Terminix Global Holdings Inc (TMX) 2018 Q1 法說會逐字稿

Ladies and gentlemen, welcome to ServiceMaster's First Quarter 2018 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, operator. Good morning, and thank you for joining our first quarter 2018 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, May 1, 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 first quarter 2018 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 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.

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 first quarter 2018 highlights. He will then provide an update on the American Home Shield separation and progress on the Terminix business transformation. Tony will follow and summarize our consolidated first quarter 2018 financial results, review the individual business unit results, provide more details in regard to our financial statements and then speak to the updated full year 2018 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 for our first quarter 2018 earnings call. As you saw this morning, we reported solid results for the quarter as we continue to execute on our strategies to drive long-term growth and drive value for our shareholders. For those of you on the call following along with our webcast deck, please turn to Slide 4.

We reported a 5% year-over-year increase to $675 million in the first quarter for ServiceMaster, with American Home Shield and the Franchise Services Group achieving 9% and 14% organic revenue growth, respectively. Strong growth across 2 of our businesses demonstrate ServiceMaster's ability to consistently drive organic growth. We have begun leveraging these capabilities across Terminix as part of our front-end transformation.

In line with our previous indications, Terminix achieved 1% revenue growth in the first quarter versus prior year, despite an unfavorable weather impact from extreme cold spells, primarily in the northeastern part of the country. We are encouraged that we are seeing positive improvements in customer satisfaction, retention as well as improvements in our sales and marketing practices for Terminix, like we have seen in our other businesses.

We also see a strong pest control season coming, and are confident that we are better positioned to capture some of that growth as we enter the weather-delayed heat, pests and termite season. Overall, we delivered adjusted net income of $59 million and adjusted EPS of $0.44 versus $46 million and $0.34, respectively, 1 year ago.

Our Terminix business transformation delivered strongly on productivity initiatives and base reduction, enabling us to improve our business model and responsibly invest in our organic and inorganic growth.

On March 30, we closed the Copesan transaction as planned, and I will discuss Copesan and our commercial pest control business in more detail in a moment. We continue to enhance our ability to deliver on our service commitments by driving a series of systematic transformational initiatives. Finally, we also continue to strengthen our leadership team and increase accountability across the entire business.

Turning to Slide 5. I'm pleased to report that we remain on track with the numerous work streams related to the AHS spin-off from ServiceMaster and continue to target the third quarter of 2018 to complete this separation. We are focusing each work stream on positioning both businesses for success, and are confident that both businesses will be well established for strong growth following the spin.

We are currently awaiting a private letter ruling from the Internal Revenue Service. We also filed an amended Form 10 with the Securities and Exchange Commission as we continue the regulatory approval process. We're continuing the process of identifying the leadership teams and reviewing capital structures for both stand-alone companies. I'm very pleased with the progress being made by our spin management team working on the separation. We anticipate providing the next update on our second quarter 2018 earnings call, currently scheduled for July 31.

I'd now like to update you on our Terminix business transformation. Please turn to Slide 6. We continue to take a disciplined approach to executing on a number of transformational initiatives designed to significantly upgrade the Terminix customer experience and drive organic growth in this business. To execute these initiatives, we have built a strong leadership team at Terminix with significant experience in consistently delivering results and driving profitable growth to lead the tremendous individuals with rich industry knowledge and experience we have throughout the company.

As previously mentioned, we added Matt Stevenson to manage the Terminix Residential business and Kelly Kambs to manage the Terminix Commercial business, as well as Dion Persson to run the spin management office and manage the overall growth strategy and business development of the company, and Pratip Dastidar as Chief Transformation Officer. I'm very pleased with the team we have assembled to make Terminix and ServiceMaster a strong, customer-focused, process-oriented organization that will create value for customers and shareholders.

Let me give you an example of how we are reinforcing accountability. The Terminix management team recently solicited input from field on ways to better serve our customers, take care of our employees and deliver profitable revenue growth. We learned that we were overwhelming our branches with requests for measurement of dozens of performance metrics that were not adding value or aligned with the desired outcome. Based on this feedback, we have established 7 key metrics for success to enhance accountability and align compensation to performance, while improving 2-way communication with the field.

These metrics include: safety, employee engagement, household counts, Net Promoter Scores, revenue, new and renewal units and EBITDA, and these are now being used to measure performance at the branch level.

The reaction by our field organization to both the new metrics and the tools, including mobile technology, has been outstanding. We're very encouraged by the passion to provide excellent customer service exhibited by these valued employees, who feel empowered with our approach to enable them to deliver an outstanding customer experience. And importantly, we have begun to see the benefits of these efforts through both higher Net Promoter Scores and customer retention rates.

In the first quarter, Terminix pest control and termite control trailing 12-month retention rates improved 70 basis points and 30 basis points, respectively, versus prior year. In addition, first quarter pest control and termite control NPS scores increased 12% and 14% versus prior year, respectively.

Our initiatives are designed to empower our technicians and branch management to deliver an exceptional customer experience that will increase customer retention levels. For example, we have instituted new baselines for our route technicians based on NPS scores to drive the right behaviors instead of penalizing them for cancellations.

We also plan to roll out new pay plans for our outside sales professionals, with an emphasis on selling recurring units to new households. And we are also introducing a new scheduling application that allows our route technicians to see, plan and reschedule stops to better serve our valued customers and increase productivity.

We remain focused on rebuilding a strong commercial pest control business as well. Historically, commercial pest and termite control has delivered approximately 20% of our annual Terminix revenue despite limited management focus and resources. Despite losing traction over the past few years, we believe that we have a tremendous opportunity to increase our share in this attractive and growing segment of the pest control market.

Turning to Slide 7, I'll briefly update you on our progress in rebuilding a strong commercial pest control business. 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 U.S. commercial pest control and termite market represents a tremendous opportunity for us, and commercial growth is a critical component of our Terminix business transformation.

As I mentioned earlier, we added Kelly Kambs as President of the Terminix commercial pest control and termite business. Adding Kelly to our dedicated leadership team will help us build a world-class commercial pest business as we invest in improving our customer relationships and service capabilities, and pursue both organic and inorganic growth.

With the March 30 close of Copesan Services acquisition, we can now combine our Terminix national account pest control operations with Copesan, one of the largest and best providers of commercial pest management for national accounts in the country. This combination will vastly improve Terminix's capabilities in the commercial pest control, providing us with significant expertise, reputation and processes 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 2 strong regional commercial operations we also acquired as part of this transaction.

Now that we've closed on this transaction, I can provide more details regarding the acquisition. We expect Copesan to generate approximately $60 million of revenue for the remainder of 2018 and approximately $4 million of adjusted EBITDA, while we invest this year in improving the sales, marketing and commercial service processes for our legacy commercial business.

We expect the adjusted EBITDA margin of the acquired business to move higher over the next 3 years toward our normal commercial account margins as we begin to improve our legacy commercial business and deliver on the synergies we have identified from the Copesan acquisition, including adoption of their commercial service processes, systems and quality processes, which we believe has enabled them to achieve world-class customer retention and satisfaction metrics.

Overall, the Copesan transaction is a key strategic step in anchoring a foundation to build a world-class commercial pest control business, and it will deliver a solid long-term return on investment. I couldn't be more pleased that it's now part of our commercial pest control business.

To summarize the ongoing Terminix transformation, we are enhancing our ability to consistently deliver on our commitments by increasing transparency, improving operational cadence and measurement systems, and strengthening business processes with the goal of creating long-term sustainable value.

I remain confident we are heading in the right direction to deliver consistently strong revenue and earnings growth over the long term, and we'll continue to update you on our progress. I'm very excited about our growth opportunities across all of 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 first quarter 2018 results. Tony?

Thanks, Nik, and good morning, everyone. Turning to Slide 8. Total company revenue grew $32 million or 5% compared to the prior year. Our results were primarily driven by continued strong organic revenue growth of 9% at American Home Shield, driven by new unit sales growth and improved price realization; and 14% at the Franchise Services Group, driven primarily by higher disaster restoration royalty fees and janitorial national accounts revenue growth.

Revenue grew 1% at Terminix, driven by termite renewals and wildlife exclusion sales. Adjusted EBITDA for the first quarter was $141 million, an increase of $7 million or 5% compared to the prior year. The increase was driven primarily by improved margins at Terminix, reflecting benefits derived from productivity initiatives, which I'll review in greater detail in a moment.

Our adjusted net income for the first quarter was $59 million, a $14 million increase versus prior year. Adjusted diluted earnings per share of $0.44 was up $0.10 versus prior year. This 30% increase in adjusted net income was primarily driven by a lower effective income tax rate from the enactment of tax reform and the aforementioned higher adjusted EBITDA.

Turning to Slide 9. In the first quarter performance of Terminix, revenue increased 1% to $368 million, most of which was organic growth. The increase was driven by growth in termite renewals revenue and wildlife exclusion sales, offset in part by the decline in termite completion and other service revenue. The decline was driven primarily by unfavorable weather conditions, which created significantly lower customer lead flow versus prior year, and 4 sub-branch closures. We estimate the weather impact on revenue to be approximately $3 million in the first quarter, and we will make every effort to recover that revenue shortfall in the next few quarters.

Adjusted EBITDA for the first quarter increased 6% or $5 million from $81 million last year to $86 million in 2018, resulting in a 110-basis-point margin expansion. If you view the waterfall chart on the bottom of Slide 9 and starting on the left side, you will see that higher revenue conversion was about $1 million favorable in the first quarter.

Business productivity improvements include: one, production labor efficiencies of $1 million related to past investments in field operations; two, chemicals and material sourcing savings of $2 million; and three, a reduction in bad debt expense of $3 million, driven by enhanced credit policies and collection rates.

The business productivity savings were partially offset by: a $2 million increase in targeted sales and marketing investments to drive unit growth; and timing of an unfavorable $1 million sales cost impact related to accounting rule changes with respect to sales commission expense timing.

In summary, our focus on business process improvements and productivity initiatives resulted in a nice margin improvement in the first quarter.

Turning to Slide 10 and the Terminix revenue drivers for the first quarter. Terminix organic growth was 0.5% versus prior year. Excluding the impact to the aforementioned unfavorable cold weather in the first quarter, organic revenue was estimated to be up approximately 1.3%.

Starting on the left side of the chart, revenue from termite completions, which includes new termite sales and related services, was $68 million, a decrease of $2 million or 3% versus prior year. Termite renewal revenue increased $4 million or 5% to $83 million.

During the first quarter, about 60% of this $68 million in termite completion and other services revenue was derived from the sale of core termite completions, meaning a first-time termite service. Core termite revenue decreased about 7% year-over-year, mainly due to the colder-than-usual first quarter.

The remaining 40% of termite completion and other services revenue comes from services such as wildlife exclusion and installation. This revenue stream increased by about 2% year-over-year. Termite renewal revenue increased by 5% compared to the prior year, driven by a modest increase in retention rates, mix and renewal timing.

Pest control revenue of $202 million in the first quarter was up 0.3% versus prior year as higher prices more than offset the decline in volume. Our core residential pest business continues to improve on a year-over-year basis, driven by higher new sales and route efficiency optimization. On the other hand, we have opportunities, as Nik mentioned, to continue to transform our commercial business going forward.

As Nik mentioned, we remain confident we're headed in the right direction to deliver consistently strong revenue and earnings growth over the long term at Terminix.

Let's turn to Slide 11 and discuss AHS's first quarter performance. Revenue increased $20 million or 9%, all organic growth. The revenue growth was mostly driven by an increase in new unit sales, which accounted for more than 6% of AHS's 9% growth, with higher prices accounting for the remaining 3% of growth. Revenue growth continues to be solid in both of our key channels to market, with direct-to-consumer, or DTC, up 11%, and real estate up 8% year-over-year.

First quarter gross margin decreased by 120 basis points versus prior year, as unusually cold temperatures in January drove high-claim incidents related to heating systems. Excluding an estimated $5 million of higher heating system claims related to the weather, gross margins would have improved 90 basis points versus prior year.

Adjusted EBITDA increased $2 million or 6% to $32 million versus prior year, with margins down 30 basis points. To understand the drivers of EBITDA during the quarter, please turn your attention to the waterfall chart on the bottom of Slide 11.

Starting on the left side, organic revenue growth was $13 million in the quarter, with $9 million related to volume and $4 million to price. Higher claims cost unfavorably impacted EBITDA by $6 million, driven primarily by the estimated $5 million of higher heating system claims, incidents related to cold weather. A $3 million increase in sales and marketing cost includes a $2 million incremental investment in digital marketing, which drove DTC unit growth of 17% versus prior year.

And finally, a $2 million of incremental investment in customer care center cost to staff, train and enhance workforce processes to deliver a new level of customer service. We know it's working because, in the first quarter, we reduced the average customer response time by 50% and increased renewal rates versus the prior year.

As we mentioned last quarter, we are seeking to increase market penetration by providing exceptional service to our valued customers. In addition to investing in our customer care centers, we are driving a lean culture to simplify our service delivery and rapidly understand where we can do better in addition to upgrading contractor capacity and quality. We're also piloting a courtesy callback feature to better serve our home service claim customers during periods of high call volume and longer wait times.

Moving on to Slide 12, let's now cover FSG's first quarter performance. Revenue increased $10 million year-over-year or 21%. The increase was driven primarily by $2 million of higher royalty fees, $4 million of higher domestic janitorial national account revenue, and the recognition of $3 million of national advertising fund franchisee contributions. The recognition of the ad fund is related to our adoption of a new accounting rule regarding revenue recognition that took effect on January 1.

I should note that we project approximately $12 million of full year favorable impact on revenue from this accounting change. But because all contributions will be used for advertising expense, there is no impact on EBITDA.

First quarter gross margins decreased by 230 basis points versus prior year to approximately 61%, driven by a higher mix of low-margin janitorial national accounts revenue and the revenue recognition accounting change. As I've mentioned in the past, we recognize all of the revenue with national accounts, which lowers the reported margin percent.

First quarter adjusted EBITDA was up $1 million or 5% versus previous year. EBITDA margins decreased 550 basis points versus prior year to 37.8% due to the aforementioned national accounts mix impact and the revenue recognition accounting change. To understand the driver of EBITDA during the quarter, please turn your attention to the waterfall chart on the bottom of Slide 12.

Starting on the left side, revenue conversion growth was $2 million, due primarily to higher disaster restoration royalty fees and owned branch revenue related to the January freeze events. And we had a $1 million increase in G&A from a number of small onetime items.

At FSG, we continue to leverage relationships with 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.

For example, the image on the top right of Slide 12 shows the ServiceMaster Clean franchisee cleaning a medical examination room, an area of profitable growth for our franchisees.

Turning to the first quarter consolidated P&L slide on 13. The year-over-year revenue increase of 5%, or $32 million, was predominantly organic. First quarter gross margin was 30 basis points higher versus prior year due primarily to the improved performance at Terminix. The year-over-year SG&A increase of $11 million primarily reflects $3 million of increased sales and marketing costs at both Terminix and AHS, $2 million of higher customer service costs at AHS and about $1 million of higher sales and onetime items at FSG. As a result, SG&A as a percentage of revenue increased by 20 basis points to 29.2%.

Net income of $40 million for the first quarter was up $1 million versus prior year. Adjusted net income for the first quarter was $59 million, up $14 million from the same period in 2017 due to the lower effective tax rate from the enactment of tax reform and the higher year-over-year adjusted EBITDA.

With respect to cash flow, as shown on Slide 14, free cash flow was $119 million in the first quarter, $10 million higher than the same period at 2017. No federal income tax payments were made in the first quarter of 2018, so there was no impact from tax reform on net cash provided from operations or free cash flow.

Our improvement in free cash flow was mainly driven by a higher adjusted EBITDA. We did not repurchase any shares of ServiceMaster stock in the first quarter of 2018, and we currently have $155 million remaining from the original $300 million share buyback program.

The full year 2018 updated outlook is shown on Slide 15. Please note that our 2018 outlook assumes AHS remains part of ServiceMaster for the full year. It excludes the impact of any future acquisitions but does include Copesan transaction, which we closed on March 30. And it excludes any increase to operating cost related to the AHS separation targeted for the third quarter of 2018.

The changes from the outlook we've provided on February 27 are as follows: first, we now anticipate full year 2018 revenue to range from $3.085 billion to $3.115 billion or an increase of between 6% and 7% compared to 2017. This was due to the estimated impact of Copesan's 9-month revenue contribution and the FSG adoption of a new accounting rule regarding revenue recognition impact. This is an increase of $70 million to both the upper and lower end of the original range.

Secondly, we now anticipate full year 2018 adjusted EBITDA to range from $695 million to $710 million, or an increase of 2% to 5% compared to 2017, primarily reflecting the estimated impact of Copesan's 9-month EBITDA contribution. This is an increase of $5 million to both the upper and lower ends of the original range.

And we also updated our projected annual effective tax rate to be between 26% and 27%, our projected cash tax rate of between 19% and 21%, and narrowed our estimated annual interest expense range to be between $145 million and $150 million.

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

Thanks, Tony. Slide 16 provides our ServiceMaster shared vision of We Serve, We Care, We Deliver. Those aren't just words to our 13,000 employees or our 15,000 contractor partners and over 4,500 franchise owners and their 34,000 employees. They represent our shared commitment towards obsessing over the service we provide to our customers, deeply caring for employees and consistently delivering the commitments we made as a company. I am confident that I speak on behalf of all our employees, contractor partners and franchise owners across the country in 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.

We are demonstrating our care for employees by enhancing their ability to win along with the company. For example, we have invested in Terminix route technician pay plans that provide incentives linked strongly to performance, while eliminating measures which penalize their pay for cancellations.

We are significantly prioritizing talent upgrades as a true differentiator of our success going forward. While bringing in the required talent at leadership levels and across the organization, we are also identifying areas of cost savings to fund and invest in this talent responsibly. We are also investing in a series of initiatives to further empower our employees to win and drive greater successes for everybody at ServiceMaster.

Together, we are creating a company that will reinvent the way customers experience residential and commercial services. We are excited to lead the charge throughout 2018 and beyond as we serve, we care and we deliver.

Before we open up the line for questions, I'd like to mention that we added Bill Cobb to our Board of Directors on April 9. Bill is the former President and CEO of H&R Block and has previously served on a number of public boards. Bill is a dynamic addition to our board and will offer powerful counsel and support in our efforts to grow profitably, significantly enhance our service capabilities and deliver long-term sustainable value.

As we continue to drive our Terminix transformation and, of course, the spinoff of AHS, we look forward to Bill's leadership, along with the active oversight of the rest of our Board of Directors.

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

(Operator Instructions) And our first question comes from the line of Ian Zaffino with Oppenheimer.

Question would be on the slide where you have the revenue growth by channel. Could you maybe, on Terminix, can you maybe just delve a little bit deeper into the puts and takes on the pest control services, that being flat? And how much of it was maybe improvements in retention or pricing? Or just any type of details you can maybe give us on that comparison year-over-year will be helpful.

As you see, overall, we delivered in line with what we've been professing since I've come on board. And we've guided between 1% to 2% for the year, with a slower start at the beginning of the year, which of course, also, got a little bit of hamper both on the pest side and the termite side by the weather, roughly $2 million around impact on the termite side and about $1 million on the pest side. What we're seeing in both these results, 70-basis-point improvement in our retention scores, in our retention, and even on our NPS scores in the pest and 30 basis points on termite. Small, yet a significant improvement in the right direction, given the efforts that we're putting into the business. This is a combination of retention rates, it's a combination -- plus the new growth, new units that we add and pricing wins the weather. So I'm actually quite pleased as to where we are taking this business. As I mentioned to you earlier, the focus we are trying to move the business towards is how do we generate a consistent rhythm of recurring accounts and new households, and not depending heavily on one-time sales that we were pushing in the past. So there is a big transition that's taking place. So we see momentum actually on all the 3 different areas that we focus on, different product lines. But as our products revenue strengthen, as we return the business back to the branches, improving the ability of our techs to serve, we are starting to see the underlying Net Promoter Scores and retention starting to improve, which, definitely, we're not happy where we are, but this is, as I mentioned, this is a journey, and we're taking the right steps in the journey. So we're going to be -- I think it's a combination of both residential and commercial. So the real big improvement we saw was in the residential side. We still have some baggage where we're dealing with 2 specific areas in commercial and in bedbug, which need significant work and improvement. And as you know, bringing in Kelly Kambs, supporting her with strong leadership, bringing in some best practices from Copesan, is definitely going to bode well as we move forward and even strengthen both the commercial segment and additional segments, such as bedbugs and mosquitoes.

Okay. That's very helpful. And then I know you just closed on Copesan, but I guess in the time that you -- or brief time you've had running it, maybe give us an idea of kind of updated thoughts there. I know you're excited by getting some of the learning systems and some of the processes from them. I think you've talked about the retention rates previously. But maybe give us maybe some incremental thoughts on Copesan now that you've been running it for, I guess, a month now.

Well, if anything, my belief that we made the right -- absolutely the right move to strengthen dealing with the world-class operations of Copesan right from the leader, Deni Naumann, the kind of knowledge and expertise that she brings to the table along with a very strong team. We've already had several exercises where Terminix commercial and Copesan employees have been working very closely now over the national accounts in how we integrate our national accounts into Copesan, given their lead and their world-class retention rates. They are a benchmark, and we've got a lot to learn from them. Largely, our commercial business, as you know and I've mentioned before, was largely an extension of how we ran our residential business, and we need to do a lot of work to get to the levels of Copesan. So if you ask me, I think it was a great move. We almost, I would like to say, we planted our flag in the commercial space, announcing that we are very serious about this business. We believe that we have an incredible opportunity to capture a lot of share in this market in terms of how -- but we have to improve how we serve these customers, and adding Copesan just gives us a tailwind.

Our next question comes from the line of Toni Kaplan with Morgan Stanley.

I wanted to ask about margins. So the Terminix margins were greatly improved this quarter. And some of the items you highlighted in terms of why, it sounded pretty sustainable, like the sourcing savings. And so just trying to get a sense of which of the items you would think could continue. And when I look at the guidance, the guidance raise on EBITDA was only about $1 million so -- and this quarter was better than expected, that's ex the Copesan $4 million that you mentioned, and EBITDA this quarter was better than I had thought. So I just want to get a sense of how to think about the rest of the year in terms of EBITDA. Was it -- was there something that I'm sort of missing because I thought that, in theory, guidance on EBITDA could have been higher.

Toni, as I've mentioned in earlier discussions, that one of our prime focus of bringing in somebody like Pratip Dastidar is to drive a culture of transformation in the company. And underlying the transformation is not just growth transformation, but also focus on waste elimination and strict streamlining of processes. So, a, we've become easier to do business with; b, we drive more responsible sustainable processes. So we're seeing the first results of these, which you may call it the low-hanging fruit, and we aim to continue to drive some of these initiatives and even additional initiatives that are planned. But I have mentioned earlier, there was a concern that we have to invest a lot in this business, which we do, but we're also going to find a way to continually pay for them. So this is why we're keeping the EBITDA guidance to where we were because we do have to take a lot of these savings that we drive and reinvest those back, especially where we need to drive the growth and we need to drive some consistent practices. We just enhanced and enriched our pay plans, for example, taking effects of cancellations out from our technicians, which we, I believe, was quite unfair, and giving -- and putting in a pay structure that pays for performance. And enabling our employees to win along with the company just goes a long way, not only in our value of deeply caring for them, but also how they treat our customers. So all this adds up. And I think, don't underestimate the power of -- for us to continue to drive cost reduction and waste out of the system, because that does 2 things. It not just makes us a better company and easier to do business with, but provides necessary funding to responsibly pay for any investments we plan to make.

That's great. And I know we haven't seen the Form 10 yet, but what are your updated thoughts on paying dividends, just given the strong free cash flow profile?

We are working it, but as I mentioned earlier, we are pretty much on track here now to deliver on the spin. And as we go into the next phases of filing the Form 10 publicly, sometime in Q3, we will elaborate further on what our capital structures, cash needs and allocations will be.

Our next question comes from the line of Andrew Wittmann with Baird.

I guess, I want to build a little bit more detail on the last question. And specifically, I guess, since the margins were good in Terminix, you said they would be flat year-over-year. Is that suggesting, Nik, that the plan includes incremental investments that were not contemplated at the last guidance update? Was the implication that the Terminix margins are flat? We also have to recognize here that Copesan is mixing the reported margin profile down for the balance of the year, so maybe that's a factor. Is that part of the reason why they're flat? They're actually trending above plan organically, but now that you've folded Copesan in, that brings them back down to flat. Just trying to understand the moving pieces around the Terminix margins would be helpful.

Yes. Andy, we've consistently maintained that we will be investing in this business, and we will find ways to fund it versus just adding more investments at the cost of delivering on the bottom line margin. So it's a responsible way of running the business. And one thing I'm steadfast about is long-term growth. I see no reason why both Terminix residential and commercial can't return to at or above market growth if we obsess about the service to our customers, we deeply care about our employees and have them completely engaged. So there's a lot of investment in terms of training in systems, technology that we plan to make. But it's going to be very systematic because, ultimately, it has to drive the necessary results and the momentum that we're starting to build. So I'm pretty happy about the momentum. I think Terminix -- Copesan margins, if you think about the whole business, including the operations of it, the margins are no different than what our normal commercial business would be. The reason we are doing it in a staged way is because we want to leverage the benefit of excellent customer service and retention rates that Copesan has consistently delivered. So rather than onboarding some of those accounts strictly just for EBITDA's sake, I think it's much more beneficial for us to continue to streamline our own internal operations before we bring in some of that business over the next years, thereby not only enhancing our brand equity or brand value, but continuing to improve our retention rates towards, as I mentioned, Copesan has demonstrated that to be benchmark in the industry.

Okay. I guess, I want to kind of do my follow-up on Copesan, so thanks for kind of going that direction a little bit. I guess, when you guys first gave us the revenue target that you're seeing at Copesan, you were talking about like $65 million of annual revenue. Now you're talking about a partial year contribution of a similar amount. So I guess, I want to understand the delta. Does that include some level of contemplating that some of that revenue will be brought in-house? And then as soon as you account for that new revenue that's been brought in-house from Copesan, is that going to be considered organic when you bring that in? And do you plan to disclose how much revenue you're bringing in so that we can look maybe at the remaining Terminix business on an apples-to-apples type basis, recognizing that Copesan is a little bit of a different animal?

Let me -- you're -- let me clear up what I think is an obvious misunderstanding. When we talked about Copesan in the previous quarter, where we had just signed them a deal, we are bringing the entire revenue of Copesan in. It's just the margins, because we are still outsourcing the work with the individual partners, that are coming over time. So the revenue was always the same. We have taken a conservative estimate because, at that stage, we just signed a deal where we're still waiting for certain approvals. So the $50-plus million was prorated for 2018, so it's apples-to-apples. It's just that we were able to close by March 30, which -- it's just a timing issue. So it's -- we closed earlier than we expected. This is why it's getting a higher revenue in this year.

Our next question comes from the line of Judah Sokel from JPMorgan.

I just had a couple, 2 quick questions. The first one is, to what extent was weather already contemplated in guidance when we spoke just a couple of months ago, both on the AHS side in terms of the claims as well on the termite side in terms of those completions?

We never -- unless we are absolutely sure of seeing the impacts, we never guide to weather or make guesses on it. I mean, if you look at, for example, we had revenue impacts on Terminix, we had the incidence impacts on AHS, but we had a favorable impact on our restoration business. But we're not also -- we're not forecasting, for example, the hurricane season because, last year, we had a pretty heavy hurricane season. Every time we forecast, we use normalized weather patterns. So no, Judah, we didn't really take that into account as that story was building up while we were having the conversations.

Got it. So it was all because of the weather that happens, the new weather surprise that happened after the last time you gave guidance? Understood. And then one other, sorry...

It's -- we have these cyclones -- bomb cyclones and other things, unusual weather patterns. And it's a matter of what happens from January to March. But this -- it takes a while for us to completely understand the impact exactly of weather. So we weren't -- in February, when we gave the quarterly guidance, none of this weather was baked into it.

Understood. Okay, that's fair. The other follow-up question is just about -- is a follow-up to what Tony asked earlier in terms of the components of the margin within Terminix. Just trying to understand specifically the bad debt expense. I think people's instinct is to look at bad debt expense and say that's not a real genuine productivity initiative, but it sounds like, if it's stemming from improved collections, improved credit policies, perhaps that is a recurring dynamic. So maybe you could just give us a little bit more elaboration on what's going on there and how long and to what extent we can expect that to recur over the next few quarters.

Judah, it's Tony. I'll take this one. This is really all about business process improvement. And Nik mentioned Pratip Dastidar and the great work he's doing with Lean Sigma across our business. It's really about the ease of doing business with our customers, improving that. We really focus hard on that. Our business practices in the field translate into improved collections as well as, in the financial area, we did tighten up the credit policies as well. So it was really those 2 actions, better processes in the field, coupled with better procedures in corporate and managing credit.

Our next question comes from the line of Sam Eisner with Goldman Sachs.

Just going back to the Copesan numbers that you provided. I was wondering if you could maybe give us some pro forma numbers for 2017. If you took your existing commercial business, added on the 2017 Copesan revenue, and also gave us a margin or an EBITDA associated with that, what would it be? I'm just trying to understand how big this business really is on a stand-alone annualized basis.

Sam, it's Tony. I'll take this question. If you -- essentially, you could see this is -- it was baked into our guidance. We added, essentially, $60 million of revenue related to Copesan for the 9 months in 2018 and roughly $5 million of EBITDA. And that's all reflected in the guidance.

I guess, what is the 2017 existing commercial revenue and EBITDA? Because, Nik, you're making comments about how you expected to get up to commercial margins. I'm really trying to understand what the profitability of your commercial business is going to be, looking out really to '19 and '20 and beyond that. I recognize you're going to see margin expansion over time, but I really want to know what it is today when you combine the new Copesan, which is a low-margin business, and your existing commercial business, which is maybe a bit higher?

Well, we've -- if you look at our breakoff -- breakdown between our residential and commercial business, it's 80-20 of our total Terminix business, so 20% being commercial. Of course, adding Copesan, as we mentioned, $60 million for the rest of the year, you can pretty much annualize what that would be in terms of revenue, combined with our commercial business. Now we've always mentioned that commercial business margins are a few basis points below our residential, so if you take the total margins, you can see where they fall, say, between 18% to 20%, given different quarters and the breakdown. And Copesan margins, I'm not worried about the Copesan margins at this level because that's how we -- with the acquisition, because we're getting EBITDA dollars now for that for gaining -- for winning the business and maintaining the accounts. We're still outsourcing the work to individual partners. And as we mentioned, as we improve the branch performance of Terminix, it will be easier for us to start on-boarding this and thereby deliver the kind of outstanding service that Copesan delivers today. The #1 priority for me is that this -- the service levels -- the quality of the service level should be the same or better in terms of delivery to the customers. This whole transaction should be transparent from the customer's perspective, and that is critical for us, while we actually benefit from this partnership and improve our own underlying practices, thereby, helping even our own margins and synergies with them. So I'm pretty encouraged, and just mathematically, as I mentioned, had we brought all this operation in on day 1, the margins of Copesan wouldn't be any different than the commercial margins we deliver today.

Our next question comes from the line of Tim Mulrooney with William Blair.

So I'm sorry if I missed it, I'm juggling a couple of calls this morning. But did you say retention rates were up 70 basis points in pest?

Yes. That's correct. In pest, it was up 70 basis points.

All right. So do you guys attribute that expansion and retention to the improvements in service that you've implemented over the last several quarters? And do you expect similar improvements in retention throughout 2018? Just the 70 basis points is pretty impressive turnaround, kind of happening faster than I had expected.

Tim, it's -- unfortunately, it's never a straight line, but I'm very encouraged with the initial progress. And we see much more progress on the residential side. We still have a lot of work cut out for us on the commercial side and some specific products. So commercial is going to be a challenge as we grow, but if we -- I'm pretty encouraged, given the kind of turnaround Matt and the team have brought in Terminix residential or starting to bring, we follow those same practices, same discipline, I'm pretty encouraged we're going to see that change of NPS scores and retention, even on the commercial side, even though we're just in the beginning of the journey with Kelly's addition to the team of changing a lot of people in the team, learning from Copesan as we go. The one fundamental thing is really getting the pay plans in place by the end of December as we had committed to our technicians. We're driving better service because we have returned the business pretty much back to the branches. Our technicians today have a much bigger and better ability to see the schedules of their customers and have a better control on it than we had in the past when we were controlling it with a large instrument from a central office structure. So we're turning that business back, giving them the flexibility, giving them the information technology, tools to deal with the customer and incentivizing -- the team has been driving significant contests, significant energizing efforts for the branch managers where they -- we've gone from forcing them to report on over 40 to 50 metrics, constantly changing on a daily basis, to 7 simple metrics, which they drive by. And their ownership of the business, and they're held accountable for it, but these are the metrics they came up with. So this is taking their feedback into account and then running the business as our branch managers would like to run it. So that empowerment is really helping see that initial rush in momentum, and we can -- we aim to continue to build on it. And then layering that with the transformation efforts that we're driving at the company, ultimately what we want to do is build a company that's able to sustainably deliver high-growth revenue or high -- profitable revenue. It's not about winning a quarter, it's about winning the war in the end.

Yes. No, that makes sense. So if pest retention rates are growing, they grew 70 basis points, why aren't we seeing that trend...

Can you speak a little louder? It's hard to hear you.

Yes. Sorry, can you hear me now?

Loud and clear.

How is that?

Perfect.

Okay. So if the retention rates are growing, which they are, why aren't we also seeing organic growth growing in pest? And we all know the math, 100 basis points in retention is $10 million to $12 million in incremental revenue. Is it just the new customer growth is still lagging? Or is there -- is it -- was it just related to weather? Can you help me bridge that gap or understand it? I know it's not that simple.

Yes. Apart from the basic math of new sales retention pricing, there's other factors, such as the commercial, where we, as I mentioned, we have bigger challenges which we're getting to work on. And I'm starting to see some promising improvements there as well, which will bode well for the future. We also have a lot of focus on some special pest spaces that -- or product strategies that we work on, such as bedbugs and mosquitoes, which we are also working hard to improve. And then, as I mentioned, I think, in our last conversation, we also were dependent in the past a lot on some of the one-time sales. So we overemphasized the one-time sales at the cost of building recurring headcount with new households or new customer accounts. So that is where we're putting our focus on. So losing some of those one-time sales causes some turbulence in our numbers in the beginning. But over time, as we to continue to build that household count, we will see much more sticky growth as we go forward.

And there are no further questions on the phone lines at this time. I'll now turn the call back to our presenters. You may continue with your presentation or closing remarks.

Great, thank you. Thank you again for your participation in today's conference call and webcast. As a reminder, a replay of the call will be available on our website about an hour from now. We look forward to speaking with you on the second quarter earnings call currently scheduled for July 31. Thank you.

Ladies and gentlemen, that does conclude the presentation for today. Thank you for your participation. You may now disconnect.