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Edited Transcript of SERV earnings conference call or presentation 7-May-19 1:00pm GMT

Q1 2019 Servicemaster Global Holdings Inc Earnings Call

Memphis Jun 19, 2019 (Thomson StreetEvents) -- Edited Transcript of Servicemaster Global Holdings Inc earnings conference call or presentation Tuesday, May 7, 2019 at 1:00:00pm GMT

TEXT version of Transcript

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Corporate Participants

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* Anthony D. DiLucente

ServiceMaster Global Holdings, Inc. - Senior VP & CFO

* Jesse Jenkins

ServiceMaster Global Holdings, Inc. - Senior Director of Treasury & IR

* Nikhil Madhukar Varty

ServiceMaster Global Holdings, Inc. - CEO & Director

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Conference Call Participants

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* Andrew John Wittmann

Robert W. Baird & Co. Incorporated, Research Division - Senior Research Analyst

* Dan Dolev

Nomura Securities Co. Ltd., Research Division - Executive Director of Business Services

* Gary Elizabeth Bisbee

BofA Merrill Lynch, Research Division - Analyst

* Ian Alton Zaffino

Oppenheimer & Co. Inc., Research Division - MD and Senior Analyst

* James Martin Clement

The Buckingham Research Group Incorporated - Analyst

* Judah Efram Sokel

JP Morgan Chase & Co, Research Division - Analyst

* Keen Fai Tong

Goldman Sachs Group Inc., Research Division - Research Analyst

* Michael Edward Hoffman

Stifel, Nicolaus & Company, Incorporated, Research Division - MD & Group Head of Diversified Industrials Research

* Seth Robert Weber

RBC Capital Markets, LLC, Research Division - Analyst

* Timothy Michael Mulrooney

William Blair & Company L.L.C., Research Division - Analyst

* Toni Michele Kaplan

Morgan Stanley, Research Division - Senior Analyst

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Presentation

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Operator [1]

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Ladies and gentlemen, welcome to ServiceMaster's First Quarter 2019 Earnings Call. Today's call is being recorded and broadcast on the Internet. Beginning today's call is Jesse Jenkins, ServiceMaster's Vice President of Investor Relations and Treasurer, and he will introduce the other speakers on the call.

Please go ahead, Mr. Jenkins.

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Jesse Jenkins, ServiceMaster Global Holdings, Inc. - Senior Director of Treasury & IR [2]

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Thank you, Keith. Good morning and thank you for joining our first quarter 2019 earnings conference call. Before we begin, I'd like to remind you that throughout today's call, management may make forward-looking statements to assist you in understanding the company's strategies and operating performance.

As stated on Slide 2, all forward-looking statements are subject to the forward-looking statement legends contained in our public filings with the Securities and Exchange Commission. These forward-looking statements are not guarantees of performance and are subject to the risk factors contained in our public filings that may cause actual results to vary materially from those contemplated in the forward-looking statements. Information discussed on today's call speaks only as of today, May 7, 2019. The company undertakes no obligation to update any information discussed on today's call. This morning, ServiceMaster issued a press release filed with the SEC on Form 8-K highlighting our first quarter 2019 financial results. The press release and the related presentation can be found on the Investor Relations section of our website.

We will reference certain non-GAAP financial measures throughout today's call, and we have included definitions of these terms in our press release, which is available on our website at servicemaster.com. We have 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 are to adjusted EBITDA, as defined in our press release.

Joining me on today's call are ServiceMaster's Chief Executive Officer, Nik Varty; and Chief Financial Officer, Tony DiLucente. For those following the presentation posted on our website, Slide 3 shows the agenda we will cover today.

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

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Nikhil Madhukar Varty, ServiceMaster Global Holdings, Inc. - CEO & Director [3]

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Thanks, Jesse, and thank you all for your time today. I will start with Q1 financial highlights on Slide 4.

ServiceMaster delivered a solid Q1 performance, reflecting progress on all of our strategic initiatives. We reported 13% revenue growth in the quarter, including 3% organic growth at Terminix and 5% organic growth at ServiceMaster Brands.

We also completed 11 acquisitions in the first quarter. Acquisitions helped drive the 11% growth at Terminix, including year-over-year growth of 6% at Copesan and 11% at Assured, as many of our acquisitions continue to grow at rates faster than the industry average.

The 5% organic growth at ServiceMaster Brands includes progress in high-growth verticals such as commercial restoration, health care cleaning and commercial cleaning national accounts, all growing significantly faster than the base cleaning and restoration business.

Adjusted EBITDA came in as expected as the strong organic and inorganic revenue contributions were reinvested into the business to fund additional sales and marketing, investments in people, further commercial pest development and transformational initiatives. These investments will drive sustainable profitable growth as they develop.

We delivered on a major shareholder commitment during the quarter with the back-stream monetization of our 16.7 million shares of Frontdoor. This transaction allows us significant opportunities to pursue our strategic initiatives. And despite the reality of negative weather impact on our Terminix business, which Tony will discuss in detail in a few minutes, the results of the quarter met our expectations and we remain on track for all previous -- our full year 2019 guidance.

We will build on the positive momentum of the first quarter throughout the rest of the year by executing on the value creation strategy detailed on Slide 5.

Our value creation strategy is focused on 3 priorities. First, we are committed to continuing our focus on building the core of our strong businesses. Leveraging our leading brands in the fragmented and growing industries of pest control, restoration and cleaning, we have the opportunity to drive significant growth by continuing to develop and perfect our operating consistency and service delivery.

As part of the strategy, we continue to make strides in the lucrative commercial and national account space with 17% growth in national accounts in our cleaning business this quarter.

At the same time, we are leveraging our existing strong customer relationships to expand into adjacent markets with new products and services our customers want such as our recently launched Terminix Tick Defend System and the pilot of an on-demand home and closet organizing service through our Merry Maids brand.

Strategic M&A is allowing us to explore geographic expansion, moving to urban centers through our Assured acquisition and expand our capabilities in our core businesses.

Underlying all of these initiatives is reimagining the customer experience. Excellent customer service, easy to talk about but incredibly difficult to consistently deliver. My job as the leader of ServiceMaster is to empower our customer-facing employees with the training, tools and motivation needed to deliver consistently excellent customer service at every touch point. We are creating a culture obsessed with service delivery. And while that mindset will take time to permeate throughout our organization, we are already making great strides.

Turning to Slide 6. Our focus on the fundamentals of customer service is continuing to strengthen our core business. And Slide 6 provides examples of the progress we're making, including achieving all-time high NPS scores in residential pest, commercial pest and termite at the end of Q1.

Starting in Terminix. In addition to the 3% organic revenue growth I mentioned earlier, we have seen considerable progress in other areas of the business. Improving customer service drove a 6% reduction in customer cancellations year-over-year in residential pest. Commercial pest has made considerable strides with 3-year highs in customer retention. The expertise of Copesan's holistic customer relationship strategy has rapidly changed the level of service in Terminix Commercial, and we are starting to see this pay real dividends.

We are making investments in commercial sales and marketing to develop the sales engine and are planning for growth in this business over the rest of the year. We have seen encouraging early results from our newly developed residential outside sales professional, or OSP, compensation plans. We designed our plan with 2 main goals in mind. We wanted to improve employee retention rates while driving the sale of new recurring units.

I am happy to report that OSP retention is up 7% and that new unit sales are up 8% year-over-year with the plan working as designed. Having these OSPs trained and ready as we move into the peak pest season will continue to pay dividends for us in the quarters to come.

At ServiceMaster Brands, in an effort to accelerate our growth initiatives, we realigned our teams around the pillars of restoration and cleaning with a clear focus on developing highly differentiated service offerings. Hagan Kappler, who joined the company just over a year ago after holding various business development positions at Ingersoll Rand, Starbucks, McKinsey and Goldman Sachs, expanded her role from leading Merry Maids to President of the entire cleaning business to including the commercial ServiceMaster Clean business. Hagan is tasked for driving growth in cleaning through further development of national accounts and health care cleaning as well as innovative offerings at Merry Maids like the previously mentioned home and closet organization service.

We are pleased to announce Aster Angagaw will be joining ServiceMaster Brands as the business unit leader effective May 13. Aster brings with her decades of strong leadership experience in highly reputable service companies, most recently at Sodexo. I will have more to share on Aster and the continued evolution of our ServiceMaster Brands strategy in the upcoming weeks.

As part of this realignment, we would also like to thank Mary Kay Wegner, who will be leaving the company, for her work in ServiceMaster Brands' franchise operations and her 9 years of leadership at ServiceMaster at various roles. We wish Mary Kay the best in her future endeavors.

All of these developments are the result of our renewed focus on our people, and we will continue to drive performance in our core by investing in our people and improving employee retention.

In addition to the new OSP pay plan, we are investing in all of our associates. In 2019, we are pushing equity awards deeper into the organization in order to reward strong performance. We are also helping our employees take part in our strong company performance by introducing a new employee stock purchase plan with a 10% company match in the coming months.

In 2019, we already strengthened employee benefits through improved on-boarding and maternity and paternity benefits. Our people remain the differentiator, and we are making strides towards becoming the employer of choice in our markets and industries.

As we turn to Slide 7, I'm happy to report that we continue to successfully execute on strategic M&A with 11 acquisitions in the quarter. On March 11, we closed on Atlanta-based Inspect-All Services, which is a PCT Top 100 listed company. From 2015 to 2018, Inspect-All was named to the Inc. 5000 list of America's fastest-growing private companies, and we're excited to add them to our business.

Andrew Klein and his team at Assured continue to make progress on the development of an aggressive urban strategy that will allow us to replicate his success in the New York market across other major metropolitan areas. Our Assured acquisition gives us the opportunity to expand previously difficult-to-enter urban centers, and recent development of our health care vertical offers strong opportunities in the cleaning business.

We are also moving closer to discipline and strategic global expansion as we continue to explore fast-growing markets where we can replicate our North American size and scale. We are also innovating our product offerings. We recently launched our Terminix Tick Defend System, an integrated pest management system that helps protect yards and homes from tick infestations. The Terminix Tick Defend System combines leading technology with technician expertise to help guard against all 7 common tick species found across the country. The new service reflects our improved ability to better assess our customer needs and efficiently launch innovative product and service solutions.

The launch comes in partnership with Genevieve Gorder, the acclaimed celebrity designer who lives with Lyme disease. In recognition of Lyme disease awareness month in May, Terminix will donate 10% of proceeds from its new Tick Defend System during the months of May, June and July to the Global Lyme Alliance to help raise awareness of this tick-borne illness and how to guard against it.

Turning to Slide 8. A continued focus on developing highly trained and motivated people is what will set us apart going forward. We have fully completed our service delivery boot camps in Terminix Residential, but this is only the beginning of our renewed focus on reimagining the customer experience. We are developing a systematic plan to reinforce this training with personal mini boot camp refresher visits with low-performing branches. And our realigned technician day plan will reinforce key focus areas such as pre- and post-service customer communication, showing up within the time window for scheduled visits and ensuring the proper service rule is followed at every stop. As I mentioned earlier, these initiatives are showing up in the numbers with cancellations down and NPS scores at all-time highs.

On the commercial side of the business, we continue to make strides in customer service improvement. The quality assurance program for national accounts customers has been a key driver of improvement, and as a result, NPS scores are up 20% year-over-year and customer retention is at 3-year highs.

Through our transformation and clean sheet initiatives, we are engaging our employees to help us design workflows that greatly improve the customer experience while driving increased efficiency and productivity across our operations. The clean sheet design will also be the key driver for configuring and later implementing our Salesforce platform, which allows us to institutionalize and drive exceptional service on an ongoing basis. We remain on track with our Salesforce implementation and are progressing towards the pilot phase scheduled for the third quarter of this year. I am confident that execution on the 3 prongs of our strategy will allow us to deliver sustainable profitable growth at or above industry levels.

I will now turn it over to Tony to discuss the financial performance of the quarter. Tony?

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Anthony D. DiLucente, ServiceMaster Global Holdings, Inc. - Senior VP & CFO [4]

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Thanks, Nik, and good morning, everyone. I'll be covering our Q1 consolidated financial summary and segment-level results, cash flow and 2019 guidance. Turning to Slide 9, let's start with the Q1 financial summary.

Revenue grew $54 million or 13% compared to the prior year. Organic growth at Terminix was 3% in the quarter, highlighted by 4% organic growth in residential pest control and 2% organic growth in termite and home services. Terminix acquisitions added $41 million or 11% growth in the quarter driven predominantly by the Copesan and Assured acquisitions, which grew 6% and 11%, respectively, year-over-year.

ServiceMaster Brands grew $3 million or 5% in the quarter, including the high-growth verticals of national accounts, health care cleaning and commercial restoration.

Excluding the impact of $11 million in the prior period for historically allocated American Home Shield costs, EBITDA in Q1 would have been flat to prior year. Although flat, it is important to note that the spin dis-synergies drove $4 million in increased expense in the quarter. The Salesforce implementation also added $2 million of higher costs in the quarter.

Additionally, we reported $3 million in adjusted EBITDA at the corporate segment primarily through a reduction in automobile, general liability and workers' compensation expense through continued improvements in our claims management process. We currently believe we are adequately reserved for a future claims expense and are not planning or guiding to additional savings in this area over the remainder of the year.

Turning to Slide 10, I'll discuss Terminix starting with the revenue growth by channel. It was another strong quarter for revenue growth in the period with growth in all of our revenue channels. Starting with the termite and home services column on the left side of the chart, revenue increased 4% in the quarter. Breaking this area down further, termite renewals were up $1 million or 1% in the quarter as pricing more than offset volume declines. If you recall, cold weather in the first quarter of 2018 negatively impacted termite completions. This now carries over and results in lower termite renewals in Q1 2019.

Termite completions in Q1 2019, which include new core termite and home services sales, were up 7% based on strong price realization and growth in home services. Approximately 43% of the $72 million in termite completions is related to core termite sales, which were up 7% year-over-year.

Home services completions, which include attic insulation, wildlife exclusion and crawlspace encapsulation, represent 57% of the revenue in this category and were up 6%. Total termite and home services revenue grew 2% organically, with 1% of the growth coming from M&A activity.

On April 1, the company successfully

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the divestiture of its termite fumigation business. The full year impact of the divestiture is approximately $21 million in lower revenue with negligible impact to adjusted EBITDA. Going forward, the company will provide organic growth numbers, including the divestiture and on a normalized basis. This divestiture was factored into our previous organic growth guidance of 2% to 3% for the year.

Residential pest control services were up 13% in the first quarter over prior year, including 4% organically. Organic growth in residential pest control was driven by strong price realization in the quarter and customer count growth as a result of reduced cancellation rates. New sales in the quarter were negatively impacted by lower lead flow due to unseasonably cold weather and flooding in the Midwest.

Commercial pest control revenue of $89 million was up 43% versus prior year driven by acquisition revenue predominantly from Copesan and Assured acquisitions. As a reminder, Copesan was acquired at the end of March 2018 and will become organic starting next quarter.

Organically, commercial pest was flat in the first quarter but continues to show positive momentum through improved customer service levels. With customer service at high levels and retention rates at 3-year highs, the base business is performing well. We are still ramping up our commercial sales staffing levels. In addition, we're working on expanding our team and revamping our commercial sales professional pay plan.

Overall, Terminix revenue grew over 14% in the quarter, including 3% organically. Similar to prior year, we estimate that weather-related branch closures as well as the reduced lead flow impacted the quarter by approximately $3 million.

Turning to Slide 11. Adjusted EBITDA for the first quarter decreased $3 million or 4% to $83 million. Adjusted EBITDA margins of 19.8% in the quarter represent a decrease of 370 basis points year-over-year as we continue to invest in future growth initiatives and absorb the full impact of the dis-synergies related to the American Home Shield spin.

Organic revenue growth of $11 million converted to $6 million of EBITDA improvement or a conversion rate of 54% as we continue to invest the healthy margins of the organic business to fuel future growth. Production labor increased $1 million year-over-year due to training costs as we rightsize our staffing levels in order to better serve our customers.

Included in the investment growth bucket is $2 million in increased sales and marketing costs, including the $1 million in increased sales labor Nik mentioned earlier that drove OSP retention increases of 7% year-over-year and sets us up for peak season. Also included are $2 million related to the Salesforce implementation that remains on track for a Q3 pilot and $1 million in both transformation and building out our commercial pest team. We also recognized $4 million in the quarter for spin-related dis-synergies.

We currently have many initiatives underway to improve productivity over the course of the year, but we continue to plan on approximately $4 million incrementally per quarter in Q2 and Q3 from these additional costs.

We have also broken out for the first time an EBITDA contribution from acquisitions. The $41 million in revenue from acquisitions in the quarter contributed $4 million to EBITDA or an incremental EBITDA margin of approximately 10%. This margin was impacted significantly by the mid-single-digit margins of the Copesan business, which will move to organic starting next quarter.

Excluding the impact of $6 million of dis-synergies and Salesforce investment, the incremental margins for Terminix in the quarter were approximately 5%. Incremental margins will continue to increase throughout the year, and we still expect the full year incremental margins to be approximately 30%.

Let's move to Slide 12 and talk about ServiceMaster Brands' Q1 performance. Revenue increased $3 million year-over-year or 5%. The increase was driven organically by 7% growth in health care cleaning and disinfection, 17% growth in cleaning national accounts as well as 35% growth in commercial restoration. The commercial restoration growth benefited from a large onetime job that completed in the quarter. Normalized for this, commercial restoration would have grown 19%.

There are minimal weather impacts in the quarter as revenue from area-wide events was down only slightly compared to the same period in the prior year. Adjusted EBITDA in the quarter was flat to prior year as the flow-through of higher revenue was largely offset by dis-synergies in the period.

Moving to Slide 13. I'll now briefly discuss our cash flow for the quarter. Free cash flow of $81 million improved $16 million or 25% year-over-year, and free cash flow conversion improved to 75% versus 67% in the prior year.

Timing-related cash uses for working capital were more than offset by higher year-over-year adjusted EBITDA, reduced cash interest and a reduction in property additions as we cycle construction-related costs from the move of our global service center to downtown Memphis. Property additions are still expected to be approximately 2% of sales for the full year.

We continue to expect free cash flow conversion between 50% and 60% for the full year 2019 as we pick up additional savings throughout the year from further debt reduction as a result of the Frontdoor share monetization. And speaking of the monetization of our Frontdoor shares, let's move on to Slide 14 to look at our capital structure now that we are through all the steps of the spin.

As Nik mentioned earlier, we successfully executed on the tax-free monetization of the Frontdoor shares, and as a result, we have been able to significantly reduce our debt and optimize our capital structure. By the end of Q1, we paid down $434 million of the senior secured term loan B, $7 million of the 7.45% notes maturing in 2027 and $3 million of the 7.25% notes maturing in 2038. As a result, our net leverage ratio dropped from 3.7x as of 12/31/2018 to 2.6x as of 3/31/2019, well within our long-term targeted net leverage ratio.

In April 2019, we repaid another $38 million of the senior secured term loan B and $1 million of the 7.45% notes. Our capital structure is now at the optimum level that gives us significant flexibility to execute on our strategic initiatives.

Let's now talk about our full year outlook and move to Slide 15. We expect consolidated revenue for 2019 to range between $2.02 billion and $2.05 billion or growth of 6% to 8%, and we expect consolidated adjusted EBITDA to range between $435 million and $445 million. At Terminix, we expect organic growth rates for the full year between 2% and 3% when normalized for the impact of our fumigation divestiture.

Including the additional investments in growth in Terminix, we expect incremental margins of the business to contribute approximately 30%, excluding $11 million of dis-synergies and $9 million of additional costs related to the Salesforce implementation. It's important to note the 30% incremental margins are for the full year and will increase throughout the year as productivity initiatives are realized and retention rates continue to improve. We expect a positive inflection point in our year-over-year adjusted EBITDA margins in the second half of 2019 as a result of revenue conversion more than offsetting dis-synergies and investment in growth.

At ServiceMaster Brands, we expect mid-single-digit organic growth and slight margin pressure as we grow EBITDA dollars by expanding our commercial cleaning national accounts business. For the total company, we expect Q2 and Q3 incremental dis-synergies of approximately $4 million each, predominantly impacting the Terminix segment. Our interest expense run rate after the monetization of our Frontdoor shares is now between $75 million and $85 million annually. Additionally, as I mentioned earlier, we expect CapEx to be approximately 2% of sales or just above $40 million based on the midpoint of our revenue guidance.

And with that, I'll turn it back over to Nik for final comments. Nik?

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Nikhil Madhukar Varty, ServiceMaster Global Holdings, Inc. - CEO & Director [5]

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Thanks, Tony. Today, we've discussed the ServiceMaster value creation strategy for sustainable profitable growth. But the right strategy can only take you so far without the right people to execute on that strategy. We continue to develop a deeper bench of talent throughout all levels of the organization to drive this business. We are investing in talent by attracting the best and putting programs in place to engage, develop and retain our talent better.

Our goal is to become the employer of choice in the markets and geographies we serve. We recently completed an organizational culture assessment in which we asked our employees what makes ServiceMaster special and what can make it better. We also discussed the characteristics needed in a winning culture. Using their responses, combined with the data we have about our strengths and opportunities, we are developing a playbook for building a culture that will differentiate us.

Culture is a difficult thing to manage, but we are focused on a systematic, strategic way to drive a fundamental change in how we interact with our customers, business partners and each other. We want to move towards a culture of empowered, motivated, accountable and highly capable people who will drive results now and well into the future. We are developing a service leadership mindset, which creates an environment which strongly empowers our people to succeed where leaders listen and help remove obstacles to success.

I will now turn the call back over to Jesse to lead us through a Q&A session.

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Jesse Jenkins, ServiceMaster Global Holdings, Inc. - Senior Director of Treasury & IR [6]

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Thanks, Nik. As a reminder, during the question-and-answer session, we encourage you to ask any questions that you may have, but please note that guidance is limited to the outlook we provided in our press release and webcast presentation. (Operator Instructions)

Keith, let's open the line for questions.

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Questions and Answers

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Operator [1]

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(Operator Instructions) And our first question comes from the line of Seth Weber of RBC Capital Markets.

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Seth Robert Weber, RBC Capital Markets, LLC, Research Division - Analyst [2]

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Tony, in your prepared remarks, I heard you mention termite pricing a couple times being better. That's consistent with some of the survey work that we've done recently on the pest control market. Can you just talk about what's driving the better pricing? Is that just Terminix kind of going out and getting what it feels it deserves, where it's been lacking? Or do you feel just like the market is supportive of better pricing? Could you just sort of frame what's driving the better pricing? Because that's something that we're definitely seeing in our survey work.

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Anthony D. DiLucente, ServiceMaster Global Holdings, Inc. - Senior VP & CFO [3]

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Sure. Thanks, Seth. And I think the latter explanation you gave is really the best answer. The market can support relatively modest price increases year in, year out, and we typically have done that historically, and we did that this year as well. So if you think about -- would we bill out for these termite services, the increases per customer are relatively small and could be absorbed fairly easily. So pretty typical thing for us.

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Nikhil Madhukar Varty, ServiceMaster Global Holdings, Inc. - CEO & Director [4]

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And Seth, this is Nik, and I want to appreciate you guys sharing the survey. It's pretty heartening to see an independent validation of our efforts, really was a nice boost for our Terminix team. It's good to get some pat on the back for a change from them, and I think that brings some incredible work to continue to drive the efforts for our customers.

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Operator [5]

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Our next question comes from the line of Michael Hoffman of Stifel.

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Michael Edward Hoffman, Stifel, Nicolaus & Company, Incorporated, Research Division - MD & Group Head of Diversified Industrials Research [6]

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With regards to the residential growth and retention, can you parse that between renewals versus new starts and completions and sort of how I think about the scope of the change in the retention? I realize you're not telling me a retention number but sort of the scope.

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Anthony D. DiLucente, ServiceMaster Global Holdings, Inc. - Senior VP & CFO [7]

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Yes, Michael, I would say that we did see some reduction in cancels this quarter, so that was certainly part of the growth and new sales as well. So we were encouraged to see better performance in the reduction in cancellations. If we move the needle a little bit more than we have maybe in prior quarters, we're -- we still have a lot more to go in that area in the second through fourth quarter, but good progress overall.

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Nikhil Madhukar Varty, ServiceMaster Global Holdings, Inc. - CEO & Director [8]

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Yes. I think it was both residential pest and termite showed good improvements, but we made a significant improvement in commercial pest business where our NPS score is at an all-time high and even our retention rate's at a 3-year high. So it's really a great progress made by the commercial side as well.

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Anthony D. DiLucente, ServiceMaster Global Holdings, Inc. - Senior VP & CFO [9]

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Yes. That's a good point. Both commercial and residential did improve retention, but commercial improved even more. So they were really impressive this quarter.

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Operator [10]

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

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Judah Efram Sokel, JP Morgan Chase & Co, Research Division - Analyst [11]

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Just wanted to follow up on the topic of retention, which just came up. In previous quarters, the progress that you guys have seen on the top line and margins was primarily attributed to operational levers like start rates, completion rates, but obviously there was a pivot today to talking more about retention. So I was hoping you could just review with us the total opportunity for improved retention for overall Terminix as well as the revenue and margin implications for any improvements you could see in retention.

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Anthony D. DiLucente, ServiceMaster Global Holdings, Inc. - Senior VP & CFO [12]

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Yes. Thanks, Judah. You may recall in previous quarters, we said we were approaching a fairly high level in our operating performance as far as start rates and completion rates. So really, that strong performance simply carried over, and so it wasn't as -- year-over-year as significant as an impact as it had been in the third and fourth quarter. Like I said, we did see a little bit of a bump up in reduced -- because of reduced cancels on the residential side, a nice pop on the commercial side. So that had a little bit more on the calculus for the revenue growth this quarter as well as the new sales units.

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Nikhil Madhukar Varty, ServiceMaster Global Holdings, Inc. - CEO & Director [13]

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But that's also a reflection of the start rates and cancel -- completion rates being improved, also as a major factor towards improving retention as we go forward. So we're starting to see that. We had mentioned earlier there is a strong correlation in our business. It's just a time lag, and we're starting to see at least the signs of that, which is really encouraging.

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Operator [14]

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

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Toni Michele Kaplan, Morgan Stanley, Research Division - Senior Analyst [15]

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I wanted to ask about the commercial pest growth. It continued to be a little bit weaker in the quarter organically. How are you expecting that business to trend in 2019? And how long until some of the experience you're gaining from Copesan could start providing some benefits to the legacy commercial business?

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Nikhil Madhukar Varty, ServiceMaster Global Holdings, Inc. - CEO & Director [16]

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Good question, Toni. As you know, for commercial, just about a year or plus ago, we set up a whole new focused business unit, created a whole leadership team for that, have hired some really incredible people throughout the organization who are starting -- and their efforts are starting to show, pay dividends. We -- as you see, the growth sort of flattish because -- but that's a big improvement over where we have been. So we're still sort of paying for some of the losses we have had in the past. And the retention going up was quite a great sign, but we also -- and there's also a lot of other mixed things in there. For example, onetime sales were light and our retentions up. But the main part of retention being up, that's a sustainable factor if we continue the levels of service.

And a lot of it is despite a lot of the efforts we've made, but it's also given a tailwind because we are incorporating the quality assurance practices, best practices at Copesan, which is best in class in the industry we're bringing in. So we're using, leveraging their knowledge of serving one of the toughest verticals, which is the food service vertical, into other areas of the business as well. So that has actually helped us get to these levels much faster than we would have anticipated from where we were. So it's like starting a race behind the start line and we're -- if you -- your other part of the question was 2019. Our forecasts or estimates are based on seeing reasonably good growth coming in this vector of our business as well.

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Operator [17]

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Our next question comes from the line of Dan Dolev of Nomura.

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Dan Dolev, Nomura Securities Co. Ltd., Research Division - Executive Director of Business Services [18]

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So in the last 2 quarters, I think you put up some really good comp, right, more 5%, 5% plus. You called out about $3 million or about a 1% drag from the weather so that gets you from like 3% to 4%. Can you maybe bridge that sort of extra point? And what needs to happen for you to get back to that 5% leverage?

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Nikhil Madhukar Varty, ServiceMaster Global Holdings, Inc. - CEO & Director [19]

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Well, it's a year-over-year comparison, so as we continue to grow, you have to continue to put numbers above that, and I think it's -- like I said, I've been mentioning over time, it's not a straight line. There's a lot of facts, as you understand, Dan. There's the weather, then there's onetime sales. What I like about it is this time, we've seen a consistent improvement in our reduction in cancels across residential pest, across commercial pest and across termite as well. So commercial growth is one thing we have to continue to expand on. As you know, the residential journey started for us before the commercial. We did start the commercial journey, we've got some great tailwind because of Copesan and bringing in some solid leaders, but one of the big efforts going on in the last few months is reinforcing commercial sales teams. So we have restructured the team. We are continuing to build, bringing in some incredible talent. As we mentioned, we changed our residential sales pay plans. We are in the process actually of changing the commercial sales pay plan, which we also believe, based on the learnings we've had, will pay some great dividends going forward. So this continued -- I mean, for me, the best part is getting the retention starting to move up was a part of the sign. So it's -- as we said, our main focus is to get all our entire business to at or above market growth rates. So continue to see that.

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Operator [20]

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

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Timothy Michael Mulrooney, William Blair & Company L.L.C., Research Division - Analyst [21]

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So you guys acquired 11 pest control companies in the quarter, and it looks like for about $100 million according to the cash flow statement. Am I right about that? And can you share with us approximately what you expect the annualized revenue of those 11 pest control companies to be?

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Anthony D. DiLucente, ServiceMaster Global Holdings, Inc. - Senior VP & CFO [22]

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You are correct, it was a -- we did acquire 11 separate pest companies, and $100 million is the right acquisition amount. You see it right in the cash flow statement. As far as the impact to the revenue, those acquisitions should drive about $40 million in Q1 and roughly $60 million rest of the year.

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Operator [23]

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Our next question comes from the line of Ian Zaffino of Oppenheimer.

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Ian Alton Zaffino, Oppenheimer & Co. Inc., Research Division - MD and Senior Analyst [24]

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Firstly, on the guidance for 2% to 3%. It just seems to me that everything is going right as far as retention is getting better, NPS scores are up, pricing is up, but yet you're still only looking at the 2% to 3% growth for the whole year organically at Terminix. Are there any like headwinds that we're maybe not thinking about? I know you mentioned onetimers. Maybe give us an idea of like how much onetimers that is and what the headwind should be as you kind of move away from onetime sales or any other headwinds because I'm just trying to reconcile this 2% to 3% organic growth guidance.

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Nikhil Madhukar Varty, ServiceMaster Global Holdings, Inc. - CEO & Director [25]

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Ian, as you know, our guidance is based on the best information knowledge we have in understanding our markets, where we're going. One of the things you've got to factor in is on April 1, we sold our -- divested our fume business, which has about a $21 million annualized impact on our sales. Now there's negligible EBITDA impact of that business. The other thing is we did better in Q3 last year and Q4. So the comparisons also start becoming tougher as we go. So like I said, again, ultimately, it matters to how we continue to improve our service levels, continue to bump up our retention levels. And then if you start really cranking the engine on commercial, we'll start seeing that growth. But at this stage, we see comfortably between the 2% to 3%, and that's what we're guiding towards.

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Operator [26]

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

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Andrew John Wittmann, Robert W. Baird & Co. Incorporated, Research Division - Senior Research Analyst [27]

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I guess my question is on the Copesan deal, and obviously, you guys -- the learnings are helping you with your organic commercial business. I was just wondering about the ultimate pot of gold in improving those Copesan stand-alone margins, which I think was always part of the plan, Nik. Can you just give us an update as to where you are on getting those businesses cost synergized to the way you want them? Has that started to happen yet? I know that you've been very focused on making sure that those customers are very happy before you change anything. But I think just an update on that would be helpful.

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Nikhil Madhukar Varty, ServiceMaster Global Holdings, Inc. - CEO & Director [28]

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Yes. I think number one, we benefited significantly in other parts of the business. So we're seeing their help to improve customer service levels, retention on the remaining Terminix commercial business, which already has good payback for us. On the other hand, as you know, we've acquired quite a few of the partner providers like Assured Environments, Seitz Brothers, Cooper Pest Control. So that's one area that already -- we've already paid for those margins. We'll be acquiring those companies now, bringing those margins in back home. And we are exploring even beyond. I mean -- so first of all, mid-2019 was -- continued to bump up some business in. But as you know, we are also leveraging some of the partners' capabilities, and we're finding new ways of cooperation with them that will help us significantly improve synergies between us and these companies as well. So there's about 3 different factors we're looking at. One is learnings. Second is the acquisitions. And third, apart from bringing them in, in combination, is also looking how we can leverage some of the capabilities to drive even accelerated growth of those areas.

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Operator [29]

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Our next question comes from the line of George Tong of Goldman Sachs.

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Keen Fai Tong, Goldman Sachs Group Inc., Research Division - Research Analyst [30]

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Your termite and home services organic growth rate came in at 2% in the quarter. You touched on improvements you've seen around retention overall. Can you elaborate on how much further improvements in retention you could achieve in termite control and what your expectations are for new business trends there?

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Anthony D. DiLucente, ServiceMaster Global Holdings, Inc. - Senior VP & CFO [31]

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I still think we have some room for improvement in termite control. I think we probably have even more improvement in residential pest control. But we still do have, I think, some line of sight to further improvement in termite control. And we're seeing the NPS scores in termite continuing to increase. So we're optimistic that it will come eventually.

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Keen Fai Tong, Goldman Sachs Group Inc., Research Division - Research Analyst [32]

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And new business trends?

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Nikhil Madhukar Varty, ServiceMaster Global Holdings, Inc. - CEO & Director [33]

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What was that again?

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Anthony D. DiLucente, ServiceMaster Global Holdings, Inc. - Senior VP & CFO [34]

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I'm sorry, George, can you repeat the second part of your question? We misunderstood.

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Keen Fai Tong, Goldman Sachs Group Inc., Research Division - Research Analyst [35]

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Yes, the new business trends that you're seeing in termite control, how those are performing.

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Nikhil Madhukar Varty, ServiceMaster Global Holdings, Inc. - CEO & Director [36]

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I mean what we're seeing right now is based on our new -- renewed efforts to focus heavier on preventative rather than just curative is starting to pay dividends. It's just an initial rollout of our bundled offerings. So this will take some time to take traction, but already our customers are appreciating in our pilot programs sort of what's happening. I'm also even more excited for the future where we're driving these clean sheet designs, and termite was the first program we picked up on where we're completely redefining how we do business with our customers and completely reimagining the journey and touchpoints that we have. So I see a lot of good -- and all of this new stuff that we're going to drive is only going to work if our service levels start creeping up. And seeing the NPS score month after month after month improving and also finally starting to see the cancellations turnaround is a very positive sign for our termite business.

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Operator [37]

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Our next question comes from the line of Jamie Clement of Buckingham Research.

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James Martin Clement, The Buckingham Research Group Incorporated - Analyst [38]

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Tony, have you all -- to the extent that in certain regions you're seeing technician retention improve at rates that are above the company average, which obviously is improving, are you noticing customer retention also improving kind of in a correlated way?

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Anthony D. DiLucente, ServiceMaster Global Holdings, Inc. - Senior VP & CFO [39]

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We did see nice improvement in retention this quarter, especially in the commercial side, but also to a lesser degree, in the residential side. We had less cancels year-over-year. So I think there is a lag impact between service, delivery improvements and retention. So we're really starting to see the first parts of that improvement, I think, in Q1. So that's obviously a good sign. Now we expect much more improvement going forward. We still have a long way to go. But we are starting to see the first signs of that. Again, a particularly good retention quarter in commercial. And although their revenue growth was flat, they were still digging out of some of the issues we had in prior years, coupled with lower onetime sales in the quarter. So overall, we're encouraged.

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Operator [40]

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And our next question comes from the line of Gary Bisbee of Bank of America Merrill Lynch.

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Gary Elizabeth Bisbee, BofA Merrill Lynch, Research Division - Analyst [41]

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With the balance sheet now a lot stronger, I guess could you update how you're thinking about capital allocation? And within that, how do you think about share repurchases versus the M&A, which you have obviously accelerated? And on the M&A front, is there anything chunkier out there? Or is these smaller type of deals the more likely path forward from here?

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Nikhil Madhukar Varty, ServiceMaster Global Holdings, Inc. - CEO & Director [42]

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Gary, we -- it's all sort of in line with the strategy that we outlined at our Investor Day. So our primary focus is going to continue to look at acquisitions that are accretive to us in terms of capabilities that we can bring in. So we look at acquisitions in a couple forms. One is where we can look at some strong companies that we bring in, in terms of like Assured Environments, which is going to be a major accelerator and pillar for us to drive our urban strategy where we had relatively weak market shares. So this bodes well, bringing in stuff like Cooper Pest Control with bedbugs; Hometown with lawn care, which is essential in Florida to bundle up with pest. So looking at several of these, we continue to explore those.

And the next -- the second level is where we look at pretty smart tuck-ins, which help us with the density improvement, which also not just helps us improve our service levels or get better growth rates but mainly help to improve profitability as well. But the underlying factor for the -- these are -- we are going to continue to follow a very disciplined approach in terms of what kind of multiples we pay for these businesses and what kind of synergies we see going forward. Then as you know, we started a very structured, systematic share purchase plan, which is the next thing for us. And we'll selectively also look at debt refinancing and debt paydown as we go.

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Jesse Jenkins, ServiceMaster Global Holdings, Inc. - Senior Director of Treasury & IR [43]

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All right. That concludes our call. Thank you again for your participation in today's conference call and webcast. As a reminder, a replay of the call will be available on our website in about 1 hour from now. We look forward to speaking with you next during our Q2 2019 earnings release tentatively scheduled for August 6. Thank you.

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Operator [44]

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Ladies and gentlemen, that concludes the conference call for today. We thank you for your participation and ask that you please disconnect your lines.