Q3 2019 Earnings Call
Ladies and gentlemen, welcome to Servicemasters third quarter 2019 earnings call.
Today's call is being recorded in broadcast on the Internet.
Beginning today's call is Jesse Jenkins, Servicemasters, Vice President of Investor Relations and Treasurer.
I'll now turn the call over to Mr. Jenkins cool introduce the other speakers on the call.
Thank you certainly good morning, and welcome to our third quarter 2019 earnings Conference call.
Again, I'd like to remind you that throughout todays call management may make forward looking statements to assist you in understanding the company's strategies and operating performance.
Stated on slide two all forward looking statements are subject to the forward looking statement legends contained in our public filings with the FCC.
These forward looking statements are not guarantees or 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 todays call speaks only as of today November 5th 2019, the company undertakes no obligation to up.
Any information discussed on today's call.
This morning, Servicemaster issued a press release filed with the FCC on form 8-K, highlighting our third quarter 2019 financial results. The press release in the related presentation can be found on the Investor Relations section of our web site at Servicemaster Dotcom.
I will reference certain non-GAAP financial measures throughout todays call and we have included definitions of these terms in our press release. We've also included reconciliations of these non-GAAP financial measures to the most comparable GAAP financial measures in our press release in the appendix of this presentation in order to better assist you in understanding our financial performance.
All references on the call to EBITDA or to adjusted EBITDA as defined in our press release.
Joining me on todays call or Servicemasters, Chief Executive Officer, Nick Party in Chief Financial Officer, Tony dealer Cindy.
Three of the presentation posted on the Investor Relations section of our website shows the agenda. We will cover today I'll now turn the call over to Servicemaster CEO , Nick Marty Nick.
Thanks Jessica.
And thank you all the time today.
I will start to the Q3 performance highlights on slide four.
As we have shared with you over prior quarters, we ought to determine journey to become the best and most customer centric pest control home and commercial services company not industry.
We understood that there would be challenges and some ups and downs as we made progress on this journey.
We have to a great people and much of what capabilities and investments needed to be made ahead of the profits that could come from these investments.
We have also be focused on effectively managing legacy risks and issues such as Carmike damage claims and fumigation services.
Despite these issues we are convinced that we continue to make significant progress on our journey.
Like even I would absolutely committed to do what is needed to return our company market leading growth sustainable margin improvements.
We're determined to do this in a smart deliberate and focused manner.
Thank you are doing the right way to sustain these improvements.
We'll continue to focus on and prioritize our core business Adobe reach our goals.
We will also aggressively and thought only address these hurdles quickly and decisively.
Both management issues and legacy issues.
Well certainly be other setbacks along this journey.
We are improving visibility and management focus across all of our businesses that will allow us to address the future issues faster more efficient manner, providing increased performance consistency to our shareholders.
So this master Delaware, 7% revenue growth in the third quarter as we continue to make progress on our strategic initiatives.
Organic growth in Terminix was 2% despite the competitive against strong prior year organic growth rates driven by improvements in stock rates and completion rates.
Acquisitions in Terminix accounted for 5% of the revenue growth in the quarter.
As we strategically added tuck ins in the residential business and continued strong performance over short environments and our carbon strategy in New York City.
Servicemaster Brian's also had a strong quarter posting 5% revenue growth as initiatives to grow commercial national accounts, and healthcare cleaning and disinfection gain traction.
We remain focused on re imagining the customer experience and companies to drive better service levels.
NPS scores in the Terminix business are up across all of our service lines with the hard work of our customer facing technicians to improve our service delivery.
These improvements Lord daily cancel rates and increased retention, excluding the impact of chromite renewals in the mobile Alabama region.
How many commercial continues to build on a strong foundation of quality assurance processes leverage from corporate center to drive retention improvements over 300 basis points versus prior year.
Initiative is focused on consistent customer communication.
Quality audits and engaging with the customer gearing on time appointments are driving better customer satisfaction that is translating to organic growth.
Greg rather, Florida and his team have done a tremendous job in a very short time in setting the business on a growth trajectory.
So investments and the sales team, including a new VP of sales, we can drive new customers at a higher base in glut in food service delivery network.
Turning to commercial also recently added significant capabilities and talent through the recent acquisitions of to corpus and our gross.
The cloud services and Gregory pest control each AG unique capabilities in high value verticals that will act with the depth of our commercial business.
The leaders and technicians, we added share a common culture of serving our customers getting put our people and delivering results and they will be invaluable tradition to the team.
And finally, we are holding on refinancing of our current loan book today that will allow us to take advantage of a strong that market grew about interest rates and extend our debt maturities into the future.
Turning to slide five.
Our value creation strategy focuses on three priorities.
First we are fully committed to continuing our progress on varying the core of our strong businesses.
Hi brand awareness and large segments and growing markets.
While we continue to make progress our Q3 EBITDA performance is the reminder, that we still have more work to do.
We also are continuing to expand our addressable markets through new geographies innovative products and expanded service offerings.
M&A remains a micro part of our longer term strategy.
Underlying and supporting all of these initiatives is the critical progress, we're making you mentioned the customer experience.
Better service levels on the basis of our company mission.
Stock when serving our customers.
We are making progress on a customer first culture change that we realigned every person in the organization, but think about how we are making things cleaner healthier and safer, but all of our customers.
Pumps or changes take time.
And there are many milestones along the way, but we are prioritizing this important aspect of our strategy and beginning to show meaningful results that are gaining traction.
Turning to slide six.
I would like to highlight the progress we are making on improving our service levels and what we are building curtailments, even farther into the future.
In residential pest continued execution on the basics of customer service are driving improvements in the base business.
Continued progress on the initiatives could never Miss an appointment speaking with customers before and after every service visit and improvement of our service delivery and effectiveness have helped drive a 3% Yodle, we had improvement in both daily cancellation rate and NPS scores in the portal.
We still have a long way to go to achieve our goal of best in class service levels and delivery, but it is nice to see continued progress in these areas.
Commercial pest continues to show a dramatic year over year improvements as well.
We're communicating more consistently with our customers and striving for on time delivery of service and best in class responsiveness.
Our initiatives are being well received by our customers as evidenced by MBS ratings at a 4% highest score year over year.
These improvements are translating quickly to customer attention as again trailing 12 month retention is up over 300 basis points from a low base in the prior year.
Despite the recent challenges in our termite business in the mobile mobile Alabama region. The remainder apart from my business continues to grow.
Excluding this region, our daily cancel rates have improved 6% year over year.
Yes floors, driven by customer service and quality actions, we're taking have improved 2% year over year.
North clean sheet initiative, a completely revamped service delivery model has been developed that focuses on improving process capabilities at every customer touch points.
This ultimately will provide a much better customer experience and improved Carmike protection.
The findings from this initiative and the completed Validations are being used as a basis for our Salesforce implementation.
Labor efficiencies improve customer employee retention and digidyne workflow quite a few of the many benefits that will come from the Salesforce initiative.
What particular, adding up importance to us that we will be monitoring closely in the pilot branches in Arizona.
Documentation capabilities.
Vical aspect of our services the ability for document for work performed.
With Salesforce all the information on prior services customer signatures and chemical application will be digitized and that the fingertips of everyone across our company.
Turning to slide seven.
Terminix has long enjoy a leading market position in the termite business.
A key part of the value proposition to our customers is the best in class warranty against damages, which has allowed us to build acquisition.
The profitability levels will the business have historically included spending approximately 4% to 4.5% of Carmike revenue annually in the settlement companies termite damage claims nationally.
And the base up our business outside of the mobile Alabama area continues to operate that these historical levels.
Most of these claims to handle directly to the customer and involve relatively minor repairs, but a few occasionally involve litigation and the payment of beverages.
In the past few years, we have seen an increase in the lumber an average cost of Carmike damage claims in the mobile Alabama area related performance on Carmike activity.
We also seen an increase in the number of Carmike damage claims in that region that involve litigation.
These two trends have increased our property damage claims cost as a percentage of carmike revenue between seven and 8%.
Given the increased volume we have seen we expect additional cost increases in 20, pointing before our mitigating actions fully take effect and we begin to gradually return them to historical norms.
I'd like to reiterate that the cost increases above historical trends are attributed almost exclusively to foremost and productivity in the mobile Alabama area.
We're not seeing trends of this time in any other job would be even those with promotion carmike activity.
We have been focused on managing damage claims since January of 2018, and the mitigating actions, we're taking a showing positive signs.
And with our larger larger business initiatives, we began with improvements across the board customer service levels. This includes better training of our technicians on application of chemicals and rigorous new customer inspection process.
At the beginning of 2019, we began a pricing initiative in the mobile Alabama area to better align the cost we change we charge during my customers with the actual cost mean color could provide services in the area.
We anticipate some customer reductions as a result of the pricing change, but they have accelerated faster than we originally projected and as a result on impacting termite renewal revenue and profitability in the short term.
As these customers renewing contracts, we conducted a detailed inspection and when necessary retreat properties.
We have added a dedicated quality assurance team that is solely devoted to these inspection laundry treatments.
Another key initiative was to increase awareness of these issues in the area and trained technicians mortgage effectively on inspection methods to identify and document aspects of our wholesome termite activity that are different from to update and impairments.
Inspection and documentation process is vital to ensure we set customer expectations regarding property damage that may predate our treatment and conducive conditions that may limit our treatments effectiveness.
Another action do you think it's been through our claims management process through a third party administrator.
This administrator helps us several any new claims that may arise at a faster pace than our historical norms.
In the long run we believe these actions will help us return what historical damage claim norms.
However, as we actively inspect properties retreat actress properties and result claims faster than our historical base. They are impacting us negatively in the short term.
Our Carmike services work effectively on Formosa termites, and we have a list of initiatives you have been driving the limit our legacy risk exposure.
Unfortunately, this issue will take US time couple leaders all the mitigating actions, we're taking our aimed at returning us to our normal profit levels and carmike overtime.
The termite business remains attractive strong value propositions for end customers and strong profitability.
Turning to slide eight I will touch on the difficulties, we have had sourcing of communication services and what we're doing to resolve them.
In order to resolve potential legacy risks related to litigation operations. The company outsource completion services to a third party provider.
This commentary to see arrangement allows the company maintained its position with customers as a full focus pest control provider.
In order to rapidly address these risks, we experienced execution missteps, which resulted in higher than expected outsourcing costs, which impacted our bottom line.
We are implementing the production plant group of homes to better subcontractor management and negotiation of better pricing with our service providers to ensure that the business has attractive economics going forward.
And before I turn it over to Tony to go with the financials I will briefly touch on the European market expansion strategy on slide nine.
Our normal acquisition will contribute approximately $60 million in revenue and $14 million of EBITDA and strategically position us as the number four player in the European pest market.
Which is the second largest best marketable work.
Europe is roughly 3.8 billion dollar market growing faster than GDP that exhibits many of the same attractive dynamics of the U.S market.
It's a heightened fragmented market the pop for providers accounting for less than 50%, but the market. The remaining portion consisting of approximately 8000 businesses.
We have an opportunity to expand on our global look on presence into euro we existing relationships, we have in place that from its commercial and 12%.
Several of stolen and as highly experienced team no the market and the underlying dynamics and have a history of both organic and inorganic growth in the European pester industry.
We plan to work from the strong portfolio, we have in the mornings expand our presence over time into the broader view.
In addition, we acquired a smaller global accounts focus business in the UK to help us build foundational capabilities to serve euro based global accounts.
It was very important for us to separate the management and reporting of these businesses so as not to slow down the progress, we're making the transformation of Terminix.
John Pearson will take ownership of the European operations and helps lender and his team work and independent group strategy in the region.
There will be more the pump, but I'm excited about the attractive opportunities in front of us.
And with that I will turn it over to Tony.
Thanks, Nick and good morning, everyone.
Turning to slide 10, let's start with the Q3 consolidated financial summary.
Revenue grew $32 million or 7% to $528 million Terminix grew organically $9 million or 2%, excluding $3 million of year over year revenue decline from the previously discussed divested fumigation services line.
Revenue from acquired businesses at Terminix added $20 million or 5% growth in the quarter predominantly through tuck in acquisitions in residential passed and the assured environments acquisition and commercial past.
Servicemaster brand that $3 million or 5% in the quarter, including strong growth in key focus areas of the business commercial national accounts in health care cleaning. We also saw approximately $4 million and revenue in the period from the September six acquisition have no more holding a b in Sweden and no.
Our way.
As a reminder, nomar will be reported at the corporate and other operations area of our financials to allow clear visibility to the base terminix business and better aligned with the management structure of the business.
Excluding the $11 million in the prior period for historically allocated American home shield costs EBITDA on Q3 would've been down $9 million year over year.
EBITDA was lower in the period, primarily due to increased investments in the Terminix business.
Revenue flow through due to termite renewals the fumigation issues previously described by Nick and increases in termite damage claims.
Turning to slide 11, I'll discuss the Terminix revenue growth by channel.
Overall terminix delivered revenue growth in all channels, starting with the termite and hope services column on the left side of the chart revenue increased 3% in the quarter, 2% of which was organic.
Alright renewals were down $1 million or 1% in the quarter predominantly due to higher than expected customer cancellations in the vote mobile Alabama area of the country.
We expect this trend to continue into the fourth quarter.
These termite renewals convert to EBITDA at a high level and I'll discuss the impact of this and the next slide.
In the fourth quarter, we will be lapping a 2 million dollar one time acceleration of revenue related to an accounting methods change for a bundled past and termite services offering that we made in order to comply with new revenue recognition standards.
We currently expect to see a decline in termite renewals in the fourth quarter due to both of these issues.
Termite completions at home services were up 8% in the quarter, including 6% organically based on pricing realization and unit growth in both core termite at home services, driven by accelerated marketing spend in the quarter approximately 47% of the $71 million in turn.
Mike completions is related to core termite sales, which were up 4% year over year.
Services completions, which include attic installation wildlife exclusion and crawl space encapsulation represent 53% or the revenue in this category were up 10%. This strong performance in termite completions, coupled with our improved customer service levels sets us up for renewal growth.
Both in 2020.
Residential pest control services were up 6% in the third quarter over the prior year, including 2% organically organic growth in residential pest control was driven by price realization in the quarter and improvements in daily cancellation rates. This growth came despite lapping a strong prior.
Your organic growth quarter, driven by onetime accelerations of start and completion rates that are difficult to meaningfully improve the on certain levels.
Commercial pest control revenue was up 13% versus prior year, including 1% organically organic growth in commercial past was driven by the 300 basis point improvement in retention rates offset by lower what type sales predominantly a bed bug services, which of the topped off.
Year.
Acquisition revenue contributed the remaining 12% growth in the quarter predominantly from the assured environments out of New York City.
The new additions of Macleod in Gregory will ensure that acquisition revenue growth continues into 2020, as we grow our size and capabilities in commercial pest control.
I would also like to note strong year over year growth of 8% for $2 million in our product sales business. We have seen strong results. This year at product sales driven by a concerted effort to grow. This channel. However, it's important to note that these sales flow through to EBITDA at approximately 10% and half a mile.
Different profitability profile than our base Terminix businesses.
Overall, terminix revenue grew 7% in the quarter, including 2% organically as we continued our focus on improving service levels in driving organic growth, we expect to see organic growth determined exit between two and a half at 3% for the full year just like the third quarter, we will be lapping starting.
Lesion rate improvements in residential as well as the 2 million dollar accounting method change in termite renewals.
Turning to slide 12, adjusted EBITDA for the third quarter decreased $9 million or 11% to $72 million, reflecting a margin of 15.7% below original company expectations working across the bridge and the bottom of the slide.
You can see organic revenue growth of $6 million converted to $2 million in the quarter. This includes the lower margin flow through a product sales as well as the impact of lower termite renewals in the mobile Alabama area. This mix shift, particularly as it relates to termite renewals was more severe than expected.
Factors into our difficult quarter.
As Nick discussed earlier, we had a $4 million in profitability erosion related to the execution of the outsourcing of fumigation services. The outsource cost the fumigation completions were higher than anticipated price increases attempting to recover the cost.
Increase caused volumes to decline significantly this resulted in decreased volume and lower margins combining to drive this 4 million dollar Miss.
We expect continued declines in the fourth quarter, but if a focused action plan that will soften the margin declines in improved volumes as we head into next year.
Acquired revenue growth of $20 million contributed $4 million to EBITDA or a margin of 20% in the quarter, excluding our European past acquisition, which is reported in corporate and other operations.
We expect more than $25 million from acquisition revenue in the fourth quarter to contribute approximately 20% EBITDA margins.
We had $6 million of investment in growth and productivity in the quarter, including 2 million increase sales and marketing, which produced higher new units in core termite at home services $2 million that investments in our customer experience platform with Salesforce technology and 2 million dollar.
As to optimize our commercial pest business. This represents an increase from prior guidance predominantly in marketing spend to drive new leads.
There was also a $2 million increased damage claims expense due to the increase foremost in termite activity in the mobile Alabama area of the country termite damage claims, particularly claims that involve litigation are difficult to estimate in both sides and timing, but currently we expect a year over year end.
For damage claims of approximately $4 million in the fourth quarter.
Original estimates at their termite damage claims expense improving the back half of the year through the mitigation actions we implemented in prior periods.
These results were below our expectations for the quarter with profitability impacted by revenue mix shift in addition to the larger than expected impacts of damage claims and fumigation outsourcing.
As Nick as discussed we are actively addressing these issues and we're confident we can return to the levels. We are expecting in this business.
Let's move to slide 13 to talk about Servicemaster brands Q3 performance.
Servicemaster brands delivered a strong quarter with revenue increases of 5% or $3 million $63 million.
The increase was driven by our initiatives to grow commercial national accounts up again this quarter by 7%.
We're also gaining traction on our expansion in health care cleaning and disinfection, which was up 13% on the year in total we saw 3% growth in royalty revenue in the period converting to EBITDA at a high margin.
Adjusted EBITDA was up $2 million or 7% in the period, primarily due to the flow through of royalty revenue growth. The brand team continues to focus on improving its ability to support our franchises through centers of excellence in key verticals and geographies, including healthcare and reconstruction.
As we anticipate the fourth quarter. It is important to note that we will be lapping the benefits. We received in 2018 from Hurricane Florence and Michael.
Moving to slide 14, I'll discuss our cash flow for the quarter.
Free cash flow of $191 million year to date improved $22 million or 13% year over year and free cash flow conversion improved over 300 basis points to 57%.
Reduced cash interest driven by debt reduction after the front door share monetization and a reduction in property additions as we cycle construction related costs from the move of our global service Center to downtown that were the primary drivers of the improvement.
Looking to the uses of our cash you can see we continue to invest in strategic acquisitions and have spent $345 million year to date, excluding both Gregory and Mcleod that we closed in early October we ended the period with $140 million of a value of available cash.
Cash generation at 57% of adjusted EBITDA continues to be a strong story for the company. Our continued focus on working capital improvements and EBITDA conversion remain priorities for the businesses.
We remain diligent in the U.S uses of the generated capital ensuring all investments we make provide returns for investors at rates well in excess of our cost of capital.
Let's move to slide 15 to look at another way, we are adding value through our recent refinancing.
We will be closing on a debt refinancing, though that will enable us to take advantage of a very receptive debt market to refinance $441 million unsecured debt with a new 600 million dollar terminal b.
This loan extends our maturity by approximately three years, while also lowering our interest rate by 75 basis points on the right side of the slide you will see our capital structure post this restructuring refinancing our total net debt leverage ratio. After the transaction is approximately 3.5 times.
As we have long discussed we have the cash flow and flexibility to extend our debt levels in a responsible manner for the right opportunities that being said, we're still targeting a net debt level of between 2.5 and 3.0 times.
After the refinancing we expect a run rate of cash interest to be roughly equivalent to today, while reducing our blended interest rate to below 5%.
Looking ahead, we now expect total service faster revenue for the full year 2019 of between 2.07 and $2.085 billion or growth of 9% to 10% the $25 million increase from previous guidance is primarily.
By acquisition contributions from our European past operations as well as the rate reset in the cloud in Gregory acquisitions in commercial pest.
We now expect acquisition revenue of approximately $130 million for the year, including over $40 million in the fourth quarter.
Adjusted EBITDA is now expected between 415 and $425 million for a servicemaster EBITDA margin of approximately 20% that $20 million reduction from prior guidance includes approximately $10 million in damage claim expense from prior.
Expectations the previous damage claim expectation included year over year favorability from mitigation actions that are taking longer than expected to show results in the mobile Alabama area of the country.
It also includes the $10 million reduction from the combined impact of fumigation outsourcing execution issues and termite renewable reductions in mobile Alabama.
We also spent an additional $5 million odd growth initiatives, primarily additional marketing in Q3 that helped accelerate new units that termite completions and hope services.
These increases were offset partially by approximately $5 billion EBITDA contribution from new acquisitions.
Terminix, we expect organic growth rates for the full year between two and a half a 3% when normalized for the impact of her fumigation divestiture in the fourth quarter, we expect more than $25 million in revenue from acquisitions.
Adjusted EBITDA in Q4 is expected to be impacted.
The previously discussed damage claims expense and fumigation services offset by conversion of continued organic and acquired revenue growth.
Servicemaster brand, we expect mid single digit growth.
And slight margin pressure as we grow EBITDA dollars by expanding our commercial cleaning national accounts business and driving active initiatives to generate value for our franchisees and customers.
Servicemaster brands will also be lapping the area wide hurricane weather events of Florence and Michael from the fourth quarter of 2018.
At corporate and other operations, we expect over $15 million in revenue from our European past operations, we expect the full year effective tax rate to be between 21 at 23% given the tax regained from the monetization of our front door shares that said the Q4 effective tax rate.
<unk> is expected to range between 26, and 28% as the rates normalize post the monetization.
And given the refinancing we expect cash interest.
Between 80 and $90 million annually going forward.
And with that I'll turn it back over to Nick for final comments Nick.
Thanks, Tony.
We are fortunate to have an incredible pest business wonderful industry with an outstanding Brian leadership position and strong customer relationships led by our daughter frontline associates.
As we complete your tool for complete transformation of this business to address it's underperformance I remain encouraged and confident in our business fundamentals and in our ability to continue on our joining built from the strong foundation, we have developed over the past two years.
Over the last few years, we have improved our NPS scores and are starting to see consistent traction retention numbers as well.
Highlighted by recent rapid gains in our commercial business.
We have added much needed commercial capabilities in high value verticals to our targeted acquisitions.
We have also made improvements in our field operations by focusing on the fundamentals improving our safety records on time services customer communication cadence service and inspection protocols as well as start and completion rates.
Even though we have accomplished a lot in the first two years of our transformation Alok remains to be done as we are reminded by our underperformance this quarter.
We have identified and rapidly addressing the three key items that cost us underperformance.
Your legacy Carmike damage claims subpar execution of outsourcing of our legacy residential fumigation business at a much lower conversion from a revenue mix largely driven by lower provide renewals.
These items emphasize that we must and will focus on our on improving our execution, both current and legacy initiatives and work towards setting and meeting achievable expectations with improved analytics and project management cadence.
Our under performance this quarter also reinforces our need for commitment to our cultural transformation, which we have started rolling out this year.
We are focusing on improving our problem solving project management and analytical capabilities.
We had investing in a much needed salesforce operating system, which will create a major upgrade another industry and our ability to serve our customers and make the jobs of our frontline easier.
We are working on a clean chewed initiative, and our Carmike journey and on targeting 2020 for the roll off.
This frontline led transformation is a breakthrough opportunity that can differentiate our ability to serve our customers.
These commitments will ensure that we will be position for drive continued and sustainable profitable growth and allow us to regain of profitable growth leadership in pest.
Let me also address our change in leadership in our residential pest business.
Matt Stevenson was a strong contributor the actions needed in the first two years of our transformation journey.
His ability to focus on driving improvements in our fundamentals was critical for turning the tide for this business.
And was responsible for the early successes, we have seen in returning to organic growth and improving customer metrics.
As we move to the next phase of our transformation journey, we felt a change needed to be made as we look at the items, we now need to address.
Primarily sustainable operational excellence backed by a strong operating system.
I remain confident into the progress, we're making on our Jordan and our ability to continue to drive sustainable and profitable growth and appreciate your support and patients as we continue in this challenging and rewarding transformation.
I will now from the call back over to Jesse will lead us to accumulate session.
Thanks, Nick.
As a reminder, during the Q and a session. We encourage you to ask any questions that you may have foot. Please note. The guidance is limited to the outlook. We provided in our press release and webcast presentation. Additionally, since the Q as long. This morning, please limit yourself to a single question. So that we can get to everyone. In the allotted time Searcy, let's open up the line for questions.
Thank you if you would like to register question. Please press Star one followed by the four on your telephone you hear me Tom prompt to acknowledge your request is your question has been answered and you would like to withdraw your registration. Please press star one followed by this through.
As a reminder, please limit yourself to one question one moment. Please first question.
First question comes from Michael Hoffman of Stifel. Please go ahead.
One question see many cricket secondly, 20.
Okay.
So I guess I'm going to focus on retention and I'm I'm trying to figure out in the messaging good retention non improve in residential but it did in commercial.
And and if it didnt improve what are you doing to get it really started to improve again.
Retention, Michael good morning retention improve across all our product lines in residential pest and termite as well as in commercial pest in commercial passed we saw a significant improvement of 300 basis points as you know for quite quite a few years. This business was in decline and we've been supporting.
And with great pound being build up carving it out as a separate business unit and bringing in some incredible capabilities through some of our partnerships with culberson and some verticals that we've acquired since then like a short on the residential side, we did see improvements in termite they were almost flattish, but positive if you exclude the losses.
We faced in the mobile, Alabama area, which was the result of finally trying to match our pricing with the cost to sort of in that area, but we do see continued improvement.
Seen quite a substantial improvement over the last three quarters of prevention on residential pest.
It's like we said we have to continue to work on sustainable practices will be removed the underlying basics much much better on time performance better completion, we continue to maintain a high level of stock rates.
But we have to continue to do that 75000 times a day that we knock on doors of all our customers.
Thank you. Our next question comes from Tim Mulrooney, Brian Brian . Please go ahead.
Good morning.
Good morning.
So.
If I only have one question, it's that Nick why should investors have confidence that other cities outside of mobile phone also become more litigious.
That's a good question as we've seen.
Good for Molson termites, the is a possibility of them existing and new seen them below the 30 35, North Latin view in non reserve life and does it like conditions, but we've seen much more aggressive activity, where the soil composition in certain conditions exist like the river deltas in mobile, Alabama area and predominantly of you've also seen in.
New Orleans now in New Orleans, we do not sort of customers directly there so that doesn't impact us, but we've seen the acuity significantly in other areas for most firms do exist, but over the year since we've seen the spike in claims in the mobile Alabama area, we have not seen any similar trend.
Areas.
As you know since starting 2018 port significant.
Movements in service quality.
Foams off documentation in terms of inspection training Retreatment better inspection, so we don't competitor pre existing conditions.
And do you also.
Working directly with our customers who several.
Any of that issues directly with them rather than it becoming cost be litigations in the future, but as I said.
First of all I think we got to understand but we did off where we do offer a differentiated warranty so.
Offering which has allowed us to become the market leader in the past because the primary concern for people as the value of the home now.
Allowing that we've seen about 4% to 4.5% because as carmike damage claim costs across the nation in.
Whether it's a formal some from lights or otherwise and the increases in almost exclusively related to performance and from activities. As you know being very invasive in that area, but we have not seen that trend at all in other areas at all so.
Thank you. Our next question comes from Toni Kaplan of Morgan Stanley . Please go ahead.
Hey, this is Jeff wholesale for Tony.
Im just a follow up on that last question. If I can just on this termite liability that is out there could you help us understand what is the maximum liability you can piece in terms of dollar figure. So I know, 2% of foremost and activities in the mobile Alabama area, but I think you just mentioned some other cities that possibly be and.
So just given like Dell litigation that's out there maybe theoretically have all the homes that were in the mobile Alabama area.
Filed some type of damage claims just just in terms of a dollar figure how should investors be thinking about the liability that exists.
Yes, I think the I think the best this is Tony do you Sandy I think the best way to look at this is that.
Across the country, our termite damage claims expense are running about 4% of revenue.
They are running higher in the mobile, Alabama area and that drove our percentage up to 7% to 7.5% this year.
The it's it appears that this is really isolated to this is this one area for us where we have these unique soil conditions kind of close to a river Delta we don't see the exposure anywhere in like this anywhere else at this time.
It's hard for us to predict with any certainty with what's going to happen in the future, but thats, our best estimate right now.
And if you've seen the 7% to 7.5% kind of rate starting in 2000 early 2017 under discussions on Q1 of 2017 on this so we pretty much been able to manage within that range and we believe given the actions.
We're done with the consistency and Trentwood, which we've been operating in those in this area.
We believe you will get lease in the future.
But we will be able to return to historical norms as we see these things continue to be managed better.
Thank you Sir our next question comes from Ian Zaffino of Oppenheimer. Please go ahead.
Hi, great. Thank you very much.
I also wanted to ask on the termite damage clean side.
How are you thinking about price and retention levels and trying to match basically the pricing with the cost to serve.
And then also basically.
Do you think about.
Pricing versus kind of cost mitigation as you charters store kind of the termite damage claims to historical levels. Thanks.
Good morning.
As you know in this area since January of 2018, right. After I was able to completely assess the situation and we've been putting some strong practices in place unutilized.
In order to serve this particular area with the activity. We had we had to use several methods such as much.
More stringent inspection rigid regimen.
I have to recruit certain areas, we have to power down on that what we call dual defined with depending on liquid and made some houses. So we have to enhance the pricing in this area to match.
The cost to serve and we've seen some.
Expected, but it was leading you saw a much larger than expected decline in customers in this area. So as customers continue to renew with US. We obviously do re inspections and recruits and much much would improve documentation as we go forward.
On these cases, but we've seen that at least where now pricing. These in line with what we believe the cost of service and continue to match that increase that as we see the service levels I mean being increased.
Thank you. Our next question comes from Gary Bisbee Bank of America Merrill Lynch. Please go ahead.
Thanks, Sadly I'll continue on the same line of questioning so I guess my question a little different though you alluded to this continuing for a while I think Nick you said into 2020 can you give us just a sense as to how you think this impacts next year, what what part of the cost is it just higher claims is a cleaning up.
All the litigation and and as part of that also.
Like to understand how much revenue you expect you're going to lose a bridge that you gave for the change in full year guidance lumped in.
Renewal reductions and the fumigation, that's that's not real helpful. As a $10 million can you tell us how much is the revenue reduction and how much was that fumigation and.
Really what matters to next year as what I'm getting at.
Yeah.
Good morning, I'll answer the first part of it and I'll, Let me give you the bridge answer on back one.
As I mentioned earlier that we've seen across the country on normal cost of doing business and termite.
About 4% to 4.5% on baton different kinds of damage claims.
None of that we based on a warranty that we serve and we still see an incredible value proposition that business and highly profitable.
Including that cost we've seen overall assets and 17 that costs have gone off.
7% to 8% break 7% to 7.5% right now and we've seen the volume increase from our mitigation actions. So the issue is we've seen so we started working more directly with customers.
Backhaul, obviously resulted in some non litigated claims, but park lane that helps us better with our dialogue with the customer than these becoming expensive litigations in the future. We are expecting as you mention as Tony mentioned earlier this cost to go up slightly in the fourth quarter and we see that continued marginal increase in 2020. So we believe it should be.
Right around that range was slightly higher in 2020 as the as our actions in eventually start bearing fruit and reducing litigated claims reducing even issues and claims you have in better documentation better service as we go forward.
Thus, allowing us we believe that we can get back to historical affordable and a half range in the future.
Yes, Gary you bring up good point obviously.
The this will have some impact in 2020, our estimates are roughly $2 million in renewable revenue.
But I think we have to stay focused on the and the fact that.
It's important that we.
Take into effect with the cost to serve is in these regions and adjust our pricing accordingly for that and we're out.
So for the long run its definitely the right move, but it will have some impact in 2020.
Thank you. Our next question comes from Seth Weber RBC capital markets. Please go ahead.
Hey, good morning, guys kind of want it take another stab at this termite cost question.
I think you said it was an incremental 2 million in the third quarter going and then it's going to an 8 million dollar incremental in the fourth quarter, which.
Sounds like a $4 million swing year over year, but.
Is there something in this fourth quarter number is there a kind of an accrual as or some sort of big lump sum settlement or something I'm, just trying to understand why its.
Such a big jump from Threeq to Fourq, you and then.
I think we're all trying to understand really what the jumping off point into next year is going to be as if this fourth quarter kind of run rate.
If you could give us the for the full impact I guess for 19, maybe that would be helpful. Number to have and then kind of use that as a starting point for 20 and any additional color there. Thanks.
Yes.
This is Tony I'll take that one so in Q3 termite damage claims were roughly $2 million higher year over year.
Is there going to be $4 million higher year over year in Q4.
That brings you to 6 million the other 4 million relates to the fact that it was our expectation that we would actually have a reduction in.
Terabyte damage costs in the year.
We've seen higher volumes of non litigated claims.
Which is which in some ways is good for the long term because we're aggressively working those.
In the right way.
And so thats all.
Also was a little bit contributed some high claims that were awarded litigated side. So that's what really drove that $4 million why we didn't realize that $4 million lower than expectation. So thats the bridge to the 10 million.
Yes.
Thank you. Our next question comes from Judah Sokel of JP Morgan. Please go ahead.
Hi, good morning.
Good morning.
On on you referenced the fact that it can take years to fully settle.
Claims that come out of the termite practice, but but the one and three Q arising from a 2016 claims so how long do you expect it to take until we've cycled through all potential claims.
Policies that were underwritten before you started year mitigating activities are mitigating actions in 2018. Thanks.
Sure they were practices in place where.
These teams were served well as you see given the nature of this big case, there are some homes that we haven't seen deal like will be but as these will buy there's a lot of discussion, but more and more as the several non litigated claims she'd better.
And the legal part of is really tough for time, especially both in terms of timing and severity, but the more our practices fake.
More houses between spec more recruit wins, we do.
The more we continue to several deals at reasonable with our customers along mitigated way. It continues to mitigate our future risks. So it's difficult to predict what we believe we are continuing to improve the future exposure within the limits.
Thank you. Our next question comes from Jamie Clement Buckingham Research. Please go ahead.
Hi, good morning, gentlemen.
Switching gears a little bit.
What you would get out no more.
Hi platform acquisition and obviously.
Your longer term leverage target is maybe a little less than where our where you are today.
How high would you take leverage gives a short run the tax of businesses ought to know more.
Well.
Yes, Thanks JB.
Like we said all along our target is to would have to three no doubt about that we set for the right opportunity we would.
I would go over that it for a period of time and with our strong cash flow eventually bring that back into the two and half.
The three range so how much higher would we go above 3.5, we.
We don't really have any plans right now to go any higher and obviously I think where we were pretty comfortable going after the three and a half but going any higher than that probably not in the short term and Jamie.
We are pretty we generated significant cash, notably from our base business, but also.
We look at.
The.
Targets that we bring in a pretty cash rich as well in terms of the kind of business we have.
And Weve spend two years really building in line with our strategy, where we wanted to boost our commercial business, which drove the acquisitions or things like 4% assured Gregory and Mcleod.
We believe we've added not only revenue which was not the primary reason for doing is the primary reason was adding the much needed to capabilities to become one of the strongest commercial business in the future and as we can see that have benefited us significantly in comes off.
Continued improved retention rates and finally, starting to see positive growth and stringing quarter by quarter positive numbers, we absolutely we've brought in a new retail sales in this business. We are strengthening the sales function that AG continued new sales. In addition to the retention that we're driving some so these are paid their dividends and I believe we've got.
From a lot of the capabilities the ups actually needed we don't have anything sort of larger than the feature in the horizon at this stage, but that doesn't preclude us if opportunities come on play will continue to focus in the future on very smart tuck in type opportunities that give us strong density going forward, but these are maybe.
On a much smaller in size larger numbers is that doesn't really impact in the big way, how we look at our leverage ratios.
Thank you. Our next question comes from George Tong Goldman Sachs. Please go ahead.
Hi, Thanks, Good morning, I wanted to go back to the termite claims activity. You've previously indicated that visibility into claims can be somewhat limited can you discuss what initiatives you have to improve visibility into claims costs and provide more clarity into how you expect claims cost to basically go back to 4% of revenues.
From 7.5% today.
Yes.
The best way again, George we Couldnt be addressed this is we the customers that we serve we have gone back into the high risk areas. We continue to Reinspect, we understand the situation a lot better we continued to retreat as needed. We continue to have conversations with our customers and thats, how we and one of a big things we've done is so.
Handling the process in house, leaving Asian about a year ago little less than a year ago with a third party administrator, who has brought a lot of professional cadence and disciplined in how we approach these customers and address any open issues before they become a sizable by nature. So it's better to understand those treat bills on time and.
Forward and that's one of the reason why it gives us confidence that we've said we've seen some incredible results from the from the actions we've taken so but these things take time to materialize.
Thank you. Our next question comes from Andy Wittmann of Baird. Please go ahead.
Okay, Great I guess my questions for for Tony and Thats in actually focused on the third quarter, a little bit more I wanted to understand.
EBITDA Bridge I guess, that's kind of based on slide number 12, and and specifically like a lot of the items that are listening with.
You guys knew about when you gave your guidance for the year.
You know growth investment particular, dis synergies are two of the larger buckets.
On this list so.
And the fumigation kind of offsets the acquisition.
EBITDA impact so when I look at all of this and then look at kind of.
How the quarter came in it feels like there are there things in the quarter were negatively impacted EBITDA and I was wondering if you could go through some of those factors that maybe we're also in the in the EBITDA results for the quarter that maybe are bridged here or could have.
Ben reasons for a little bit of the shortfall that we saw in the results.
Yes.
That's a good question I think the one thing.
With that I wanted to mention with on the organic revenue conversion.
That's that's a little bit lighter than we expected mainly because we saw a different mix.
Than we were expecting we had a large increase in product sales.
And we had the lower termite renewals.
That we've already talked about and given the the profitability of termite renewals that is a very significant.
Part of.
The other Miss I guess in the expectations.
One of the mainly the from Mike If you look at the renewals and the bulk of those or acute majority of those were customers that we ended up losing in the mobile Alabama area, which is where we did not have been in the world. So in the short term.
Much faster more accelerated than you had expected.
For the long from this.
Should be helping our call it as we continue to manage the situation.
Thank you at this time I'd like to turn the call back over to our hosts for any closing remarks.
Thank you again for your participation in todays conference call and webcast as a reminder, a replay of the call the available on our website in about an hour from now. Thank you for your continued interest in our company.
That does conclude the conference call for today, we thank you for your participation and I would you. Please disconnect your lines comes from capital bone.