Q4 2019 Earnings Call
Ladies and gentleman won't come to Servicemasters fourth quarter and full year 2019 earnings call today's call is being recorded and broadcast on the Internet.
Beginning today's call is Jesse Jackson, Servicemasters, Vice President of Investor Relations and Treasurer.
I'll now turn it over to Mr. drinking who will introduce the other speakers on the call.
Thank you Frank good morning, and walk before we begin I'd like to remind you the 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 Securities Exchange Commission. 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 doing.
We're looking statements information discussed on todays call speaks only as of today February 27 29.
The company undertakes no obligation to update any information discussed on todays call. This morning, Servicemaster issued a press release filed with the S. You see on form 8-K, highlighting our fourth quarter and full year 2019 financial results. The press released in the related presentation can be found on the Investor Relations section of our website at service.
Master Dotcom, we will reference certain non-GAAP financial measures throughout todays call and we had included definitions of these terms in our press release. We also included reconciliations of these non-GAAP financial measures to the most comparable GAAP financial measures in our press release and the appendix of this presentation in order to better assist you.
In understanding our financial performance all references on the call or to EBITDA.
Oh references on the call to EBITDA or to adjusted EBITDA as defined in our press release, joining me on todays call or Servicemasters, chairman and interim CEO and Arrangers, Audi and our Chief Financial Officer, Tony If you listen to slide three of the presentation posted on the Investor Relations section of our website shows the agenda, we will cover today before I turn it over time.
Irene I would like to remind you effective January 120, 20 in conjunction with the strategic alternatives review of Servicemaster brands. All operating results of Servicemaster brands were moved to discontinued operations. All forward looking statements on todays call, including 2020 guidance, we're focused on continuing operations.
I will now turn it over to the Rangers all right.
Thanks, Jesse and thank you all for joining our call today I'll start with slide four.
Before I cover our financial results I'd like to make a few comments on our decision to explore strategic alternatives for our servicemaster brands business as part of our annual strategic planning process management completed a portfolio review of our businesses. This review included an assessment of the markets, we compete in as well as the strategic plans.
Developed for each of our businesses and the capital we had to deploy in support of these strategies as a result of this review management in the board agreed that we should explore strategic alternatives, including a possible sale of our servicemaster brands business.
We feel that we have two great businesses, each with exciting opportunities to deploy capital in order to grow the business and create value for our shareholders. In addition, based on other recent transactions in the markets were Servicemaster branch competes we felt now was a good time to explore options.
Depending on the outcome of this process, we expect to be in a position whereby both businesses will be able to pursue the exciting opportunities they see in front of them.
But we're still early in the process. We're very pleased with the enthusiastic response, we're seeing from potential suitors.
Moving onto our financial results 2019, with another year of solid progress against our strategic priorities.
Our focus on improving fundamentals drove improvements in the customer experience as reflected by increases in customer retention and net promoter scores and declines in cancel rates across all of our business lines.
We delivered $2.077 billion revenue, an increase of over 9% year over year, including 2.6% organic growth in terminix organic growth accelerated over 2018 levels and we met our increased 2019 guidance of 2.5% to 3%.
We also delivered $417 billion of adjusted EBITDA with strong free cash flow generation of $216 billion.
In the fourth quarter of 2019, we strengthened our leadership team with the addition of Kim Scott to lead our Terminix residential business.
Jim has extensive experience in industrial and service businesses and is built customer centric teams wherever she has been.
Our track record of executing safety and efficiency programs across large dispersed service network in employee base fits well with our strategic plan for the Terminix business.
Jim also has a background in environmental engineering and her experience and knowledge in this area has played a major role in accelerating our termite damage claims mitigation program.
We've made substantial investments in our infrastructure, which will help us more efficiently run our day to day business and enable us to drive more and faster synergies from the strategic acquisitions, we pursue.
Well, we're still early in the early phases of these efforts we're excited by what we're seeing so far.
We went live in the pilot of our new customer experience platform powered by Salesforce technology in a call center and to Phoenix area branches.
This deployment was the culmination of one of the largest cross functional endeavors in company history involving over 200 employees from field technicians to executive team members.
Our users are excited and feel empowered with better and more accessible information to do their jobs and serve our customers more effectively.
Reimagine field standard operating procedures or project clean sheet has been completed for termite business and the results are very encouraging.
Although the results reflect only one location. We are pleased that metrics like net promoter score cancel rate close rates and employee retention are improving.
We're planning to rollout key aspects of this program to our remaining branches and are excited to have modern and efficient standard operating procedures that can be replicated in scale easily across the network.
While we're pleased with our progress for the year. Our Q4 Q4 results show that we still have worked to do to improve our consistency.
Organic growth at Terminix dipped, a 1% as Tony will discuss in more detail in a moment.
We also made several acquisitions in Europe. They put short term pressure on our margins were excited about the platform. These acquisitions bring us which will significantly enhance our ability to effectively support global commercial customers.
Once we complete our integration work and optimization, we're confident we'll reach our longer term margin expectations.
Margins were also negatively impact our year over year growth in termite damage gains.
This impacted both the fourth quarter and the full year results and we are laser focused on addressing the issue for our customers and our shareholders.
Before we move our attention to termite damage claims I'd like to discuss our strategic priorities for 2020 as seen on slide five.
As we look to 2020, we're excited about the market opportunities, we see and our ability to continue to make progress against each of our strategic priorities.
The market continues to be attractive with industry growth rates above GDP in both our residential and commercial service lines are Terminix brands continues to have very strong awareness and customer satisfaction as validated by independent third party studies and the fragmented nature of the pest control industry creates.
Opportunities for us to continue to grow what they've got organically and via strategic and tuck in acquisitions.
With this as a backdrop our strategic priority for 2020 remained focused on familiar objectives.
First we are committed to reducing employee turnover, especially within our frontline teams through our revamped onboarding process improved training better tools for our frontline employees and a continued focus on employee safety.
Okay, well improve customer retention through better employee engagement and improved customer analytics that will provide a deeper understanding of the drivers of customer cancellations.
Third will enhance our profit margins across all lines of business using the new tools and procedures were developing to our front line employees, including the customer experience platform and termite clean sheet initiative, along with better prioritization and alignment on our key business initiatives cost productivity.
Marketing optimization and better labor management will be the key margin enhancement drivers in 2020.
And the final pillar of our strategy focuses on revitalizing our termite business will continue to roll out or clean sheet standard operating procedures per turn might enhance our product offering to better align with touched customer purchasing preferences and accelerate our mitigation program in the mobile Bay area.
Turning to slide six you'll find more detail on our termite damage claim mitigation program.
Over the past three years, we've seen a steady increase in our expenses related to termite damage claims.
As Tony will discuss in more detail virtually all of the increased claims have been isolated to the mobile Bay area of Alabama and attributable to damn like damage caused by foremost in termites.
We've analyzed these claims associated trends to better understand the drivers and how we can address that.
In addition to our own analysis, we engaged to third party to help validate our findings with deeper statistical analysis.
The global valuation consulting firm, we engaged as over 15 years of experience in a wide range of complex legal liability issues and many of the largest companies in the world leverage their economic and financial expertise. They confirmed our analysis of the geographic distribution of risk areas and have helped us better under.
Stand drivers of high cost claims.
In addition, we've spoken to several entomologists and service providers in geographies, where we have limited claims history.
All appear to confirm and validate our conclusions that our primary risk is limited to the mobile Bay area, which is why our mitigation plan. Initially focus is on this geography, we will continue to evaluate our claims activity and consult with these industry and subject matter experts and modify or mid mitigation plan as need.
Good.
We focused our initial efforts on stopping additional termite damaged by accelerating the pace of a previously discussed supplemental treatment program.
This will ensure that we've treated all 15000 mobile bay area customers with a supplemental treatment before the end of 2020, we've already completed approximately 2500 supplemental treatment of which many were for our customers who have chosen our dual band bait and liquid solution.
While this initiative will depress our margin in 2020, we believe it's the right thing to do for both our customers and our shareholders.
We're taking these aggressive steps out of an abundance of caution to make sure that we get to the root cause of the issue stopping further termite damage and ensuring that we're providing the best possible termite protection for our customers.
We continue to make improvements in our reinspection in quality assurance processes, using best practices and tools from our clean sheet efforts.
We're supporting our reinspection efforts with better scheduling procedures to improve access to the home for more thorough examination.
Proven inspection tools and techniques will help us identify potential damage earlier, improving customer satisfaction and mitigating higher costs from prolonged infestations.
We're also expanding the size of our quality assurance teams. These teams lead our training efforts and also review the effectiveness and quality of inspections and treatments.
By adding supplemental resources to these teams were able to better maintain or improved quality standards and ensure consistent delivery of services, leaving our customers better protected and minimizing the likelihood of future infestations.
The third prong of our strategy focuses on continuing to strengthen our claims management and contracting processes. We will continue to engage with a third party claims management firm to centrally managed the claims process and accelerate the pace of came claims resolution.
Even though this pulls forward cost efforts to solve these problems earlier in the earlier phases of claims resolution will improve customer satisfaction and ultimately reduce our total expense.
We're also making changes to our contracts with customers to better align terms and pricing what we've learned about the real cost to serve.
Average as we've seen from the experience of others in the industry. This is certainly an issue that can be managed effectively and we are fully committed to doing the right thing for our customers and our shareholders I'm confident the execution of this mitigation plan will pay dividends for years to come I'll now turn it over to Tony to discuss the fund.
I have to impact we've seen from termite damage claims our 2019 financial results in our financial outlook for 2020, Tony Thanks, The rain and good morning, everyone turning to slide seven let's start with a deeper look at termite damage claims in 2019. This view breaks out the mobile Bay area versus.
Rest of the country. It further breaks down litigated damage claims or those that end up in arbitration or a trial versus non litigated damage claims are those that are settled directly with the customer.
I wanted to take a moment to explain the accounting change that we have made on litigated cases. According to the accounting guidelines for contingencies reserves can only be recorded when the losses probable and estimatable.
Historically this occurred at the time cases move through discovery and we eventually had enough information, including an outside counsel opinion to make this determination and 2019, we experienced and an increase in the number of litigated claims and assisted by our work with third party valuation firm we can now.
The specific attributes of these cases at the time of filing to make an initial estimate using statistical regression analysis. As a result, we recorded an additional liability of $45 million per pending cases, the bulk of which are attributable to the mobile Bay area.
The onetime adjustment we made for this change in estimation timing has been excluded from our non-GAAP measures in the current period. However, this change now becomes a normal part of our ongoing operations. This means that going into 2020 expenses will be recorded both when new litigated cases are filed.
As well as when case settlements differ from previously recorded reserves.
While the timing of when future cases will be file will be difficult to predict we do expect to see an increase than litigated cases filed in 2020.
Moving to non mitigated damage claims you could see an incident rate of approximately 5% in the mobile Bay area. This raised approximately 20 times higher than the base rate for the rest of our termite business.
As a reminder, non litigated claims are accrued based on warranty accounting principles, where we where we recorded an initial estimated liability based on known claims.
And expected, but not incur damage claims for all contracts through their next renewal date. We also had a change in estimation technique for non litigated claims of $8 million to take into account both the expected geographic distribution of claims as well as the value the variation in the cost per claim in those geographies.
Our guidance for 2020 assumes approximately $70 million of termite damage claims expense, including $10 million for the mitigation program on an adjusted EBITDA basis. This represents a 20 million dollar increase over 2019.
For clarity I've also included on the chart, our current $80 million balance sheet reserve for each of these categories. These balances include the year end adjustment entries I spoke about earlier.
Turning to slide eight I'd like to talk about the process that we went through with an independent third party to calculate our expected liability over the next 10 years for all of our 1 million plus termite customers.
In December we provided our termite damage claims data from 2010 to 2019 to a third party firm for actuarial statistical analysis.
The from reviewed thousands of damage claims that explored many customer attributes that it could indicate the likelihood of future claims. They use these variables develop a formula its statistical model to apply against our existing termite customer base and mitigation plans to estimate annual liability into the future.
Sure then extrapolated that formula over a 10 year time horizon. The results of this robust study give us valuable analysis to better understand which customer attributes are the best leading indicator of future damage claims. So we can improve our practices going forward.
In the chart on slide eight you can see our claims expense history and expectations segmented the five year pockets.
This shows a clear divide between the historical norms in 2010 to 2014 bucket and the increases we have seen over the last five years.
As you can see by the Red Bar. These increases are driven almost exclusively by the Imobile Bay area. During the five year period from 2015% 2019, the company incurred approximately 200 $230 million in total termite damage claims expense the results of the study established an expert.
Station of approximately $230 million for the years 20, 20% 2024 before returning to historical level of approximately 4% to 5% of termite and home services revenue in the last five years of the decade.
In total we expect incremental expenses about 4% of termite at home services revenue to be between 130 and $150 million over the next 10 years. The majority of these incremental expenses will occur in the first few years as our mitigation program starts to take hold.
Approximately $45 million or around 35% of these higher than normal termite damage claims expenses are expected to occur in 2020.
As we have seen from competitors in the industry improving our historical damage claims expense rate, it's certainly possible and represents an additional opportunity for us as we move forward.
Turning to slide nine our analysis also confirmed that the issue is largely isolated to one geographical area as a part of the analysis, we examined all geographies for any additional cost in our customer base beyond our historical claims experience.
While the analysis identified a few areas of moderate risk for foremost in termites and the adjacent Gulf Coast counties in southeastern Hawaii showed in yellow into map. The overwhelming majority of the total increases coming from the mobile Bay area. The analysis reflected that no other areas of the country have significantly deviated.
From their historical patterns. Our analysis leads us to conclude that were not likely to see an acceleration of claims in moderate risk areas over the next 10 years.
Turning to the results for the quarter on Slide 10, you can see the consolidated Q4 financial summary for the business, including Servicemaster brands.
Revenue grew $50 million or 11% to $507 billion adjusted EBITDA was roughly flat to prior year, while adjusted net income improved 12% driven primarily by lower year over year tax expense in the quarter.
Servicemaster brands revenue grew 8% in the quarter through continued progress on commercial national account and health care cleaning and disinfection.
Adjusted EBITDA for brands was roughly flat year over year with revenue growth coming from lower margin National accounts healthcare and owned branch operations as Jeff mentioned earlier going forward Servicemaster brands will be classified as held for sale and we'll move to discontinued operations while we.
Quick alternatives for the business.
Our European past operations reported $18 million in revenue in the quarter, primarily from our 2019 acquisitions of Nomar, which operates in Sweden, Norway and Termine ex UK as a reminder, our European pest operations are reported in the corporate and other operations area of our financials to.
Allow clear visibility to the base Terminix business and provide better alignment with management structure of the European pest business.
Adjusted EBITDA contribution from no more operations was offset by ongoing integration and carve out expenses and optimization efforts and Terminix UK that Terminix UK business is a national accounts only carve out of the former Mighty pest control business optimization efforts it.
Clued revenue right sizing as we add additional accounts that the business that will add density to the existing national accounts portfolio.
Early results are encouraging and we're excited about the opportunity to grow this valuable global platform, but margins will be pressured at the beginning of 2020, while we work through these operational system improvements.
Turning to slide 11 August Skus, the Terminix Q4 revenue growth by channel.
Overall, terminix delivered revenue growth of $30 million or 8% with $27 million of growth coming from acquisitions.
Starting with the termite at home services column on the left side of the chart revenue declined 1% in the quarter.
Organic decline of 2% was partially offset by acquisition growth of 2%.
As expected in discussed into Q3 earnings call termite renewals were down $2 million or 3% in the quarter driven primarily by lapping at 2 million dollar one time acceleration of revenue related to an accounting methods change for a bundled pest and termite services offering that we made in order to comply with new revenue.
[music] recognition standards in 2018.
We also experienced continue slight revenue declined in the mobile Bay area from customer attrition.
Termite completions at home services were up 1% in the quarter driven by acquisition growth as the rain discussed earlier revitalizing our termite business is a key priority for 2020, and we're excited about the rollout of the new monthly pay termite offering during the year.
Residential pest control grew 5% in the quarter over prior year, including 4% organically organic growth in residential.
Pest control was driven by price realization in the quarter and unit growth and Mosquito services, which were up 13% for the full year.
Growth in residential pass was delivered despite lapping a 7% prior year organic growth quarter. There was driven by onetime accelerations of start and completion rates that are difficult to meaningfully improve beyond the levels we have achieved.
Commercial pest control revenue was up 26% versus prior year, including 2% organically organic growth and the commercial pest was driven by a 2% improvement in retention rates offset by lower onetime sales.
Acquisition revenue contributed the remaining 24% growth in the quarter predominantly from a short environments, which moves to organic in Q1 of 2020 as well as the October acquisitions of Gregory if a cloud.
Turning to slide 12, adjusted EBITDA for the fourth quarter increased $2 million or 4% to $58 million, reflecting a margin of 13.7%.
I'll highlight a few of the items across the bridge on the bottom of the slide.
Revenue growth contributed $6 million of adjusted EBITDA, mainly from the impact of 2019 acquisitions, we delivered $5 million of sourcing productivity through better pricing on chemicals and supplies.
This was partially offset by $4 million of additional production labor as improved hiring processes and lower employee turnover have allowed us to step up and train employees in advance of the peak season, we expect the trend of higher production labor costs to continue into the first quarter that this will normalize.
Over the course of the year as the rain mentioned earlier, reducing employee turnover is one of our four strategic priorities. In 2020 is this will improve customer service and eventually retention.
Fumigation expense increased $2 million as we continue to work through the margin in volume reductions from outsourcing this high risk service.
We expect an additional $5 billion of increased expenses year over year from this outsourcing in Q1 of 2020 before fully lapping the initiative by Q2.
Sales and marketing was up $4 million in the quarter five primarily driven by increased sales commission from higher summer sales in 2019, which contributed to the increase in past growth I mentioned earlier.
These increased expenses were offset by a $9 million reduction in incentive compensation due to our full year 2019 financial performance.
Turning to guidance on slide 13, we expect 2020 to be another solid year of progress on our Terminix transformation journey. As a reminder, guidance addresses continued operations only and excludes any financial impact from Servicemaster brands as we continue to external.
Eric alternatives.
We expect revenue will grow at total between nine and 10% and range between 1.98 in $2 billion. We expect adjusted EBITDA total will range between 320 in $335 billion with margins of between 16 and 17%.
Turning to the Terminix segment, we expect organic organic revenue growth will range between three and 4% with acquisition growth of approximately $60 million carrying into 2020 normalized organic incremental margins are expected to be approximately 25%, but are offset by.
$10 million, an incremental termite damage claims expense $10 million and termite damage mitigation program and $5 million related to fumigation outsourcing.
Adjusted EBITDA contributions from primarily commercial acquisitions of Gregory in the cloud our expected at rates in the mid to high teens as we focus our efforts on integration and capturing synergies in those businesses during 2020.
Terminix adjusted EBITDA margins will be pressured in the first quarter, primarily due to the impact of this week fumigation outsourcing.
We'll lap the fumigation outsourcing initiative after Q1.
On slide 14, you'll see some additional details on guidance for damage claims expense as well as the European pass business. In 2020, we expect termite damage claims expense to increase the $70 million, including an increase of $10 million in claims cost and $10 million right.
Related to the previously discussed termite damage claim mitigation program as I mentioned earlier litigated damage claims will now be expensed at the time to cases filed making that difficult to predict on a period to period basis. Our guidance is our best estimate given our litigated claims history and predictive analytic.
From our third party actuarial and economic valuation firm.
For European past operations, we expect to see approximately $75 million of revenue with margins in the low to mid teens.
In the low twentys.
Present margins in the del Mar business will be offset by our ongoing efforts to integrate to rebuild the revenue base of the primarily national accounts business of Terminix UK, the European Pet business will start the year below the full year margin expectation and improved as the improved through the years. These efforts take hold.
Additional bottling details for the full year 2020 included expected book tax rate of between 27, and 29% with a lower cash tax rate of 12% to 14% as we benefit from a large refunds in 2020 for a prior period net operating loss carry forward before returning to our.
Mid term expected cash tax rate of approximately 20%.
We expect capex to continue to be less than 2% of revenue or below $40 million.
And with that I'll turn it back over to the rain for final comments right. Thanks, Tony spending last month with many of the key leaders in the field and in our corporate office has reinforced my strong conviction that we have a great business the talent and passion I see to provide excellent customer service permeates the entire organization.
Clear focus and better prioritization that alignment on our four key business initiatives will continue to allow us to execute on our strategic goals.
Our strategy remains focused on reducing employee turnover, which will help us continue to drive improved customer retention and ultimately lead to better financial returns.
Our focus on returning our termite business to the core of our success will also support our delivery of these goals I am confident in our strategy and look forward to updating you on our progress in the future.
Before I turn things back over to Jesse and open up the line for questions I wanted to spend a minute on our CEO search.
We've engaged in leading executive search firm to help us with this search and we're already beginning to screen potential candidates over the past few weeks of received several questions regarding the surge in what characteristics were looking forward our next CEO.
We're looking for somebody who is skilled both commercially and operationally ideally here. She will have experienced leading large distributed organization and the demonstrated ability to create follow followership in this environment.
And of course, we're looking for a customer centric executive who is familiar with recurring revenue businesses like ours somebody with a kenai for talent and a demonstrated ability to recruit retain and develop diverse talent.
And finally someone who embraces the servant leader model and understands the importance of enabling and empowering our frontline employees, so that bacon delight our customers.
Continuity during the service Master brand strategic alternative review as well as the CEO search and leadership change is Paramount Im thankful to be able to leverage Tony his experience and knowledge of the business. During this time and I'm happy to report that we've entered into a retention agreement to make sure he'll be a failure.
Through these transitions.
So all in all we're making good progress on a number of fronts across the company. We're excited about the future and focused on executing on all four prongs of our 2020 strategy to drive shareholder value.
I'd now turn the call back over to Jeff to lead us through Q in a session.
Thanks, Ryan with the Q being long. This morning, please limit yourself to a single question. So that we can get to everyone in the allotted time, Frank let's open the line for questions.
Thank you.
If you like to register a question. Please press the one follow up with a four on your telephone you will see three Tom prompt to acknowledge your request. If your question has been asking if I know there and you would like to withdraw your registration you May press for one followed by the Sthree.
Once again to register question is a one followed by the former telephone.
Our first question.
Comes from a line of.
Mario quite a lot Chu with Jefferies. Please proceed.
Hi, Thank you guys source for the time.
Obviously questions about the.
Litigation and termite expense.
So just.
Could you give us a sense of the cadence for that 230 billion over the next four years, obviously I think you said that.
A good chunk thats going to be in 2020, but I guess, what's the cadence in the out years and then how much litigation is baked into that 230 million.
And you guys had the 45 million in litigation reserve, but.
I guess, what are the odd that going up or down again, how much of the litigation is baked into that some 30.
Okay, Hey, Mario. Thank you. This is Tony he was any.
Obviously in 2020, we signaled that that's going to be the peak.
Of the termite damage claim expense and then it's going to.
Slowly trend down and.
Back to that 4% to 5% average out.
The last five year period, the 2025% 2029 period.
So thats the general trend that we're seeing your other question I think was around.
Litigation.
Yes, I. This is the rain I would say that the cost that we put out there in that range in really includes all of our cost of mitigation flatline loss mitigation costs as well as the actual claims settlement in there so that should be the total impact of the termite damage claims.
Thank you. Our next question comes from a line of Tim Mulrooney with William Blair. Please proceed.
Good morning.
Good morning, Tim morning, Tim.
Yes, so the.
Question on surprisingly also on termite, but it's a broader question I mean, I know you are retreating all the homes Dynamo Bill I think Thats 15000 customers you've done a few thousand so far.
Do you think there are other region that will also require additional retreatments I see that yellow other high risk region.
Million termite customers nationwide, how should we think about the implications to your termite margins over the next several years. Thank you.
Yes, Tim this was an array and I'll answer that based on this the analysis that we've done there's no indication that the the problem or the concerns are outside of that mobile Bay area. Clearly, we're going to continue to monitor the data and see if there any new trends, but right now we're very comfortable and it's isolated to that mobile Bay.
Area, and that's where our initial focuses.
Thank you. Our next question comes from a line of too difficult with JP Morgan. Please proceed.
Hi, good morning, Thanks for taking my question.
I just wondered also thank you for providing that being passed it brings that assessment very helpful.
Maybe just turnover of the Q and a little bit to organic revenue I thought the three to four guidance that you put out was very encouraging and so I was hoping that you could just provide a little bit of how their by channel, which which areas of the business commercial versus residential term ever since past, where do you really think that you're going to see.
That acceleration are there certain area, they're going to see more or less.
Thank you very much.
Thanks, Judah this is Tony Hey, I really encouraged with the commercial pest control business in particular.
In Q4 organic growth rate was 2%, but we're seeing nice improving trends in our retention rates.
That are really I think going to give us some acceleration going into 2020, so thats probably the most significant.
Changes that I am saying, we did have a strong residential pest control growth quarter, as well, 4% organic growth and if you will recall we were lapping a.
A 7% growth in Q4 2018, so I was really pleased to see the organic growth at that 4% level for this quarter.
So those are the areas that I am most encouraged.
Thanks.
Thank you. Our next question comes from the line of Toni Kaplan with Morgan Stanley. Please proceed.
Thank you.
Decision to explore alternatives for brands.
Vincent timing of when we should expect an announcement like how how quick you're expecting to.
Complete that process and how you're expecting to use the proceeds and then just given that you're exploring alternatives with brands, but you also.
Selling the entire business as well thank you.
Lockdown impact there Tony let me start with kind of the timing of process I mean clearly.
We're very early in the process right now and while we're very encouraged we're not in that we're not anxious to rush. The process, we want to make sure. We go through a thorough evaluation and normally what we've been told is kind of.
Four to six months is kind of typical for these types of things. So that's kind of what we're working towards but again, we're not going to push the schedule, we want to make sure that we find the right home and probably more importantly get the right value for our shareholders. We think it's a great business and Fortunately it looks like others do as well as far.
Yes.
The rest of the business, there's no intention there I mean, we are the businesses not for sale. We think we got a great business. We think we've got plenty of opportunities to drive both growth and operational improvement we were looking forward to driving those improvements in creating value.
And then finally as far as the use of proceeds I think we've talked about that in our press release, clearly we will pay down some debt to get our.
Get back to our target leverage ratio, we are losing some EBITDA with this we think there'll be plenty more to continue to invest in the business for organic and to the extent, we see continued to see opportunities for acquisitions out there and if theres leftover funds will look at the opportunity to redeploy back to our shareholders and one.
Ashen or another.
Our next question comes from a line of Andrew Wittmann with Baird. Please proceed.
Okay, great. Thanks.
I guess first off I wanted to ask Tony on free cash flow here, if you could give us some help of what you're expecting you for 2020, presumably some of the $53 million reserve that you took on termite is going to be cash costs. This year other factors between EBITDA and cash flow as well. So if you just kind of bound for us what you think the cash flow could come in.
This year that would be helpful. And then also I wanted to get just a little bit more detail as it relates to the the independent quality assurance teams and the third party claims administrators, how those two items are how they work and how they're going to help you.
To address the termite issues that you've had in are having.
Hey, Andy Thank you.
As far as free cash flow conversion, we still see that mid 50% 50 is 55 ish range for 2020, and there will not be any impact to that conversion.
Based on the.
Reserve, we took for termite damage claims will obviously pay claims as they go so again around the mid 50 range for the free cash flow conversion.
And the second question was on Q in a in third party administrator. Yeah. This underwriting I'll go ahead and take that the Q 18 was really supplement our traditional operations people. The Q 18 provides the training for our tax and they'll make sure that they're up to date with latest both.
Inspection techniques as well as the supplemental treatment techniques using the work that we've come out of our clean sheet termite process.
And then also be involved we're doing quality control reviews of the work that we're doing.
When initially in that mobile Bay area, but clearly.
They'll continue to provide value across our entire network.
Then the third party claims administrator. This was actually changed it was made over a year ago to have a professional organization reviewing those claims and really with a goal of moving faster than we were able to move when the claims were being handled at the branch level clearly our data and analysis shows the more quickly we can resolve these claims.
The better customer satisfaction and much less likelihood there is any type of continued damage. If there is an infestation. So speed is really important to us and we want to make sure have adequate resources to pursue that.
Our next question comes on line of Gary Bisbee with Bank of America. Please proceed.
Hi, guys. Good morning, So I appreciate all the incremental color on the termite claims I guess I wanted to ask about what seems to me or to other key components of the termite business. So so first just the operating cost base I guess, you talked about the incremental mitigation expense in 2020, but.
But how has that been trending and how do you see that cost base long term as you get through these are you or your operating costs higher than they would have been historically to manage claims back down to the level.
In the second part of that is the 10 million sort of onetime in 2020 that incremental mitigation cost or or do you expect that to continue and then that the third piece of other termite cost I Wonder if you could comment on is obviously renewals, where you don't have an issue at the home.
Is your highest margin business interests in Terminix. So how do we think about what you've lost from customer losses, as you've tried to push higher price in other regions. How much is that impacting the for profit outlook I know, there's a lot there I apologize for that but really trying to understand this issue. Thank you.
So Gary let me kind of address the termite piece first and that $10 million that $10 million, we view as a onetime costs to go back and provides a supplemental trading in the inspection for the 15000 homes in the mobile Bay area, so that should truly be a onetime costs there as far as the.
Long term margins, we still feel excited about the opportunity to continue to improve margins I think we've seen some good progress, but as you're aware, we're making significant investments with the clean sheet work the new customer experience platform and we have a series of other productivity initiatives on the sourcing side on the.
Tivity and on the marketing efficiency side, so we continue to see opportunities.
To to drive margin improvements as we move forward clearly some of that will take investments and we're making those investments on the renewal side again.
I think from when you look at the pricing we didn't make some adjustments in pricing in the mobile Bay area and that was really to align ourselves with the cost to serve.
Understanding better now what are real cost to serve their.
What the real cost to serve is when you look at our other pricing increases across the rest of the network I think their normal type of price increases that are consistent with the way it costs move on a normal basis, and we're always looking at retention and the trade off between pricing and retention of those and the good news is we've.
Consuming continuing to see improvement in our retention metrics or cancellation metrics. So we feel good about the trade offs that we're making there.
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Our next question comes from the line of Ian Zaffino with Oppenheimer. Please proceed.
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A question would be on the CEO search.
Touched on some details maybe give us the sense of timing.
We're looking for a public CEO or some of this in a larger company and then also you mentioned in the service culture.
What has been kind of your experienced so far trying to implement that.
And is that the right way to go about this or you're right.
See different type of strategy. Thanks.
Yes, so as far as the search goes and clearly I think given the timing will be based on our ability to attract and find the right candidate. My guess is again based on what we're hearing me executive recruiters in that four to six month timeframe.
Thank you again based on preliminary list, we have seen theres a lot of talented people out there with the skills and capabilities loved to find somebody who has been a public company CEO and has the experience dealing with the external side, but it doesn't necessarily that's not a hard requirement it could be a private company.
Or could be somebody in the next level down in a public company, whose add that external exposure.
The third piece that was around the servant leader model.
Again, our our customer experience is driven by our front line people. They are the ones in the home in the business is every day and Thats, what our customers see when they think of Terminix, especially so I think it's very important I think we've done a nice job over the past couple of years of kind of turning that around and putting.
Ourselves in a position, where we better serve them, we're making the investments in technology platforms and the training and I think again in this type of business in a recurring revenue business, where retention is so important to customer experience. So important having a leader who understands that model and the importance of supporting that front line.
It is absolutely critical.
Our next question comes from the line of Jamie Clement with Buckingham Research. Please proceed.
Good morning, gentlemen, update Tony just on the on the termite study methodology.
The terms you guys used was customer attributes as being sort of like the factor being looked at and I'm just kind of curious methodologically.
Why not look at things like.
Climate prevalence of foremost soil conditions or even like historical measures of your own service quality.
As factors to figure that maybe those factors were considered and maybe I'm just trying to look for a little bit more on methodology there.
Yes, Jamie those other factors were definitely considered we consulted with our own entomologists and an external entomologists then took into account.
Things like soil condition, and weather and climate in the area.
Obviously, we took into account.
Mitigation plan that the rain has talked about so all of that was factored into the analysis. So you're seeing a complete the typically base that also based on actions, we're taking and other external considerations in the environment.
Jamie and add a little bit to that remember they data that was used was our entire claims history over the last 10 years. So clearly all of that is embedded into the raw data and so we're looking at ZIP codes, where the homes our home values going talk about customer characteristics, it's not that.
Generally income and things like that it's the home characteristic size five at home so more of that and again, it's using all of our claims history over the last 10 years. So all of the service capabilities and everything are embedded in that raw data that was used to build the models.
Thank you.
Next question comes from a line of George Tong with Goldman Sachs. Please proceed.
Thanks, Good morning, I'd like to go back to.
The termite claims costs, you've provided that $230 million ring fence for termite claims for 2023 2024 can you elaborate on what litigation incidence rates are assuming in your outlook and what gives you confidence that claims cost will revert back to 5% after 2025.
Yes, so again, we use that.
The historical statistical data the very granular level, taking into account some of the factors. We just talked about home size and so forth that come up with the trends that we're seeing in litigated claims clearly it shows that they spike in 2019 2020 add that shred starts to move down.
After that based on everything and that including the supplemental treatments. The mitigation plans that were doing all factor into that downward trend that you're seeing after those two years of spike.
Thank you Im showing no further questions I will now turn the call back to you.
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