Terminix Global Holdings Inc (TMX) 2016 Q4 法說會逐字稿

Ladies and gentlemen, welcome to ServiceMaster's fourth quarter and full year 2016 earnings call. Today's call is being recorded and broadcast on the internet. Beginning today's call is Jim Shields, ServiceMaster's Vice President of Investor Relations and Treasurer, and he will introduce the other speakers on the call. At this time we will begin today's call. Please go ahead, Mr. Shields.

Thank you, Christy. Good morning and thank you for joining our fourth quarter 2016 Earnings Conference Call. Joining me on today's call is ServiceMaster's Chief Executive Officer, Rob Gillette; Chief Financial Officer Alan Haughie and Senior Vice President, Tony DiLucente.

For those of you who haven't had a chance to download the investor presentation from our website, I'll walk you through the agenda items shown on Slide two. Rob will lead off by providing some opening remarks and then provide a summary of fourth quarter and full year 2016 consolidated financial results. Rob will provide our fiscal year 2017 outlook, Alan will then review our performance by segment and provide more details of our consolidated results. Rob will then provide summary comments before opening the call to your questions.

Before we begin I would like to remind you that throughout today's call management may make forward-looking statements to assist you in understanding the Company's strategy and operating performance. As stated on Slide three, all forward-looking statements are subject to the forward-looking statements legends contained in our public filings with the Securities and Exchange Commission. These forward-looking statements are not guarantees of performance and are subject to the Risk Factors contained in our public filings that may cause actual results to vary materially from those contemplated in the forward-looking statements. Information discussed on today's call speaks only as of today, February 23, 2017. The Company undertakes no obligation to update any information discussed on today's call.

This morning ServiceMaster issued a press release filed with the SEC on Form 8-K highlighting our fourth quarter and full year 2016 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. We have included definitions of these terms in our press release, which is available our website. We have also included reconciliations of these non-GAAP financial measures to the most comparable GAAP financial measures in our press release and presentation in order to better assist you in understanding our financial performance. All references on the call to EBITDA are to adjusted EBITDA as defined in our press release.

I'll now turn the call over to ServiceMaster's CEO Rob Gillette for opening comments.

Thanks, Jim. Thank you all for joining us today for our fourth quarter full year 2016 earnings call. Before I walk you through our financial results for the quarter, I want to speak to you about some of the recent changes we have made at ServiceMaster. On January 18th, we announced that Alan Haughie, our Chief Financial Officer, will retire from the Company in March. Upon his departure, Alan will be succeed by Tony DiLucente. Tony comes to ServiceMaster from HDT Global, a provider of mobility solutions for military and government applications, where he served as Executive Vice President and Chief Financial Officer since 2011. Prior to HDT, Tony was the CFO of Masonite, a leading building products company, and has significant finance and general management experience with Johns Manville and Honeywell International.

Alan was instrumental in guiding the Company through several milestone events including the spin off of the TruGreen business in January 2014, ServiceMaster's initial public offering, and the recently completed $2.4 billion refinancing. I want to thank Alan for his dedication and his many contributions during his time here at ServiceMaster. Alan will remain in his current role with the Company through the filing of our 2016 10-K.

Tony brings a strong background in financial management and operational expertise across a broad range of industries and companies. I previously worked with Tony at Honeywell and know his track record of driving business growth and process improvement. We are very excited to have him join the team.

In addition to Alan's retirement and Tony joining the team, last quarter we announced the promotion of Marty Wick to the newly created role of Chief Operating Officer of Terminix; and Mary Kay Wegner to the position as President of the Franchise Services Group, succeeding Marty. As Terminix COO, Marty will be responsible for the customer experience to the management of all field operations and the customer call centers. Marty has been with ServiceMaster since 2009 and has a track record of operational excellence and success. Marty did a great job as the Franchise Services Group President. He led the divestiture of the Company on MerryMaids branches and improved our relationship with franchisee's. In 2012, he was named Vice President of Operations for American HomeShield. During his tenure at AHS, Marty was responsible for all aspects of the customer experience and service quality. Marty brings vast knowledge and dedication to his new role and will be instrumental as we continue to improve service quality at Terminix.

Over the past year, Mary Kay has served as the Senior Vice President of Service and Operations of Terminix, in addition to running our strategic sourcing group. During her tenure leading these organizations, Mary Kay implemented new branch service delivery initiatives and centralized and streamlined our purchasing process. In her new role Mary Kay brings the leadership and organizational skill required to build on these improvements we have made in the Franchise Services Group.

With the addition of Tony and the promotions of Marty and Mary Kay we are well positioned to leverage our operational expertise to continuously improve the customer experience and drive growth across the Company.

Now let me turn to the results on Slide four. 2016 was another good year. For the full year, ServiceMaster revenue grew over 6% compared to the prior year, and 7% if we exclude the conversion of MerryMaid's branches to franchises. Revenue growth was driven by strong organic growth at American Home Shield, supplemented by acquisitions of OneGuard Warranties, Landmark Home Warranty and our acquisition of Alterra in Terminix.

Through our acquisition of OneGuard and Landmark, we have expanded American Home Shield's footprint in several important states including; Arizona, Utah, Idaho, Nevada and Oregon. We also strengthened our contractor network, added resources to our real estate channel and solidified our position as the leader in the Home Warranty market. Over the coming months, we not only expect to realize significant synergies from these acquisitions but also expect to capitalize on the unique set of capabilities that each of these companies bring.

For example, OneGuard offers a host of services not presently offered by AHS. These include re-keying of homeowners locks, reprogramming of garage door remote controls, carpet cleaning, pest control and termite treatment under its Home Warranty umbrella. We are now evaluating if these service offerings fit under the American Home Shield brand and how we can add value for our current and future customers.

With regard to Landmark, it markets itself is as a provider of personalized Home Warranty services. Each customer gets a higher level of service than under a typical Home Warranty. Today American Home Shield's value proposition focuses on saving customers money and helping them avoid large unplanned costs associated with home systems repair. In the future we also hope to include a service offering that expands our customer base to consumers who are more interested in convenience. These customers value a higher level of service, such as quicker response times, tighter service windows, and emergency type services. We are learning from Landmark how best to serve this type of customer. As the leader in the Home Warranty market, American Home Shield has the breadth and the scale to capitalize on the capabilities of these acquisitionsand expand the market beyond the Traditional home warranty customer.

With regard to Terminix's acquisition of Alterra, which we closed over a year ago, we are very pleased with its performance. It has exceeded our expectation and has yielded good returns. As we mentioned in the past, we consider Alterra a large tuck-in acquisition.

Typically with tuck-ins, we immediately realize synergies and cost reductions by reducing the administrative and sales costs and integrating the back-office. We leveraged Terminix established sales channels to cross-sell other services to the customers we acquired in the acquisition. This is true in the case of Alterra, where we retain the customers and technicians but eliminated the sales and administrative functions. But unlike most tuck-in acquisitions, we delayed the integration of the back-office operations because of Alterra's sheer size. We have now just completed the integration and have begun to cross-sell other services such as termite and mosquito to these customers. The benefits of this acquisition are clear; up front profitability, new customers ad cross-selling to these customers.

Now turning back to the financials for the year, adjusted EBITDA increased $45 million or 7% compared to prior year. The increase in EBITDA was primarily the result of the conversion of higher revenue, driven by organic growth at American Home Shield and acquisitions at both American Home Shield and Terminix. This was partially offset by investments we made throughout the year for future growth. These investments include $19 million in technology spend on our ServSmart initiative, a $12 million increase in marketing and sales at American Home Shield and a $6 million increase in labor at Terminix to add and train sales people and technicians. Taking these investments into account and the lower revenue associated with the conversion of Merry Maids branches to franchises, EBITDA margin was largely flat year over year.

Our adjusted net income for the full year was $281 million versus $245 million in 2015. The increase was largely driven by an increase in adjusted EBITDA, a lower provision for taxes and lower interest expense. For the full year, adjusted diluted earnings per share of $2.04 was an increase of $0.24 or 13% versus last year. This was driven by an increase in adjusted net income, partially offset by higher weighted average diluted common shares outstanding.

Now turning to slide five. ServiceMaster had a solid fourth quarter. Revenue grew over 5% compared to the prior year and 6% if we exclude the conversion of Merry Maids branches to franchises. Similar to the full-year results, revenue growth was driven by strong organic growth at American Home Shield and the acquisitions in both American Home Shield and Terminix. American Home Shield continues to perform well as revenue grew 14%, 8% of which was organic.

We continued to see strong demand for our products in both the real estate and direct-to-consumer channels. Our real estate channel had a great quarter and year. Over the past 18 months, we have placed a renewed emphasis on this channel. As a result in 2016, we had our best sales year in over ten years. In addition, we are seeing retention rates for first year real estate customers increase, which helps drive future growth and profitability.

In the direct to consumer channel, our marketing dollars continue to yield significant returns. We are optimizing our marketing spend by using mixed media approach of digital, broadcast and direct mail to drive sale growth. As I have mentioned before, our marketing, pricing and product strategies continue to evolve. We are constantly learning by testing new services and plans to make them more attractive to customers. These efforts are paying off and American Home Shield is well-positioned for continued growth in 2017 and beyond.

With regard to Terminix, we continue to see steady progress in our core termite business, as sales this quarter exceeded sales during the same period last year and retention rates remained solid. This is a good sign for the future, as termite is one of our most profitable services with high retention, good margins and a high lifetime value. We are the industry leader and plan to continue to invest in and grow this market.

With regard to pest control, our organic pest control continues to be a challenge for us. As I reported last quarter, our sales engine is performing well, but we need to continue to drive improvements in our product offering and service quality. Although our long-tenured customers remain loyal and have high retention rates, we are driving actions that will improve retention both for first year pest customers. Many of the changes we are driving are basic and fundamental but will take time to generate results. Our actions are aimed at driving sustainable profitable growth over the long-term. That means focuses on our customers' needs and properly motivating our technicians and front line personnel to better serve and retain these customers.

The first step in the process is to make sure we are adequately staffed. It typically takes about three months to license and train a technician. Managers are now being held accountable to be sure they anticipate turnover and that branches are adequately staffed. Today we have 350 more technicians than we had one year ago. To grow in Terminix, we need to have the people in place who have a great attitude, are well trained and motivated to both sell and serve customers.

In addition, we are experimenting with incorporating customer satisfaction metrics and on-time performance into our techs' compensation plan. We are conducting pilots for the top performing, most experienced technician in each branch, and is dedicated solely to providing the initial and first year service for pest customers. We want to incentivize our technicians for the quality of their service not quantity.

We are encouraging branch managers to stabilize production by evenly distributing the number of stops a technician make in a day, which enables them to engage with customers and improve retention. We know there is a direct correlation between our customer satisfaction scores and retention. A customer with a higher satisfaction score on the initial visit retains a 25% higher rate for termite and at a 17% higher rate for pest.

Our branches with highest scores are those with the highest customer engagement. We are now taking the lessons learned from these branches and translating them across our network, including adhering to a more rigorous pre- and post-treatment customer notification process. Our technicians will be able to see on their handheld when a customer is first year, and when their renewal will come due. This enables them to proactively engage the customer and improve renewal rates.

Over the long-term, technology will pray a key role for improving service quality at Terminix. Today 1300 sales professionals have an iPad with which they access their daily schedule and driving directions, view and schedule appointments, and see nearby prospects and host of other features. All 5,000 technicians recently received an iPhone that will allow them to more easily communicate with and respond to their customers. Again, these changes are all in the early stages but we are confident we are on the right track.

Adjusted EBITDA for the fourth quarter increased $20 million or 16% compared to the prior year. The increase in EBITDA was primarily the result of the conversion of higher revenue driven by organic growth at American Home Shield, acquisitions at both American Home Shield and Terminix and $11 million decrease in contract or claim costs primarily associated with the prior year use of out of network contractors, an increase of $4 million in labor cost and Terminix related to our investment in recruiting and training sales and service personnel partially offset the overall strong EBITDA growth in the fourth quarter.

Our adjusted net income for the fourth quarter was $60 million versus $45 million or up 33% versus prior year. This is largely driven by an increase in adjusted EBITDA and a lower provision for taxes. For the fourth quarter adjusted diluted earnings per share of $0.44 was an increase of $0.11 versus prior year. This is driven by an increase in adjusted net income and slightly lower weighted average diluted common shares outstanding driven by our share buyback program. During the quarter the Company used $8 million in cash to purchase 225,000 shares at an average price of $35.57 a share. In addition since the start of this year we used $40 million in cash to purchase an additional 1.1 million shares. Since the inception of the program one year ago, we have used $100 million to purchase 2.7 million shares.

Also this past quarter we completed a refinancing of our $2.4 billion Term Loan B due 2021 and our $300 million revolving credit facility with the proceeds of a new $1.65 billion Term Loan B due 2023, $750 million of unsecured high yield debt due 2024 and a new $300 million revolving credit facility due 2021. With this refinancing we reduced our weighted average cost of debt, extended our maturities, diversified the maturity schedule of our debt and increased our flexibility to raise capital in the future.

In addition, we executed a $650 million interest rate swap commensurate with this transaction, which increased the ratio of our fixed-rate debt to our floating-rate debt from approximately 40% to close to about 65%, protecting us from potential future interest rate increases.

Our 2017 outlook is shown on slide six. We expect full year 2017 revenue to range from $2.885 billion to $2.915 billion, for an increase of between 5% to 6% compared to 2016. Full year 2017 adjusted EBITDA is anticipated to range from $700 million to $715 million, for an increase of 5% to 7% compared to 2016. Our 2017 outlook excludes the impact of any potential acquisitions in year.

We expect organic revenue growth at Terminix to range from 1% to 2% for full year 2017 compared to prior year. For the first quarter of 2017, the Company expects Terminix organic growth rate to be flat compared to prior year. The Company expect organic revenue growth to accelerate in the second half of 2017 as we focus on customer service, particularly in pest control, to drive higher customer retention. As we improve service delivery, we inspect to incur additional labor production costs in 2017, resulting in Terminix EBITDA margin remaining flat to down 1% compared to 2016, long-term Terminix incremental margins will be between 30% and 35%.

The Company expect American Home Shield full year 2017 revenue growth to range from 12% to 14%. In 2017, there will be a small one to two percentage point headwind to organic growth productivity phase out of our third-party business. This is the business that we had previously conducted with banks and mortgage companies that combine the sale of a Home Warranty with a mortgage and would collect the Home Warranty payment with the mortgage payment. Due to the regulatory environment, many of these financial institutions no longer sell or service some warranties. Our last large financial institution customer has decided to exit this business at the end of the first quarter. We have put marketing and sales programs in place to retain these customers, but we expect a significant amount of attrition due to this change.

Now let me turn it over to Alan to go over the segment financials. Alan?

Thanks, Rob and good morning everyone turning now to slide seven and Terminix's performance; starting with the fourth quarter on the left-hand side, revenue increased year-over-year by $9 million or 3%. Acquisitions made in prior periods accounted for about $8 million of this growth. Alterra revenue for the month of October 2016 is included is a component of this acquisition revenue, but Alterra revenue for November and December 2016 is classified as part of the organic base. So organic revenue growth for Terminix as a whole was just $1 million for the fourth quarter. But if we exclude the organic contraction of Alterra, the remainder of Terminix grew organically by about $3 million or 1%.

EBITDA for the quarter declined by $3 million, from $76 million in 2015 to $73 million in 2016. And we incurred about $4 million in additional labor costs, reflecting the hiring and training of pest technicians well in advance of the peak pest seasons with the aim of increasing service levels to improve customer satisfaction and so boost organic growth. We had signaled an anticipated increase in labor spend on our third quarter call.

We also continue to invest in technology and carrying $2 million of higher expense than last year. And despite the additional $4 million in labor cost and $2 million of technology investments, EBITDA margin fell just one point in the quarter compared to last year. For the full year shown on the right-hand side, revenue increased by $80 million or 6% and acquisitions contributed $60 million or four points of this growth.

Alterra contributed significantly to Terminix's growth in 2016. Rob spoke briefly about the benefits of the acquisition and I would like to reiterate those benefits again and add that additional scale provided by the Alterra acquisition positions Terminix well as it continues to invest in growth. For 2016 Alterra contributed approximately three points of revenue growth. To be clear these customers had an initial decay rate slightly higher than our existing customer base, but that was fully considered as part of the business case and reflected in the purchase price required to meet our return targets. Furthermore, the business case described does not include the opportunity for cross-selling which should be substantial.

From our financial reporting perspective, the inclusion of November and December Alterra revenue and the attrition of Alterra's customers since acquisition, as predicted in our business case, reduced Terminix's reported organic pest control revenue growth by about 1% in the fourth quarter. And as we enter 2017 with a fully integrated Alterra, the Company is focused on leveraging the Terminix sales team to cross-sell to the Alterra customer base.

Now moving on to full year EBITDA, which increased by $24 million, the additional revenue produced $36 million of EBITDA when including normal variable costs of service, and we also had $5 million of benefit from lower field prices. However, the increase in production labor over the second half of the year, $6 million, combined with the $12 million of increased technology throughout the year resulted in a flat EBITDA margin of 24%.

Turning to slide eight and Terminix's revenue drivers for the fourth quarter; revenue from termite and other services of $120 million is an increase of $5 million or 4% over prior year, with completion revenue up $4 million or 7% to $63 million and renewal revenue up $1 million or 2% to $57 million. During the quarter about 60% of this $63 million in termite completion and other services revenue was derived from the sale of core termite completions, meaning a first time termite service.

Now, the fourth quarter is generally a slow selling season for termite services, nevertheless core termite revenue increased by 7% year-over-year continuing the unbroken trends established during November and December of 2015 of a year-over-year increase in the number of core termite completions. And termite services is one of our most profitable offerings with high retention margins and lifetime value.

Increases in first year sales or termite completions are a good sign for future renewal revenue growth in the long-term profitability of this segment. The other 40% of the $63 million of termite completion and other services revenue comes from services such as exclusion and installation and this revenue stream increased by about 9% year-over-year. Furthermore, termite renewal revenue increased by 2% driven by increased prices and a gradual mix shift to the better retaining product, another good sign for the long-term of the termite business.

Pest control revenue of $209 million increased by $2 million or 1% over the prior year. Acquisitions contributed about $7 million of the revenue increase, specifically $4 million from Alterra and $3 million from other acquisitions. Pest control, therefore, fell organically by about $5 million or 2% for the quarter including $2 million of organic contraction from Alterra. So as already mentioned, if we excluded attrition of Alterra customers, then pest control revenue fell organically by about $3 million or 1%.

Rob has already mentioned our disappointment in the organic pest growth at Terminix and there are steps being taken to improve service quality, retention and growth. So overall for Terminix, given the strong operating leverage, both gross margin and EBITDA margin remain healthy even with the investments in growth. The termite strategy in particular is proving effective, and will soon mature into a healthier highly profitable renewal stream and the challenges of organic pest growth are being tackled with a measured focused approach.

So let's turn to slide nine and discuss American Home Shield. Starting with the fourth quarter on the left-hand side, Home Shield had good topline revenue growth and strong gross and EBITDA margins. Revenue increased by 14% from $206 million to $234 million, with organic growth contributing 8% of this. This organic revenue growth comprised about 2% from pricing of 7% from customer account growth, partially offset by a slight mix shift towards traditionally lower priced real estate contracts. The OneGuard and Landmark acquisitions mentioned by Rob contributed about $12 million or 6% of growth.

EBITDA for the quarter increased year-over-year by $18 million or 56%, and margins expanded from 16% to 21%. The largest contributor to the increase in EBITDA and to margin expansion is $11 million of favorable year-over-year claims reflecting a return to normal stable use of in network contractors compared to the same period last year when we experienced an increase in customer claim due to an increase in the use of out of network contractors at that time.

Also contributing to the EBITDA increase this quarter is about $6 million as a result of organic growth, of which $5 million relates to an increase in the number of customers and $1 million is the conversion of price increases, net of normal inflation and contractor costs. The One Guard and Landmark acquisitions contributed about $2 million in EBITDA this quarter and technology costs were $1 million higher than last year.

With respect to the full year on the right-hand side; revenue increased by 11% or $103 million, and now exceeds $1 billion for the whole business. This growth comprised about 9% organic growth, reflecting be the usual 7% customer count growth and 2% pricing for the balance coming from the acquisitions made in the second half of the year. EBITDA increased by $50 million or 7%. Organic growth contributed about $33 million of which $27 million relates to an increase in the number of customers and $6 million is the pass through ofprice net of normal impossible inflation associated with contractor costs. The OneGuard and Landmark acquisitions contributed about $4 million of EBITDA.

Offsetting these contributions were $12 million of additional selling and marketing costs, $7 million of technology spend and $3 million headwind from prior year investment gains. As Rob mentioned, we expect our technology spend to be flat in 2017 since marketing spend in 2016 was elevated due to the shift in timing of an $8 million marketing campaign. From the traditional December time period in 2015 to January 2016, we expect our sales and marketing spend increase to be less dramatic in 2017.

Now on Investor Day this past May we highlighted the stability of American Home Shields gross margin. On Slide 10 we show Home Shield's revenue growth and gross margin percentage over the last six years. Over this long period, we have accelerated growth into the low double-digits while maintaining a stable gross margin of about 50%. And as we have said before, there will be extremes of temperature that may impact quarterly results, and as we expand to former whitespace, increase the density of customers and expand our contractor network, there will be inevitable occasional growing pains, but as this trend shows, the long view of this business is one of high stable gross margins which provide significant profit which can and should be invested in a variety of ways tocontinue to generate revenue growth.

Slide 11 shows [FSG's] performance. Focusing on the left-hand side, fourth quarter revenue fell year-over-year by $4 million or 7%, with a $6 million reduction in revenue due to the conversion of Merry Maids branches to franchises, being partly offset by $2 million of increased disaster restoration fee revenue. And once again, we mitigated the impact on EBITDA of the Merry Maids conversions through cost reductions and this, in combination with the increased fee revenue raised the EBITDA margin by seven points to 42%. And if we look at the full year performance on the right hand side, then the story is basically the same.

Turning to the full year account on page 12 looking at the business in its entirety, the year-over-year revenue increase of over 5% or $32 million includes $18 million or three points of net organic growth. The remaining $40 million of revenue increase comprises $8 million due to acquisitions within Terminix and $12 million from the acquisitions in Home Shield, partly offset by $6 million of revenue diversified to conversion of the Merry Maids branches to franchises.

Gross margin as a percentage of revenue improved by 210 basis points, largely as a result of the improvement in claims cost at American Home Shield.

Year-over-year SG&A increase of $12 million reflects the higher technology costs of $3 million. SG&A assumes OneGuard and Landmark acquisitions within Home Shield of $5 million, combined with higher selling cost and other of about $4 million. As a result, SG&A as a percentage of revenue increased by 0.6 of a point to 26.2%. As mentioned on prior calls, we expect technology costs in 2017 to be similar to the levels established in 2016.

Now recall that in the fourth quarter of 2015 we recorded a $23 million charge for the proposed 401(k) plan corrective contribution and $9 million related to the penalties on the fumigation related matters. In the fourth quarter of 2016, by contrast, we wrote off $32 million of previously capitalized debt costs as a direct result of the recently refinancing the Company's debt.

So for the fourth quarter, we have generated pre-tax income of $41 million compared to $33 million over the same period last year. Now our effective tax rate is around 22% for the quarter, more favorable than our run-rate for the first nine months of the year, which was about 38%, due mainly to excess tax benefits related to stock compensation and the release of a reserve for federal taxes. This results in net income for the quarter of $31 million compared to $17 million last year. And of course to aid in comparability, we also reported adjusted net income which I will go over in a moment, and this increased by $15 million to $60 million.

So slide 13 provides our standard two reconciliations. First we walk our segment performance measure, adjusted EBITDA, down to net income and then the reconciliation back up to adjusted net income. Nothing surprising here, of course, with the loss of extinguishment of debt being excluded from adjusted net income.

Slide 14 provides a fourth quarter and full year simplified cash flow. In the fourth quarter, we generated $100 million of free cash flow compared to $98 million over the same periods last year. This increase of $2 million is the sum of a number of moving parts, but the most significant are the $20 million of higher EBITDA being offset by $7 million of increased cash taxes and $10 million paid to unwind out of the money interest rate swaps following the debt refinancing. In accordance with the GAAP, this $10 million will be discharged prospectively in the P&L account in 2017 and 2018, with the charge in 2017 being about $6 million of noncash interest expense. And please note that a formal reconciliation from the US cash flow statement to free cash flow is provided in the appendix and in the press release.

Now that largely concludes my prepared remarks, so I'm going to take a little bit more of your valuable time to express my gratitude to all employees of ServiceMaster, my colleagues on the executive team, and to the exceptional finance team here, all of which have made my tenure an absolute delight. Lastly, of course, to Rob Gillette for making it a really fun ride. So for the last time, I'll turn it back to Rob.

Thanks, Alan. We had a good quarter driven by strong organic growth at American Home Shield and acquisitions in both American Home Shield andTerminix. Our termite business continues to improve as our sales grow. We have taken the right steps to improve our pest control business byimproving service quality to drive customer satisfaction and retention. We are investing in technology to improve our service quality and our ability to drive growth in the future. We feel good about our progress and the opportunity we have in the future. Thank you for joining us today and for investing in our Company.

We would also like to thank Alan for his time here at ServiceMaster and his many accomplishments. He is a good friend and he will be missed. We wish him the best as we moves on to new endeavors. Now I'll turn it over to Jim for Q&A. Jim?

Thanks, Rob. As reminder during the question-and-answer session, we encourage you to ask any questions that you may have. But please note that guidance is limited to the outlook we have provided in our press release and webcast presentation. Additionally since the queue is long this morning, please limit yourself to one follow-up question so that we can get everyone in the allotted time. Christy, let's open it up -- the line for questions now.

Thank you, sir. (Operator Instructions). Our first question comes from the line of Annie Singh. Please go ahead.

Hi. This is Anj Singh from Credit Suisse. Thanks for taking my questions. First off wanted to say thanks to Alan for all your help and I wish you my best in your future endeavors. So I guess turning to questions, first off, I wanted to touch on the longer-term incremental margins. I think you guys are expecting those to moderate a bit to 30% to 35%. I think last quarter you were still confident that it could continue to be at about 35%. So is it just the additional labor costs that are being factored in here? Curious as to what you found to moderate your expectations for the incremental margins in Q3.

Yes. This is Tony DiLucente. That's correct. It's essentially the additional labor costs that both Rob and Alan talked about. We're going to continue to invest in growth in Terminix to drive the organic growth.

Okay. Got you. And then as it relates to the flattish organic growth expected for Terminix at Q1 and your guidance for the full year organic growth, could you just speak to the factors that provide your confidence in that growth accelerating in the back half? Seems the performance has been pretty lumpy quarter to quarter, so just wanted to better understand the visibility that drives your outlook here.

It's basically the focus on improving our retention rate, which is really driven by specific actions that we're taking to improve the customer experience and customer quality. So we're very confident that we will see that bump-up in the second half of the year.

And, Anj, it's Rob. We're actually coming to you from the downtown Sheraton in Memphis, Tennessee where we have all of the branch managers and field Management Team here where we have been talking about exactly what we're going to be doing to go out and make sure that we engage customers and drive that retention. So we feel confident in the actions that we're taking. The team is pretty fired up and when I'm done answering you guys' questions, I'm going to go fire them up some more and send them back to the field.

Okay. Got it. Thanks a lot.

Yes.

Thank you. Our next question comes from the line of [Tony Kaplan]. Please go ahead.

Hey. This is actually [Jeff Gold] on for Tony.

Hi Jeff.

How should we be thinking about market expansion within American Home Shield next year?I know margins down a little bit in 2016 primarily related to the increased claims costs you incurred. Should we be expecting margins to get back to somewhere around a 2015 level? Just really trying to understand the puts and takes there.

I'm sorry. Could you repeat that you were actually breaking up a little bit on our side. Could you repeat your question?

I apologize. Yes. I was asking about American Home Shield margin expectations for next year. Because I know in 2016 they came down primarily related to some of these increased claims costs you incurred. But should we be expecting margins to get back to somewhere around a 2015 level?

A couple things you should take in account relative to margins. We don't give specific margins at American Home Shield, but if you turn to the American Home Shield page for the full year, there's a number of different one-offs that we have in there, such as technology is going to be remaining flat over on a year-over-year basis. In addition to that you can take a look at sales and marking spend that Alan had pointed to. Probably not going to be increased quite as dramatically as that.

And also on that page we also have an investment income of basically a $3 million drag. That's not going to be there. So you -- we don't give it out, we don't give guidance, you. We say that our long-term incremental margins at American Home Shield are about 35%. We're consistent with that. I think relative to this year there might be a slight drag associated with that incremental margins just because we made a lot of acquisitions in 2015 and we need to integrate them into -- excuse me -- 2016 and we need to integrate them during 2017.

Okay. That's helpful. Thanks. And then just -- you have spoken about obviously the increased investment your making in Terminix to accelerate growth there, but just thinking bigger picture; what's the right way to think about long-term growth in this segment after some of the recent issues you have seen? I mean is this a GDP plus grower, can you match the mid-single-digit growth at some of your competitors? Just really what you're long-term target in this business.

I think that in general it wouldn't vary from what we have already said or said when we went out with the IPO. We always talk about one to two point in market, one to two points n price and one to two points in acquisition. That's kind of of the way it's averaged a little over -- compounded over a long period of time. If we can, through all these efforts, continue to improve on retention and drive more growth, we sure will. I guess we err on the side of being conservative with these actions. We're confident they're going to get traction and make an impact. But we don't want to over sell it until we can come back and tell you that we did. So that's kind of where we're at.

Thank you.

Yes.

Thank you. Our next question comes from the line of Andrew Wittmann. Please go ahead.

Great. Thanks. I notice the change on your guidance approach this year which -- was exclusive of acquisitions. I think that makes sense, but given that, guys, I wanted to get a sense of where you are on the acquisition curve. Last couple ever years have been probably a little bit more active than we would have expected, coming out of the IPO. And I was just wondering if the last couple years investments in you think are a good template for what we could be seeing in the year ahead?

Yes. I think we will continue to invest obviously as part of our growth strategy and add services and capability to what we do. I the American Home Shield arena a lot of it is what's available when. So it's more of a timing thing. And we look to add to that business and we have a target list, but the list is relatively short when you think about the traditional players in that game. So that's one thing. And I think on the Terminix side, we'll continue to pursue the business like we have; identifying good quality targets that we can add to the business that help tie into our strategy of growth and retention and growing the business overall. So I think directionally you can think of it as similar practice in 2017. We just made sure to tell you that none of the acquisition -- or potential acquisitions are included, other than what was acquired in 2016.

That makes sense. My follow-up question I wanted to talk about the contractor network at American Home Shield in particular. Obviously, you had the -- I guess you would call it an easy comp on the claims cost. I just wanted to check back in really on two things. One, how do you feel about your out of network claims costs in the contractor base side? And are you seeing any impact to your ability to find contractors willing to work for you now that they are getting more alternatives to find volume in their work from technology?

Yes. I would say the team -- especially because of some of the we faced in late 2015 kind of carrying over into 2016 -- the team this year has done a great job in making sure that we develop the contractor base and add contractors. So I think we have added roughly 10% to the overall contractor base and also branching out into new contractors other than the traditional ones that we have worked with. So we're paying a lot of attention to the capacity side of the equation, and we want to make sure that we can maintain the service quality with those contractors and maintain the growth profile and still serve customers. So we're investing in both the call center and the contractor base and we don't have a shortage of people that want to work with us. In fact, we're focused on developing new and there's many, many apparel people interested in being market of the business.

As Rob also said in the event the acquisitions also contributed to our built-out of our network also. That should benefit in the areas where we were sort of light.

Thank you.

Thank you. Our next question comes from the line of George Tong. Please go ahead.

Hi. Good morning. I also want to extend my thanks to Alan. Can you elaborate on how your investment initiatives in Terminix differ between termite control and pest control? And when you might expect to see these initiatives translate into in retention rates and new customer acquisition trends?

Well, as you know, most of the opportunities out there to acquire businesses are predominantly pest control, so fewer and fewer have termite businesses of significance. So I don't even remember the ratio. But it is clearly the minority of what we have purchased. Most of those businesses that are out there today in that mid-sized range are predominantly pest control. So when you acquire them it's more about where they are positioned, how does it fit in the portfolio relative to what we have in permanent of footprint, and what types of things do they do and are enabling to grow their business organically, which is what we look at, too. So we look for quality people that can help us drive the things we talked about like retention and growth so -- and a lot of it is when people decide to sell what and -- what their thoughts are. So we have active conversation with them all the time.

Got it. And the follow-up question in the American Home Shield segment, can you talk about how spending will need to change this year in marketing and in growing your in network contractor base in order to sustain the trends you have seen in organic revenues?

Yes. I think as Alan mentioned, we had a one really large increase in marketing spend this year because of the shift between 2015 and 2016. He did also mention that we're going to see probably a continued increase on this, but not nearly to the degree we did last year. I think the key element here is that our overall cost of acquisition of customers in that DTC channel remains pretty constant during this time period. So we continue to invest in that marketing spend going forward. We do basically moderate it based upon the capacity of our contractor network so that they lineup appropriately. But, again we're really confident and we're very excited in terms of that fact is we continue to see stability relative to our cost of acquisition in that channel.

Got it. Thank you.

Thank you. Our next question comes from the line of Gary Bisbee. Please go ahead.

Hey, guys. Good morning. Hey Rob in your discussion of the strategies being implemented at Terminix, I heard an awful lot of we're piloting this, we're testing this, we're trying in this branch. Can you just give us a sense of the range of strategies that you have discussed this quarter and last quarter? How much of it is largely implemented or -- and how much of it is in the trial phase where you'll decide in the future if it works and then implement it more broadly? Just trying to think of the cadence of the strategies in total.

Yes. I would tell you that in the last six months we've implemented a lot of things and so I think part of it is -- in equal measure -- I think we mentioned before that there were an awful lot of initiatives, too many initiatives going on I think that kind of defrayed the focus on growth and customer retention so we have been talking to the team here about growth and growth being both new acquisition and retention.

The investments we've made in reference to the $4 million labor increase in Q4 is not just technicians, but it's also sale people and training, right? So I think as I told you guys, what the significant difference between the start of this year versus the start of 2016 is the sheer number of trained people that we have in sales and service, right? So that bodes well for us in terms of executing. So that -- when you think about it, if you got trained guys with a great attitude ready to hit the busy season, that's when you capture the growth.

And then a lot of these other changes, we don't want to make changes that would disrupt anything that we have put in place. So we have a couple different approaches that we're trying on the technician pay plan that basically are focused on supporting the idea of NPS and customer satisfaction and growth in different variances. We rolled out the technology so everyone has the iPhone 6, which then deploys this dispatch technology, on my way notifications, and five star ratings which we have already deployed in certain branches which has made a magnificent impact in actual NPS in those branches. In some cases more than doubling it. So we know that it works. And then we're rolling it out to make sure the guys are trained to do it.

So I would telling you most of the work is the fundamental work and the focus of the team on customer engagement, pre- and post-communication, and ensuring we're on time and engage the customer. And most of that is just a primary focus on what the guys need to do and ensuring that they do it. So a big part of it is verifying they do it and then measuring the results of each.

So I'm excited about the improvement made already and I just sat through individual skip levels with groups of 20 over the last four days, the branch managers, right? So they are the guys on the ground they understand exactly what we're doing. They're excited about it and I'm excited about what we can do this year.

Great. Thanks. And then the follow-up -- you alluded to the potential expansion of the AHS strategy to think about -- the concierge market or more people looking for higher service level as opposed to just the insurance component. Where are you in that? You have alluded to that as a possibility in the past, but is this acquisition -- what's the timeline to really think through and determine how you might leverage that going forward?

Yes. I think we have had a lot of discussion about that and I think Tim and I have decided in a small way we may pilot it on a limited basis to get a feel for it, which would be in a specific geography of relatively affluent high density. So you think about the services we're going to go out and investigate what people are willing to pay for and then what the service level commitment is. And Landmark is one that kind of sold as a company that was -- tended more toward concierge than the traditional service. So we want to learn from what they have done in both price and product positioning and then see what we can do to leverage that into the product line of AHS and how we would go-to-market.

So we have always talked about it, Gary, over time. So we're pretty excited about what it could be because we know people are willing to pay for convenience, but if you take that step you got to be really, really good at what you do and we would make sure we are before we do it.

Okay. That makes a lot of sense. Thank you.

All right.

Thank you. Our next question comes from the line of Sam Eisner. Please go ahead.

Yes. Good morning everyone.

Hey Sam.

Hey. So just on the kind of longer-term operating model for the Company, not so much about 2017, but as we look out to 2018 and beyond; these investments that you're making in technology, the investments that you're making in sales and marking, particularly in AHS; do those start to get levered in the future? Is that something we should expect to continue to grow, going forward? Any kind of additional long-term business model commentary would be great.

Yes. Hey Sam, specifically as it relates to the American Home Shield, yes the technology spend that Alan mentioned is going to be flat. So that is definitely leveragable going forward, because it's going to be sort of flat on a year-over-year basis. I think even beyond 2017, we have talked about it even in our -- on the Investor Day, that we don't expect that increasing over beyond even 2017 or 2018 to remain at the same level. So that's definitely leveragable.

And relative to sales and marking is the other sort of expense that we have on the bottom line there, Sam, and that number -- it will consistently grow over time and sort of match our overall growth rates. So we have a model that we're confident in there is that we have about 50% gross margin and it's been stable in the past. We think it's going to be stable in the future and we have basically said about 35% incremental margin there at American Home Shield and we think that's going to be the right level going forward there.

The other thing I would say, Sam, on the sales side in Terminix, we rolled out the iPads and the global technology for sales. And that's been really successful. And so we implemented sales training which we haven't effectively done in a lot of years. And we implemented that in September, so that was part of the our investment. But the iPad enables these guys, as you can see, to go out and, canvas, cold call, schedule, communicate and pitch with their iPad driven with collateral that comes down from the marketing guys. So I'm pretty excited about what they can do with that and that investment is made. So we just continue to tweak it and evolve it and the sales guys are pretty excited about how that converts, too. So we actually have improvements in conversion which would be a point of leverage kind of backing up what Jim said.

Got it. And maybe just sticking with the Terminix comments, Tony, you made what I would argue to be kind of a pretty confident statement regarding the kind of acceleration in the back half of 2017 from organic growth. I was wondering is there anything that you can point to that kind of gives you that confidence? I mean I understand that you have more feet on the street. I recognize the increase in the number of technicians. But are there any kind of statistics that you can point to that would give investors greater confidence on the acceleration? Thanks.

Thanks. No. I would say just sitting through the meeting the last three days here with the Terminix team we have not only a lot of energy, but a lot of specific actions really aimed at improving retention. We're going to manage that metric real closely by region, by branch. And I really believe that there are our new sales engine is working very effectively and it's really a matter of just focusing on the customer experience and improving those -- the customer service. That's going to have a pretty profound impact and that's where I gain my confidence that we'll see that back half improvement.

Thank you. Our next question is a follow-up from the line of Anj Singh. Please go ahead.

Hi. Thanks for sneaking me back in. I had a quick follow-up on Gary's earlier question. As it relate to some of the additional services your recent acquisitions provide in AHS, can you speak to whether your current contractor network base is capable of servicing those new services? Or would you need to find different or additional contractors? Just trying to understand what may be limiting factors in a broader rollout with an AHS, aside from perhaps just piloting in select geographies as you had referenced. Thanks.

No. The contractor base that we have collectively is a company clearly can do all this work. And in a lot of cases you can get it done for the cost of a trade service fee on average. So -- and it's -- you know what it is. It's another touchpoint in communicating with the real estate customer, where you get in and address and remind them of the services that you can provide. And then get our contractor base in and think about negotiating with them and having them be part of the group, get giving them opportunity to put their business card in front of these customers and to capture retail work going forward, which is the model we pursue with our contractors.

So in the case of vision of a concierge type product, the advantage to our contractor base is this access at a retail type price scenario for them. But then you have to have a service level agreement within same day service and response and so forth so they would have to understand that. So we think it fits really well with the contractor base that we have.

Understood. Thank you.

Thank you.

Thank you. There are no further questions at this time.

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

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