Terminix Global Holdings Inc (TMX) 2014 Q3 法說會逐字稿

Ladies and gentlemen, welcome to the ServiceMaster Company's third-quarter 2014 earnings conference call. Today's call is being recorded and broadcast on the Internet.

Beginning today's call is Brian Turcotte, ServiceMaster's Vice President of Investor Relations. And he will introduce the other speakers on the call. At this time, we will begin today's call.

Please go ahead, sir.

Thank you, Francisco. Good morning and thank you for joining our third-quarter 2014 earnings conference call. Today you will hear from ServiceMaster's Chief Executive Officer Rob Gillette; and Chief Financial Officer, Alan Haughie.

For those of you who haven't had a chance to download the investor presentation from our website, I'll walk through the agenda items shown on slide 1. Rob will lead off by providing a summary of our third-quarter financial results and review our performance by segment. Alan will then review our consolidated results in more detail, and provide a fourth-quarter and updated full-year 2014 outlook. Rob will then provide summary comments before opening the call to questions.

Before we begin, I'd like to remind you that throughout today's call management may make forward-looking statements to assist you in understanding the Company's strategies and operating performance. As stated on slide 2, all forward-looking statements are subject to this 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, October 30, 2014. The Company undertakes no obligation to update any information discussed on today's call.

This morning, ServiceMaster issued a press release filed with the SEC on Form 8-K highlighting our third-quarter 2014 financial results; and we have posted a related presentation, both of which can be found on the Investor Relations section of our website.

We will reference certain non-GAAP financial measures throughout today's call, and we have included definitions of those terms in our press release, which is available on our website. We have also included reconciliations of the relevant non-GAAP financial measures to the most comparable GAAP financial measures in our press release and presentation, in order to better assist you in understanding our financial performance. All references on the call to EBITDA are to adjusted (technical difficulty) find in our press release and the figures labeled as such therein.

I will now turn the call over to ServiceMaster CEO, Rob Gillette, for opening comments. Rob?

Okay. Thanks, Brian. Good morning to everyone. Thanks for joining us for our third-quarter 2014 earnings call. As you can see on slide (technical difficulty) another strong performance in the third quarter. Total Company revenue increased $49 million or 8% versus prior year, driven by strong performances by all three businesses. American Home Shield, or AHS, revenue was up 12%; and both Terminix and the Franchise Services Group, FSG, grew at 6% versus prior year.

Third-quarter EBITDA improved $29 million or 22% compared to prior year, driven primarily by Terminix, up $12 million or 18%; and AHS, up $7 million or 13%. Please note that the EBITDA comparison to 2013 continues to include the benefit of roughly one-quarter of the $25 million of annual corporate costs transferred to TruGreen commencing in January 2014.

Third-quarter adjusted net income of $61 million improved $29 million or 88% compared to prior year. Third-quarter adjusted diluted earnings per share of $0.45 increased $0.10 versus prior year. I should note that the diluted shares outstanding for the third quarter of 2014 were 135 million compared with 92 million shares for prior year, as a result of issuing 41 million shares in our IPO, which closed on July 1.

Pre-tax unlevered free cash flow of $121 million is an increase of $36 million over prior year. Free cash flow also continued to represent a very high cash contribution rate, at about 77% of EBITDA at quarter end, an improvement from 66% over last year.

Moving to segment performance, slide 4 provides the strong third-quarter results for Terminix. Revenue increased 6% over last year, reflecting 5% and 9% growth in pest control and termite revenue, respectively. Third-quarter 2014 adjusted EBITDA for Terminix was $77 million, up $12 million or 18% compared to last year, primarily reflecting the flow-through effect of higher revenue and production labor and overhead cost efficiencies. The EBITDA margins improved 230 basis points year-over-year.

Slide 5 provides more detail in Terminix revenue growth by channel. As you can see, we achieved year-over-year growth in our three key channels. The 9% increase in termite revenue reflects improved pricing, an increase in both new unit sales and renewals, offset in part by a 2.6% decline in the contracted customer count as of the end of September.

As I mentioned last quarter, we have levers to pull that drive organic revenue growth. This benefits all periods, but is especially important when cooler weather conditions lead to a weak or absent termite swarm season. The team continued to do a great job in the third quarter, driving revenue growth through the increased sales of innovative products like wildlife, exclusion services, and crawlspace encapsulation.

Moving to pest control, the 5% increase in revenue reflects improved pricing and favorable product mix. Pest control customer counts as of the end of September increased slightly. This was the first year-over-year increase in contracted pest control customer accounts since the fourth quarter of 2012. In addition, the pest control retention rate as of the end of September increased 80 basis points year-over-year to 80.2%.

I should point out that some innovative services are one-time in nature, and not renewable or annually contracted. In addition, some customers prefer one-time treatments to address their pest problem, and are not interested in an annual contract. We're happy to provide these customers service because it's good margin business. And, in general, we found that many single-treatment customers like and value the service we provide, and later agree to an annual contract to protect their homes or businesses. However, that doesn't mean that our Terminix sales team and technicians don't pursue renewable, annually contracted termite and pest control business with the same intensity exhibited in the past.

Turning to the AHS results on slide 6, third-quarter revenue was $245 million, up 12% compared to the prior year. Revenue associated with the HSA acquisition at the end of February 2014 represented over two-thirds of the increase versus prior year, with the balance driven by organic growth, including 3.4% higher customer accounts, excluding HSA, and a favorable product mix. The AHS customer retention rate increased 140 basis points as of the end of September, and includes the impact of HSA.

Third-quarter adjusted EBITDA was $61 million, an increase of approximately $7 million or 13% compared to a year ago. This increase primarily reflects the flow-through effect of the higher revenue, lower claims costs, and operating efficiencies, partly offset by the incremental $5 million of marketing spend to drive AHS revenue in 2015, and structural SG&A we absorbed with our acquisition of HSA.

I should note that our direct-to-consumer channel first-year sales have increased over 20% in the third quarter, end September year-to-date, versus prior year.

Although first-year customers in this channel typically file one more claim per year, on average, than a first-year real estate channel customer, a direct-to-consumer customer's lifetime value net margin is over twice that of a real estate customer.

In regard to contractor retention, I'd like to point out that the AHS base of approximately 10,000 contractors is, in general, extremely loyal and sticky, since we provide them with a significant percentage of work with no customer acquisition costs. In addition, the contractors benefit by being able to offer additional services to those customers we provide to them.

The Franchise Services Group third-quarter results, shown on slide 7, include revenue of $64 million, an increase of 6% compared to prior year, driven by an increase in janitorial national account revenue. Third-quarter adjusted EBITDA was $19 million, a decrease of less than $1 million or 3% versus prior year, reflecting the mix impact of higher growth in lower-margin janitorial national accounts, lower product and license sales, and timing of some general and administrative expenses.

Alan will now review our third-quarter and year-to-date 2014 results in more detail, and then provide the fourth-quarter and updated full-year outlook. Alan?

Thanks, Rob, and good morning, everybody. I will now briefly cover the third-quarter 2014 consolidated results, shown on slide 8. Now, as Rob mentioned, revenue increased 8% or $49 million versus the prior year. And we can categorize this as $31 million or about 5% of organic growth, with actually similar growth rates in all three segments; plus about $18 million from the HSA acquisition within American Home Shield.

I should also note that within American Home Shield, there was no impact this quarter from the in-year timing of revenue compared to 2013. You may recall that we mentioned in the second quarter a $9 million year-over-year revenue increase impact. This will be offset in the fourth quarter, and will make no difference to the full-year revenue.

So, gross profit increased by $29 million, $9 million of which was due to the acquisition of HSA. Therefore, $20 million of the $29 million gross profit increase was largely organic, representing a conversion rate of 68% of incremental revenue into gross profit. Hence, the gross profit margin increased by 1 point to 48.2% of revenue, including the benefit of lower claims costs at American Home Shield, which actually contributed about 0.5 point of gross margin improvement across the whole organization.

Selling, general, and administrative expenses decreased $5 million in the quarter versus last year, and by roughly 3 points of revenue. And this improvement in SG&A reflects the impact of about $6 million of costs being transitioned to TruGreen; and the fact that since the IPO, we no longer pay management fees of $2 million per quarter to our equity sponsors.

However, we did also absorb about $6 million of additional structural SG&A with the acquisition of HSA, which occurred at the end of February this year. And as discussed last quarter, and just now by Rob, we invested approximately $5 million more into American Home Shield marketing than in the third quarter of 2013.

Now, I mention all this to point out that if taken in isolation, these four discrete items would actually result in a net increase in SG&A of about $2 million. So the fact that SG&A [fell] by $5 million reflects year-over-year functional cost reductions and overhead efficiencies of about $7 million.

So, as discussed on the second-quarter call, both the IPO and the term debt refinancing became effective on July 1, with payment of the high-yield debt reduction taking place on July 16. As a result, the other significant components of our net income in the third quarter versus last year were the loss on extinguishment of debt of $65 million, which includes $35 million of prepayment premiums and the write-off of $30 million of previously capitalized debt issuance costs; and, of course, the consulting agreement termination fees of $21 million.

So as a result of this debt reduction, we actually lowered net interest expense by $12 million compared to last year. So, although we're showing a pre-tax loss of about $5 million, this is after charging $86 million of IPO and refinancing-related items.

Now, as you might expect, we report a small tax benefit on this $5 million of pre-tax loss, resulting in a $3 million net loss from continuing operations; and, ultimately, a $4 million loss when including $1 million of losses from discontinued operations. I'll discuss our tax position in a moment with the year-to-date results. I don't think it makes a great deal of sense to discuss taxes on a virtually breakeven result.

So, third-quarter adjusted net income -- which, again, I will discuss further in a moment -- increased by $29 million over the prior year to $61 million. And third-quarter EBITDA of $157 million increased $29 million over the prior year, reflecting obviously the improvements in both gross margin and SG&A, as discussed.

Slide 9 provides two reconciliations. First, we walk our segment performance measure, adjusted EBITDA, down to income from continuing operations, and then walk the reconciliation back up, as it were, to adjusted net income.

And two concepts require explanation or clarification in the second reconciliation. First, we exclude all amortization expense -- $13 million for the quarter -- from adjusted net income. As I explained last quarter, the majority of this amortization -- about $10 million, in fact -- actually stems from the definite-lived intangibles that were created when the Company was originally taken private in July 2007.

Now, the second point is that the $86 million of IPO and related debt refinancing costs are also excluded from adjusted net income to give a measure of the sustainable net income generated in the quarter. I should note that the tax impact of the adjustments shown in the reconciliation apply slightly different tax rates to the various line items, but the blended rate is about 36%.

Turning to cash flow, we show here a third-quarter and September year-to-date simplified cash flow statement on slide 10, in an attempt to better explain the sources and uses of cash for ServiceMaster. Now, pre-tax unlevered free cash flow is our preferred measure for the sustainable cash-generative capacity of the Company, and the components are shown at the top of the slide.

So, starting with the third quarter, pre-tax unlevered free cash flow was $121 million, a $37 million improvement over the prior year. And this improvement is, of course, largely the result of the EBITDA increase.

But I'd also like to stress that the revenue growth in the quarter clearly did not require any significant working capital investment. And, furthermore, this quarter's pre-tax unlevered free cash flow represents a 77% conversion of EBITDA, up 11 points versus the prior year.

And the remainder of the items on this cash flow summary are actual amounts paid, not movements in balance sheet items. In other words, in the third quarter of 2014, we generated $121 million of pre-tax unlevered free cash flow. We paid $82 million in interest; $2 million dollars in cash taxes, primarily state taxes; paid $11 million for acquisitions; and had other sundry payments of about $2 million. And this means that we generated $24 million of cash in the quarter, technically available for debt pay down.

If we repeat the same exercise for the first nine months of the year, shown on the right-hand side, then we've generated $140 million of cash available for debt reduction. And although, as shown on this slide, we contributed a portion of this to the TruGreen spin at the earlier part of the year, the remainder was used for debt paydown, along with balance sheet cash from the beginning of the year.

Now please note, also, that a formal reconciliation of the US GAAP cash flow statement to pre-tax unlevered free cash flow is provided in the appendix and in the press release.

Now, our September year-to-date consolidated results, as shown on slide 11. September year-to-date revenue increased by 7% or $120 million over the prior year. This reflects about $70 million or 4 percentage points of organic growth, plus $41 million from the HSA acquisition, and $9 million of in-year timing of revenue at American Home Shield. Gross profit increased by $60 million, representing a 50% conversion of additional revenue into gross margin. And the gross profit as a percentage of revenue increased slightly, by 0.2 point.

Now, if we repeat the exercise of stripping out the impact of the HSA acquisition, the in-year timing of revenue, then we're left with about $71 million of organic growth and $37 million of organic gross profit improvement, a conversion of 52% of incremental revenue into gross margin. And again, rather like the deconstruction of SG&A, my point is simply that even in the absence of these other factors, the underlying business operates at a healthy variable gross margin of 50%.

So, on to SG&A for September year-to-date. These decreased $22 million versus the prior year, and by 3 points of revenue. And again, similar to the third-quarter SG&A discussion, there are three major offsetting items: the transition on the year-to-date of $19 million of costs to TruGreen; offset by $13 million of SG&A acquired, so to speak, with HSA; and $6 million of incremental marketing spend at American Home Shield. These three items net to zero, leaving essentially the $22 million of reported SG&A improvement wholly attributable to functional cost reductions.

So, income from continuing operations decreased $23 million to $22 million from the prior year, with the improvements in gross margin and SG&A being largely offset by the loss on extinguishment of debt, the software impairment from the first quarter, and the consulting agreement termination fees. However, adjusted net income increased by $62 million versus the prior year to $135 million, given that the aforementioned items and the amortization expense are excluded from the measure.

So, our year-to-date effective tax rate is about 54% compared to 49% last year. And the principal reason for this higher tax rate is actually the non-deductibility of the loss on extinguishment of debt and other termination fees for state tax purposes. Our full-year 2014 effective tax rate is projected to be about 49%. Quite high; but if we exclude a couple of discrete items, including a one-time deferred tax adjustment related to the TruGreen separation, the rate would drop to a more indicative corporate rate of about 39.5%.

So, September year-to-date EBITDA of $443 million is $82 million higher than prior year, due to the improvements in gross profit and SG&A, as discussed, naturally. I should also note that the reconciliations of income from continuing ops to adjusted EBITDA and adjusted net income for September year-to-date are provided on slide 16 of the appendix of today's webcast presentation.

Now, turning to the fourth-quarter and full-year outlook on slide 12, we have provided a range for revenue and adjusted EBITDA, as well as a comparison of the outlook to the prior year. Starting at the top with the fourth quarter, we're projecting 6% to 8% revenue growth versus last year, and 12% to 18% adjusted EBITDA growth. This actually includes our increased marketing reinvestment in Home Shield, with roughly a further $6 million expected to be incurred, over and above last year's fourth-quarter marketing spending in Home Shield.

And moving to the full-year 2014 projection shown on the lower half of the slide, you'll see that we are projecting 7% revenue growth, and 21% to 22% EBITDA growth. And we currently believe we'll generate at least $543 million of EBITDA for the full year, an increase of $8 million from our projections in August. Our net leverage is projected to be about 5.4 times, based on this EBITDA range. As you may recall, pre-IPO, at the end of March, leverage was 7.8 times. And the pro forma leverage anticipated post-IPO was 6.6 times, so a very healthy improvement there.

So, that concludes my comments on ServiceMaster's financial results and outlook.

And I'll turn the call back over to Rob for closing comments.

Okay, great. Thanks, Alan. Since joining ServiceMaster a little over 16 months ago, we've made a great deal of progress executing our strategic vision for the Company. We've been sharing this story along the way. And you'll recall that our first order of business was adding new executives to the leadership team. We then successfully completed the spinoff of TruGreen in mid-January; went public on June 26; and closed on our IPO and debt refinancing on July 1. Also, in July, we conducted a strategic review with our Board of Directors to plan the path forward for the new ServiceMaster.

As noted in our earnings press release this morning, we announced that AHS President, Mark Barry, has also assumed leadership of the Franchise Services Group, and will serve as Group President of both businesses, though these businesses will continue to report financial results separately. Mark has done a great job leading AHS since 2012, and we think he's the right leader to take both AHS and FSG into the future.

In addition, Marty Wick has been appointed President of FSG, reporting to Mark, and will oversee all of our franchise brands. Marty is a strong leader who has introduced and championed many of the operational changes implemented in AHS to drive improvements in our call center operations and create a better experience for our customers and contractors.

Marty joined ServiceMaster in 2009 as part of the innovation and process improvement group, before moving to AHS in 2011 and being named Vice President of Operations in 2012. Prior to joining ServiceMaster, Marty held numerous leadership roles in sales, service, product management, and distribution, with telecommunications leaders Sprint and CenturyLink. We believe this realignment will allow us to accelerate top- and bottom-line growth of both AHS and FSG by simplifying our Company and potentially reducing duplication.

We also believe that consolidating the leadership of the two businesses will allow us to apply the great work AHS has done in the digital space to our franchise businesses, and leverage our franchise expertise and relationships to drive growth and differentiation in AHS.

With the decision to realign the two businesses, Tom Coba has chosen to leave the Company and pursue other opportunities. I'd like to thank Tom for his leadership at the Franchise Services Group over the past three years. His tenure with FSG was marked by a number of improvements at our franchise operations, and we all wish him well in his new endeavors.

The realignment is consistent with our overall strategy to drive growth and profitability at ServiceMaster, leveraging talent and best practices across our businesses wherever possible.

As we think about the future, we're focused on a number of opportunities, including improving lead conversion in overall growth rate at Terminix; expanding our efforts to grow AHS in the direct-to-consumer channel; accelerating franchise development in FSG, and exploring franchise opportunities in AHS; continuing our tuck-in acquisition strategy; expanding our footprint in North America; and identifying other value-added services we can provide to our existing customer base; continuing to drive process improvement and margin expansion, while remaining committed to using our strong cash flow for debt reduction, as Alan mentioned earlier.

In closing, we have great businesses, strong brands, passionate associates who are providing essential services, visiting more than 75,000 homes and businesses each day. We're committed to taking these additional steps necessary to continue to drive growth and increase shareholder value. And I look forward to sharing our performance with you in the coming quarters.

I will now turn it over to Brian for Q&A.

Thanks, Rob. As a reminder, during the Q&A session, we encourage you to ask any questions you may have; but please note that guidance is limited to the outlook we provided in our press release and webcast presentation this morning. Additionally, since the queue is long this morning, please limit yourself to one follow-up question so we may get to everyone in the allotted time.

Francisco, let's open the line for questions, please.

(Operator Instructions). Karru Martinson, Deutsche Bank.

Let's see, customer count is up slightly in pest control for Terminix. And I was kind of wondering how the other parts of the business were doing, and what's the outlook here for building on customer acquisitions?

Okay. In the body of the presentation, we mentioned customer count. This offset customer count roughly down 2.6%. But I would say the decline in general has reduced; so a positive trend in both the pest side, we mentioned, but also in termite. It was a light demand season for termite, which I think you are all aware.

But I'm proud of the team and what they have been able to do to improve the customer experience, and actually grow the count on the pest side. And we'll continue to work on improving this service as we provide all of them.

Okay. And then when you mentioned in the areas of focus -- the tuck-in acquisitions, value-added services -- are these more focused on building out the existing verticals, or expanding into new categories, and what are the opportunities out there?

I'd say we look at both. The primary focus is expanding the verticals that we serve today. But we also are evaluating services that we think are complementary. We have close to 5 million customers in total that are different by brand and business; some similar, but a lot of differences; so we're looking to leverage those relationships we have. And I think a great example of that is the innovative product sales that the Terminix team has done, primarily with our existing customer base so we can bring value to them and think about different ways to help them with their needs.

So we'll focus on that as primary, and then again think about new and different ways to leverage our skills and abilities to pursue value-added services, like we talked about before, that people will appreciate.

Thank you very much, guys. Appreciate it.

Kevin Ziets, Citi.

My question is on the American Home Shield side. Did the deductible increase have a positive impact on the quarter, and when do you anniversary that?

Yes, the interesting -- this is Alan here. The interesting point about the deductible increase, it went in place a year and half ago, two years ago, and it takes a while to filter through. So, yes, a part of the reason for American Home Shield's increase year-over-year is the increase in that deductible. So, the good point is that's permanent because it's now part of the, let's call it, the pricing structure, if you will. And we look -- we're still looking at when the best point is to increase that deductible again.

And, really, the best way to do it is by changing the structure of the product and bringing in new products with different sets of features. And that really is probably the best mechanism for changing the deductible.

And I think one of the examples we've quoted before is having a slightly lower price point and a higher deductible. I think there's greater exploration in areas such as that, by actually changing the product shape rather than just a routine increase in deductible. But at this point in time, we haven't decided when we'll next raise the deductible across the board.

Yes, I think just to add -- this is Rob. We also introduced new products on the real estate side of the business, where we're really offering customers the opportunity to choose that mix and benefit, as Alan mentioned, between the premiums they may pay and the deductibles they have.

But also then on a direct-to-consumer side, allowing them to choose different types of coverages that fit their need, which also gives some balance between the premium and the deductible. And many are choosing higher deductibles and different plans. So that's pretty innovative, we think, in the market.

Okay, that's helpful. And then I guess my follow-up is on the last call, you mentioned a bigger push into digital marketing. And I was wondering if you could update us on the progress there, and which divisions are benefiting from that.

Yes, I think that we talked a lot about American Home Shield and the work that they've done. And, in fact, now we generate about 30% of our revenue directly through consumers buying online, which is great. And that's up over 20% or less, just a year and a half ago.

That's at Home Shield?

I think that's phenomenal. And then the services they've provided in terms of handheld applications and the ability for people to schedule -- roughly half of our schedules to service come either through IVR and/or the Internet. So, customers appreciate it. And I think they form opinions about our servicing capabilities through what they see digitally.

And we're translating a lot of the best practices from American Home Shield to the Terminix team. And they're working hard to continue to improve what they do and provide services to customers. And I believe that we'll be able to translate a lot of that digital capability in social media; interface with customers to the Franchise Services Group with the combination of the two.

Thanks very much.

Samuel Eisner, Goldman Sachs.

Can you talk a bit about the pricing benefits that you saw in termite and pest? What specifically is driving that? And do you believe that's somewhat short-lived, or do you see an opportunity to get further pricing in the fourth quarter; and then, ultimately, next year?

Well, it's a fundamental feature of this business that, on a year-over-year basis, we can virtually always increase prices by at least, let's call it, the underlying rate of inflation. So, price increases in this business -- this is a dangerous statement -- are what you might call a permanent feature. It's a characteristic of the nature of the services we offer. So, yes, we can always push prices up, basically along with the people's -- let's call it consumer's sense of underlying inflation.

Understood. And then just as a follow-up, regarding the cash conversion, Alan. It's around 77% of adjusted EBITDA in the current quarter; but it's much higher, it seems like that, in the first half of the year. Can you maybe just talk a bit about the delta between the third quarter conversion and the first half of the year?

Yes, that's essentially -- if you think about the way we recognize revenue, particularly in most of our businesses, largely a portion of our cash comes up front. So if you forget the way it's accounted for in the moment, in American Home Shield when we get a real estate contract, the cash is paid up front; direct-to-consumer customers pay monthly. With Terminix, certain services are paid for up front, termite completions. And then renewals and pest work is paid ratably.

But we don't recognize revenue naturally in the same pattern, so what you get really in the third quarter is deferred revenue being recognized through EBITDA, but we got the cash in a previous quarter. So, Q3 is traditionally one of the lightest cash flow quarters, actually. And, hence, that's why you get this gap between EBITDA and cash flow, which totally normalizes by the end of the year.

Understood, thanks.

It's really a function of when revenue is recognized.

Suzanne Stein, Morgan Stanley.

This is Denny Galindo on for Suzi Stein. I had a question about September and October trends. Your competitor mentioned that they were seeing a very strong September, and October also looked good, and that they thought maybe some of the demand that didn't come through in the spring was coming through now. So I was curious if you agree with that statement. Are you seeing the same thing? And maybe is this something that drove some of the pricing and mix in the pest control?

Okay, it's Rob. I'll take that one. I think the positive trend that you saw in pest in terms of the customer count would be indicative of a positive trend towards the end of the quarter and maybe into October. So I think that's a plus. And I think for us versus their business, we've done a lot on the innovation side. And we continue to sell to customers some of the insulation services and other things that we provide. So we've got a sales team in place that's doing that, so I think that that will be a positive for us as well.

I think, considering Q2, or Q1 and Q2 demand scenarios specifically for termite, which didn't really come to fruition as we all might have liked, and we redistributed our effort and energy on selling these other services. So, I'd say a positive. Not overwhelming demand changes, but I think part of what you are seeing at our business is the differentiated services we provide.

Okay. And then going a different direction for the follow-up, I just wanted to know if you could delve in a little bit more to the combination of American Home Shield and Franchise Services Group, and how you expect that change.

First, what areas will you focus on with the merged group? And then how do you expect the financials of either group to change? Will there be potentially some margin benefits, or maybe sales growth should be lifted in Franchise Services Group? Or just maybe walk me through the financial goals that you have for the new merged unit.

Okay. Well, I would first start as to the reasons why. I think I've mentioned it before. Our history has been, we run our businesses very autonomously. And I think one of the most strategic advantages that our franchise services team has is the connectivity to the larger ServiceMaster -- our customers, the capabilities, the sourcing relationships we have, and our abilities to do different things like the digital technology we discussed. So I think there's significant opportunities for them to get closer to the core of what we do, and then translate that to our franchise customers and help them grow. So that's the primary reason.

In terms of the financials, we believe that there is some synergy. But the focus is really on growth and margin expansion. And I think we can do a better job there. I've left it up to Mark and Marty to decide how best to do that. So we just made the announcement obviously today, and talked to the teams yesterday. So we're going to give them the balance of the year to sort through a lot of those opportunities and then identify what we can do to grow.

So, the primary emphasis is that, and I believe it is our advantage. I think there's opportunity to take advantage of the 70 years plus that we have, with franchisees and franchising, to look at what we can do with AHS as well, and developing franchises for that. We've mentioned that before also in our conversations with the team.

So, I think it's a good combination of skill base that will enable us to enhance both businesses and what we do. Financially, we mentioned we'll continue to keep the two separate from a reporting basis, so you can expect to look at them side-by-side that way. And as we continue to focus on how we grow the business and improving the financials, we'll update you with the results.

Andy Wittmann, Robert Baird.

I wanted to dig into the guidance a little bit. If you just look at the EBITDA guidance that's implied for the fourth quarter versus consensus, I know you guys didn't give the quarterly guidance, but you beat the consensus EBITDA by $15 million. You raised it about $8 million. There's a $7 million gap. Maybe the way to address this to you guys is the implied margins on a year-over-year basis, on the EBITDA margin basis, looks flat to slightly down if you use the midpoints. Given you got a little bit of help from TruGreen and some other things, I was wondering what could explain that disconnect.

Well, a couple of things. In American Home Shield, remember there is the impact of this second-quarter revenue timing, which as I said, will come home to roost in the fourth quarter, so that's obviously baked in. But fundamentally -- and we will still, by the way, year-over-year, still get the final quarter of that TruGreen benefit in SG&A of $6 million or so, year-over-year. Cost of transition will take place, the final piece of that in the fourth quarter. But it is a forecast that we're confident that we can meet or beat, I'll put it that way.

Okay. That's helpful. And then maybe just, Rob, on the Terminix, you talked about how you have some levers if the termite season is weak. It looks like it came through pretty well. I was just wondering for your updated view on how often you can go to this well. I think I maybe asked this question last quarter, but were there special incentives? Did you pull forward demand on some of these one-time items that maybe somebody was thinking about it, they saw a price, and they did it? Just some of your commentary, I think, to delve into that a little bit more as we head into the fourth quarter, and then even into the first quarter before we get the next big swarm.

I think that it has grown with our customer base over time. Because we have now -- we demonstrate and develop these new product offerings in a limited number of branches to make sure that we get them right. And then what we have done is translated that and done the training to the other branches, so it's really just gaining momentum. So if you think about some of the work that we've done in encapsulation and the rest of the work, we didn't do it in a number of branches in 2013. And we just started executing across the board, I would say, in the second half of 2014. So I think part of what you're seeing is momentum of that. And I think we are continuing to do that.

It helps us -- especially if you think about the insulation side and encapsulation, this time of year you would tend to see the demand for pests and termite obviously starting to fade, as you get into the colder months. But the insulation side and encapsulation is something people look to do this time of year, before the cold weather sets in. So I think it's helping us smooth the seasonality of Terminix and grow the business in different ways. So, we'll continue to look at what we can do there. And we expect to have more innovative products in the future.

Thanks. Hey Alan, just a quick one. Can you just give the acquired revenue for Terminix? Maybe I missed that in the script. Can you give what it was in the quarter?

We didn't disclose it, I'm afraid. And to be honest, year-over-year, the acquired revenue that hit in the quarter was actually very, very small; so, not a great deal, is the most I'll say.

Okay, thank you.

George Tong, Piper Jaffray.

In the Terminix segment, could you provide additional color on your progress in investing in sales and marketing staffing, how these initiatives will translate into new sales growth in termite and pest, and when we should see the impact?

Yes, I think we're starting to see it now. I mentioned the improvement of some of the seasonality and some of these product offerings extend more into the fourth quarter. So we have retained the salesforce in a greater way than we have in the past. And we're continuing to sell these new products and innovations into Q4.

So, I think that part of it is training; part of it is timing. But I think we'll continue to focus on the core of what we do, which is the contracted businesses for termite and pest, and you saw a little bit of improvement on the pest side there; as well, make sure that we translate and execute these new product offerings. And in general, we have increased the salesforce this year versus prior years.

So, on the marketing side, we continue to look at improving our digital efforts on that side of the equation in Terminix and serving customers. But we also continue to invest, and invest in Q2 on the direct mail side and other campaigns to continue to drive growth. So, I'd say, in general, we are probably continuing to invest in, and maybe have retained longer, a number of the commercial guys that we have to grow these other product lines that we have.

Thanks. And then can you comment on the competitive landscape in Terminix and American Home Shield? Whether you are seeing any share shifts, and how you think about approaching the so-called unpenetrated market opportunity in both markets?

Yes. I'd start with American Home Shield. We're a leader by far in that business -- over 40% share and probably growing. We haven't looked at it recently. And I think in the direct-to-consumer channel, we lead by far, and are somewhat creating that segment through our efforts in advertising and outreach, in terms of social media and other things. So that's pretty exciting.

We mentioned year-to-date and in the quarter was up 20%, so that's phenomenal growth in this business. We're still at only 3% to 4% penetration of households. So we think this direct-to-consumer side is going to help people understand the value, and then help us to grow the business. So we'll continue to invest there. So I would say, in that sense, we're almost creating that market versus shifting it from someone else.

And real estate has been pretty steady for us, and we'll continue to invest in that. And we offered a couple new products, as I said, that simplify and provide people with choice in that segment, so we're excited about that.

I think in terms of Terminix, it is still the same. A lot of these innovative services -- we're extending our relationships with the existing customers we have. So, higher revenue with some of the key customers that we've had in the past, and we'll look to continue to grow.

And I would say on the competitive landscape, it is still more focused on the independent contractors, the 17,000 or so that are out there, and the ability that we have to provide professional services that work for customers. So that's really where we gain share; and have done pretty well on the commercial side, which I think we mentioned in Q2, as well.

So we are continuing to invest in and develop our capabilities in commercial, which will also give us growth into 2015.

So, I would say, again, the competition that we pursue and come in contact with most is the individual, independent contractors.

Very helpful. Thank you.

Gary Bisbee, RBC Capital Markets.

A question on the FSG segment. The growth dipped a little bit this quarter. And this is the business where I think you are expecting the most acceleration versus the longer-term historical performance. So, is the management change a sign that maybe you aren't progressing as well as you'd hoped or expected with the growth the strategies there? And I guess in particular for this quarter, why did the royalty revenue have a pretty sharp deceleration versus the pace of the last quarter or two? Thanks.

Okay. I'll talk about the business side, and then Alan can chime in on the royalty side. I think it's more a reflection about executing and implementing our strategy, as we mentioned during the presentation. And, obviously, we'd prefer to have more versus less growth, but I think it's more a timing issue as it relates to the revenue we generated.

And with some of the changes financially in the marketplace, we had to refile a number of -- with a number of states to sell -- for the requirements of our listing. So when we changed and spun TruGreen, it sets us back a little bit in terms of new franchise sales, because by state there's different requirements. So that has impacted us somewhat.

I think the pull-through strategy to support our janitorial customers on developing national accounts is obviously working well, and that's part of the mix impact which Alan can speak to, as well.

So, I think we had a lot of different ideas about how to grow in different places. And some have been very successful, like the national accounts I spoke of; and then some have been less successful. So I think the combination of the two is to get better leverage on growth for both AHS and Franchise Services, and to bring them closer to the core of the business, and think of new and creative ways to grow both.

So, Alan, if you want to speak to some of the royalty mix?

Yes, sure. The royalties from Merry Maids are a little flatter in terms of not growing at the same rate as the previous quarters. And one of the other aspects is that because -- oddly enough, because of the IPO and because of the TruGreen spin, that actually slows down the rate at which we can sell new licenses. It's just purely a regulatory feature, and to do with filing with the various states. And that slows down the ability to sell new licenses, largely through bureaucracy. And so that's one of the reasons why the fee revenue has slowed down, because we have been selling licenses at a slower rate this year than last year, largely, because of that regulatory problem. I think it's just a blip.

Obviously, what helps is the filing of our third-quarter results, actually, with positive net worth, and so on. And that should actually help get some of these regulatory filings accelerated, and increase our ability to sell into some new licenses in some of the major growth areas. So that's a feature in the slowing down the growth of the fee revenue.

Okay, great. And then the follow-up question, just any details you'd be willing to share from what came out of your strategic review from the Board. Or should we think that it's much more just blessing the medium-term growth rates and strategies that you've discussed since coming public? Thanks.

Okay. Yes, I would say more specifics greater than we have, we probably wouldn't discuss. But some of the steps that we are taking today are a result of that strategy discussion. And we'll continue to look at the existing businesses we have today, and what's the right way to grow them, and where we should focus our priorities versus maybe historically. And that includes the other businesses, as well. So I think there's pieces of, I'd say, specifically commercial is a broad-brush comment for not just Terminix, but also for the Franchise Services team.

I think many of our customers would deem us more residential, which is true in terms of our revenue. But I honestly think we have significant opportunity to broaden our customer base by doing more commercial business. And Bill and the Terminix team are focused on that there, but I think we have opportunities in the franchise side to do it, as well.

So, that would be a common theme I think that overlays all of it. And we've done phenomenally well on the residential side, but there's certainly opportunity to expand that. And we have teams and personnel today that are pretty used to dealing on a B2B level where our history has been more B2C.

So, that's a common theme. I think continuing to drive the productivity -- like we've discussed a number of times with the investment community and our own guys -- is another primary focus that applies to all; whether it's driving field productivity and how efficient we serve customers, and how well we're on time, and the number of calls we can do per day to some of the leverage opportunities that exist, whether it's advertising spend across the board, or narrowing the supply base that we work with. I think we still have a lot of room to improve there, but also we get benefits off the investments we make today.

So, as broad statements, I would say that's core. This direct-to-consumer idea and marketing digitally is, I think, a big space for us to grow. And we've exhibited and demonstrated how we can do that in American Home Shield, and I'd like to see us translate that across the board. It's been a great surprise to all of us, and I think a significant opportunity for the future.

So it's those three things in general; and then, specifically, as we focus on different business areas, and what we do at the core -- we'll keep you posted.

Great, thank you.

Sara Gubins, Bank of America.

Good morning, this is Brian Davis in for Sara Gubins. I'm wondering how much of an impact weather had on the American Home Shield business versus your initial expectations. Specifically, you had mentioned lower claim activity. Was that driven by weather, or was that driven by other factors?

There is a weather impact in there. And the claims favorability here for the third quarter compared to last year is about $3 million. A portion of that is the product changes that we've made that are obviously having a, let's say, a slightly greater impact than we had originally expected when we put them in. And so there is a portion of that claims favorability, maybe half of it is probably weather-related in the third quarter; because, yes, it has been a mild summer.

Okay, very good. And then switching gears to acquisitions and M&A, you had mentioned roughly $11 million in acquisitions in the third quarter. And I'm just wondering, how does that tie in with the international expansion opportunities that you had mentioned during your analyst day? And generally what is the pipeline looking like, and what regions and segments are you focused on? Thank you.

To start with, the largest portion, but by no means all of it, the acquisition payments in the quarter were for our Terminix business in Canada. So, it's not exactly a massive leap across the ocean, but branching out into Canada is still relatively new for us. So we're certainly increasing our Canadian presence. There are a number of large markets there that we're very interested in.

But the -- our progress, let's say, on the international front is an aspect that we're still developing. We have to determine the right means and the right markets. And as Robert often says, basically wherever it's hot and humid, there are opportunities, particularly for the pest control business. And as we've said before, many of the aspects of the franchise business, particularly disaster restoration -- that basically can translate overseas, too. But in terms of broader international strategy, we're still developing that.

I would say the other thing is part of the opportunity of thinking about international, too, is we have a -- I won't quote an exact number, because I'm not sure; Brian can maybe find it for you -- but we have a pretty significant presence through franchising around the world. So, we look to franchises, and our franchisees in North America, as potential partnership opportunities. But I think it's not one that we've examined or taken a close look at in our business internationally. So we have an extensive network of franchisees all over the world. So that's a first starting point is to how we might think about new markets internationally.

Okay. Thank you, guys.

Sanjay Singh, Credit Suisse.

My first question is just on American Home Shield. The new warranty plans you had touched upon earlier -- can you share how the reception has been thus far; what sort of impact this may have on our forecasts as we think about next year? Is it more of a revenue opportunity or margin, or really too small to be able to tell at this point?

Well, I think the team in the industry would describe it as a breakthrough, mainly because there's been very few product offering changes over the years. We had one core offering on the real estate side. So I think the difference is is that we're providing consumer's choice, so I would hope that would expand the number of people who participate, and the penetration in the market; but also help drive value to them, and profitability to us.

As Alan said, we're giving them the choice to decide what balance they would like to take a look at, in terms of the service fees they buy or the deductibles that they have, versus the fees they pay in premium. So, we're starting to offer differentiated services in different packages.

So, if someone is concerned about, specifically, HVAC, they can proceed solely with that. If they want a full home warranty and coverage of all mechanical systems, we can certainly do that. So I think it's going to help us grow the business. And I think it's going to help encourage customers to think new and differently about it.

Is it going to shift the curve monumentally in the near-term? I would say no. But I think it offers us significant opportunity, and maybe a different customer base to access as well.

Okay, that's helpful. And on the Terminix side, I know you mentioned that team's execution in driving traction in the newer product offerings. I was wondering where you were seeing traction beyond what you may have anticipated, and other innovative products that you are excited about going forward.

Yes, we have a number of things that we're working on and beginning to execute. I'd say this is our first year with the mosquito product that we had. And I think we're pretty excited about our ability to execute in a stronger way in 2015. So I would say you can expect that. And I think we did really well. The product worked great; customers liked it. I think we can translate that in a broader way as we go forward, so that would be one primary area.

I think some of the other focus areas and translating it to the broader number of branches we have, whether it's encapsulation or the other services we provide, I think it introduces our capabilities to customers in ways that they may not have thought of us before. So I think we have a pretty creative, entrepreneurial team of people on the ground. And they think of new and different ways to do things all the time. And I think a lot of customers sometimes struggle to find qualified, motivated, and professional contract services like we can provide. So I think that's a growth area for the team as well.

We'll continue to think of new and different ways. And I'm pretty confident, as we translate that and get more accustomed as a team to selling those services, that we can accelerate growth.

Okay. Thank you.

There are no more questions at this time. I turn the call back to you.

Great. Thanks, Francisco. Unfortunately, Jeff Volshteyn from JPMorgan fell out of the queue, but he did send me some questions. And I think we've answered most of them.

But Rob, Alan, do you have any competitive landscape commentary in Canada? I'm assuming he's speaking to the pest control industry.

No. Over the last 16 months, we're entering the market obviously through acquisitions. And so we're excited about the opportunity to grow and provide the services that we do in the United States to customers in Canada. So, I would say we're excited about it. We have a good footprint today, and I think we can build on the services and processes we have to grow.

Great. And the last question is, did the changes to the incentive comp plan at Terminix, how did it impact turnover -- with techs, I'm assuming?

Actually, I would say that it hasn't affected it at all. And that I think that it encourages our team in the field to improve and focus on retention equally, and then in the future have opportunities to benefit through providing and selling services to our customers. So, as we mentioned before, one of our big focus areas is to empower the service techs to be able to provide services to their customers, and participate and increase their earnings through doing so. So that's one of the things we're focused on, too.

Great, thanks. So, I want to thank you again for your participation in today's call. As a reminder, a replay of the call will be available on our website in about one hour from now. We look forward to speaking with you again when we announce fourth-quarter and full-year results, probably sometime in mid-first-quarter of 2015. So thanks again, and have a great day.

Thanks.

Thank you.

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