $51 million of Term Loan B debt we paid off in Q3, we plan to retire all $750 million of our 2024 high-yield bonds on November 15. After the applicable estimated taxes and fees associated with the sale, we plan to add approximately $347 million of cash back to the balance sheet, reducing our net leverage ratio to just below 1x last 12-month adjusted EBITDA.

The debt reductions will save us approximately $40 million in mostly cash interest on an annual basis, and pretax will improve our earnings per share by approximately $0.30 on an annual basis. The 1x leverage ratio is below our targeted long-term range, giving us ample capacity to continue to pursue accretive bolt-on acquisitions, while preserving capacity to explore large strategic deals, should they become available.

As part of the sale of ServiceMaster Brands, our Board has authorized a new $400 million share repurchase plan that we plan to use systematically to offset dilution as well as opportunistically in times of weakness in the market. The leaner balance sheet provides support as we focus on organic growth and operational consistency as a pure-play pest control business.

Before we turn to the impact of the Mobile Bay Formosan termite settlement, I thought it would be helpful to refresh investors on the specifics of our original ring-fence estimates, as seen on Slide 11. As we discussed in February, we expected to see between $130 million and $150 million in termite damage claims expense, above our historical norms of 4% of Termite and Home Services revenue through 2029. As we discussed at that time, we expected the expenses to be front-end loaded, with $45 million above historical norms expected in 2020 and $100 million expected by 2024.

Turning to Slide 12. I'd like to walk through some of the details of today's Mobile Bay Formosan termite settlement and the resulting changes to our ring-fence estimate. There are 3 main components to the $49 million settlement.

The first component is the establishment of a $25 million state-sponsored consumer fund. The fund will be managed by an appointed facilitator that will oversee various remediation efforts as well as manage the refund of price increases to customers in the Mobile Bay Area. As I discussed on the termite service line breakup, this resulted in a $3 million reduction in termite renewal revenue recorded in the third quarter.

The facilitator will also have the authority to resolve consumer disputes on future termite damage claims. This will provide customers with a state-sponsored process for the speedy resolution of claims rather than the lengthy litigation process. Over time, this process should decrease the number of disputes that moved to litigation and reduce the volume of high-cost litigated claims and the associated legal fees.

The second component of the settlement includes $6 million to reimburse various state agencies for administrative costs. The third component is a $19 million settlement with the state. Under Alabama law, this settlement mitigates future punitive damage awards for litigated claims filed by Mobile Bay Area consumers after the date of the settlement.

Essentially, the settlement serves as a pull forward of those punitive damages and provides more certainty on the total amount of damages we may have to pay. This helps to reduce the expense recorded on future-litigated claims filed, dissuade consumers from seeking costly and time-consuming litigation and limits the potential negative outcomes that may occur in volatile arbitrations. While we still have a backlog of litigated cases outstanding to work through during 2021 and early 2022 that are not impacted by this settlement, we are confident the effects of this settlement will limit our future liability and reduce litigated claims cost in our P&L in the coming years.

Turning to the ring-fence estimate bridge. You can see the impact of the settlement and its associated benefits on the expected total future liability. Starting on the left, the consumer fund increased the ring-fence by $25 million. The reimbursement of the administrative costs increased the ring-fence by $6 million. And the settlement added an additional $19 million.

The benefits from reducing future punitive damage awards and litigation filed after today is expected to reduce the estimate by $15 million to $20 million. And the expected reduction in future case volume from the establishment of the consumer fund is expected to reduce the ring-fence by between $15 million and $20 million. These factors result in a new ring-fence estimate of between $140 million and $150 million above historical norms over the 10-year period.

It's also worth noting that we still believe 2020 to be the peak claims expense year. And as you can see, including the cost of the settlement in claims expense through the third quarter, we have already recognized $81 million of the total expected amount above historical norms.

With the improved clarity on total expenses that the settlement provides, we were able to tighten the total range by $10 million. While we are now trending towards the high end of our previous estimates, we believe this settlement provides significant value to Mobile Bay customers, while providing Terminix with better certainty from expected future termite damage claims expense.

In total, we expect between $59 million and $69 million of remaining elevated termite damage claim expense through 2029. And consistent with the previous estimates, this is expected to be front-end loaded, with most of the costs coming in the next few years.

The positive trends in both litigated and nonlitigated claims and the benefits of this settlement give us confidence that we can move forward with better predictability into 2021 and beyond. Before I move to the guidance page, I would be remiss if I didn't thank the Mobile Bay supplemental treatment team for all of their hard work in 2020 to get us to this point.

Moving to the outlook on Slide 13. For the fourth quarter, we expect revenue between $445 million and $460 million, We expect adjusted EBITDA between $60 million and $70 million, and margins between 13.5% and 15.2%.

Organically, we expect continued strong demand in termite and residential pest to be partially offset by lower year-over-year summer sales units and the continued lower trends in bed bug services due to reduced travel during the pandemic. The guidance assumes less than $5 million of revenue from U.S. acquisitions completed during the 12 previous months primarily from small tuck-in deals, evenly split between Residential and Commercial Pest Control service lines.

We expect double-digit revenue growth in our European Pest Control businesses to deliver between $18 million and $20 million in the fourth quarter. The outlook assumes commercial pest will continue the positive trends we've seen over the last several months as the economy continues to reopen, and that residential demand will not be negatively impacted by economic issues associated with the prolonged COVID impact or resurgence.

Adjusted EBITDA will see the flow-through of higher revenue and expected continued productivity and indirect expense benefits from the second quarter cost actions. The year-over-year margin comparability is negatively impacted by the lapping of $9 million in lower incentive compensation expense from the fourth quarter of 2019.

Normalizing 2019, the year-over-year margin improvement for the fourth quarter of 2020 would be over 300 basis points. For the full year, we expect adjusted EBITDA above the top end of our prepandemic full year adjusted EBITDA guidance as we continue to see strong momentum in the business.

And with that, I'll now turn it over to Brett for closing comments. Brett?

Thanks, Tony. Before I pass it back to Jesse for the Q&A, I wanted to thank the many teammates who have helped me get up to speed over the last few weeks. I am energized by the passion across the organization to deliver creative solutions for our customers in their time of need.

The velocity of improvement we have made in the underlying metrics of the business, like employee retention, customer retention and margin expansion, is a testament to the hard work and dedication of many during a difficult pandemic backdrop. And with today's settlement behind us, I am confident that we have considerable opportunities to continue to strive for more consistency in our performance across the business. By equipping the frontline with the enhanced support, training and technology needed, we can continue to build upon our impressive performance.

As we look towards the future as a pure-play pest control company, we have considerable flexibility to self-fund investments in those initiatives that will drive sustainable, profitable growth for years to come. I look forward to sharing more with you on some of those specific initiatives and the forward-looking strategy on our next earnings call, but I'm encouraged by the strong foundation already in place and the momentum of the team as we work to deliver a strong close to this challenging 2020 year.

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 that we can get to everyone in the allotted time. Let's open the line for questions.

(Operator Instructions) Our first question comes from Tim Mulrooney with William Blair.

I'm going to leave the termite questions for somebody else. My question is for Brett. And congrats on the new gig, by the way, Brett. We're excited to see what your leadership means for the company. And that's really what my question is about.

I know you've addressed this a little bit in the prepared remarks, but I wanted to drill down very specifically on the residential turnaround effort. How do you think about what stage or phase or inning the company is in with respect to the turnaround effort? And has the heavy lifting been done? And now it's just about making sure that retention rates continue to rise? Or do you still view this as there's a significant amount of work that still needs to be done here?

Thanks, Tim. First of all, I appreciate the warm welcome and the question. Over the past 10-plus years or so, I've been more of a turnaround guy, candidly. And so I don't know that I would necessarily characterize us as a classic turnaround, Tim, from my perspective. But let me share with you a little bit on why I say that.

First of all, our brand at Terminix is a wonderful brand. In fact, we have an industry-leading brand at this company. And I believe that this brand is not yet playing up to its full potential.

We got a great culture here at Terminix, and I've seen that firsthand in my first 50 days in the company. We got 10,000 passionate teammates that love this business and are committed to taking care of our customers, and truly proud to be a member of Terminix nation, as am I, candidly.

In my short time here, I've seen clear evidence at multiple levels of the organization of our team's focus and commitment on improving the customer experience. I've been really impressed, so far, with the progress we've made in 2020 across all 4 of the strategic priorities we've set out to achieve this year. I clearly understand the strategy that we set out. I believe in it, and I think the team is very focused on the right metrics here.

We're seeing great improvement in our leading indicators. Employee retention has been in the right direction, customer retention improvements. And both of those are clearly translating well into organic growth and margin expansion, as we covered in our Q3 results today.

I'd say our starting point here is very good. We have a strong foundation in place. We've got good operating momentum in our business. But having said that, Tim, I will say it, I do believe there is significant opportunities here to drive meaningful improvement in our business and really focus on improving the consistency in our operating performance going forward.

50 days in, I've identified a few areas that I think we'll dig in deeper on over the next few months. Number one, I see the opportunity here to improve our customer acquisition marketing. We're in the very early, early innings of development. What I'll say is we want to have, which is the world-class digital marketing strategy, to drive lead generation in our business. I have some extensive experience in this area in my career, and I'm also very excited about the new marketing leadership we have brought on board to drive this going forward.

We have a significant opportunity to drive operational consistency at Terminix from branch to branch and tech to tech. And consistent with what I've seen in other companies that I've been at over the year, and those companies that have grown primarily through acquisition, there's a real opportunity here to drive standardization across the organization., I think, by taking the best practices from our top-performing branches and institutionalize those best practices across all of our other locations.

We need to create a standard playbook here for our teams to execute against. And the playbook is going to be only as good as our ability to train against that, so we need to develop a more robust training strategy here at Terminix.

Seize some opportunities around enhancing our commercial sales and marketing efforts here, we've had the opportunity to strengthen our capability to drive significant growth in our commercial business. I was really excited to see the investments we made in M&A over the last 1.5 years or so. We've added a lot of capability to our company and our team. We have the opportunity now, I think, to scale that and build upon that.

Another area, I think, we have an opportunity to improve on and strengthen our analytics here at the company in 2 particular areas of importance to me. One is the opportunity to strengthen our capability around pricing. We need to understand deeper price elasticity and the opportunity to leverage, I think, market segmentation data to drive more localized pricing strategies in our business.

In addition, I think there's opportunities to improve our analytics around route density and optimization. I quickly learned in the short period of time here in the business that -- and how important route density is to our business model. That drives customer satisfaction, teammate satisfaction and certainly has the opportunity to lower our cost to serve.

And I'd say, probably, lastly, the other opportunity is around refining our organizational structure here to simplify the business model and get us really focused on our new model, which is a pure-play pest organization, with the organization that's 100% committed to supporting our frontline teams. So all in all, Tim, I'd say, I feel great about the foundation where we're at, certainly wouldn't characterize this as a turnaround. But I still see significant runway ahead for us in terms of driving significant meaningful improvement in our business.

Our next question comes from Ian Zaffino with Oppenheimer.

Good quarter. But maybe you could talk a little bit about, obviously, the termite side and Mobile, Alabama. I believe you were down there. Maybe walk us through some of the reflections you have, kind of the thoughts, and any kind of ground level details you have.

Sure, Ian. But as you would expect, one of the first markets I wanted to go visit was Mobile Bay, given the sensitivity to our business and the challenges that we've had in this area, felt it was extremely important to go down to that market for 2 reasons.

Number one, I wanted to thank the team for doing a great job of executing the supplemental treatment plan this year. And 2, I really wanted to understand at the ground level the opportunities or the issues that we have, and the opportunities that we created to improve our operating performance there.

So I had first-hand experience here with visiting consumers' homes, and I saw firsthand how we conduct the supplemental treatment plans being administered by our team. It's quite impressive to see how the team operated. I had a chance to spend a little bit of time with customers and hear firsthand how they appreciated the efforts that Terminix was going to, to re-treat their homes.

I was also very pleased to see the dedicated quality assurance teams that we had in place that provided, really, the enhanced training to our team and execute the quality assurance audit process that we put in place. There's clear metrics in place to measure performance, and our team is executing well against those metrics. I have truly left Mobile, I would say, inspired by our team and also very confident in the capability that we've established there to drive consistent performance in our business there going forward.

A couple of other areas that I've looked pretty hard at as well related to Mobile Bay is our claims trends. And I've been very encouraged by what we've seen in that particular area. Our outstanding nonlitigated claims in Mobile Bay are down 27%, Q3 versus last year. And our nonlitigated claims filed are down 42% versus Q3 of last year. So I feel pretty strongly that the efforts that we've put in place is translating nicely into improved performance in our operation there.

But I would say there's 2 key takeaways for me coming from the market. Number one, the Mobile Bay situation reinforces, in my mind, the importance of driving operational consistency in our business. This consistency will clearly lead to higher margins, improved customer satisfaction and, obviously, retention and, hopefully, less management time spent with regulators going forward. I left Mobile highly committed to doing what's best for our customers and making the necessary investments in our teammates to ensure that they have the tools, training and technology to properly deliver on that commitment.

Our next question comes from Toni Kaplan with Morgan Stanley.

Just wanted to make sure that I understand the settlement correctly. It seems that the $140 million to $150 million isn't exactly a cap on how much you'll have to pay out for the termite damage claims. But it could -- so could it be above that number? Is that fair?

It sounds like the settlement does limit the punitive damages, which I think is probably one of the most important factors. So I'm not trying to dismiss that. But just how should we think about the potential to come in above the ring-fence?

Okay. Thanks, Toni. I'll take that question. So the $140 million to $150 million ring-fence is our estimate of future liabilities. We feel confident in that estimate for a number of reasons.

Number one, we did a -- we're doing the mitigation program in Mobile that Brett just talked about. That's absolutely critical for us going forward. And we're already seeing the benefits from that, as we talked about, with the -- our outstanding claims being down 27% in that area and the new claims filed being down 42%. So we feel great about that.

The consumer fund that we're going to establish is going to be a really great thing for us for the consumer, number one, because they'll have an independent facilitator helping us to more timely file these claims going forward. And what that will do is reduce the number of litigated cases going forward. So we're pleased with that part of it, obviously.

We do feel the settlement does help reduce punitive claims going forward. So the cost per claims are going to go down in the future as well. We factored all of this information into our model that we used NERA, an outside company, an actuarial company to help us estimate this. And that's really the basis of the $140 million to $150 million ring-fence.

And so if you look at it, so far, we've incurred about $81 million through Q3, and that includes the settlement. So that means there's another $60 million to $70 million that will happen going forward.

Our next question comes from Mario Cortellacci with Jefferies.

I guess -- just my question is around the long-term margin profile of the business. I mean you made good progress this year with the cost takeouts that will benefit next year. But it sounds like, from Brett, you guys are also going to do some standardization. You're going to do some training. I'm assuming there's going to be some costs associated with that.

And then on just -- then I think you're also going to get some benefit from, it sounds like, refining the organizational structure. I don't know if that includes headcount, but I'm assuming there'll probably be some benefits there for the margin.

But I guess, just kind of having those building blocks and maybe even some others, just including some route density, I guess, where do you think you are in 2 to 3 years from now? And if you're able to provide any color to those building blocks, that would be super helpful.

Sure. I'll take that question. And as far as the sustainability of our margin improvement, the first key point I want to make is the G&A and indirect cost reductions that we made early in 2020, which realigned $18 million of improvement this year and annualized run rate of $30 million next year. That's absolutely critical into our success, so far, this year in the margin expansion.

Also key is the termite growth. Termite is higher margin, and we've seen great growth because of our new tiered products. So that's definitely -- will continue in the future and helps sustain the margins.

What I really like about what we did in 2020 was a really focused effort around 4 key priorities. The first priority was employee retention. Well-trained, well-onboarded techs are going to provide better customer service, which helps your customer retention and also helps your margins as it reduces training costs going forward.

We've made really good improvements in our business processes around, I'll call it, direct cost management as far as labor, number one. And you see all the labor productivity this year, fundamental improvement there. And then we did improve our vehicle maintenance. We have a new outsourced provider that's helping us there that we really feel good about going forward.

We're also obviously not done. We're in this journey. We're now a pure-play pest control company. That gives us a unique opportunity to focus on organizational structure so we can focus our priorities better going forward to help improve our business. And we think that's going to further cement the improvement.

So when you think about the guidance we've always given on this business, it's certainly intact. We see those 30% incremental margins, long-term average for this business, which puts us in a pretty good overall EBITDA margin perspective.

Maybe just to add a little more strategic color to that as well, Mario. Look, I've been here for 50 days, so I'm clearly not going to establish near-term targets here for the business. Tony clearly has covered that.

But from my perspective, if you start with our brand position in the company, we have a really strong industry-leading brand. And I see no reason why that the strongest brand in the industry shouldn't be commanding strong industry growth rates as well as margin performance in our business.

And as Tony said, we have a significant opportunity here to, I think, self-fund a number of the key initiatives that we have identified in the business. And this opportunity that we now have to get really hyper focused on being a pure-play company, certainly, will play well, I think, in our focus and create some additional opportunities to expand margins going forward.

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

If I can follow up on the margins more, sort of, tactically thinking through what was just incredible strength this quarter. The -- I hear you, Tony, on the G&A being sustainable. It sounds like the vehicle is a real improvement.

On the other hand, a portion of labor, at least, I would think, is somewhat COVID-impacted. The sales and marketing, it sounds like, is timing. And so is the -- how should we think about the next couple of quarters? Is this really the right level? Or was there some level of maybe timing that benefited this quarter that might not over the next few? I guess, just any of those moving parts.

And maybe, as part of that, one other one, given all of the termite updates and more clarity you now have, is it safe to think that, in '21, that $10 million of mitigation costs sort of goes to 0? Or is there some tail of that, that would continue into next year? And I guess that's really a 2-parter.

Yes. Thanks, Gary. You bring up a good point to mention. The -- obviously, we have some favorable tailwinds in 2020 from COVID in certain areas, travel expense is one you didn't mention. But we will see travel eventually increase, not to the levels that we were in 2019. But make no mistake, we have some benefit there that's probably driven by COVID.

On the labor side of it, yes, I think employee retention has definitely improved from the initiatives that we've undertaken. But there's also some tailwinds that you get from the fact that there's less opportunities and less, therefore, less people moving to new roles. So I certainly accept that. But when you look at the magnitude of the labor productivity, that's what was part of that is sustainable, and it's based on better practices and employee turnover. And I mean that helped improve employee turnover.

So I do think that there is significant fundamental sustainable improvement in the earnings. But it is important to recognize that there will be some changes in areas like travel expenses, and it will be a little bit more challenging on the employee turnover side just because there'll be more opportunities for employees as the economy picks up.

Our next question comes from Seth Weber with RBC Capital Markets.

I hope you're doing well. I wanted to just touch on something that I think I heard you say. The resi pest -- residential pest would have been up 8% organically if you were to sort of normalize for the summer sales program and the bed bug. Is that -- I guess, is that what you're saying?

And then is the implication from that, I mean, do you feel like that this business is now going forward in a position to kind of perform at industry growth levels? Maybe if you could just give us any kind of color on -- more color on retention rates and pricing that are contributing to that kind of 8-ish percent number.

Yes. I'll take that, Seth. So yes, you're correct. If you normalize the impact on summer sales, because we did pull back on that this year for safety concerns, then if you would normalize the impact of lower travel and bed bug, that's roughly $3 million each or $6 million for the quarter. And if you normalize that, you come up to 8% on a normalized basis.

So as far as the sustainability of that and our pace in getting to industry-leading organic growth rates. I think we made an important step ahead in that journey in 2020. And I think it was thanks to focus and prioritization around improving that employee turnover, focusing in on the drivers for customer cancellations and really working on the fundamental service levels.

And I think we're seeing that with respect to lower cancels in residential, which are down significantly this year, and NPS scores continue to improve. So all the underlying metrics and factors are there now, coupled with a very strong brand and the opportunity that Brett mentioned on digital marketing, which I'll turn it over to Brett to talk about that.

Yes. Sure, Tony. Just jumping in here. Yes, the team, I think, has done a great job this year on driving growth through being focused on retention.

But as I mentioned earlier, I think we have a significant opportunity to drive customer acquisition and get our lead flow much more robust than the business with concerted focus here on digital marketing, improving our online presence, with a really strong focus on improving our SCO performance in the business. I think you couple that focus on marketing, along with driving for consistent operating performance across our business, and we feel pretty good about closing the gap in our performance long term versus industry growth rates.

Our next question comes from Andrew Wittmann with Baird.

Sorry, I want to go back to the termite settlement a little bit more, just to make sure that I understand it one other way. It sounds like the way you described the mechanism is that you're going to be -- you're expected to reduce the amount of punitive damages.

But it doesn't sound like you actually limited your actual liability on that. That sounds like more like you're opening up a new channel that people who have previously chosen to litigate claims can now go to this more expeditious route without all of the headache.

And you think that it's really just other route, channeling this way with less litigation, less paperwork, all the strike that goes along with that is really the fact. They're not actual limitation on your liability. So is that the correct understanding of this? Or am I wrong on that?

Yes. Andy, it's Tony. I'll take that one. So the consumer fund provides for independent facilitation for consumers to resolve their termite damage claims issues. And that's going to reduce the number of litigated claims going forward because there's more rapid process on to resolve these disputes. So the number of future-litigated cases will go down. That's number one.

Number two, we do feel that it will reduce punitive damages on new litigated cases in the future because the settlement basically provides is a pull forward of those punitive damages. And so that's why we think the cost per litigated claim will also go down in future periods on litigated claims. So two-pronged, number of litigated cases reduced and the cost per litigated case goes down.

Our next question comes from George Tong with Goldman Sachs.

Termite and Home Services organic growth moderated a bit to 4% from last quarter's 7%. I know last quarter benefited from certain onetime items. But can you discuss the puts and takes that impacted organic growth in Termite and Home Services this quarter, and elaborate on some of the specific initiatives you have to accelerate that growth?

Yes. George, it's Tony. Look, we still had a pretty strong Termite and Home Services organic growth number because, if you normalize the reported 4% organic growth rate for the terms of the Mobile settlement on the price refund portion of that, we would have reported a 6% normalized organic growth, fairly similar to the amount we saw in Q2 as far as organic growth.

So the core termite portion of that line is -- it continues to do very well. The tiered product is definitely a success for us, one of the best launches I've ever seen in my career. I tip my hat to our team on that.

And then we're seeing the strength in home services. A lot of that is cross-selling off of the core termite growth. Some of that is due to the fact that more of us are at home working, and we notice things that maybe we haven't noticed before.

But we're really encouraged about what we see in termite. And remember, termite is a higher-margin segment for us, so that helps our margins as well.

Our next question comes from Michael Hoffman with Stifel.

And welcome onboard, Brett. Look forward to seeing you next week.

My question is about retention. And I apologize, I have 3 for earnings calls today. So if you talked about this earlier, I'm asking to repeat something.

We think you entered this year having gotten residential to about 80% and commercial somewhere between 80%, 85% and termite was 85%-plus. If those are the right numbers, from my perspective, how have you improved that through the year? What's the relative improvement?

Thanks, Mitch, and look forward to spending some time with you next week. Look, we're still making pretty good progress in Residential Pest and termite. While we're encouraged by the progress, there's still room, clearly, to become, I think, best-in-class. And the team right now is digging into all the customer touch points along the journey to understand what influenced this customer satisfaction to continue to drive that improvement going forward.

On the commercial side, pest control certainly has been impacted by COVID and some targeted reductions in profitable customers that we've done through price increase actions throughout the year. So excluding those items, we're roughly flat to prior year and still below industry levels as we continue to improve our service levels in the commercial side.

Yes. If I could just add a little bit to the Commercial Pest retention. We -- I want to remind everybody that we did aggressively address price on underperforming national accounts. And so that had some impact on our retention rates in commercial.

We made a lot of fundamental improvement in commercial retention in 2019, more flattish this year due to those factors and COVID. So just a point that I'm pleased with the progress we've made in commercial service levels and retention over the last couple of years.

Mr. Jenkins, there are no further questions at this time. Please continue with your presentation or closing remarks.

Yes. Thank you, and thank you for your continued interest in our company. We look forward to talking to you again on our next earnings call, tentatively scheduled for Thursday, February 25 of 2021. Thank you.

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.