Terminix Global Holdings Inc (TMX) 2017 Q4 法說會逐字稿

Ladies and gentlemen, welcome to ServiceMaster's Fourth Quarter and Full Year 2017 Earnings 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 Treasurer, and he will introduce the other speakers on the call.

At this time, we'll begin today's call. Please go ahead, Mr. Turcotte.

Thank you, Tommy. Good morning, and thank you for joining our fourth quarter and full year 2017 earnings conference call.

Before I review the agenda and introduce the other speakers, I'd like to remind you that throughout today's call, management may make forward-looking statements to assist you in understanding the company's strategies and operating performance. As stated on Slide 2, all forward-looking statements are subject to the forward-looking statement legends contained in our public filings with the Securities and Exchange Commission. These forward-looking statements are not guarantees of performance and are subject to the risk factors contained in our public filings that may cause actual results to vary materially from those contemplated in the forward-looking statements.

Information discussed on today's call speaks only as of today, February 27, 2018. 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 2017 financial results. The press release and the related presentation 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 these terms in our press release, which is available on our website at www.servicemaster.com. We've also included reconciliation of these non-GAAP financial measures to the most comparable GAAP financial measures in our press release and presentation to better assist you in understanding our financial performance. All references on the call to EBITDA are to adjusted EBITDA, as defined in our press release.

Joining me on today's call are ServiceMaster's Chief Executive Officer, Nik Varty; and Chief Financial Officer, Tony DiLucente.

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 3. Nik will lead off by providing full year 2017 highlights. He will then provide an update on the American Home Shield or AHS separation, progress on the Terminix business transformation and review the company's strategic growth priorities. Tony will follow and summarize our consolidated fourth quarter and full year 2017 financial results, review the individual business unit results, provide more details in regard to our financial statements and then speak to the full year 2017 outlook. Nik will then provide summary comments before opening the call to your questions.

I'll now turn the call over to ServiceMaster's CEO, Nik Varty, for opening comments. Nik?

Thanks, Brian, and good morning. Thank you all for joining us today on our fourth quarter and full year 2017 earnings call. As you saw this morning, we reported solid results for the quarter and year while continuing to execute on our strategies to deliver long-term growth. For those of you on the call, following along with our webcast deck, please turn to Slide 4 and our 2017 highlights.

Since joining ServiceMaster in July, I've had the great pleasure of meeting many of our approximately 13,000 employees over 15,000 contractor partners and more than 4,500 franchise owners. I'm impressed and humbled by the tremendous efforts to take care of our customers, reaching into more than 75,000 homes and businesses every day.

This focus on customers is reflected in our results. We delivered value across all our businesses in 2017. We reported a 6% year-over-year revenue increase in 2017 for ServiceMaster, with American Home Shield achieving high single-digit organic revenue growth for the third consecutive year and 13% revenue growth overall.

We delivered adjusted net income of $286 million and adjusted EPS of $2.11, up 2% and 3%, respectively, over the prior year.

At Terminix, we launched a series of systematic, transformational initiatives to significantly upgrade the customer experience, improve customer retention rates and are better positioning ourselves to deliver consistently strong revenue and earnings growth. We are beginning to see the benefits of this transformation through the increase in the Net Promoter Scores submitted by our customers. While we know it takes time for these initiatives to impact the business, we are excited by the strong customer feedback we are already seeing.

We continue to strengthen our leadership team, adding significant experience to our executive ranks, which I'll review in a moment.

We're also creating an organizational structure that enhances personal accountability and support a high-performance culture.

With the current significant value to our owners in the form of share buybacks and debt retirement, in 2017, we purchased over $85 million in shares at an average share price of $13 per share lower than the share price at year-end.

In addition, we used $31 million of cash to retire a portion of our high coupon legacy notes in 2017, saving over $2 million in annual interest expense. We also reduced our net debt leverage from 4.1x to 3.7x in 2017 as a result of overall debt retirement, an increase in available cash and adjusted EBITDA growth.

Through the efforts of our people and by executing on our strategic initiatives, we will continue to build value for all our stakeholders, customers, employees, the communities in which we do business and our shareholders.

Turning to Slide 5. Seven months ago, we announced our intention to separate AHS from ServiceMaster into a separate publicly traded company for a tax-free distribution to the company's shareholders. I'm pleased to report that we are on track with the numerous work streams and continue to target the third quarter of 2018 to complete the separation.

To date, we have requested a private letter ruling from the Internal Revenue Service and filed a Form 10 with the Securities and Exchange Commission. The initial filing was required to be confidentially filed because we did not yet have audited full year 2017 financials at the time of submission. As part of the expected process, we'll also need to respond to any SEC comments on that submission before filing publicly.

I should note that we're also in the process of identifying the leadership teams and reviewing capital structures for both stand-alone companies. Two decisions that have been made regarding the leadership teams are: Tony and I will continue to serve in our current roles of CFO and CEO at ServiceMaster post-separation. I know that our shareholders and debt holders as well as employees, vendors and partners have other questions regarding this transaction, and we are committed to keeping you informed that this process moves forward.

We anticipate providing the next update on our first quarter 2018 earnings call, which is currently scheduled for May 1, 2018.

The AHS separation from ServiceMaster will better position both companies to focus on the unique business needs and market opportunities and grow according to their own distinct business strategies. It will enable both current shareholders and potential investors to evaluate and invest in each business with greater clarity based on their individual merits and very attractive future growth prospects.

I'd now like to update you on our Terminix business transformation. Please turn to Slide 6. As I mentioned, we are taking a disciplined approach executing on a number of transformational initiatives to significantly upgrade the Terminix customer experience, enhance our employee engagement at the technician and sales professional level, improve customer retention rates and profitably grow our share. We are building a strong leadership team with significant experience in delivering results and driving profitable growth to lead the tremendous individuals we have throughout the company.

As I mentioned last quarter, we added Dion Persson to head the spin management office and manage the overall strategy for the company and Matt Stevenson to manage the Terminix Residential business. In December, we added Pratip Dastidar as Chief Transformation Officer for ServiceMaster. Bringing Pratip on board reflects our ongoing commitment to make ServiceMaster a strong, process-oriented, customer-focused organization that will create value for customers and shareholders.

Prior to joining ServiceMaster, Pratip held numerous executive roles in quality management and operational excellence for global businesses in the industrial, technology and digital sectors, including XP, Amazon, Applied Materials, WABCO and Honeywell.

Most recently, he led process innovation as part of the operational scale-up at Salesforce, the cloud-based enterprise software pioneer. Pratip is a certified Lean Master and Six Sigma Master Blackbelt. Under Pratip, we will continue to invest in the required resources to grow our business profitably, and we will use lean initiatives and digital capabilities to drive efficiency and process excellence.

Last month, we added Matt Loos as Vice President of Marketing and Sales for the Terminix Residential business. Matt joins us from Firestone Building Products, a division of Bridgestone Americas where he led its marketing organization. During his nearly 20 years at Bridgestone, Matt developed and executed world-class go-to-market strategies across large tiered organizations. In his new role, Matt is responsible for the complete go-to-market strategy across Terminix Residential and aligning sales and marketing for maximum effectiveness.

We're also creating an organizational structure that enhances personal accountability and supports a high performance culture. For example, Terminix Residential President, Matt Stevenson, recently held leadership meetings with more than 800 branch, service and sales managers in 5 cities across the United States. His goal was to solicit input from the field on ways to better serve our customers, generate profitable revenue growth and take care of our employees, because a unique approach that was greatly appreciated by the field organization and really set the tone for 2018. His organization is in the process of establishing key metrics for success, enhancing accountability and aligning compensation to those metrics while improving 2-way communication with the field.

As part of this effort, we are empowering our route technicians to deliver an exceptional customer experience. We are giving them the tools they need to stay connected to customers, including mobile technology, while providing them with timely customer feedback. It's still early in the process, but we have begun to see the benefits through both higher Net Promoter Scores and customer retention rates.

In summary, we are enhancing our ability to consistently deliver on our commitments by increasing transparency, improved operational cadence and measurement systems and strengthening business processes with the goal of creating long-term sustainable value. I remain confident we are headed in the right direction to deliver a consistently strong revenue and earnings growth over the long term, and we'll continue to update you on our progress.

Turning to Slide 7. We are developing a strong commercial pest control business that are able to commercial customers, which represents a significant growth opportunity. Dedicating resources to commercial allows us to focus on national accounts and local business owners' unique needs, offering us more opportunities to attract and retain customers. The $3 billion commercial pest control and termite market represents a tremendous opportunity for us, and commercial growth is a critical component of our Terminix business transformation.

We recently added Kelly Kambs as President of the Terminix commercial pest control and termite business. Kelly joins us from CBG Building Materials where she served as Senior Vice President and defined the commercial strategy for the business and established the sales, marketing and contractor base. In her new role, Kelly will have full responsibility of the Terminix commercial business and will focus on driving growth and profitability. Adding Kelly to our dedicated leadership team will help us build a world-class commercial pest business as we pursue both organic and inorganic growth.

I'm also very pleased to announce that last night, we entered into an agreement to purchase and combine our Terminix national account pest control operations with Copesan Services, one of the largest national providers of commercial pest management in the country. This combination would significantly improve Terminix's capabilities in the commercial pest control business as the Copesan brand will provide us with significant expertise, repetition and process for delivering pest management solutions to sophisticated commercial customers.

We are excited about working with Copesan's strong, experienced national accounts and commercial team, its exceptional service provider network across the country and its 2 strong regional commercial operations. The transaction is expected to close in the next 30 to 45 days. We expect Copesan to generate approximately $50 million of revenue for the remainder of 2018 following the close, with mid-single digits adjusted EBITDA margins while improving processes for our business. The adjusted EBITDA margin should move higher than the future as we realize synergies from this combination.

Turning to Slide 8. I'll briefly update you on our strategic growth priorities for each of our businesses. At Terminix, we will continue to execute on the business transformation I just reviewed. Our initiatives are designed to increase technician and branch management empowerment to improve customer satisfaction and increase customer retention levels. For example, to drive the right behaviors, we have instituted new pay plans for our route technicians, while we're now using Net Promoter Scores to drive positive reinforcement instead of penalizing them for cancellations. We're also rolling out new pay plans for our outside sales professionals with an emphasis on selling recurring units to new households. We are also rolling out a new scheduling application that allows our route technicians to see, plan and reschedule stops to better serve our valued customers and increase productivity.

At AHS, we will also seek to increase market penetration by providing exceptional service to our valued customers. As we've mentioned, we invested to improve call center response times, are driving a lean culture to simplify our service delivery, rapidly understand the underlying route cause of our service defects and provide sustainable fixes as well as upgrading contractor capacity and quality. We're also piloting a courtesy callback feature to better serve our home service plan customers during periods of high call volume and longer wait times.

At FSG, we will continue to leverage relationships with the insurance companies that currently provide us with disaster restoration leads as well as form new relationships to grow that business.

The ServiceMaster Clean business will work to both increase share with existing national accounts as well as add new accounts to drive higher revenue growth. For example, we are targeting high-growth verticals for our ServiceMaster Clean franchisees where we both acquire national accounts and provide our franchisees with any specialized training needed for those verticals. FSG leadership is also exploring opportunities to extend the current reach beyond the core franchise model as well as more traditional franchise development to drive profitable growth.

I'm very excited about our growth opportunities across all our businesses and plan to continue to share our progress as we move forward.

I'll now turn the call over to Tony, who will cover full year 2017 and fourth quarter results. Tony?

Thanks, Nik, and good morning, everyone. Turning to Slide 9. For the full year, ServiceMaster revenue grew $165 million or 6% compared to the prior year. Revenue growth was driven primarily by a 13% increase at AHS due to an increase in new unit sales growth, improved price realization and the impact of the OneGuard and Landmark acquisitions. AHS organic revenue growth remained strong with an increase of 8% versus prior year. FSG delivered 6% revenue growth in 2017 versus prior year, while Terminix revenue was up 1%, almost half of which was organic growth.

Full year adjusted EBITDA increased $11 million or 2% compared to prior year, driven largely by growth of 18% at AHS and 10% at FSG, mostly offset by an 11% decline at Terminix, primarily due to investments in the business transformation initiatives and higher sales and marketing expenses to drive future organic revenue growth.

Full year adjusted net income was $268 million, an increase of $5 million or 2% versus 1 year ago. The increase was largely driven by the increase in adjusted EBITDA.

Adjusted net income and EBITDA does not include the impact of tax reform legislation that I will review in a moment.

Full year adjusted earnings per share of $2.11 was an increase of 6% or 3% versus last year. This was driven by an increase in adjusted net income and lower weighted average diluted common shares outstanding due to our previously mentioned share repurchase program.

Turning to the fourth quarter consolidated financial results on Slide 10. Total company revenue grew $32 million or 5% compared to the prior year. Our results were primarily driven by continued strong organic growth of 8% at AHS where we continue to see strong demand for our product in both the real estate and direct-to-consumer channels, coupled with the favorable impact of our acquisition of Landmark Home Warranty last year. FSG delivered 11% revenue growth in the quarter, driven primarily by higher royalty fees and janitorial national accounts revenue. Revenue grew 1% at Terminix, driven by higher core termite, wildlife exclusion and product sales.

Adjusted EBITDA for the fourth quarter decreased $9 million or 7% compared to the prior year. The decrease was the result of small increases at AHS and FSG being more than offset by margin compression at Terminix versus prior year. I'll cover the fourth quarter performance at Terminix in more detail in a moment.

Our adjusted net income for the fourth quarter was $48 million, a $12 million decrease versus prior year, and adjusted diluted earnings per share of $0.13 was down $0.08 versus prior year. This 19% decrease in adjusted net income was primarily driven by the aforementioned lower adjusted EBITDA and higher depreciation expense, mainly driven by our investment in sales vehicles and better information technology platforms to help improve the customer experience.

Turning to Slide 11 and the full year performance of Terminix. Revenue increased 1% to $1.541 billion. The increase in core termite control and wildlife exclusion, installation and mosquito sales and improved price realization were offset by the decline in core pest control, including the $19 million decline in revenue associated with the expected customer attrition from Alterra. I should note that the projected Alterra customer attrition in 2018 should be consistent with our normal customer base, and we will no longer break it out as a cause of the change. The temporary closure of 53 Terminix branches primarily in Texas and Florida due to Hurricanes Harvey and Irma negatively impacted revenue by $4 million.

Full year adjusted EBITDA declined by $41 million or 11% from $371 million in 2016 to $330 million in 2017. If you view the waterfall chart on the bottom of Slide 11, and starting on the left side, you'll see that higher revenue conversion was about $10 million favorable for the year, including the unfavorable impact of the Alterra customer attrition.

Moving to the right, we incurred about $11 million in additional production labor costs associated with our efforts to improve safety, customer service and retention. We believe that operational improvements will produce modest labor productivity in 2018.

The $10 million increase in termite damage claims reflects increased warranty claims and reserve requirements in 2017. As I mentioned on the previous call, large claims increased in the third quarter compared to our historical norms, primarily on the Gulf Coast. We are continuously evaluating how we estimate future claims, but as of now, we are expecting a $1 million to $3 million increase in termite damage claims in 2018 versus prior year.

The $6 million increase in our insurance programs was principally driven by an increase in the number of company-owned sales vehicles versus prior year. We don't expect further increases in 2018.

The $20 million total increase in sales and marketing cost versus prior year to drive organic revenue growth, please note that we're planning to increase our total sales and marketing in 2018 by a combined $4 million to continue to drive organic growth.

And finally, $6 million of other costs, which includes a number of items included in the unfavorable impact of the 53 temporary branch closures related to the hurricanes and increased technology cost to increase productivity.

In summary, regarding the additional cost, we invested in growth and are committed to finding efficiencies that will improve margins. For 2018, Terminix adjusted EBITDA margin should be relatively flat versus prior year.

Turning to Slide 12 and the fourth quarter performance of Terminix. Revenue increased 1% to $353 million, most of which was organic growth. The slight increase in core termite control, wildlife exclusion and product sales were offset by the decline in core pest control, including the expected decline in revenue associated with the Alterra customer attrition.

Adjusted EBITDA for the fourth quarter declined by $11 million from $73 million in 2016 to $62 million. If you view the waterfall chart on the bottom of Slide 12, and starting on the left side, you'll see that higher revenue conversion was about $1 million favorable in the fourth quarter, including the unfavorable impact of Alterra customer attrition.

Moving to the right, we incurred about $1 million in additional production labor cost associated with our efforts to improve safety, customer service and retention. Termite damage claims increased $1 million in the fourth quarter of 2017 as previously estimated. Vehicle insurance cost increased $1 million year-over-year in the fourth quarter as previously estimated. As I guided last quarter, sales and marketing cost increased $8 million as we invested to drive future business growth. And the $2 million in other costs includes a number of offsetting items.

In summary, we continue to reinvest in our business capabilities in the fourth quarter of 2017 to drive sustainable growth.

Turning to Slide 13 and the Terminix revenue drivers for the fourth quarter. Terminix revenue growth versus prior year was 2%, excluding the impact of Alterra customer attrition in the fourth quarter.

Starting on the left side of the chart, revenue from our termite completions, which includes new termite sales and related services, was $65 million, an increase of $1 million or 2% over the prior year. Termite renewal revenue increased $2 million or 3% to $58 million.

During the fourth quarter, about 60% of the $65 million in termite completion and other services revenue was derived from the sale of core termite completions, meaning a first-time termite service or a onetime nonrenewable service. Core termite revenue increased about 1% year-over-year, continuing the trend established in the fourth quarter 2015 of year-over-year increases in the number of core termite completions.

The remaining 40% of termite completion in other services revenue comes from services such as wildlife exclusion and installation, and this revenue stream increased about 4% year-over-year.

Termite renewals increased by 3% compared to the prior year, driven by price, mix and an initiative to upgrade our bait monitoring stations for a small subset of our customers.

Pest control revenue of $209 million in the fourth quarter was flat versus prior year as higher price offset the revenue decline, primarily associated with the Alterra customer attrition.

As we have previously discussed, we have significantly invested in improving service levels and driving our new growth in Terminix. Although we have much more to do, we have seen significant improvement in the customer engagement and service as evidenced by higher Net Promoter Scores and real-life significant growth in new sales during 2017.

We are increasingly confident that we have taken the right steps on our continuing journey to transform service quality, improve retention and growth and position the business for a long-term sustainable growth. For 2017, organic revenue growth at Terminix, excluding the impact of the hurricanes, was 1% for the full year.

Let's turn to Slide 14 and discuss AHS' full year 2017 performance. AHS had another strong year with significant top line and bottom line growth versus the prior year. Revenue increased from $1.02 billion to $1.157 billion or 13%. As Nik previously mentioned, 8% of that growth was organic, with 7% of it coming from an increase in customer account and 1% of it from higher prices. The remaining 5% of growth, about $56 million, came from the OneGuard and Landmark acquisitions.

Revenue growth continued to be solid in both of our key channels of the market. Year-over-year organic growth in both the direct-to-consumer and real estate channels was 8%. We remain focused on sustaining our strong growth rate through optimizing our advertising, promotion and direct mail campaigns to drive new sales units as well as improving service quality to improve retention rates.

Full year gross margin was up 30 basis points versus prior year at 49%. Adjusted EBITDA increased year-over-year by $40 million or 18%, and adjusted EBITDA margin increased 90 basis points to 22.5%.

To understand the drivers of EBITDA growth, please turn your attention to the waterfall chart on the bottom of Slide14. Starting on the left side, the largest contributor to the increase in EBITDA was $47 million (inaudible) from organic revenue growth, with $34 million of it related to volume and $13 million related to price. Higher claims cost unfavorably impacted EBITDA by $8 million as inflation more than offset favorable incidence rates. The acquisition of OneGuard and Landmark contributed about $12 million in 2017.

G&A savings of $4 million was primarily driven by the integration of previous acquisitions. A $5 million increase in full year sales and marketing cost reflects investments to drive sales growth. The $6 million increase in customer service cost was driven by high labor cost to improve service levels in our customer care centers. And finally, a $3 million nonrecurring prior year investment gain.

Slide 15 is a chart we originally showed on the fourth quarter 2016 earnings call to demonstrate how, in periods of strong revenue growth, AHS maintains consistently high gross margins. We updated it for 2017, and it again shows that even with 30% revenue growth, the business produced 49% gross margins for the third consecutive year. Although some quarters see higher-than-normal claims cost, over the course of the year, the variation tends to be minimal.

Let's turn to Slide 16 and discuss AHS fourth quarter performance. Revenue increased from $234 million to $257 million or 10%, with organic growth contributing 8 percentage points and the Landmark acquisition driving the remainder. The organic revenue growth was mostly driven by an increase in customer account, which accounted for more than 6% of AHS' 8% organic growth and higher prices accounted for 1% of the organic growth in AHS. The Landmark acquisition contributed about $6 million or 2% of growth.

Revenue growth continued to be solid in both of our key channels to market. Year-over-year organic growth in both the direct-to-consumer and real estate channels was 7%. Fourth quarter gross margin decreased by 220 basis points versus prior year at approximately 47%. EBITDA increased slightly year-over-year, with margin down 180 basis points to approximately 20%.

To understand the drivers of EBITDA during the quarter, please turn your attention to the waterfall chart on the bottom of Slide 16. Starting on the left side, organic revenue growth was $10 million in the quarter, with $7 million related to volume and $3 million to price. Higher claims cost unfavorably impacted EBITDA by $8 million, with both higher claims cost per incidence and an increase in the incidence rates. The acquisition of Landmark contributed less than $1 million in the fourth quarter. G&A savings of $1 million was primarily driven by the integration of previous acquisitions. A $3 million increase in sales and marketing costs reflects the increase in our marketing spend compared to prior year to drive more units as we enter 2018. And finally, the $1 million increase in customer service cost reflect the investments to improve customer service levels.

Moving on to Slide 17, let's now cover FSG's full year performance. Revenue increased $12 million versus prior year or 6%, primarily driven by $7 million of higher royalty fee revenue related to disaster restoration services and $9 million of higher janitorial national accounts revenue, offset, in part, by a $6 million decrease in revenue from Merry Maids branch conversion to franchises. Excluding the conversion of the Merry Maids branches to franchises and a master distributor acquisition, revenue would have increased 8% versus prior year. Full year gross margin increased by 90 basis points versus prior year at approximately 61%. Full year adjusted EBITDA margin was $87 million, $8 million or 10% higher than the previous year. EBITDA margins increased 160 basis points versus prior year to 41%.

To understand the drivers of EBITDA during the year, please turn your attention to the waterfall chart on the bottom of Slide 17. Starting on the left side, revenue conversion growth in 2017 was $8 million due primarily to hurricane and wildlife-related disaster restoration fees. We had $1 million increases related to previously company-owned Merry Maids branches converted to franchises. Sales expense was up $1 million due primarily to higher labor and a $1 million decrease in other costs.

Moving on to Slide 18, let's now cover FSG's fourth quarter performance. Revenue increased $5 million year-over-year or 11%. The increase was driven by $2 million of higher royalty fees and $4 million of higher domestic janitorial national account revenue, offset, in part, by $1 million of lower product sales. Excluding the conversion of Merry Maids branches to franchises and the master distributor acquisition, organic revenue was 10% higher year-over-year.

Fourth quarter gross margin decreased by 190 basis points versus prior year to approximately 59%, driven by a higher mix of janitorial national accounts revenue. Fourth quarter adjusted EBITDA was $22 million, $1 million or 5% higher than the previous year. EBITDA margin decreased 230 basis points versus prior year to 40.5%.

To understand the drivers of EBITDA during the quarter, please turn your attention to the waterfall chart on the bottom of Slide 18. Starting on the left side, revenue conversion growth was $2 million, primarily due to hurricane and wildfire-related disaster restoration fees. Sales expense was up $1 million to invest in future growth. And we had a $1 million increase in G&A from a number of small onetime items.

Turning to the fourth quarter consolidated P&L on Slide 19. The year-over-year revenue increase of 5% or $32 million includes $25 million or 4 percentage points of net organic growth. The remaining $7 million of inorganic revenue growth was primarily driven by the Landmark acquisition at AHS.

Fourth quarter gross margins was 140 basis points lower versus prior year due primarily to higher labor, termite claims and the equal insurance cost at Terminix and higher warranty claims cost at AHS. The year-over-year SG&A increase of $16 million primarily reflects $8 million and $3 million of increased sales and marketing cost at Terminix and AHS, respectively, $2 million of higher bad debt expense at Terminix and $1 million of higher customer service cost at AHS and about $2 million of higher sales and onetime items at FSG. As a result, SG&A, as a percentage of revenue, increased by 120 basis points to 27.3%.

Net income of $306 million for the fourth quarter was up $275 million versus prior year due to the income tax benefit from the enactment of the Tax Cuts and Jobs Act that I'll cover in a moment. Excluding the tax benefit from this new legislation, adjusted net income for the fourth quarter was $48 million, down $12 million from the same period in 2016 due to lower adjusted EBITDA and higher depreciation.

Slide 20 will hopefully assist you in better understanding the 2017 impact from the enactment of the Tax Cuts and Jobs Act on December 22, 2017. U.S. GAAP and SEC regulations require the company to remeasure its deferred tax asset and liability balances in the period of enactment to reflect the new corporate tax rate of 21%, as these deferred items will ultimately be taxed at a reduced rate. The majority of ServiceMaster's net deferred tax liability is related to indefinite lives, intangible assets that arose in connection with the CD&R acquisition in 2007. As the company is in a net deferred tax liability position, the reduction to the deferred tax liability on the balance sheet is reflected as a benefit in income taxes from continuing operations.

Looking at the 2 tables, the table on the left side explains the fourth quarter and full year annual effective tax rate calculation and tax expense benefit with tax reform. As you can see, we had a $271 million tax benefit due to tax reform, which produced a negative full year tax rate of 37.6%.

Without tax reform, as shown in the table on the right, the annual effective tax rate for 2017 would have been a more customary 35.5%. The large tax benefit from the Tax Cut and Jobs Act grow significantly higher fourth quarter and full year net income and earnings per share, but this benefit was not included in the calculation of the non-GAAP adjusted net income and adjusted earnings per share metrics.

I'll review our 2018 projected tax rate when I review the outlook in just a few moments. With respect to cash flow, as shown on Slide 21, free cash flow was $46 million in the fourth quarter, which was $54 million lower than the same period in 2016, primarily due to higher cash interest and cash taxes as well as payments on fumigation-related matters and restructuring. We did not repurchase any shares of ServiceMaster's stock in the fourth quarter of 2017. We currently have $155 million remaining from the original $300 million share buyback program.

For full year 2017, free cash flow was $338 million, which was $68 million higher than 2016. In 2016, we made payments of $90 million related to the U.S. Virgin Islands fumigation matter. The after-tax impact of the payment resulted in a $56 million negative impact to 2016 free cash flow. After adjusting prior year for this payment and despite significant 2017 investments in the Terminix business transformation, free cash flow continue to grow.

The 2018 outlook is shown on Slide 22. Our 2018 outlook assumes AHS remains part of ServiceMaster for the full year and excludes the impact of any acquisitions, including the previously announced Copesan transaction during the year and projected cost related to the AHS separation.

We expect full year 2018 revenue to range from $3.015 billion to $3.045 billion or an increase of between 4% and 5% compared to 2017. Full year 2018 adjusted EBITDA is anticipated to range from $690 million to $705 million or an increase of 2% to 4% compared to 2017.

We expect organic revenue growth at Terminix to range from 1% to 2% for full year 2018 compared to the prior year. For the first quarter of 2018, Terminix organic revenue growth is projected to be flat to up to 1% compared to the prior year, but we expect it to accelerate in the second half of the year as we begin to see greater benefits from the transformational initiatives.

We also plan to focus on improving the overall quality of our revenue growth by focusing on either improving or rationalizing lower margin in underperforming territories and products. We expect Terminix's EBITDA margin to remain relatively flat in 2018 compared to the prior year.

Longer term, we still believe that Terminix's incremental margins will be between 30% and 35%. We expect AHS to deliver high single-digit organic revenue growth again in 2018, with relatively flat gross margin versus prior year. Although we plan to increase our investment in sales, marketing and service to drive further direct-to-consumer growth in 2018, we expect our adjusted EBITDA margins to remain relatively flat versus prior year.

We expect FSG to deliver mid-single digit organic revenue growth in 2018. Given that we're cycling a record year for U.S. severe weather-driven disaster restoration fees that contributed over $3 million of additional high-margin royalty fees, lower margin janitorial national accounts growth will comprise a greater share of the FSG revenue growth in 2018, which could create EBITDA margin pressure for the business similar to what we experienced in the fourth quarter of 2017.

To further assist you with your modeling, I'll provide a few key metrics for 2018, including a projected annual effective tax rate of between 25% and 26%, a projected cash tax rate of between 18% and 20%, estimated annual interest expense of between $140 million and $150 million and depreciation and amortization expense of between $100 million and $110 million.

I'll now turn the call back over to Nik.

Thanks, Tony. I'm pleased to announce that we are in the process of moving into our new corporate offices, which we refer to as our global service center in downtown Memphis as shown on Slide 23. At our global service center, we expect to foster the next great wave of innovation, customer service and performance in a contemporary, collaborative work environment, where the sole focus will be supporting our employees, contractors and franchisees who serve our customers directly. By retrofitting a downtown mall abandoned years ago into our new global service center, we will bring a new level of energy to the City of Memphis, another way of giving back to the community in which we live and work.

We look forward to hosting you at this amazing facility in the months and years ahead. In 2017, we reaffirmed our vision to ensure our invaluable brands are the unparalleled best at serving our wonderful customers. Putting our customers at the heart of everything we do will allow us to continue to strengthen and expand our customer relationships, driving sustainable growth throughout our business.

We are committed to demonstrating our care for our employees, contractor partners and franchise owners. This care is an essential ingredient of our ServiceMaster transformation plan. Our employees, partners and franchisees perform our most important work, and we are confident that demonstrating our care for them will improve their ability to provide outstanding service opportunities to our customers, ultimately, benefiting all our shareholders.

Every day, ServiceMaster delivers peace of mind for our customers. Whether we are keeping homes and commercial properties clean, protecting them from pests, restoring them after disaster or fixing heating and cooling systems, we are protecting our customers' biggest investments, their homes and facilities.

We are also enhancing our ability to deliver for our other stakeholders by improving our operational cadence and measurement systems.

Before opening the call to questions, I am confident that I speak on behalf of all our employees, contractor partners and franchise owners across the country and the world when I say that ServiceMaster and its powerful brands are better positioned than ever to deliver on our commitments to our customers, our communities, our shareholders and each other. Together, we are creating a better company that will reinvent the way customers experience the residential and commercial services. We are excited to lead the change into 2018 as we serve, we care and we deliver.

Thanks, Nik. (Operator Instructions) Tommy, let's open up the line for questions.

(Operator Instructions) And we'll get to our first question on the line from Anj Singh with Crédit Suisse.

So first one for you, Nik, on the Terminix organic growth. It seems your fiscal '18 guidance for that business is a little bit below, I think, what most were anticipating. And given the Alterra adjusted growth that you've been putting up of around 2% recently, is the 1% to 2% guide just conservatism? Or is there something else you're seeing? Maybe just talk about what you're seeing today for retention rates, new customer acquisition levels. Is the retention showing sort of a slow and steady improvement? Just help us understand the puts and takes as it relates to your organic growth guide there.

Well, thanks, Anj, for the question. The way I look at this is, as we've gone through my first 6 or 7 months here, we are -- I treat this as a steady slow progress because there's a lot of work that needs to be done in rebuilding some of our capabilities in our branches, retraining our employees, connecting in a better way with them. And I must say that I'm very pleased of the significant progress we're making on this. But a lot of work still needs to be done. And as you see through our commentary, there are a few things I'm going to focus on. Number one is our commercial business needs a lot of work. So if you see that number, it's a combination of both our residential and commercial. And we've already seen some very promising signs in both our Net Promoter Scores and retention rates specifically on the pest side, more so than even termite improving quite a lot. So I have high level of confidence going on in the residential business. Again, we're also going to focus on some things such as the quality of the revenue that we generate. For example, I want to make sure that the marketing dollars that we are spending are spent on the right type of revenue, so whether it's the profitability that comes with it, and also focusing on the life cycle value of those customers. We're going to go after more customers that have higher retention rates, certain geographies that we either shouldn't be playing in or focusing on geographies that are much more beneficial to us. So all this transformation has to be done very carefully. I mean, we're in here for the long haul. My goal and our goal at the company here is to build a long sustainable journey for a company that can consistently deliver at or above market growth numbers. We -- I had made a commitment that we're not going to do crazy things to knee-jerk and try to grow on a quarterly basis or so but make sure there's a sustainable [churn].

I mean, there's never a straight line, as you understand, with such a massive undertaking. What I can say is I'm very encouraged that in -- within 6 to 7 months, we've seen a tremendous amount of grounding and progress in many areas, but a lot still needs to be done in terms of our capacity planning. I mean, we continue to put technology in our people's hands, but we have to continue to evolve that technology into better tools. We are learning from our customers, what we need to do in terms of being better to serve them. We want to make sure that we are controlling how the kind of selection and the type of customers, which include better payment cycles, better [climate] performances and stuff going forward as well. So it's a combination of all those, but primarily, our focus on commercial, which will take -- where our work has just begun, we -- just 1.5 weeks ago, we announced bringing in a leader for that business, a business that was relatively sort of given a stepchild sort of a seat in the business, and bringing it to the fore, bringing the new leader in, announcing a tailwind of an acquisition. By the way, our guidance does not include any addition from the Copesan acquisition or any future acquisitions that we might be planning. So for me, I think this is a balanced approach to how we look at the business, and as we go forward, we'll continue to update on that number.

Okay, okay. Got it. That's really helpful. And for a follow-up, one for Tony. Could you just talk about the EBITDA guidance? If I heard correctly, you're expecting flattish margins in Terminix, so maybe just talk about what could cause it to be down year-over-year in '18? And then on the AHS, is there a reason why you're stepping up the investment so much higher to cause flattish EBITDA margins year-over-year given the sort of 35% incremental margins you've spoken to in the past? And I didn't hear you reiterate the 35% target for that business. So is that still intact?

Yes. Good questions, Anj. Let me talk about Terminix first. As you know, we -- and as Nik just mentioned, we're investing in our capabilities to better serve the customers, and we're continuing to see opportunities. We're going to continue to invest as needed. But what we're also going to do is generate productivity and efficiency. We talked about Pratip coming onboard to drive Lean Six Sigma to our operations. We believe that improvements that, that will generate will offset any additional investments that we'll have to make. So that's why we believe margins will be basically flat in Terminix. Now I'll -- Nik is going to talk about the increased investment in AHS, but I will say that, before I turn it over to him to address that, that incremental margins were higher, were 35% or better in 2017 and we still expect that going forward. So Nik, do you want to talk about the investment?

On the AHS, what's critical to me is, as I came in, I saw an incredible groundbreaking opportunity in this business. As you know, we've been serving -- we just touched -- crossed our customer count to over 2 million in this year, which is a big achievement for the business, but what lingered in my mind is there's 120 million homes in America. How do you get to those levels because the market, the way we defined it, we were counting us having about 47% market share, so we've been through an intensive amount of effort and work to see how we can serve beyond the 4 million homes and how do you capture a significant portion of the 116 million homes going forward. And that's just counting the United States as of now and not even really expanding our thinking process to outside our boundaries in commercial and other places. The fantastic part about this business is it's one of a kind, which is a -- which guarantees service to its customer through incredibly strong technical platform that connects 15,000 contractors in America. We monitor, manage, score and train and help them improve to over 2 million customers. There's a huge ability to expand this, but we have to look at other avenues beyond the warranty model that we offer today in terms of retail services and stuff. So and whether we go into retail services or not, it is imperative in today's world to be the best-in-class in customer service, and we're investing a lot to reduce our hold times, to improve our customer service levels. Pratip is also helping us drive significant mindset shift in terms of how we understand our customer issues and complaints, rapidly understand the root causes and put permanent solutions in place to give service that we can be very, very proud of, which becomes a huge barrier to entry in the future. This will also give us a nice foothold as this company becomes independent to expand beyond its own capabilities today in the warranty space to retail and concierge services or the likes. So we've done a lot of work to understand that, but it does take that upgrading that service. Plus, we're -- I strongly believe in digital capabilities that this business can benefit hugely from, which gives even higher ability to deliver increased margins in the future because you're going to be a lot more dependent on artificial intelligence, machine learning and other capabilities, which this business is very, very well suited for.

We'll go to our next question on the line from the line of Sam Eisner with Goldman Sachs.

So maybe just to kind of ask some kind of straightforward questions here. In terms of just the deal statistics associated with Copesan, if I understand how it fits into the portfolio from a kind of strategy standpoint, but any kind of deal statistics that you can share, revenue multiples, EBITDA multiples, synergies, how you're financing, and anything of that nature?

Yes. I'll give you part of the answer. I'll leave it to Tony to talk about the financing part and stuff. Copesan, number one, to understand, it's an incredibly great asset that we've been able to create this deal with. Copesan brings to us an unparalleled capability in this industry to serve national accounts. And as you know, Sam, bulk of our commercial business was to serve a lot of small and medium businesses, which we've combined with capabilities to acquire and retain over the long term, strongly retain national accounts that Copesan has demonstrated with average retentions well into the double-digit years, brings a huge complementary benefit to this -- to our companies together. We will be benefiting from strong leadership that Copesan has, which will come along with this business. And the way the deal is structured is we're paying $100 million upfront, as you can read it, and there's about $40 million to $50 million that will be paid in over the 3 years or towards the end of the third year. And we're -- we have a relationship with that -- or the way the deal is structured, it gives us a lot of ability to drive synergies over the next 1.5 to 3 years to significantly upgrade not only the EBITDA performance but exponentially help our commercial space to grow. So I'm very encouraged because we're getting some systems capabilities that we would otherwise have to be investing in on our own. We are getting leadership capabilities that were very necessary specifically in the national account space. And we are also getting some best -- industry best practices that significantly upgrade our commercial space, which would have taken us at least 4 to 6 quarters to reinstate or install in our own business in our own way. So that's going to be some money that we need to invest to make this combination deliver significant returns in the future. But I also see that this is sort of a huge tailwind or a cornerstone deal that I'm really happy about.

And I'll follow on with a little bit of information on the transaction, Sam. We'll pay approximately $100 million at closing and approximately another $50 million 3 years from closing. We'll fund that out of cash flow. As far as specific 2018 impact, as we talked about in the script, we're expecting about $50 million of revenue assuming it closes 30 to 45 days from now which is likely. Initially, the margins will be light around mid-single-digit range, and they'll improve significantly as we move into 2019 and beyond with the implementation of synergies.

So maybe I'm just trying to understand this deal better. So you're paying by prorate that $50 million for full year. It seems like you're paying well north of 2, 2.5x sales here. I guess, why is the multiple -- the multiple relative to other things I have seen seems to be on the upper end of historical spectrum. So what is it about this transaction that is causing you to pay that level?

Well, you're -- remember, the transaction's going to close in the second quarter, let's call it. So you're talking about $50 million for a 9-month period.

Right. I understand that. And is the growth rate particularly interesting for this transaction? What was -- this is a business that's doing $65 million or so of revenue annually. What was it last year? Is it growing at a particularly fast rate? Again, just trying to understand the price paid coupled with the earnout relative to the earnings profile.

Yes. I think given our brand equity in Terminix and the kind of incredible capabilities and customer relationships that this company has, we see some complementary benefits where we can expand even the existing national accounts with more locations and grow into additional national accounts. It gives us a significant benefit. If you look at the overall revenue, we're looking at just around 2x of revenue, but we see huge amount of synergies, both on the growth side and the profitability side going forward. And we're also counting synergies where we would have to significantly invest a lot of cash flow and capabilities in terms of technology and capacity that -- or building branches. I mean, bear in mind, we're getting around 325 service locations that come with it, which we would have to steadily build in the commercial space to grow at our own pace. And as the transaction closes, Sam, we'll continue to provide more color on this deal.

We'll go to our next question on the line from the line of Toni Kaplan from Morgan Stanley.

Are there any changes that you're planning to your investment strategy in 2018 as opposed to this year? So which areas are you planning on spending more? Where are you pulling back? And just in terms of the investment plan so far, this was asked a little bit earlier. But have you seen any sort of increases in Terminix retention since you've started the investment?

Yes, we -- as I mentioned earlier and even if you -- in my script, what I said is we have seen very encouraging signs both in the improvement in our Net Promoter Scores and also our retention rates. For competitive reasons, we don't declare -- give out exact numbers, but we're seeing close to, I would say, about 150 basis points improvement in our pest retention for example. And we're seeing significant improvements, like I said, in our Net Promoter Scores as well. So yes, so I would say our investments are working, but are all of them working in the same direction or the quantum that I want them? No, as I've learned through the last few months, which is what I said, one of the fundamental shifts we're going to make, even though it may cost us some small percentage of revenue growth, I want to divert the marketing dollars, divert the sales efforts, divert the regional strategies to areas and products and customers where we have higher life cycle values. So we're creating a longer-term benefit for the company rather than shooting for short-term growth kind of strategies as well. So where our focus will be, number one, will be in continuing to build the growth platforms. So it's going to be -- we're going to be very steadfast in delivering the growth for the future that we need in this company. As you saw from the M&A perspective, bringing in highly synergistic acquisition like Copesan because it gives us a huge presence in the upper end in not only the, for example, national accounts but in sectors or segments like certain specific verticals, where -- which were missing for us, so we are broadening the scope of commercial services that we provide. And I see commercial longer term as a much faster growing path for us in this business as well. I see great promise with residential. It's going to be a steady grind and buildup, and I'm very confident with the initial results. So yes, we're going to invest in our growth. We're going to invest in technology, more and more in digital capabilities and also, continuing to invest in capacity and capability where it's absolutely necessary to drive that growth. But as I promised by bringing in a Chief Transformation Officer and already starting not only in continuous improvement but change management projects, we are going to balance the act of -- we're not just going to willy-nilly invest and dilute our margins. We're going to continue to build that margin strength so we can continue to deliver stronger cash flow, which will help fund some of these activities as we go forward.

That's great. And then now that you're a little further down the path for the spinoff, can you give us an update on your thoughts around future capital structure of the 2 businesses? Or what's the corporate cost that the new entity will take on? Or are you waiting just until you have done the filing?

Yes. You'll see more, Toni, when we do the filing. As what Nik mentioned, we did a confidential filing, and as we proceed through the process and make this thing public, you'll see all that information.

As you can imagine, Toni, it's a complicated process. We have over 18 or 19 work streams that are working very diligently towards it. What's encouraging to me is we are absolutely on track not only in our filing and stuff but all the work we're doing in terms of the physical separation of these 2 companies, setting up the right teams. And so I think there's an incredible amount of work, where we have to be very thoughtful on how we allocate the right people to the right jobs, whether we bring in some talents externally. There's a lot of great internal talent that'll help us, but we're also -- as I mentioned earlier that Tony and I have decided and it's been agreed with the board that we will be staying on with ServiceMaster, which I'm very happy about, but we're -- we've also launched -- or searched both internally and externally focusing on people, get the best C suite candidates and CEO for the company going forward as well. But we're pretty encouraged. There's a lot of work. And as I said, as we know, you will know, so we're going to be very transparent in things that are readily shared with people. I mean, I think I mentioned right in the first call, #1 priority for me is maintain an absolute transparent relationship here.

We'll go to our next question on the line from Ian Zaffino from Oppenheimer & Co.

Just sticking on the retention question. Nik, since you've been in there and you've been running the show, what's sort of your thoughts on retention going forward as far as what were your expectations? I know you can't disclose exactly what they were. But what were your expectations initially compared to what you're seeing now? And to get that retention up, is it really just a matter of focusing on certain areas? Or maybe you can give us a breakdown of the retention improvement, how it would kind of manifest itself as far as within each specific region versus switching regions, if you can kind of give us any detail there. And then I have a follow-up.

Thanks, Ian. Great question. I mean, this is kind of the heart of the question of what Terminix is all about or any service business is all about. So there's 3 fundamental things that we focus on, which is why -- which sort of aligns completely with our new vision, which is we serve, we care, we deliver. It also -- it's -- the #1 priority is always the service. So the first component is ensuring flawless service to our customer because, as I've learned with my several ride alongs and branch visits and conversations with the field and our customers directly, when a pest control technician leaves a particular home and you see a smiling customer shutting the door, that's when you've secured the business longer term because they're going to drown out the noise from any competition, any ads or any flyers or brochures that come their way. And we've got to get a lot better at that. So I'm -- what I -- and the second part that goes very hand in hand with that is our ability to treat our technicians and sales professionals with the greatest care. If you treat them like gold, they're going to treat your customers like gold, which is a core practice that we have worked really hard to build and which is why, yes, we've had some separation of leaders where with the company when I joined, and we brought in some incredible talent, and one of the highest quality I look for is not just the ability to deliver or being right in the past but also extremely humble. Matt Stevenson has done an extremely amazing job bringing together several people. I mean, I barely see him because he's out in the field so much. It's really to gain the confidence of our people that this is for real. We're going to take actions that stick for the long term because we have to ensure that they have firm belief that every time they go out to the customer and promise something that the company is going to be right behind them to help them ultimately deliver the kind of service that we want to deliver. So it's -- it is a long journey, but if you ask me what are the fundamental things, it's all about getting the service level to the highest and getting -- ensuring that our employees are totally engaged, they understand. And by the way, we're getting much better feedback from our employees today who are willing to share some of the issues, which help us actually improve both the processes, systems and the capabilities that we deliver to them. And I think I've seen -- I'm actually pleasantly surprised of the pace at which the retention has improved. It's never going to be a straight line though. So it's just going to be until we get to a steady state where we're really talking about building on top of something that's solid, we are still in the foundation building mode in my mind.

Okay. And then just for Tony, the 4% to 5% revenue growth, that assumes contribution from the deal or does that exclude the contribution?

That excludes contribution from the acquisition. It's strictly our base results without regard to acquisitions.

We'll go to our next question on the line from Dan Dolev with Nomura.

I have 2 questions. First question is what have you learned from your predecessors' M&A practices, more specifically from Alterra when it comes to the Copesan acquisition? How you -- what are you doing to avoid kind of the same issues that we've had with Alterra? And then I have a follow-up.

What I learned is acquisition -- and I used to be an M&A leader in my previous life for a company. So partly that but partly also -- I mean, the best thing about history that teaches you some lessons, I mean, that's all you can really take and move forward, right? And for me, it's all about are you acquiring value or are you acquiring a short-term benefit. So it's about retention and the quality. As I mentioned, it's not just from an acquisition, Dan, but even going forward, from the marketing dollars or where we spend, we're going to be very judicious about the quality of revenue that we focused on. Life cycle means a lot in this business on how we acquire customers that have significantly longer runway for us, where we're not constantly throwing dollars just to regain. I'd like to make sure that we -- one is to improve service and care of employees and all we're going to improve, but we also -- it's like great employees. You don't do the right recruitment, you're not going to get the best results either. So it's about the recruitment of customers that we have a profile of customers that stay with us longer that actually will pay us on time as we go. So we're improving that as well. So that's the same logic on acquisition. We did a lot of studies in this, and I think what is helpful with, for example, with Copesan is the kind of retention. And we're talking 15- to 17-year retentions on many accounts, and they've done a phenomenal job demonstrating the kind of service that customers deserve. The other thing is, when you say value, you don't acquire more of the same. You acquire what's complementary to you. So what helps us with Copesan is bringing in a strong national account acquisition and management capability combined with our ability to acquire a lot of small businesses and serve a lot of small locations. You're talking national accounts with thousands of locations across the country. So it's an incredible combination. So all these factors going back. So definitely, you will never see us do an acquisition that we're doing just to fill in the blanks. It's always got to be about what is going to be better for the long term for our shareholders and company.

Very helpful. And then my follow-up is, I think, last data point you provided on the number of technician was about 5,700. I was surprised to see the margins kind of staying flat in Terminix this year or flattish. Can you maybe give us an update on the technician number and kind of where you see the steady state technician number for Terminix?

Not a material change from 2017. We -- I think we did some significant work in 2017 to improve engagement. We did see a spike up in the number of minutes per work orders, and that's stabilized. Now we're going to work on 2018 with better planning our capacity, so we manage that labor better. And we think we'll get some productivity from that, and again, we're thinking that, that's going to offset any additional investments that we want to make to further improve the business.

And I think, also, going forward, you will see some capacity adds. We're also going to better match our marketing spend in territories where those capacity adds are being done, proper training, getting them on time, so we can manage the influx of the leads and customers that we generate.

We'll go to our next question on the line from Andy Wittmann with Baird.

Just given all the focus on the Terminix segment, I thought I would just try to get a little bit of thoughts from you guys about the relative split between your outlook on the pest business versus the termite business, just kind of the relative growth rate that you see here. And specifically, for that second half comment where you're seeing accelerating growth, what are the things that you're looking at today that are going to -- giving you confidence to that acceleration in the second half for the year for the Terminix segment?

Andy, thanks for the question. If you see this year, we've made some progress on termites, but we've also seen, as I mentioned in the fourth quarter, reasonably encouraging uptake on both Net Promoter Scores and retention to pest. So we're starting to see our pest business trend upwards, and then I see that steadily building throughout this year in various areas, different geographies and segments of pest businesses that we drive. Whether it's some regular pest that we're talking, roaches or mosquito business or bedbug business. We're starting to see good traction in those, and I'm very encouraged with the trend we will see in that business. On the termite, though, we saw some upward trend. We're starting to see some challenges and flattening in some areas. We obviously had a record-breaking cold January, which is not always helpful, but we're starting -- but we're pretty encouraged that we can continue to make some progress on termites, but I would say, pest is going to be a faster trend for us going forward.

And then my second -- my follow-up question here is on the American Home Shield business. In the quarterly, the claims -- you said the incidents and the severity were both factors into the flat year-over-year EBITDA trends that you saw there. I was just wondering, as you look at the trends, is there something in the customer mix or the way you're marketing the AHS product today that might be driving that? Or what can you say that helps us get comfortable that the claims, incidents and severity is maybe more of a onetime? Or do you expect that to continue into 2018?

Yes. We expect that to continue in a similar vein. We have not seen any noticeable shift in current types of customers or the type of complaints or claims. As we go, there's definitely a lot of quarter-to-quarter variation in these given there's several factors, depends on how hot, how cold, what kind of breakdowns. I mean, obviously, for example, when you see an incredible heatwave, you're going to have a much more bigger approach, but what we're doing is we're also putting smart procedures within where we can start actually early February tuning air conditioners, attending to customers more on a proactive basis, so we smoothen out more of the significant uptake even when you get higher temperatures and stuff. So it's a way of generating productivity upfront because, then, if your volume of breakdown's not high, you're not doing more replacements. You're not putting more people into the call center to answer at peak volumes. So we're working on improving how we serve these customers. I don't see, Andy, in any way that there's, between '16 and '17, that there was a noticeable shift or so. I mean, Q4, we had some issues, but I -- but it's -- if you look at the year-over-year, the trend is pretty much the same.

And I would just add to that and say that, remember, incident rates were favorable earlier quarters this year, and for the full year, they average essentially flat at the same full year rates we had for the previous 2 years. So I think this is just normal variation.

We'll go to our next question on the line from Tim Mulrooney with William Blair.

So piggybacking on the -- just to go back to Terminix margins one more time. Can you talk about the assumptions that are built into your guidance for flat adjusted EBITDA margin at Terminix? You expect organic growth of 1% to 2%, so you're getting some revenue conversion. But you're also continuing to invest in the business. I heard you say $4 million in incremental sales and marketing, I think, in the prepared remarks. Is there anything else to consider related to production, labor, customer service initiatives, changes in tech, compensation, et cetera?

Yes. I think it's going to be a combination of improving capacity in certain areas where it's absolutely necessary not only to maintain the customer base in a happy and efficient way but continuing to grow there. So we're ensuring this investment is in high-quality revenue. We're ensuring that the capabilities in technology are going to be strong. We're going to do -- we did quite a lot in terms of residential business this year. And we're going to -- so if you look, so there's going to be some continuing run rate from that, but I think the bigger investments this year, the focus is going to turn also on commercial, where we believe this business has a significant amount of growth runway that we really didn't focus as heavier on in the past, and I believe this is going to be a very, very critical part of our Terminix transformation or turnaround. And so we have to invest some certain additional systems, capabilities, people, resources and even a lot more in terms of digital technology. Now Copesan acquisition will help a lot. So that actually takes off some pressure from us going forward in terms of the amount we have -- would have to invest otherwise without something like that. But in still, I think, bringing Kelly in has been just the first step, but we've got to look at a significant upgrade in terms of how we build leadership capabilities and system capabilities around this business. This business is much more attune in the future for things such as machine learning and other digital capabilities that we're carefully studying and analyzing those, and my vision is, in the future, how do we combine the customers and the synergies between this business and our ServiceMaster Clean business going forward as well, which is also focused on a similar level of commercial customers.

One more on the pest. You just mentioned bedbugs and mosquitoes in the Q&A here, which, I know, are 2 key growth vectors in the pest world today. Have you ever shared or can you share what percent these represent of your pest business today? And are they important growth opportunities? Or do you view them more as kind of one-off services that you're having to perform but not core to the growth story?

Yes. They're -- bedbug pest -- and bedbug and mosquito are relatively small percentages of our overall Terminix revenue. But they are growing, and they are important services for us going forward.

And this is also part of the investment story, is we need to invest in things like that, where we see a higher quality of revenue and higher growth potential, and we have to build certain product capabilities and system capabilities to support that. And we see the potential opportunities here, Tim. And like Tony said, we're relatively small today, but we see a lot of runway in this going forward.

We'll go to our next question online from Judah -- our next question on the line is from the line of Judah Sokel with JPMorgan.

One quick question. I don't know if you guys mentioned CapEx guidance in the prepared remarks. We clearly have OpEx visibility from the guidance. But in terms of CapEx, how are you guys thinking about that for 2018?

Judah, it's relatively flat versus 2017, might be up a little. We're still firming up numbers with respect to the spin, for example, which we'll disclose later. But remember, 2017 was a little higher than 2016 because of investments in the headquarters plus the Terminix investments we made in new vehicles.

Okay, helpful. And then just staying on that investment theme, another -- just one more question in terms of Copesan. Maybe you can explain exactly what you're buying. Clearly, they have regional operational providers, and then they have alliance partners with revenues that far exceed the $50 million that you guys are expecting for the rest of the year. So maybe you could explain how those alliance partners will be -- how that will apply once you guys acquire Copesan, if they apply at all. And maybe that'll help us understand also the lower margin than what we normally would expect to see at a pest control business.

Yes. Thanks, Judah. Well, the point I want to make about Copesan is it provides us some capabilities that will enhance our ability to serve the commercial market. Strong national accounts team, the alliances with these companies that they work with, that's all part of what we're acquiring, and over time, we'll see synergies in combining our national accounts efforts with their national accounts efforts. And so that's the reason why the margins are a little bit light out of the gate, but they'll go to normal levels, which you would see in this kind of business once we implement those synergies accordingly.

Nik, I don't know if there's anything you want to add to that.

As Tony mentioned, Judah, though, it's the combination of best of both worlds for us, is taking the higher end sort of national account acquisition capabilities, which we needed to enhance internally anyway and our ability with our strong brand equity and also some capabilities that we bring to the table. Now these alliance partners will be very helpful over the term with certain outsource services and stuff that we will continue to rely on. But the entire business that we have acquired is a national account business, so that's something will be 100% sort of part of Terminix-Copesan combination that we will serve. And we also, as we mentioned, acquired 2 very strong operating locations or operating commercial operations with it that help bolster how we serve, with all the best practices, serving commercial customers.

We'll go to our next question on the line from the line of Gary Bisbee with RBC Capital Markets.

I'll stick with the commercial theme. So Nik, you've been very clear. You see this as a growth opportunity, and it strikes me that the capabilities, both people and maybe the technologies you're using, the level of the techs, the -- certainly these national accounts, it's all very different from the resi market, and sounds like the deal brings some good capability. But how much more do you need to invest in people and process, et cetera? And what's the time line to get this business just with the foundation and infrastructure and people in the right place to then begin to consistently grow the business? Are you close? Are you thinking this is a multi-year process to get it where you want it to then be a consistent growth?

Gary, thanks for the question. You're right. I mean, right from day 1, there are certain themes that I talked about is, number one, was getting closer to our people, upgrading the service levels in all 3 of our businesses, focusing heavier on commercial, the complete transformation of Terminix as we do business and certain other themes like transformation, right? So I've been fixed on those. And as you know, we've said a lot of things, but we've also done an incredible amount in the last 7 months by putting the right leadership team in place, undoing certain things we were doing. We're focusing on some right systems and processes and capabilities. Now the commercial business, if you look back the past in Terminix, the stronger focus has always been residential. And I hate using the word stepchild, but let's call the commercial business as a stepchild treatment over the last few years. We separated very early in my tenure here with the leadership of that business, and it took me a while to bring in the right leader because, for me, recruiting the right leader is so important that I would rather have taken the time but make sure we get the right person in place. And I'm very, very encouraged and happy that we were able to bring somebody of Kelly's caliber onboard. Now if we had not done this acquisition, we would have had a higher investment both in terms of the kind of leadership talent and kinds of people we bring onboard. And bear in mind, commercial is not just about national accounts. So what we really got, we hear, is leadership, systems, processes, people for serving national accounts. So we can combine our national account practice with Copesan's pretty efficiently, so that saves us a lot of hard work and effort or accelerate some of our time lines. But there is a vast array of commercial customers outside of national accounts, the small and medium businesses, the factories, the schools, whatever you may. And so there's a huge amount of opportunity there, and we're looking at different angles for that. So we will continue to invest in that. There are different system capabilities necessary for that. We will inherit certain things from Copesan that can be leveraged across, but there are certain things that we will have to spend on our own. And bear in mind, this is just in a place that investments are never put into, and we truly believe in the business. We've got to do what's right to build our foundation, whether it's systems or people, right? And so it is a high -- but it'll continue to be a high priority for me and our company, and I'm just very encouraged that I feel like I got a tailwind coming into us with a partnership like Copesan and Deni Naumann, who's the Head of their business. I'm really happy that she's becoming a critical part of our team to help guide us through some growth in national accounts but also bring some much necessary leadership and capabilities and definitely, going to be a huge help for Kelly, who's not new to driving successful businesses but new to the industry. So that's a great combination for us.

And then a quicker follow-up. Both of you mentioned that revenue -- the focus on selling the right revenue, I think, in particular, the residential business, and Tony, I think you even used the term some revenue you could rationalize as you focus on recurring profitable right revenue. Is -- any more color you can provide? Is there a material piece of the base that is not the recurring revenue that you're really focused on? And should we think that, that could be a real drag as you do that to revenue growth? Or is it more on the margin and the focus on just [what you add] will be the right?

It's not substantial by any means, where we'll just drop the ball on something or just wipe out or carve out or write off something. That's not the approach. The approach is I want to make sure that while I'm committing to the business that we will give them the necessary marketing and sales dollars that we are doing a far better understanding and analysis that those dollars are being spent and analysis that those dollars are being spent for higher life cycle value customers versus customers that, well, you have to chase every year as brand-new customers, It's not -- doesn't mean we'll completely give up on some of those opportunistic moments, but we're going to be very diligent and judicious in how we spend our dollars going forward. We are going to look at geographies, which -- our white spaces because that has helped with that acquisition for acceleration versus spending a lot of money. We're going to look at branches that are underperforming and how we help them grow in the right way. So there's going to be a plus or minus takes there, Gary. It's going to be done with a very clear, good analytical approach. And there are certain geographies and territories, which we have to look at the overall profitability. As I mentioned, my dream one day is to have over 300, 10 million plus type operations around this business with branch CEO-type mentality where we provide the backbone with a brand, the capability, the digital capabilities and processes, but we pretty much leave them alone because they should know their local markets so well that they become the unparalleled leaders in how they serve these regions. But we've also got to pick on which way we want to put our higher bets on, and that's something that has to be done. Any good, solid performing company does that. We just got to get better, become our priorities.

And Mr. Turcotte, we have no further questions on the line. I will turn it back to you for any closing remarks.

Thanks, Tommy. Thank you, again, for your patience in today's call and webcast. As a reminder, a replay of the call will be available on our website about 1 hour from now. We look forward to speaking to you on our first quarter 2018 earnings call currently scheduled for May 1. Have a great day. Take care.

Thank you very much. And ladies and gentlemen, that does conclude the conference call for today. We thank you for your participation and ask you to disconnect your lines. Have a good day, everyone.