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Edited Transcript of SERV earnings conference call or presentation 6-Aug-19 1:00pm GMT

Q2 2019 Servicemaster Global Holdings Inc Earnings Call

Memphis Aug 9, 2019 (Thomson StreetEvents) -- Edited Transcript of Servicemaster Global Holdings Inc earnings conference call or presentation Tuesday, August 6, 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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* 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

* Jeffrey Daniel Goldstein

Morgan Stanley, Research Division - Research Associate

* Judah Efram Sokel

JP Morgan Chase & Co, Research Division - Analyst

* Justin P. Hauke

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

* 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

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Presentation

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Operator [1]

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Ladies and gentlemen, welcome to ServiceMaster's Second 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.

I will now turn it over to Mr. Jenkins, who will introduce the other speakers on the call.

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

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Thank you, Kevin. Good morning, and welcome to our second 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 statements legend 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, August 6, 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 second quarter 2019 financial results. The press release and the related presentation can be found on the Investor Relations section of our website at servicemaster.com.

We will reference certain non-GAAP financial measures throughout today's call, and we have included definitions of these terms in our press release. We've also included reconciliations of these non-GAAP financial measures to the most comparable GAAP financial measures in our press release and 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. Slide 3 of the presentation posted on the Investor Relations section of our website shows the agenda we will cover today.

I'll now turn the call over to ServiceMaster'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 the Q2 financial highlights on Slide 4. ServiceMaster delivered strong revenue growth in the second quarter as we continue progress on all of our strategic initiatives. We reported 8% revenue growth in the quarter, including 10% growth at Terminix and 2% growth at ServiceMaster Brands. Organic growth at Terminix was 4%, including 6% in Residential Pest, 4% in Termite & Home Services and 2% in Commercial Pest. Meaningful retention gains and pricing realizations across all service lines helped to offset lower new unit sales due to the unseasonal weather patterns in the quarter. I am very proud of the growth Matt Stevenson and our team delivered in face of a challenging environment this quarter, driving several measures anticipating and countering the impacts of weather.

Our strategic acquisition program contributed the remaining growth in Terminix as we continue to identify attractive opportunities. Growth at ServiceMaster Brands came from higher revenue performance of 16% in commercial cleaning national accounts and 6% in health care cleaning and disinfection. We are also able to leverage our relationships with major insurance carriers in the quarter to drive a 24% year-over-year increase in the amount of revenue generated from program leads.

Dion Persson and his team have led an incredible effort to deliver strong returns from our strategic acquisition program, starting from developing a creative value creation strategy with robust pipelines, building strong bottoms-up M&A and integration processes and bringing onboard much needed capabilities, talent and synergistic opportunities. We closed on 7 tuck-in acquisitions in the quarter that will deliver high returns by buying at attractive prices and fully leveraging our existing infrastructure.

We also closed on 2 other acquisitions that add strategic capabilities to drive future growth and productivity. As a result of these acquisitions and strong performance from acquisitions closed in the prior years, we are increasing our revenue guidance for the full year 2019.

Consistent with our prior statements, we will continue to make the investments that are necessary to drive continued operating advancements in our businesses and position us for sustainable growth and profitability in the future. Specifically, we continue to focus on clean sheet reimagining of our customer journeys across our business, improving our commercial pest business as well as strengthening our sales and marketing securities in Terminix.

These essential investments will be reflected in our margin in the back half of the year. Our relentless focus is to deliver sustainable profitable growth, and we are consciously investing in only those opportunities that have the highest potential to deliver long-term value.

As we turn to Slide 5, this framework should look familiar. As you know, our value creation strategy focuses on 3 priorities. First, and most importantly, we are fully committed to continuing our progress on building the core of our strong businesses, which have high brand awareness in large, segmented and growing markets. The most important priority and focus in the business is on improving the operating fundamentals in pest control, restoration and cleaning. We are seeing results from our efforts and we're successful in driving continued retention improvements in Terminix in the quarter through a number of initiatives I will touch on in a minute.

Secondly, 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 continued success on our mosquito product now in the second year since deployment.

Strategic M&A remains an integral part of our innovation strategy as we work towards geographic expansion, urban market penetration with the help of our Assured Environments acquisition and expansion into new exciting verticals and technologies. Underlying and supporting all of these initiatives is a critical work we are undertaking to reimagine the customer experience. We are striving to delight our customers at every touchpoint of their journey with us.

Providing our technicians, customer service representatives and sales associates with the tools they need to provide excellent and consistent service is the heart of our customer experience platform driven by Salesforce technologies. A new 360-degree view of the customer journey from proposal to renewal will create visibility across sales, service and back-office support to offer consistent, seamless customer experience at every touchpoint, driving continued organic profitable growth and differentiated value creation.

We are also making meaningful progress in our clean sheet project, which will help standardize service delivery via on-screen guided tutorials for our technicians. This consistency of service delivery from the clean sheet redesign and frictionless customer interactions through the customer experience platform will drive improved customer retention as well as labor efficiencies across the organization. We are being purposeful in these initial phases of the project because it is vital we get this right before deployment, but we are confident that the end product will be something that will differentiate us not only with our customers, but also with our technicians, our most important asset helping them -- helping us become the employer of choice in our industry.

Our focus on customer service is continuing to strengthen our core, and Slide 6 provides an example of progress we are making across our businesses. Residential. Starting in Terminix Residential, our focus on the fundamentals is resulting in a measurable, better customer experience built on significant improvements in the basic blocking and tackling of our route-based business. For example, missed appointments were down over 50% in the quarter versus prior year. We are also making progress against our goal of speaking with customers before and after every service visit, allowing us to clearly explain the value of our services and set expectations for upcoming visits. We are also making meaningful improvement in the most important aspect of our business, our safety culture, with preventable accidents and injuries down 15% in the quarter. Returning our teammates home safely is our top priority every day. We have been able to make these strides while also improving labor productivity by $2 million year-over-year to enhance overtime management and a targeted initiative to move many hourly technicians to a production-based pay plan.

These initiatives helped drive a 4% reduction in Q2 year-over-year cancel rates in termite and residential pest control. We're also encouraged to see external confirmation of improving customer satisfaction through positive independent survey results over the last few months, one of which recently reported 91% customer satisfaction rate for Terminix, highest in the industry. While that kind of feedback is gratifying, we're not letting up. We know there is still considerable work ahead of us as we challenge ourselves against strong prior year growth numbers in the back half of this year.

Commercial. We are encouraged by the strong quarter at Terminix Commercial as our initial efforts in the business begin to drive results. Over 2% organic growth during the quarter reflects a 3-year high in the service line and is driven by significant retention rate improvements. Every sequential month of this quarter set new retention highs, and we ended the quarter with retention up 290 basis points year-over-year. This is clear evidence of how our focus on the fundamentals is driving results. Missed appointments in Commercial are down 34% year-to-date and customer engagement with the key decision-maker, vital in successful commercial business, has improved as well.

The retention improvements more than offset lower onetime sales in the period, primarily in bird control and bedbugs, as we continue to build out our sales teams at a local and regional level. While progress at the national accounts level has been faster to materialize, we are just now turning our focus toward strengthening the sales capabilities in our Terminix Commercial and combination branches. Armed with improved marketing tools and analytics, we are prioritizing high-value and growth geographies and filling any gaps with dedicated commercial sales professionals. Over the coming quarters, continued investments in the commercial sales teams are a priority for the business as we develop an industry-leading commercial pest team.

The addition of Greg Rutherford has added experience and strong leadership to the business. The deep bench supporting Greg highlighted by the internal promotion of Aric Schroeder, maintaining continuity at Copesan, and Andrew Klein from Assured Environments taking on a larger role in urban markets and elsewhere at the company will serve the business well. The entire team is well positioned with the right talent, tools and focus to execute on a winning strategy in the back half of the year and into the future.

ServiceMaster Brands. At ServiceMaster Brands, we are focusing on improving the fundamentals of the business to enhance the value we add to our franchise network. For example, we have made significant progress in commercial cleaning national accounts with sales up 16% this quarter. We're also adding value for franchisees through our insurance company relationships in ServiceMaster Restore. As a result, insurance program work was up 24% year-over-year in the second quarter.

The right talent is vital to our future growth and Aster Angagaw, our new dynamic leader, is providing great leadership as she dives into the day-to-day operations of the business. She is building an impressive team and has recently hired [Rob Ganack] as the new leader of ServiceMaster Restore. Rob brings an impressive operating experience from Danaher and Lockheed Martin.

As we turn to innovation on Slide 7, we continue to add capabilities to do strategic acquisitions in the quarter. We bought a technology company working on some exciting new pest-related technologies, which helps us build our innovation pipeline of breakthrough products and services in the future, a key addition to our innovation strategy. As part of our strategic acquisitions program, we also purchased a ServiceMaster Clean franchise based in New Mexico. This franchise has one of the largest health care cleaning and disinfection businesses in our network, which will accelerate our effort to drive strong growth in this fast-growing and profitable segment. This acquisition will be used as a launching pad to develop a health care center of excellence at ServiceMaster Brands. This will provide the operational expertise needed to grow our business and presence in the health care market, which can be leveraged to our expansive network.

We continue to make progress on our global strategy and are exploring several exciting opportunities in both the EU and Asia markets. As we have said previously, global expansion will initially come through M&A, where we will target companies with strong management teams that know how to operate in the region and help us drive future organic growth. I hope to have more share on our progress in this area in future quarters.

I would also like to take this opportunity to update you on some previously announced innovative product offerings. In the second full year of rollout, we are seeing progress in mosquito services with sales up 19% year-to-date. This market is growing faster than the industry, and we are focused on capturing our fair share of that growth.

Similarly, the Terminix Tick Defend System, an integrated pest management system that helps protect yards and homes from tick infestations, has performed in line with our expectations for the product. We continue to sell new units directly to new customers and see ample opportunities to cross-sell the protection as we execute on our mission to provide safer homes to our customers free from tick-borne illnesses.

Turning to Slide 8, and our focus on reimagining the customer experience. We have made strong progress on retention improvements across the Terminix businesses through an improved focus on the fundamentals. We are also seeing continued opportunities as our NPS scores, a leading indicator of improving customer retention, are up year-over-year. The hard work and diligent management is paying off, as evidenced by strong independent survey results showing industry-leading customer satisfaction. We are proud of the results we have driven across our revenue channels, but we know our new customer service platform will accelerate this progress. As an example, our new system will allow remote scheduling of appointments by customers, with real-time notifications and routing of technicians. Our new customer experience platform will improve service, while giving us the analytics and machine learning necessary to run our business more efficiently and effectively. This kind of system is complex in nature and requires diligence in the early stages of the process in order to ensure its success. Our team has worked through many implementations of this magnitude, and I am confident in the velocity of our progress. I am encouraged by the progress we have made in all 3 prongs of our strategy and look forward to continued success that return ServiceMaster into a company that delivers the best value to our customer, employees and shareholders.

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 Q2 consolidated financial summary and segment level results, cash flow and 2019 guidance.

Turning to slide 9, let's start with the Q2 consolidated financial summary. Revenue grew $41 million or 8% compared to the prior year. Terminix grew organically $18 million or 4%, excluding $3 million of the year-over-year revenue decline from our divested fumigation service line. Revenue from acquired businesses at Terminix added $24 million or 5% growth in the quarter, partially from the Assured Environment acquisition, which grew 13% year-over-year. ServiceMaster Brands added 2% growth in the quarter, in line with our expectations for the business. Excluding the impact of $11 million in the prior period for historically allocated American Home Shield costs, EBITDA in Q2 would have been down $4 million year-over-year. EBITDA was lower in the period partially due to increased investments in the Terminix business as well as spin-related dis-synergies.

Turning to Slide 10, I'll discuss Terminix starting with revenue growth by channel. Before I break down the revenue channels, I'd like to note that this presentation excludes the performance of our divested termite fumigation operation. This allows us to focus our efforts on faster growing and more profitable revenue channels, including termite preventative services. However, we do still diagnose customers that are in need of termite fumigation completion jobs. When this occurs, we're able to outsource the completion to a third-party provider in order to solve our customers' problems. With the -- while the revenue will continue to decline in this area as we shift our focus, the outsourcing is going well and we expect a full year revenue decline of approximately $4 million.

We are presenting fumigation separately to more clearly reflect our ongoing performance. Our 2% to 3% organic growth guidance continues to exclude the performance of the fumigation service lines.

Despite unseasonal weather patterns in the quarter, Terminix delivered strong revenue growth in all channels. Starting with the Termite & Home Services column on the left side of the chart, revenue increased 5% in the quarter, including 4% organically. Breaking this area down further, termite renewals were up $3 million or 4% in the quarter predominantly due to pricing and contribution from acquisitions. Termite completions in Q2 2019, which include new core termite and home services sales were up 6% based on strong pricing realization and unit growth in home services. Approximately 59% of the $92 million in termite completions is related to core termite sales, which were up 7% year-over-year.

Home services completions, which includes attic installation, wildlife exclusion and crawlspace encapsulation represent 41% of the revenue in this category and were up 4%. Residential Pest Control services were up 13% in the second quarter over prior year, including over 6% organically. Organic growth in Residential Pest Control was driven by price realization in the quarter, customer count growth as a result of reduced cancellation rates and the previously mentioned unit growth in mosquito sales.

Commercial Pest Control revenue of $100 million was up 13% versus prior year, including over 2% organically. Organic growth in commercial pest was driven by strong improvements in retention rates, more than offsetting lower onetime sales predominantly in bedbug and bird services as we reorganize the commercial sales force. Acquisition revenue contributed 11% in the quarter, predominantly from strong year-over-year growth of 13% at Assured Environments.

Overall, Terminix grew 10% in the quarter, including 4% organically. We estimate that wet weather and flooding in the quarter impacted revenue by $3 million primarily in low-margin product sales and to a lesser extent termite completions.

Turning to Slide 11, adjusted EBITDA for the second quarter decreased $4 million or 4% to $106 million. Adjusted EBITDA margin of 21.4% in the quarter represent a decrease of 280 basis points year-over-year as we continue to invest in future growth initiatives and absorb the impact of dis-synergies related to the American Home Shield spin. Organic revenue growth of $15 million converted to $7 million in EBITDA. This includes the lower flow through of the Copesan revenue, now inorganic as well as our outsourced fumigation costs. We continue to make progress in the 3-year plan to transition services from Copesan Partners to Terminix Commercial branches as our service levels continue to improve.

Acquired revenue growth of $24 million contributed $6 million of EBITDA or a margin of 25% in the quarter. We now expect approximately $105 million of acquisition revenue in the full year to contribute approximately 20% EBITDA margins to the business in the full year 2019.

We have $6 million of investments in growth and productivity in the quarter, including $2 million in increased sales and marketing, $2 million in investments in our customer experience platform with Salesforce technology and $2 million in the optimization of the commercial pest business. As Nik mentioned earlier, we had $2 million of labor productivity in the quarter due to better overtime management and a concerted effort to shift hourly technicians into production-based pay plans.

There was $2 million in increased damage claims expense primarily due to activity in the Gulf Coast region. We also had $4 million in dis-synergies in the quarter. Excluding the impact of $6 million of dis-synergies and SalesForce's investments in the quarter, the incremental margins for Terminix were approximately 5%.

Let's move to Slide 12 and talk about ServiceMaster Brands Q2 performance. Revenue increased $2 million year-over-year or 2%. The increase was driven organically by our initiatives to grow national accounts in ServiceMaster Clean and insurance relationships for ServiceMaster Restore offset by national advertising fund reduction and lower locally generated royalty revenue. We're focused on the -- we're focused on these areas of the business where we can add value and drive growth, including 16% growth in cleaning national accounts and 24% growth in insurance program revenue. We also saw 6% growth in health care cleaning and disinfection, and with the recent acquisition, this area will remain a focus going forward.

The acquisition Nik mentioned earlier will have a relatively small impact to revenue and EBITDA in the remainder of the year, but adds many strategic capabilities in the fast-growing and profitable health care market. Adjusted EBITDA was relatively flat to prior year.

Moving to Slide 13, I'll discuss our cash flow for the quarter. Free cash flow of $143 million year-to-date improved $33 million or 30% year-over-year and free cash flow conversion improved 10 percentage points to 60%. Reduced cash interest driven by debt reduction after the Frontdoor share monetization and a reduction in property additions as we cycle construction-related costs from the move of our global service center to downtown Memphis was the primary drivers of the improvement. Property additions are expected to be less than 2% of revenue for the full year.

We have increased the bottom end of our free cash flow guidance and now expect to convert adjusted EBITDA to free cash between 55% and 60%. Looking to the uses of our cash, you can see we continue to invest in strategic acquisitions and have spent $119 million year-to-date. We also purchased 286,335 shares at an average price of $51.30 per share in the second quarter totaling $15 million. We ended the period with $228 million of available cash.

Cash generation continues to be a focus of the company. We are improving our free cash flow conversion in order to provide ample capital for investments and profitable organic and inorganic opportunities, while continuing to return value to our shareholders through our share repurchase plan. We remain diligent in the uses of our generated capital ensuring all investments we make provide returns for our investors at rates well in excess of our cost of capital.

Let's move to Slide 14 to review our full year outlook. While our strategic initiatives continue to drive results, we have increased our revenue guidance and now expect total ServiceMaster revenue for 2019 to range between $2.045 billion and $2.06 billion or growth of 8%, while affirming adjusted EBITDA in a range between $435 million to $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 and full year acquisition growth of approximately $105 million. Including the initial investments in growth and productivity in Terminix, we expect incremental margins of the business to now contribute approximately 20% excluding $11 million of dis-synergies and $9 million of additional costs related to the Salesforce implementation.

Organically, we expect contribution to remain around 30% with acquisitions contributing 20% in the year as we drive synergies and integration after purchase.

At ServiceMaster Brands, we expect mid-single-digit growth and slight margin pressure as we grow EBITDA dollars by expanding our commercial cleaning national accounts business and driving active initiatives to generate value for our franchisees and customers. We expect the full year effective tax rate to be between 21% and 23%, given the tax-free gain from the monetization of our Frontdoor shares. That said, Q3 and Q4 expected between 26% and 28% as the rates normalize post the monetization. We expect free cash flow conversion of 55% to 60% and CapEx to be less than 2% of revenue.

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. Two years into my journey at ServiceMaster, I am even more excited about the possibilities and incredibly proud of the progress our people are enabling to create a best-in-class company. We continue to make consistent improvements in our service levels as demonstrated by our improving customer retention numbers. We fully recognize that our employee satisfaction must be a key priority to help drive increased customer satisfaction and are seeing significant improvements in our safety performance, talent buildup and employee engagement scores, while improving benefits for our employees and investing in a servant leadership culture.

We are heavily very focused on executing our 3 strategic pillars and have achieved several milestones to become an industry leader. We are well positioned to build a strong customer and service-focused company that sustainably delivers above-market growth rates, strong profitability and cash flow. Our investments in building a talent bench strength, improved go-to-market models, innovation and customer experience platform will provide the differentiation we need to deliver outstanding shareholder value. We have transitioned new leaders into 2 of our businesses in Greg Rutherford and Aster Angagaw, and we continue to develop deep talent at all levels of the organization.

The mission of our company is to create cleaner, healthier and safer environments for our customers at home, work and play. Achieving our goals requires a cultural alignment throughout the organization as we focus on serving our customers with a servant leadership mindset. We have recently launched a companywide initiative in which leaders in our company interact one-on-one with associates to listen to what they think about our organization today, so that we can shape the culture of our future. We want to move towards an empowered, motivated, accountable organization of highly capable people who will create value for our customers, employees and shareholders well into the future. I know with the momentum we have in the business, we will drive a change through the organization and create teams with a capability and motivation to drive continued progress on our value creation strategies that will make us the best service company in the industry.

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)

Kevin, let's open up 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 Ian Zaffino of Oppenheimer.

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Ian Alton Zaffino, Oppenheimer & Co. Inc., Research Division - MD and Senior Analyst [2]

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Question would be just be focusing on M&A. What sort of multiples are you paying? What sort of multiples are you seeing for potential acquisitions? And also kind of -- we will take -- you definitely turned up the acquisition sort of cannon, call it. What's been driving that, and what are you seeing there and what gives you confidence to continue to do that?

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

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Ian, as you know, right since about 2 years, we have made it clear that acquisitions are an integral part of our innovation and growth strategy. And the way we look at acquisitions is twofold; one is there's some strategic acquisitions that we make, which bring in some very much needed capabilities for us as we've done with Assured Environments for urban strategy as we brought it up with -- as we brought Copesan, which really helped us significantly in our journey towards commercial. We've looked at Cooper Pest Control, which helped us with bedbugs. So we continue down that path of strategic acquisitions, but we're being very selective in that as to what targets we bring in based on our needs and how we can generate synergies in the future, both growth and productivity synergies. And it's a slow process where we continue to build the capabilities, we're continuing to -- but we're doing it with extremely strong discipline in what kind of targets you bring in and how we pay for them. As you know, the multiples in this area are -- have been driven quite high. But there is a way to do this in a very disciplined way of how it always -- we have a targeted return, which we will pay carefully just making sure that any of these acquisitions deliver that. The second prong, as I mentioned, we look at very selective and focused tuck-ins, which help us with density improvement in certain areas of the country rather than -- so you have to compare that. We typically compare that with what it will cost us to continue to prime the pump on marketing dollars versus bringing in some smart acquisitions that help us with just improve the density of certain branches and certain geographies where we believe we have very strong capabilities to serve.

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Operator [4]

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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 [5]

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You mentioned that you're strengthening your commercial pest marketing initiatives primarily in the back half of the year. Can you elaborate on this initiative and the expected impact it will have on Terminix margins, particularly around the timing of when this spend will happen over the next 2 quarters?

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Nikhil Madhukar Varty, ServiceMaster Global Holdings, Inc. - CEO & Director [6]

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Yes. George, as you know, when we started this journey, our #1 focus was getting our residential business back on track. And we were $200-some million player, $260 million kind of player in the commercial space but we're losing traction quite a lot over the previous years. By bringing in -- creating a separate business unit, bringing in a strong leadership, and we have -- and by acquiring Copesan and really leveraging on their capabilities, we've made some incredible strides and increase our market share and market leadership in that area. So we saw for the first time, this was -- the growth we registered this quarter was the best in 3 years that we've seen, so we're seeing positive trends. However, we're still at the beginning phases in building -- rebuilding the fundamentals of this business. One of the key areas where we're looking at is adding selectively and understanding which cities we believe we have the strongest opportunities for growth and building strong sales capabilities. So we will -- we continue to act, put soldiers, really people are focused in understanding the market, knowing what we need to deliver, but bringing in more business. This is not your residential business B2C kind of marketing. So it's really -- you got to get these boots on the ground there. So that's the investment we're continuing to make. But again, we're doing it in a selective way, which we know will generate returns in the future. And then, we're looking at pricing optimizations because as our retention -- as our NPS scores have improved and our service levels have improved, we are gaining certain credibility in the marketplace to garner a fair share on pricing. And this, again, has to be done very carefully and selectively, and I believe pricing is a factor of what your customers allow or enable, but our customers are more interested in consistent service, high-quality service and we are starting to serve more profitable verticals, like food service, health care and others, so being deliberate about where we invest our money and what -- where we focus on. So these are the kind of investments we're looking. And once we have our Salesforce system in place, that will also give us the scalability opportunities and also consistency in the delivery of service.

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Operator [7]

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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 [8]

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The resi revenue is up 6% organically. Obviously, a very solid result. Can you talk a little bit about this result? How much of this was an improvement in retention versus higher new unit sales versus pricing, like you were just discussing?

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

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Yes. Thanks, Tim. So I mean the biggest drivers in our residential pest growth are pricing -- are pricing realization, and then the -- after that I would say retention is the other biggest driver. We've never had a focus on reducing cancels though we drive throughout the field and that's been a successful program. We highlighted some of that initiative during the Investor Day and we've had good traction pulling that through this year. So those are the 2 biggest factors. The -- so on residential pest, the lead flow was okay. The lead flow was a little bit lower on the termite side, but in residential pest, we really gained from price and retention improvement mostly.

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Timothy Michael Mulrooney, William Blair & Company L.L.C., Research Division - Analyst [10]

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And the lead flow on the termite side being lower, is that primarily due to the poor weather in the quarter you think Tony?

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Anthony D. DiLucente, ServiceMaster Global Holdings, Inc. - Senior VP & CFO [11]

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Definitely a part of it, yes, yes.

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Nikhil Madhukar Varty, ServiceMaster Global Holdings, Inc. - CEO & Director [12]

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Yes.

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Anthony D. DiLucente, ServiceMaster Global Holdings, Inc. - Senior VP & CFO [13]

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It's obviously, we make an -- we gave you an estimate of what we think the weather impact is, but I think that definitely had an impact.

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Nikhil Madhukar Varty, ServiceMaster Global Holdings, Inc. - CEO & Director [14]

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And Tim, the wave for new leads, it does affect for the quarter, so we try to do a fair job of calculating what we lost. What I really applaud the team is they saw this coming and there were a lot of flexibility initiatives that were launched, like rescheduling work, optimizing some weekends, looking at cross-selling, energizing our technicians to cross-sell, training them better. I mean our technician-led sales were up 9% year-over-year, which is -- it's a small base, but this is the kind of -- I like the kind of mindset that the team is building to anticipate some of these problems that had them up first. The other thing that leads to the issue is because these leads not only affecting this quarter, but they do have some impact in the outer quarters because you don't get the recurring impact of those leads that you lost because of weather. But weather is -- again, I think weather is a standard that will happen. We just have to figure out how we counter that, how we drive business responsibly and continue to please our customers. I mean the most important part is getting our fundamentals right. And I am really pleased that this is -- month after month after month, we continue to see improving, not only improving NPS scores, but finally resulting in good retention improvements.

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Anthony D. DiLucente, ServiceMaster Global Holdings, Inc. - Senior VP & CFO [15]

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Yes. And we -- and I'll add. When we see the weather impact, we try to drive more creative leads through our technicians, and we've had some success on that in Q2 to help offset to some degree.

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Operator [16]

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

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Jeffrey Daniel Goldstein, Morgan Stanley, Research Division - Research Associate [17]

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This is actually Jeff Goldstein, on for Toni. Your largest competitor has seen slowing organic growth over the last 2 quarters and this is the first quarter in about 5 years you actually outperformed them. So maybe you can update us on what you're seeing out in the competitive environment? And do you think these recent initiatives you've been undertaking could actually allow you to consistently take share moving forward?

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Nikhil Madhukar Varty, ServiceMaster Global Holdings, Inc. - CEO & Director [18]

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Yes. I think the way I would see it is, we still see the market fundamentals fairly strong. Weather has been kind of a weird thing starting January with a very cold winter, a pretty moderate spring and then excessive rain. So those things happen and like I said, we've got to find ways to live with this, but also make sure we find creative ways around that. For us the story has all been about just fixing the fundamentals. You can see just from the number of missed appointment reductions by over 50%, that is a major customer pleaser. As you know, last year, in the back half of the year, we showed some good growth, but those came with more like the onetime events, like improving start rates, improving our completion rates, those are necessary, but some of these just can't be repeated, but the fundamentals are being fixed.

We are communicating a lot better with the customers before we visit them to help them understand the kind of service we're going to provide them, what else do they need us to be prepared for, and then communicating with them afterwards about how the service was driven, how the tech behaved. So it really helps us learn a lot. But the most important part is it helps increase the -- enhance the customer experience a lot. So for us, it's an ongoing journey. And as you know, the second aspect was really putting a stake in the ground and from -- stating that we do believe in the commercial business and we do believe we have a big right to play and be a leader, so that's how we're driving consistently. It's a matter for us is just -- we're not there yet. I mean we've just -- still got a long way to go from where we were. But I am very proud that we're seeing sustainability and consistency. The key is, again, through the second half and through next year even with growing numbers, how do we continue to build a pipeline. And in the end, retention is going to be the key saver because we've got to get from a retention perspective, that's probably the least expensive way of continuing to grow.

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Operator [19]

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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 [20]

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So this is actually just one question, but it does have some layers in it, if I can. I am trying to get a good feel for how to think about the trend by segment, 3Q, 4Q, year-over-year of the margins. If I frame that against midpoint of revs to midpoint of EBITDA, full year, it looks like you'd be up about 40 basis points in total. How do I think about the mix of that contribution between Terminix and SMB by quarter comparatively year-over-year?

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Anthony D. DiLucente, ServiceMaster Global Holdings, Inc. - Senior VP & CFO [21]

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So let me make sure I understand your question. You're basically saying, you're looking at the third quarter and fourth quarter and you're asking where we're heading from a margin...

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Michael Edward Hoffman, Stifel, Nicolaus & Company, Incorporated, Research Division - MD & Group Head of Diversified Industrials Research [22]

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What do you see -- Yes. What do you think the trend is year-over-year, 3 and 4Q by the 2 segments comparatively, given the midpoint of guidance, both rev and EBITDA has you up 40 basis points for the year?

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Anthony D. DiLucente, ServiceMaster Global Holdings, Inc. - Senior VP & CFO [23]

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Yes. We definitely have more margin improvement in the second half of the year in Terminix. I don't think there's a meaningful change in ServiceMaster Brands. And so that's -- so Terminix is definitely the driver. And we have really consistently said that all along that we were going to see lower incremental margins in the first 2 quarters and we're going to slow -- trend up particularly in the third and fourth quarter. So that's the main driver for that trend in the second half.

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Michael Edward Hoffman, Stifel, Nicolaus & Company, Incorporated, Research Division - MD & Group Head of Diversified Industrials Research [24]

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And you would expect Terminix to be better margin year-over-year in 4Q as well because you have a seasonal pattern here I got to follow as well?

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Anthony D. DiLucente, ServiceMaster Global Holdings, Inc. - Senior VP & CFO [25]

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Yes. Better year-over-year, right, given that factors into seasonality. Yes, that's right. Remember we lap the dis-synergies and the Salesforce investment in the fourth quarter as well too.

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Operator [26]

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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 [27]

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Great results. Great organic growth. Can you help us clarify some of the margin guide, the lowering of the incremental margin? It sounds like it was because of acquisitions, like kind of more where were you 3, 4 months ago versus where you are now in terms of your expected contribution of these, and what has changed?

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Anthony D. DiLucente, ServiceMaster Global Holdings, Inc. - Senior VP & CFO [28]

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Yes. Thanks, Dan. It's definitely driven by just investing more in growth, particularly in 3 areas. We talked a lot about transformation, the clean sheet redesign and let me separate that a little bit from the Salesforce investment. This is our front-end led transformation that Pratip Dastidar is leading and we're looking at ways of doing things smarter, better. We're investing more in that, which will have good long-term value for us. Standing up commercial and trying to get -- accelerate growth, getting our sales organization filled to where it needs to be is a part of it. And then on the residential side, higher sales and marketing, that we've made a conscious decision to invest more in sales and marketing for the remainder of the year. I mean, so that's the main drivers.

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Nikhil Madhukar Varty, ServiceMaster Global Holdings, Inc. - CEO & Director [29]

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Yes. I think, Dan, where fundamentally if you want to get to a level that's ultimately not just reaching market or above market growth rates and good profitability, it's also how you sustain that quarter-over-quarter. So a lot of it is building the right talent, building the capabilities, even within, we've had -- we've added quite a lot of incredible talent from several different companies that bring us a lot of richness and it's in the areas of HR and legal and not just in the business. I mean, so we are making great strides, and we're starting to see some great dividends from that. But this is really a build up towards being the best-in-class company, which will then be propped up and steadily supported by capable systems like Salesforce that take us into the future with better machine learning capabilities and helping our technicians focus much more on the customer rather than the administrative work that we were overly layering on them.

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Operator [30]

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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 [31]

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I don't know who wants to take this, maybe Tony, but one thing that came up 3 months ago, and I just -- kind of just curious to go over this, again. Obviously, second half of last year, you all saw tremendous improvement in organic growth. But if retention is improving, why does your organic growth have to decelerate in the second half of this year as implied by your guidance?

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Anthony D. DiLucente, ServiceMaster Global Holdings, Inc. - Senior VP & CFO [32]

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Yes. That's a good question. And I do think we have some very tough compares in Q3 and Q4 year over -- and we had, if you recall, 7.8% growth in residential pest in the third quarter of 2018 and 7.1% growth in residential pest in the fourth quarter of 2018. We also added an accounting adjustment that we had to make for our -- accounting change that we had to make for the new revenue recognition that affected termite positively in the fourth quarter of 2018. So we've always known that we're going to have a tough comparison in the back half. And then, you really have to go back and look at how we achieve that extraordinarily high growth in primarily residential pest in 2018. We greatly improved -- well first, we greatly -- we made a conscious decision to spend more on marketing. We drove more leads and then we, on top of that, implemented programs to really increase our start rates, our completion rates, which helped us process that revenue and achieve that growth. And we've said all along that we can't repeat that kind of improvement that we made in start rates and completion rates. And so that's why we're sticking to our guide on organic growth of 2% to 3%. We'll have some -- we've always said all along that the back half has tough compares year-over-year.

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

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And the positive thing, Jamie is, you know this industry very well and like any other recurring business, your real consistency improvement is only going to come from steady improvements and retention. And we had seen the NPS scores come up, so we knew that the correlation is there, but we couldn't predict the exact timing. And we've seen the last couple of quarters, especially this one, where we started seeing the retention needle move up. So this takes time. It's not going to be a straight line, but it's hard to do the start rate, completion rate improvement. At best, we're maintaining that, continuing to steadily make sure that we don't brittle that way, but at the same time I think retention is going to be the key game. And we're being very prudent about how we go about building this and not doing it with onetime events kind of stuff, so the whole focus is building a consistent machine for the future.

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James Martin Clement, The Buckingham Research Group Incorporated - Analyst [34]

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Okay. And then just one follow-up, if I may. I'm hearing out there over the last couple of quarters that it's become progressively difficult to fill open sales positions. Are you seeing the same thing? And if you are, what are you doing to make sure you're hiring the right people?

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Nikhil Madhukar Varty, ServiceMaster Global Holdings, Inc. - CEO & Director [35]

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One of the things we also did is we changed very clearly from a new HR look to make sure we're not just bringing in people, but we're bringing in highly credible capable people who are set up for success. We've done some tremendous improvements in onboarding of these people. So we reduced the attrition rates in the beginning of this process, but it is difficult because in the economy that we're in, be the -- it's challenging to get the kind of people you want. But we're doing some very targeted moves. We're focusing on hiring a lot more veterans, we're going towards more customer service related people that we can bring in, who understand what customer service is. We have upped our -- even our leadership development program in terms -- and then extending it beyond to more college-based recruiting. So there's a lot of initiatives that HR is taking to help us not only improve the pace at which we can bring in people, but also make sure that we're bringing in people that are not setup for failure to begin with.

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Operator [36]

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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 [37]

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M&A has come up -- M&A has come up a number of times in the Q&A, so I just wanted to follow up to get little more specific in terms of the topic of technology, given the acquisition that you guys made in the quarter. I was wondering, if perhaps, Nik, you could share some thoughts on the role of technology for the pest control industry moving forward? And more specifically on the purchase you made, can you talk about perhaps the type of technology this company employs? Is it related to digital control and monitoring or something else? Does it have residential applications or is it specifically for national accounts and commercial? Any color is appreciated.

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Nikhil Madhukar Varty, ServiceMaster Global Holdings, Inc. - CEO & Director [38]

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Yes. This is a very small acquisition, and they have capabilities from a wide range of focus, but primarily towards more electronically controlled solutions that can not only allow us to do remote tracking and monitoring, but also daily reporting to customers, creating some value add, triggering actions faster to cover. So, but bear in mind, these technologies are still in relatively early phases. So we're going through some very exciting pilot programs, which we're learning a lot from. What I'm happy about is this is the first time we've really made, as a company, a major step in this direction. We brought in more scientific capabilities and knowledge base with some incredible talent in that group. So I am really excited about this because I believe this is the way of the future. And we do want to be the industry leader. This is how we have to learn how to operate and invest in.

And the other point of commercial versus residential, this -- in the outset, I see a lot more applications towards commercial, more national accounts, because of scalability, opportunities. But again, I'll be excited to report on this as time goes by. We just want to be transparent about the activities we're doing, so we try to bring this up as -- like we did with our Tick Defend System last time and we'll continue to report on progress of all these initiatives.

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Operator [39]

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Our next 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 [40]

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Sorry, if I missed this, but on the strength in the commercial business, can you talk about whether you're seeing any traction there with cross-selling with SMB, and sort of what you're doing there to try and push that initiative?

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Nikhil Madhukar Varty, ServiceMaster Global Holdings, Inc. - CEO & Director [41]

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Seth, good question. This is going to be a major focus for us in the future, but as you know, with anything that's new, we start with some credible pilots. We have a fairly large retail chain that we've been working this with. The pilots are going really well. But it's not just about how you bundle, we're not looking at providing 1 plus 1 kind of service. We're looking at how can we redraw the lines on what is commercial cleaning all about and how we write the procedures for them, help them get better and then reduce the pest ingress because of the cleanliness, so you clean more and you spray less kind of mindset. So you're providing a highly value-based product to the customer. Apart from that, the fundamentals have to follow that. So getting -- it will be futile to sell this to the customer through our channel that performs the pest service, or our franchise partner that performs the cleaning. This has to be transparent to the customer, so we're building the interfaces that will allow single billing for these services and make it really easy for the customer to do business with us. Having said that, we have started marketing this to several other customers more to see the traction demand. We're starting to see a lot of interest in this area with couple other larger national accounts. So I am pretty excited about the promise this shows. But again, this is not a major event for the upcoming quarters, but I see a lot of promise in the future. And I'd rather be more deliberate upfront to fully understand the kind of product and package and all we provide our customers and then scale it up fast enough that we can gain a lot more traction in the future.

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Operator [42]

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Our next question comes from the line of Justin Hauke of Robert W. Baird.

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Justin P. Hauke, Robert W. Baird & Co. Incorporated, Research Division - Senior Research Associate [43]

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I just wanted to clarify on the acquisition contribution and the flow through into EBITDA. The revenue guidance inching a little bit higher on the incremental revenue, but not seeing that flow through onto the EBITDA guidance. So can you just remind us exactly how much revenue contribution you're expecting from M&A this year versus the guidance you previously gave?

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Anthony D. DiLucente, ServiceMaster Global Holdings, Inc. - Senior VP & CFO [44]

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Yes. We're expecting about $105 million of M&A revenue, inorganic revenue for the year. It's up $5 million. Essentially, it's a 20% incremental margin on EBITDA.

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Justin P. Hauke, Robert W. Baird & Co. Incorporated, Research Division - Senior Research Associate [45]

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Okay. Got it. That makes more sense then. And then I guess the second question was, so Copesan, I think, had -- this is the last quarter that there was some of that being in the acquired base. You mentioned that Assured was up 13% on it for year-over-year comparison. What was the Copesan year-over-year comparison, I think it was 6% last quarter?

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Nikhil Madhukar Varty, ServiceMaster Global Holdings, Inc. - CEO & Director [46]

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Copesan was acquired in the end of March, last day of March. So that already is part of our organic base, this is not separate. So we don't call that out anymore.

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Justin P. Hauke, Robert W. Baird & Co. Incorporated, Research Division - Senior Research Associate [47]

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Okay. So Copesan was in the 2% year-over-year organic growth?

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Nikhil Madhukar Varty, ServiceMaster Global Holdings, Inc. - CEO & Director [48]

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Yes. Including the last year's base, obviously.

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Anthony D. DiLucente, ServiceMaster Global Holdings, Inc. - Senior VP & CFO [49]

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And that was part of the improvement.

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Operator [50]

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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 [51]

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I guess just a follow up on Terminix margins. So you lapped Copesan and yet the margin was still down pretty sharply in the business. I understand all the commentary about investing, but the guidance seems to imply that expense growth for Terminix will slow sharply in the back half. And I know in Q4 you've got the dis-synergies and Salesforce spend goes away, so certainly that's a contributor, but can you just tell us how you're balancing all of the areas of investment that you've talked about on the call and over the last couple of years with the concept of delivering to the EBITDA guidance and improving margin trends?

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Anthony D. DiLucente, ServiceMaster Global Holdings, Inc. - Senior VP & CFO [52]

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Yes. Couple of things. I mean, we continue to work on productivity to offset the investments that we're making in our business. We have an active program, we meet on it every week and we're going to continue to drive productivity. We also have some acquisitions, tuck-ins that will have some impact in the second half of the year. But obviously, the focus for us is really drive as much productivity because we're going to continue to invest in growth in the business. We want to stay on track in driving that long-term sustainable organic growth, growing that recurring revenue, so that's always going to be the focus for us.

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Jesse Jenkins, ServiceMaster Global Holdings, Inc. - Senior Director of Treasury & IR [53]

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Okay. Great, and thank you. That's our last question on the call. We appreciate your participation in the call today and webcast. And as a reminder, a replay of the call will be available on our website in about 1 hour from now, and we look forward to speaking with you next during our Q3 2019 earnings release tentatively scheduled for November 15.

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Nikhil Madhukar Varty, ServiceMaster Global Holdings, Inc. - CEO & Director [54]

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Thank you, everybody.

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Anthony D. DiLucente, ServiceMaster Global Holdings, Inc. - Senior VP & CFO [55]

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Thanks.

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Operator [56]

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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.