Serve Robotics Inc
NASDAQ:SERV
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Serve Robotics Inc
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Ladies and gentlemen, welcome to ServiceMaster's First Quarter 2020 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 would now like to turn it over to Mr. Jenkins, who'll introduce the other speakers on the call. Please go ahead.
Thank you. Good morning, and welcome. 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, 2020. 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 unaudited first quarter 2020 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 have 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 Chairman and Interim CEO, Naren Gursahaney; and our 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 will now turn it over to Naren Gursahaney. Naren?
Thanks, Jesse, and thank you all for joining our call today. Before I cover the quarter, I'd like to take a moment to thank the essential workers across the world who are helping us confront the COVID-19 crisis. This includes over 10,000 people at ServiceMaster and tens of thousands more in our franchise locations who are working day in and day out under challenging circumstances to create cleaner, healthier and safer homes and businesses. We service more than 50,000 homes and businesses daily, and our work is essential to our millions of residential and commercial customers across the globe. So to all of the people for their hard work and dedication in these difficult times, thank you.
Turning to Slide 4. I'd like you to walk you through why, largely because of the hard work we've done over the past several years, we believe ServiceMaster is very well positioned to weather the impacts of the current crisis. While the pandemic continues to evolve and there is continued uncertainty around the ultimate economic impact on our customers, we have been deemed an essential service provider, and we're taking decisive steps to ensure business continuity. We have a diverse customer base of over 2.8 million customers, touching many geographies and demographics. Over 80% of our revenue is contractual, and we've made substantial improvement in our customer satisfaction scores and retention rates to drive improved consistency in our revenue.
Beyond the consistency and diversity of our revenue streams, our business has strong operating margins, negative working capital requirements and requires limited capital expenditures. These dynamics, coupled with immediate access to over $500 million in cash, allow us ample flexibility to continue to pursue our strategies while we take substantial actions to improve our cost structure.
And as Tony will cover in more detail, we have a covenant-lite debt structure with no current maintenance covenants. And after completing a tightly priced Term Loan B offering in the fourth quarter of 2019, we have no scheduled debt repayments until late in 2024.
And while this crisis is unlike anything we've ever seen in the past, and there's still significant uncertainty about what the economic recovery will look like, having an experienced leadership team with a history of strong performance across a diverse array of industries during difficult economic cycles will help us manage through this pandemic.
We also enjoy strong leadership positions in growing and resilient industries. Driven partially by increases in temperatures, insect populations continue to rise across the world. These pests are immune to economic cycles and health concerns. And with 2019 reporting the second warmest year in recorded history and 2020 already predicted to be in the top 5, these underlying tailwinds show no sign of slowing.
On the ServiceMaster brand side of the business, we're watching the world change in front of our eyes, and ensuring clean, safe and disinfected homes and businesses is vital to support the world's efforts to get people back to work. With these strong underlying demand drivers for our services, leading to high retention rates and attractive margins, we are well positioned to build on these trends in both the near and long term.
With this as a backdrop, let's turn to Slide 5 and discuss the specifics of what we're doing to lessen the impact of COVID-19 on our business. We had a strong start to the quarter. But as we moved into late March, it became apparent we needed to take quick action to mitigate the impacts of COVID-19 on our business. We quickly formulated a 4-pronged approach. Our top priority and the most important issue we had to address was protecting the health of both our colleagues and our customers. We quickly mobilized our supply chain team to obtain the PPE needed to protect all of our frontline technicians and rolled out a training protocol to ensure it was used effectively in all service lines. Providing this essential protection for our employees has resulted in increased costs, impacting our profits in the quarter, but protecting our people and our customers was a critical step in protecting our business.
We strengthened our time off policies by increasing paid time off to any employees with symptoms of a virus or direct contact with those who have symptoms of the virus, including time off to care for any sick family members. We've also changed our frontline and back office protocols to reduce face-to-face contact between our employees and our customers as much as we can while still providing exceptional service.
And finally, we made the decision to suspend our door-to-door summer sales program to further ensure the safety of our customers and our partners. This program has been a growth driver for us for the past -- in the past and suspending it will have an impact on new sales and revenue growth in the Residential Pest business line as we move into future quarters.
We also took steps to ensure continuity of our services. These actions are designed to make sure that we can continue to provide our essential service to customers while maintaining the proper safety protocols. To that end, where possible, we're emphasizing exterior pest work. This works well for quarterly residential pest treatments, but we've seen an impact in new unit sales in both termite completions and to a larger extent, in home services that require access to the interior of customers' homes. We remain laser-focused on our relationships with customers and have improved our pre-service call process to inform customers about the additional steps we're taking to keep them safe during this time.
Where customers are concerned about people coming into their homes in this environment, we've shown flexibility in allowing customers to postpone their service. We're also accommodating our commercial customers who have been required to close locations and we've seen an increase in customer postponements in impacted industries such as hospitality and retail. We've also pledged considerable financial assistance to our franchisees, including relaxing financing payment requirements and pausing royalty payments in the heavily impacted Merry Maids business line.
To help offset these impacts, we've undertaken approximately $45 million in cost actions from our 2020 plan, designated to maintain profitability and preserve liquidity. First, we rightsized our front-line teams to align with the trends that we saw in the latter part of March by reducing about 450 pest control technicians and sales professionals. The majority of these were via furlough, where they can retain their benefits and we have flexibility to bring them back when activity recovers. This had an impact of about $10 million on our variable costs to help offset the expected reduction in revenue versus our previous expectations and guidance.
We then accelerated the restructuring of our G&A costs within our business and our corporate staff functions, reducing our G&A cost for the year by about $18 million, with about $30 million of run rate benefit in 2021. We also took actions to provide short-term benefits of about $4 million, including the deferral of our planned merit increases and a voluntary 25% reduction in my salary and retainer fees for our Board. We've also taken several actions to reduce capital expenditures by about $15 million, including a reduction of fleet vehicle leases and elimination of other discretionary CapEx investments. We are continuing to monitor revenue trends in real-time and are looking at other cost actions to protect and enhance our EBITDA and EBITDA margins.
Our fourth priority focuses on responding to opportunities. We recently launched Disinfectix in our Terminix Commercial business and are seeing strong customer interest. This service disinfects and kills germs on high-touch, hard surfaces in businesses, helping minimize invisible threats, including novel coronaviruses like COVID-19. Our rapid nationwide rollout is seeing growing demand early in the second quarter with several closed deals.
On the ServiceMaster brand side, we were able to rapidly mobilize an existing disinfecting service, and we've seen considerable activity to help offset work order postponements by our commercial cleaning clients who have closed offices. We also leveraged our strong cash position to purchase over 3.7 million shares of common stock at an average price of $27.64 a share in the quarter. We closed 5 tuck-in acquisitions during the quarter and plan to continue our tuck-in acquisition program in the near term.
Over the course of this event, we've learned a lot about our ability to work remotely that will allow us to explore reducing our branch call center and office real estate footprint as we move forward. While the current events will certainly have an impact on our performance as we move into future quarters, we believe these strong actions will allow us to weather those impacts and position us well to emerge in an even stronger position once the economy normalizes.
Turning now to our strategic priorities for 2020 on Slide 6. You can see that our actions to mitigate the virus support our previously discussed priorities for the year. We continue to make good progress on these initiatives and may remain top of mind as we manage through COVID-19.
Prior to the furlough actions that I mentioned earlier, we have made considerable improvements in our employee turnover in all of our front-line positions. Out of necessity, we've gone to virtual training for our technicians and are receiving positive feedback from our techs on this change. We also made substantial improvement in our hiring process as we reduce the time to fill an open requisition by several weeks. The state of the current labor markets will allow us to bring in top talent when the economy returns. And through our improved hiring and onboarding processes, this will ensure we meet our objective to become an employer of choice in the pest control space.
Never has customer retention been more important to our business than it is today, with new unit sales likely to be challenged in the coming months. We are laser-focused on engaging customers and have implemented robust service center actions to save customers that are concerned about safety and affordability of our services.
As I mentioned earlier, we've taken our customer communication protocols to a new level to ensure our customers understand the things we're doing to keep them safe, and the results of these actions are showing in the numbers. Net Promoter Scores increased in residential pest and termite during March. And while we were impacted late in the month and are expected to see additional impact in future quarters, the first quarter saw flat cancellation rates in Termite and improvements in Residential Pest. Retention was also flat in Terminix Commercial during the quarter as we absorbed the revenue impact of exiting a few unprofitable national accounts.
I already mentioned, the approximately $45 million in cost actions we're taking in 2020 to stabilize our profit margins. A number of these back office actions are a permanent acceleration of rightsizing in anticipation of becoming a pure-play pest control company. We are relentlessly focused on discretionary spending and other cost actions and see ample opportunities that could arise as we search the ways to reduce our real estate footprint in the future.
And finally, we're making meaningful progress on revitalizing our Termite business. In the Mobile Bay Area, we're nearing completion of our staffing for the inspection and supplemental treatment teams. And have completed approximately 1,000 treatments since our last update, in addition to the approximately 2,500 dual-defend conversions previously completed.
Net of cancellations, we have approximately 9,000 supplemental treatments remaining to perform during the year. While damage claims are higher year-over-year, we're encouraged by the success of our actions and remain on track with all previous guidance on termite damage claims for the year.
On the revenue side, we're seeing positive momentum in Termite sales from our new affordable monthly payment offering. While sales will likely be challenging in the near term, we're in a strong position as we enter the termite season.
I'll now hand it over to Tony to discuss our first quarter results and cost and revenue drivers we're expecting in the second quarter. I'll return with some closing comments before our Q&A session. Tony?
Thanks, Naren. Today, I'll be covering Q1 performance, including how we're thinking about the COVID-19 impact on future quarters, our strong liquidity position and our flexible balance sheet.
Turning to Slide 7. Let's start with the continuing operations financial summary. I'm going to talk about Terminix section in more detail later. So let me first cover European Pest Control and Other operations. Our European Pest operations contributed $18 million of revenue in the period, primarily from Nomor in Sweden and Norway as well as our Terminix U.K. business. The $18 million in revenue contributed approximately $2 million in EBITDA in the quarter as strong margins in Nomor were offset by high back-office costs remaining after the carve-out of Terminix U.K. from its previous owners operating systems. As we look forward into the rest of the year, our European businesses will be impacted by COVID-19. Norway and the U.K. implemented significant shelter-in-place orders. And although Sweden officially remained open, many businesses independently shut down operations.
We also recognized the $2 million negative adjustment to our self-insurance reserves for automobile, general liability and workers' compensation reserves in the period. Over the last several quarters, we have seen positive adjustments to our self-insured liabilities, and we continue to make progress in our safety initiatives across the company. We believe we are adequately reserved for future claims.
As you'll remember from our call last quarter, our former ServiceMaster brand segment is now reported in discontinued operations as a result of our ongoing strategic review process. As a component of the move to discontinued operations, there are $3 million of costs that were previously allocated to the segment that GAAP accounting requires us to classify within continuing operations. These costs are general allocations for back-office support functions like accounting and finance, human resources and information technology infrastructure. Ultimately, some smaller portion of these costs will become dis-synergies that impact the EBITDA of the remaining business, but it's important to note that we have a focused effort underway to streamline and improve the corporate overhead structure. And as Naren mentioned earlier, we have taken a number of actions after the quarter end to reduce these costs, and those will flow through in future periods.
Adjusted net income and adjusted EPS reflect the flow-through of lower EBITDA in the period.
Turning to Slide 8. Let's take a deeper dive into organic revenue drivers for Terminix. I thought it'd be helpful to look beyond just quarterly numbers and look deeper into exactly what we saw in March. The chart on the left lays out reported organic growth and how it moved over the months of the quarter. As you can see across the board, we were in line for a strong growth quarter before the impact of COVID-19 in the last 2 weeks of the period. Starting with Residential Pest Control, 4% growth year-to-date through February was offset by a 3% decline in March. Despite improvements in customer retention and Net Promoter Scores, the last 2 weeks of March fell off considerably with work order postponements from customers and a decline in new unit sales. In April, we have seen a stabilization of work order postponements, albeit at a much higher level than normal, and have an ongoing effort around rescheduling these canceled services quickly in order to recapture some of the missed revenue as customers get more comfortable with the safety of our primarily exterior services. We expect to see continued softness in new unit sales, and it is important to note that we are going to delay our door-to-door summer sales program until it is safe for our associates and customers. With that said, we believe that Residential Pest Control will be our least impacted service line through the COVID-19 crisis.
Commercial Pest Control had a very strong quarter, posting 3% total growth. After an extremely strong January and February, with year-to-date organic growth of 5%, the business was impacted by service postponements from closed customer sites in late March. This segment continues to see strong pricing opportunities throughout the quarter as we price our offerings in line with our improved service levels. Not surprisingly, the impact to Commercial Pest is being felt differently in certain business verticals and geographies. The customer postponements I mentioned earlier are primarily coming in retail, restaurant, in hospitality verticals, which combined make up less than 20% of our revenue in this channel. Our verticals such as property management, food processing, health care and transportation, while certainly impacted, have been more resilient. We've also seen that the impact has been greater in higher virus risk areas such as New York City, where our Assured brand has seen considerable work order postponements.
As Naren mentioned, we are starting to see traction with nationwide rollout of disinfection services, which we are offering in a new back-to-work bundle with pest control for customers that previously had postponed services and are now reopening sites. Towards the back half of April, we saw an increase in the number of customers calling us to reschedule work in preparation for reopening. Overall, we expect Commercial Pest Control to be more heavily impacted from the virus in the near term, but believe we have strong momentum and adjacent revenue opportunities that will help us bounce back and emerge even stronger once we are past the crisis.
In Termite & Home Services, January and February results were in line with our expectations. However, we saw a meaningful decline in March. Retention for the business line drove strong renewal revenue growth, the new unit sales require access to the home for a full inspection and have slowed in the current environment. Termite & Home Services is made up of approximately 50% renewal revenue, 25% core termite sales and 25% home services sales in any given quarter. We expect retention to remain strong on renewals in the channel as customers maintain protection on their most valuable asset.
Preventative termite sales, usually part of the cross-selling opportunity with pest control, will be challenged as curative termite sales will largely depend on the strength of the termite season that is currently ramping up. We expect home services sales, particularly attic insulation to be most impacted in this channel as these are typically larger dollar jobs that require significant time in the home that customers may postpone in the current environment.
Beyond our main service lines, we're also a distributor of chemicals and supplies, which helps us improve our volume leverage with our major suppliers of pest control chemicals. The first quarter saw a 7% organic decline in this business as we dealt with delivery delays in supply channels. While demand for chemicals is difficult to forecast for the coming months, we have seen improvement in supply chain availability since March.
Before we turn to the Terminix EBITDA bridge, I'd like to touch on our divested fumigation channel that was down $3 million in Q1. During the first quarter, we saw significant declines to this revenue as the service requires customers to vacate their home for a period of time as treatment occurs. We expect to see continued weakness in the sale of these units due to impacts of the virus in the near term. We continue to pursue alternates, less invasive options to treat dry wood termites, like our Drywood Defend product for preventative solutions, and heat and other treatment methods for curative solutions.
Moving on to Slide 9. You can see EBITDA drivers for the quarter. Organic revenue growth of $5 million contributed $2 million of adjusted EBITDA. A as we mentioned previously, revenue was impacted in the last 2 weeks of March from customer work order cancellations in both our residential and commercial pest lines of the business.
Acquisition revenue of $17 million contributed over $1 million in the quarter. $3 million of the revenue was from lower-margin product sales revenue with $10 million from the virus impacted commercial pest line. We remain focused on our integration plans that will phase in over the course of the year and increase the EBITDA conversion rates we saw this quarter.
Termite damage claims increased $6 million year-over-year for a total expense of $14 million in the period. The expense is primarily driven from activity in the Mobile Bay Area and is in line with our previous guidance on termite damage claims. We remain on track for full year termite damage claim and mitigation expense of $70 million. As Naren mentioned, mitigation efforts remain on track, and we're making good progress on our supplemental treatment plans in the Mobile Bay area.
Expenses for the mitigation program were less than $1 million in the period, but will ramp up throughout the rest of the year now that we are approaching full staffing. To date, we have experienced little impact to our mitigation efforts from COVID-19 and remain on track to complete the program over the course of 2020.
Production labor increased $3 million, primarily related to labor inefficiencies from the rapid decline of work orders in the last few weeks of March. As Naren mentioned earlier, we have taken action in the second quarter to rightsize our frontline.
Chemicals and materials increased $4 million in the period, partially driven by an increase in cost for PPE for our employees. Although we expect to see less impact in this area for the rest of the year, we do expect slightly higher material cost to continue for the foreseeable future as we take the appropriate steps to protect our people and customers and purchase additional materials to support our new disinfection service offering in Terminix Commercial.
Fumigation subcontracting expense increased $2 million in the quarter. We've now fully lapped the fumigation outsourcing that will stabilize the year-over-year margins. But as I mentioned earlier, we continue to see declines in fumigation revenue due to the impact of COVID-19, especially in California, our biggest fume market, which has implemented significant shelter-in-place guidelines.
In all, we estimate the virus impact on our profitability by between $5 million and $6 million during the quarter in Terminix, including the revenue flow-through from lower work orders late in March, increased cost of personal protective equipment and increased sick leave and labor inefficiencies in the period. Naren mentioned that approximately $45 million of cost actions earlier will help us support our margins as we look to the rest of the year.
Moving to Slide 10. I'd like to touch on the performance of ServiceMaster Brands in the quarter. ServiceMaster Brands reported year-over-year revenue growth of 3%. Revenue increases in commercial cleaning national accounts and owned branch operations more than offset a reduction in royalty revenue in the period. Royalty revenue was negatively impacted by the mild winter and significantly less area-wide events than prior year and Merry Maids franchisee closures. Primarily due to this revenue mix shift, EBITDA declined $2 million year-over-year to $23 million.
Let's take a deeper look at the impacts from the current pandemic on each of our major revenue lines within ServiceMaster brands. Disaster restoration through the ServiceMaster Restore brand represents approximately half of the revenue of the segment. Revenue in this channel is largely driven by kitchen fires, burst pipes and to a lesser extent, area-wide events. As I mentioned earlier, we did see a reduction in restoration work in Q1, but this was mainly due to a drop in area-wide events in the mild winter. Looking forward, ServiceMaster Restore will see revenue from disinfection projects, which closely aligned to mold remediation work already performed in the business. This will help to offset the impact of the soft revenue in Q1 and impacts from COVID-19 in future quarters.
Commercial cleaning and national accounts, primarily through the ServiceMaster Clean brand represent between 30% and 40% of the revenue in the segment. Revenue has been negatively impacted by closed offices and service postponements in a similar manner to Terminix Commercial. However, ServiceMaster Brands was able to rapidly mobilize an existing disinfection offering, and they have seen a nice pickup in onetime jobs for commercial clients that is helping to offset COVID-related recurring revenue declines.
Residential cleaning through the Merry Maids brand represents approximately 10% of the revenue in the segment. It has been the most impacted of all of our brands. Residential cleaning is the only line of the business that has not been deemed essential in all parts of the country and as a result, has experienced many shutdowns in operations due to stay-at-home orders and customer discomfort on having service providers in the home. We are starting to see a number of these locations reopen where these orders have been lifted, and the franchise owners are mobilized and ready for what will likely be increased demand for disinfection services at homes as people get back to work and schools in the coming months.
Moving to Slide 11. I thought it would be helpful to walk through how we think about our cash flow dynamics given the current focus on liquidity in the markets. We have extremely strong free cash flow conversion rates in this business. I'll walk down some of the higher impact line items that contribute to free cash flow in the chart on the left side of the page. We expect working capital usage to be roughly flat for the full year as the government stimulus plan allows us to defer payroll taxes that should more than offset any delays in customer collections.
On the CapEx line, we used $10 million in the first quarter and are taking actions to limit discretionary spend, specifically in leasehold improvements in our facilities. Our cash interest is largely fixed and expected to be approximately $85 million for the full year. Cash taxes are expected to be between 12% and 14% for the full year and will benefit in the second quarter from a penalty free delay as part of the recently passed CARES Act.
Turning to uses of cash. We spent $26 million in the first quarter on several small tuck-in acquisitions. We continue to have deals in the pipeline and given our strong free cash flow dynamics, we expect to continue our tuck-in program and opportunities rise. We have scheduled debt payments primarily related to leased vehicles in previous acquisitions that are expected to be slightly over $70 million for the full year. We also completed our share repurchase program in the first quarter with the purchase of over 3.7 million shares at $27.64 per share. We have no immediate plans to seek additional authorization as we look to conserve cash and liquidity given the current uncertainty.
Cash generation remains a strong characteristic of our business and although only representing 1 month of the second quarter, collections have remained strong so far in April, and our cash balances increased approximately $40 million in the month.
On Slide 12, you can see our cash, debt and leverage ratios as of the end of the quarter. As you will remember, we refinanced our Term Loan B in November of last year, extending the maturity by 3 years to 2026, upsizing our revolver capacity and improving our interest rates by 75 basis points. We remain in an extremely strong position with immediate access to $370 million in cash from our revolving credit agreement at an attractive rate of LIBOR plus 175. The term loan is the covenant-lite instrument and as such has no maintenance covenants until more than $120 million in cash is drawn from the revolving credit facility. In the unlikely event the company draws more than $120 million from the facility, the applicable covenant would be 4x adjusted EBITDA as defined in the credit agreement to net first lien debt only. When including EBITDA from discontinued operations, that ratio is currently 1.3x. This leaves us ample capacity for both cash usage and the ability to absorb any EBITDA declines over the coming quarters.
While the impact of the virus will be felt in many aspects of our business, we believe we remain well positioned operationally and from a liquidity and balance sheet perspective to whether those impacts. We are taking aggressive actions as we manage through the pandemic and will emerge from it in an even stronger position.
Before I turn it over to Naren, I also wanted to briefly touch on the decision to withdraw our full year guidance. Given the evolving and unprecedented health and economic impacts of COVID-19 on our customers and the economy at large, it's difficult for us to accurately estimate the ultimate scale of the impact and the timing of the subsequent recovery. We'll continue to monitor the landscape and the pandemic's impact on the predictability of our earnings, and we'll reevaluate this decision when or if the impacts normalize in the coming months and quarters.
And with that, I'll now turn it back over to Naren for closing comments. Naren?
Thanks, Tony. Before I close, I wanted to provide a brief update on the time lines for 2 initiatives I've been focused on during my tenure as interim CEO. First, we remain on track with our original time line for a permanent CEO placement. Our CEO search committee has been able to conduct many virtual interviews over the past few months, and we're encouraged by the quality of the candidates that are available and excited by this opportunity. As I mentioned on the last call, the Board and I are looking for a candidate who will come in and accelerate the execution of our strategic priorities with a keen focus on improving employee retention through a servant leadership mindset, driving improvements in customer retention and improving our operating margins. I'll share more with you about the search and ultimate hire at the appropriate time.
Second, we're continuing with our review of strategic alternatives for the ServiceMaster Brands business. As I have said previously, we view the brands business as an extremely attractive business. And despite the pandemic and resulting turmoil in capital markets, prospective buyers have continued to show very strong interest in this business. Given the market turmoil, our process has slowed down, but we continue to believe shareholder value would be enhanced to becoming a pure-play pest control company and using the proceeds of an appropriately valued transaction to strengthen our balance sheet and competitive position in the market.
As I said earlier, we believe ServiceMaster is extremely well positioned to manage through this crisis. We've taken quick actions to protect our people, ensure the continuity of our operations as an essential service provider, drive costs out of the system to protect liquidity and develop opportunities such as our disinfection services and Terminix. We remain focused on our longer-term strategic priorities to improve the quality of our front-line by reducing employee turnover, driving customer retention improvements, improving our operating margins and revitalizing our termite business. As Tony described in detail, we have ample liquidity and strong free cash flow conversion that will allow us to weather the impacts of the pandemic, while remaining opportunistic in M&A in coming quarters. And now more than ever, we're focused on continued customer satisfaction and retention rates. My team and I are focused on the challenges of the coming quarters and through strong management, we're confident, we'll emerge in a position of strength.
Before I hand it over to Jesse, I'd like to end where I began, by thanking the tens of thousands of workers representing Terminix and ServiceMaster Brands for their dedication and service in these trying times. You have my thanks. And finally, I want to express my gratitude to our many residential and commercial customers. We are all in this together, and we continue to appreciate your business.
And now, Jesse will lead us through the Q&A session.
Thanks, Naren. With the queue being long this morning, please limit yourself to a single question, so that we can get to everyone in the allotted time. Let's now open the line up for questions.
[Operator Instructions]. Our first question comes from the line of Toni Kaplan, Morgan Stanley.
Glad to hear you all are doing well. Just wanted to ask about the hygiene opportunity. You talked about a disinfection product, you press released it about a month ago. Just how does the product compare to ServiceMaster Clean? Do they compete against each other? And how much could this contribute to revenue this year, just given that this is such a big focus among businesses right now to before they reopen?
Well, thanks for the question, Toni. This is Naren. It is a similar type of product and a similar type of service. So theoretically, we could argue that they compete. We had good discussions internally about that. The reality is with the size of the market and the share positions that we have in either business, I think it's going to be very rare for us to actually overlap at an individual customer. The Terminix focuses on their existing customers and offering the services either as a stand-alone or as a back-to-business bundle that includes pest control and potential -- potentially some other services in there. But we think it's a nice opportunity. It's done very well in the clean business already and in the store business. And I'd say on the Terminix side, it's new. We're getting good customer response. And we're starting to close deals. So we feel pretty optimistic about the future. But remember, we're starting from a baseline of 0 in that business.
Next question comes from the line of Judah Sokel, JPMorgan.
I was hoping to drill a little bit more into the impact of COVID during the quarter and in the subsequent time since then. First of all, I was hoping you would just be able to supply maybe a little bit of trends that you've been seeing in April since the quarter ended. You mentioned some level of stabilization, but I was hoping you could help us think about if you've seen signs of recovery, have we bottomed out yet? And then I guess, as a corollary to that question, just trying to understand the impact to residential versus commercial in that first quarter. I think you mentioned that you expect residential to be the least impacted, which makes sense, versus commercial, yet in the first quarter, both seem to be impacted semi evenly on a fairly significant basis. So maybe you could talk a little bit about what happened in residential? What you expect to change a little bit going forward?
Yes. Thanks, Judah. Great to hear from you. In residential, I think the biggest impact was work order postponements, mainly dealing with the health care, obviously, I think, has led to some just temporary cancellations of work orders, and probably the biggest impact. The unit sales, obviously, were soft in the month. And we saw a pretty big impact in residential in the onetime area, the home services, the bed bugs, the fume. You can think about fume in the standpoint that you have to exit your home in order to do a fume. And obviously, that's not going to happen in states like California, where we do a lot of fume. So that's why we saw, I think, a bigger impact in residential, maybe than we saw in commercial.
In commercial, the main areas are, again, work order postponements for businesses that shut down. Again, they haven't canceled their agreements, but they have asked that we postpone the service until they reopen. One-time was also a pretty big impact in the commercial space.
What I would say is in both businesses, we were very encouraged by where we were heading, where our trajectory was. But we did see a pretty marked drop off, particularly towards the end of the month. And of course, it was hard to really deal with the labors that quickly. So we went ahead and did furloughs after the fact, but that had some impact on the margins, obviously, in the quarter. So those were the main aspects of why we saw the drop-offs in residential and commercial. Naren, anything you want to add to that?
Yes, on the commercial side, I think it's likely to be a little bit more short term. I think it was initial fear and concern around safety and health concerns, and that probably drove the increase that we saw in work order postponements. Clearly, that's stabilized now. It's stabilized at a higher rate than we've seen in the past. But our teams are working hard to get those rescheduled and we have the opportunity. Where businesses are closed, it will be tough to get that business back until many of those businesses reopen. So there could be a little timing difference as to how quickly they bounce back.
Did you comment on April run rate by any chance?
Yes. I mean, obviously, we're going to see a bigger impact in April because -- in commercial, obviously, for -- because of which -- more businesses now are shut down. I think things are stabilizing for the most part across all of our businesses. Work order cancels are still up year-over-year, the temporary cancels, but they're stabilizing. New sales are better, a little bit better. So that's basically where we're at as we head into April.
Our next question comes from the line of Seth Weber, RBC.
Hope you're doing well. I was wondering if you could just expand a little bit on the comment in the press release about taking aggressive action to retain customers. Does that mean you're using pricing -- will pricing get softer here going forward? And then can you just help us understand this summer lead gen program? Like is there any way to frame what that typically represents as a percentage of new agreements for you in a total year?
Let me go ahead and start at first part of the question. I lost track of the question. Let me go to the summer sales program first. Summer sales program has been a nice growth driver for us for the past couple of years. Clearly, it's a seasonal type of opportunity, as you would suggest. And we think it was the right decision for us to suspend that based on concerns of customers. It's something we're going to continue to reevaluate just based on how our customers and potential customers are feeling.
Going back to the question on retention, we really -- it's a multipronged approach on retention. First and foremost, it's our save desk to any customer who calls to cancel. We get those calls to a single group of people that is our best trained people. They've got a series of save offers that we've tested over time based on the ability to keep customers for the long term. Clearly, our customer communication is a big part of it, especially in this environment. And we have very robust communication plans, proactively reaching out to customers, letting them know what we're doing to keep our employees safe, but more importantly, to keep them safe when we do come to their homes or come inside their homes, and that's a big part of that. And like I said, there's no 1 kind of silver bullet out there. This is one where we continue to test and roll out new techniques. Much of it is really just based on continuing to enhance the quality of the service and the engagement with our techs and the customers. And clearly, that will be something that will be challenged in this environment, especially in our pest control business if we're continuing to work primarily outside the home. So we have to find other tools to make sure we get that communication and engagement with our customers.
Can you just give any -- is there any better just transparency on just the way to think about postponing service versus customers that are just flat out canceling contracts? Is there any -- I mean, it sounds like things kind of held together pretty well through March. But I guess, when -- did outright cancellations increase in April? Or it was really just postponing service?
I'd say the issue is still postponing. It is not -- we're not seeing a spike in cancel rates even as we go through April. I think we're continuing to perform very well. Again, we were flat in some areas, improved in some areas in Q1. And I think that's continuing based on what we've seen in April. And even the cancels have stabilized a little bit. So we're not seeing growth in the work order cancels. But it's something we got to keep an eye on, and we're working hard to make sure we get those rescheduled as quickly as we can to mitigate the risk there.
Yes. I would just add to that. We are separately tracking temporary cancels versus service agreement cancels. We monitor that on a daily basis. And obviously, temporary cancels are up significantly year-over-year for obvious reasons. But as far as service agreement cancellations, i.e., retention improvement, we're continuing to make progress.
Next question comes from the line of Tim Mulrooney, William Blair.
Yes. Just building on that, I'd like to drill down on the residential business a little more. So some pest control companies we talk to have said their residential business actually remains resilient and even seeing positive growth through this pandemic, just focusing on exterior services. Your residential business was down 3% in March, but can you provide us all with a little more detail on how organic growth in that business trended through April?
We don't want to really get too much into Q2 guidance at this point, Tim. But I would really look at it this way. If you look at residential, we were moving along nicely through the first two months of the year, 4% organic growth, seeing nice consistent improvement in residential. And then we did see the issue in March. The most important thing that I would say about the March is the work order temporary postponements. That was the most significant component of why we saw the fall off. And so we had customers that, frankly, for either health concerns or economic concerns pushed off their service that was due in March. There was a decline in unit sales in March. And again, we saw the big impact, probably the biggest impact in these onetime sales areas, like home services, in particular, where we have to get into the home, think of attic insulation, bed bug jobs; fume, where you have to get out of the home in order to do a fume job. So that's where we saw the biggest impact in March. So I think it's really those type of temporary factors around this crisis that really drove that. I think we were on really good progress before that.
Any change to those temporary factors in April, Tony?
Well, I think I said a few minutes ago, things are stabilizing as far as temporary cancels. We're still seeing a higher level than we did in the prior year, but they're stabilizing. And that's what I can tell you so far. And I think we're monitoring it on a daily basis, and we feel good about our position, and we'll go from there.
Next question comes from the line of Brian Butler, Stifel.
Great. Could you give a little bit more color maybe on the scope of the service on holds in the Commercial Pest? And how much that hospitality, restaurant and retail kind of makes up of the customer base? And then on the residential, are you still seeing the normal kind of, if there is a normal, but the historical seasonal upswing that you get in activity? Is that still occurring? Or is that been also materially delayed?
I'd say, first thing on the commercial side, retail hospitality, that group is about 20% of our commercial revenues, historically, and that clearly is going to be the area with the biggest impact because of the shutdowns. On the residential side, again, we are seeing the normal seasonal pickup we would expect to be. So we're doing all of our comparisons versus prior year. And that would build the seasonality into it as we look at the performance there. So no significant changes in the typical seasonal pattern of the business.
[Operator Instructions]. Next question comes from the line of Gary Bisbee, Bank of America Securities.
I'll start off by saying, I'm looking out of my home office window. I see a Terminix truck in the neighbor's driveway across the street. So hopefully, that's a sign -- hopefully, the guy is in the house because I can see him, but hopefully, that's the sign that some aspects of your business are beginning to normalize. The question I wanted to ask is just on the Terminix financial results and appreciate as always the waterfall chart and EBITDA. You called out $5 million to $6 million hit or impact that you think you saw in the first quarter from the COVID. But obviously, even if we add that back, the profitability was down significantly year-over-year and I think quite a bit more than where they can sense is estimate had been prior to the virus coming into play. So it looks like termite claims are up more than they were in Q4 or Q3 and obviously, the materials and chemicals cost you talked about. But what are the other moving parts? And how do you think about the key ones there, maybe versus how you were thinking about guidance before virus?
Gary, this is Naren. Let me provide a bit of intro, and then Tony can kind of provide a little bit more color to it. I mean, the other year-over-year changes were things that we had expected coming into the year. They were part of our guidance and part of our expectation. When we talked -- gave our fourth quarter results and talked about guidance, we laid out a few of the things that we knew were going to be headwinds in Q4 -- or excuse me, Q1 from an EBITDA perspective. Tony can walk you through a few of those key items.
Yes. In other words, the areas that we expected as far as margin pressure was termite damage claims. If you recall, we said that this is going to peak in 2020, and we saw exactly what we were expecting in the first quarter. And things are on track to our expectations there just as we saw them.
As far as some of the other areas. If you take a look at fume, we have signaled that we have outsourced fume, April 1, 2019. And so we would see the year-over-year margin pressure in the first quarter. And obviously, on the labor side of it, some of that is definitely -- much of that is definitely COVID related. The COVID impact in total is $5 million to $6 million, which is a combination of the revenue delays and the EBITDA flow-through on that, coupled with the fact that the labor, we weren't able to take off instantaneously, we had to take it out after the fact. So those were the -- that was probably the unexpected impact in the quarter, that $5 million to $6 million that we saw from the COVID. But everything else came right towards what we were expecting in our guidance.
Next question from the line of Ian Zaffino, Oppenheimer.
Thanks for the update on the brand sale. Can you just maybe give us a little bit more detail as far as maybe where you're seeing some of the interest from? And then also just given the environment, does it make sense to delay? Or are you really just seeing the prices you want and therefore, you're continuing the process?
Well, Ian, I'd say a couple of things. Of course, we're not going to be able to talk about potential suitors at this stage. It's just not something we would normally disclose. We still feel very good about the business and the attractive nature of the business, one of the better assets that's out there. I think on a relative basis to all the different kinds of industries out there, it's performing relatively well in a difficult environment for all businesses. I think as I look at the process, we're starting to see a little bit of stabilization in the equity markets. The credit markets have clearly improved. So the overall drivers that would make any deal attractive in here continue to go. And then we've continued to be in contact with those people who have been interested and they remain interested in the asset. So clearly, the process is going to take longer than we had originally expected because we want to make sure that we allow things to stabilize because that will ensure we get the best value for our shareholders. But we still feel like there's a good opportunity to do something that will truly benefit our shareholders.
Our next question comes from the line of George Tong, Goldman Sachs.
You talked about $45 million in cost actions in 2020 to stabilize profit margins. Can you elaborate on the timing of these cost savings? And what that means for the cadence of margins moving through the year? And then longer term, how do these savings impact your investment initiatives and growth outlook coming out of the pandemic?
Yes. Thanks, George. Good to hear from you. First, we said $45 million. The first point I wanted to make is we did furlough employees to rightsize our front-line with respect to the revenue. That's a variable cost reduction, obviously. So keep that in mind. About $18 million of the savings represents cuts that we've made in G&A. That's the in-year impact. If you look at the full run rate impact heading into 2021, that would be $30 million, but $18 million in year. $4 million of basically temporary actions like deferrals of salary increases and roughly $15 million of capital cuts, capital deferrals and reductions of debt.
Got it. And then longer term, do your savings impact your investment priorities and growth.
I'm sorry, George, I just want to make other points. On the $18 million in the G&A cuts, it's back-end loaded to more in the second half of the year. We apologize for missing that.
And George, on the growth side, again, we're continuing to invest on the platforms and things that we've talked about in the past, the new customer experience platform. We're moving forward on that investment. We made and we continue to make significant investments in our marketing capabilities to strengthen our marketing capabilities and enhance what we're doing both on the lead generation and the pricing side. So there's -- we're continuing to invest to grow the business. And as we talked about in our prepared comments, we'll continue to look at tuck-in acquisitions to grow inorganically to the extent that there are meaningful opportunities out there that make economic sense.
Next question comes from the line of Justin Hauke with Baird.
I just wanted to circle back on the termite damage claims. So it was $6 million in the quarter. I think you said in the past that you're expecting the year-over-year increase to be about $20 million. But then I thought you had some comments here that those claims are going to be higher in the back half. So maybe just clarifying that. Is this about the run rate, $5 million, $6 million a quarter that you're expecting for the balance of the year?
Yes. I don't believe we can give any specific guidance on the quarter-by-quarter timing in 2020. I think what we said is that 2020 would be the peak of the incremental termite damage claims that we were seeing.
Yes, I think a lot of it, from a timing perspective, it's tough for us to manage that. We now book the reserve at the time that the case is filed. Clearly, that's something we don't necessarily have control of it. But for the year, we still feel comfortable with our overall guidance and expectation.
And that guidance, is it $20 million year-over-year increase?
Yes.
Yes.
Okay. And then I guess the second question that I had is just on the PP&E needs. I guess how much of what you spent is kind of a onetime thing versus maybe an ongoing expense that you're going to have to have to service that business. So if it was $4 million in the quarter, how much of that is kind of a permanent cost increase?
It's hard to say, but I think it's obviously not going to be as high as you saw in Q1. But it's hard to give you an exact number on that right now. But...
Yes. I think you hit it right, though. I mean, Q1 included some onetime costs that we had to take as well as some run rate things. But -- so I would not expect that it's going to be $4 million a quarter?
No, absolutely not.
Comes from the line of Mario Cortellacci with Jefferies.
Hope you all are well and safe. Just touching on the cost structure. Just -- I know you took the $45 million out here to discuss that. But just wondering how much of the remaining cost structure is variable or could be taken out if things get worse? I think consensus is that maybe things have bottomed. But if it does get worse, how much of the cost structure can you take out? And then what does incremental margins look like in Q2 and beyond?
Well, obviously, we're still looking at opportunities to improve our margins in several different areas. And that's going to be a continuing process for us. Our costs are largely variable, and we have to make adjustments as quickly as possible on those when demand patterns change, and we've done that. But there's still opportunity in the rest of the cost structure for improvement, and we're going to continue to focus on that to improve the margins.
Fine, I think that's right. Clearly, we have a highly variable cost structure, and that's one of the advantages of the model. I think what we have to be cautious of, they are variable over the long term. They're not necessarily variable over a 1 to 2 weeks period. So clearly in Q1, we saw the revenue drop-off in the last couple of weeks of March. It's hard to move that quickly, even with the variable nature of it. But we took action as we got into April, and we're continuing to monitor the revenue trends very closely, and expect to be in a position where we'd be able to respond quicker. And we're continuing to look at all kinds of cost opportunities. And frankly, what we've learned over the past 6, 7 weeks about working remotely, we think gives us a nice longer-term cost reduction opportunity around our real estate footprint and that's our big offices like in Memphis, but also in our call centers as well as in our branch structure. That would be something that we'll work on over time because most of those are leased facilities, and we'll look at lease expirations. But we want to make sure that we learn from what we've dealt with over the past 6, 7 weeks and make our business better as a result of that.
Yes. And the one point I wanted to make, too, with respect to labor, one of our biggest cost elements. The first quarter, more of the labor is fixed in the short-term than variables because we're hiring a lot of people for the busy season. We're training them. They're not productive during the training period. And, obviously, through the end of February, we're expecting a pretty strong season and so -- hence, we have abnormally higher fixed cost in labor in the first quarter. And it is what it is now. We had the impact and we've adjusted.
And that concludes our Q&A session. Thank you, again, for your participation in today's call and webcast. As a reminder, a replay of the call will be available on our website in about 1 hour from now. Stay healthy, and thank you for your continued interest in our company. Thanks.
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