Serve Robotics Inc
NASDAQ:SERV
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Serve Robotics Inc
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Ladies and gentlemen, welcome to ServiceMaster's Third Quarter 2018 Earnings Call. Today's call is being recorded and broadcast on the Internet. Beginning today's call is Jesse Jenkins, ServiceMaster's Treasurer and Senior Director of Investor Relations, and he will introduce the other speakers on the call. Please go ahead, Mr. Jenkins.
Thank you, Keith. Good morning, and thank you for joining our third quarter 2018 earnings conference call. Before I review the agenda and introduce the other speakers, I would 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 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, November 6, 2018. 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 third quarter 2018 financial results.
The press release and the related presentation can be found on the Investor Relations section of our website. We will reference certain non-GAAP financial measures throughout today's call, and we have included definitions of these terms in our press release, which is available on our website at www.servicemaster.com. We have also included reconciliations of these non-GAAP financial measures to the most comparable GAAP financial measures in our press release in the appendix of this presentation in order to better assist you in understanding our financial performance. All references on the call to EBITDA are to adjusted EBITDA as defined in our press release. As will be discussed in more detail in a few moments, ServiceMaster's successfully completed the spin-off of the American Home Shield segment on October 1.
While the press release and SEC filings for the third quarter will contain the operating results of the American Home Shield segment, comments on today's call will focus entirely on the remaining ServiceMaster businesses. All references to consolidated results except where expressly noted exclude American Home Shield. Information on American Home Shield and their third quarter performance can be found on their new parent company's website, frontdoorhome.com. Additionally in an effort to show more detail on the progress we are making, and where opportunities remained in relation to the Terminix transformation, we have broken out organic and acquisition revenue growth between termite, residential pest and commercial pest for the first time this quarter. We hope that this additional level of transparency will prove valuable in better understanding the performance of the company.
Joining me on today's call are ServiceMaster's Chief Executive Officer, Nik Varty; and Chief Financial Officer, Tony DiLucente. For those following along with the presentation available on our website, I'll walk through the agenda items shown on Slide 3. Nik will lead off providing third quarter 2018 highlights. He will then discuss the American Home Shield separation and progress on the Terminix' transformation. Tony will follow and review business unit results and then speak to the updated full year 2018 outlook. We will then open the line for questions. I will now turn the call over to ServiceMaster's CEO, Nik Varty. Nik?
Thanks, Jesse, and thank you all for our interest in our company at this exciting time in our history. I will start with our highlights on the quarter on Slide 4. We reported over 10% revenue growth across the business in the third quarter, including 2.6% in organic revenue growth at Terminix. The initial focus of the Terminix transformation was in residential pest and we saw strong gains to 7.8% organic revenue growth in that area in the third quarter. The main drivers in growth were improvements in route completion rates to empower technicians and growth in new unit sales aided by operational improvement in new sales corporates. Our franchise service group continues to grow revenue despite cycling historic hurricanes from the third quarter of last year. Growth in commercial disaster and fire restoration coupled with continued execution on national accounts are driving the gains in this segment. I'm excited about the near-term prospects in the existing and adjacent FSG markets and look forward to sharing with you our growth plans in these areas going forward as they will take on a larger priority for the business after the American Home Shield spin.
Talent is a key differentiator in our business. And I'm pleased to announce 3 additions to the executive management team. Our new Senior Vice President and General Counsel, Michael Bisignano has a wide range of experience in international markets, mergers and acquisitions, intellectual property and technology that will serve our business well as we execute our plan -- business plan going forward. Michael's addition plus the completion of the spin allows Dion Persson to devote his focus entirely to business development and growth strategies. As we continue to be impressed by the strong capabilities we're seeing in the Copesan acquisition and the potential for even greater application in our business, we have asked Deni Naumann to expand her role from Terminix National Accounts President to Interim President of Terminix Commercial. Her decade-plus experience in the pest industry and track record of growth in the competitive commercial market are laying the foundation that will help us build a strong commercial pest business. David Dart has also joined us in our team as our Chief Human Resources officer. With talent development and acquisition being such an integral part of the vision of the company, David's leadership will be invaluable as he drives changes to the businesses and work to attract and maintain talents at all levels. We are also upgrading talent beyond the executive level to strengthen our bench with key new placements in several business and functional areas that I will discuss later.
Turning to Slide 5. I will briefly touch on the American Home Shield spin. On October 1, as committed to our investors, we completed the timely and tax-free separation of American Home Shield. I would like to take a moment to thank the dedicated team that grow that process. With 19 different work streams touching practically every department of the business, it was a complicated and resource-intensive understanding that was executed successfully and on schedule. As the team returns its entire focus to our business, I'm confident that we will begin moving even faster on our key business initiatives. I wish the best to Rex, Brian and the rest of the management team as they move forward as an independent company.
In conjunction with the separation, AHS took on approximately $1 billion in debt and $251 million in cash in marketable securities. As a result, Servicemaster reduced our net debt leverage ratio by 10 basis points to approximately 3.6x adjusted EBITDA. In addition, we retained approximately 19.8% of the shares of the new parent company, Frontdoor, that we intend to monetize by June 14, 2019 in order to preserve the tax free nature of the transaction. We currently intend to deploy the proceeds from that transaction to further reduce debt. This is an exciting time for ServiceMaster. With the spin successfully behind us, we can now focus on the next chapter. And the leadership team and I would like to discuss with you how we intend to continue our positive trajectory and drive sustainable growth at ServiceMaster. The future is extremely bright for our business, and I invite you to join us at our Investor Day, which will be held in New York on December 11, where we will share the strategies of the business and its segments. Additional details about the events will be communicated soon, and I look forward to seeing you all in person in New York City.
On Slide 6, you can see the Terminix transformation strategy and where we are making progress. We continue to build the leadership team of not only Terminix but the company at large.
Beyond the executive-level placements I previously mentioned, Terminix has promoted a strong leader in Jeff Storck, the Division VP of the vital Southeast region. Jeff is an instrumental leader in the business. Having been with Terminix over the past 25 years and brings a deep background in sales, service and field leadership. His experience and guidance will be extremely valuable as we continue to empower branches and technicians to improve service levels and operational metrics. We have also added a new VP of Supply Management to Tony DiLucente's team. Jim Summerville steps into lead an already successfully group that has provided $8 million in EBITDA improvements from chemicals and materials sourcing to Terminix so far in 2018.
Continued business productivity from Jim's team will help us deliver results as we move forward. Our goal is to be an employer of choice for both current and prospective associates, and we are excited about the strides we have made to become that organization. We are driving accountability at all levels of Terminix. And let me highlight a couple of areas where we made excellent progress this past quarter. The first is new sales start rate. We have a business goal of starting all new sales within 24 hours. New residential pest start rates improved 9% year-over-year. We know that the successful start of a new sale within 24 hours sets the tone with the customer that we are service-first organization. Combining our successful start process with strong new unit sales in the third quarter lays the foundation for increased customer satisfaction, and ultimately sustainable organic growth and profitability in quarters to come. The second key area of improvement was our route completion rate. Route completion rates improved 290 basis points in the third quarter over prior year. Empowering our technicians and then holding them accountable the completion of their route is a vital part of implementing a service-first business culture.
We continue to see results from empowering our technicians and branch management to deliver an exceptional customer experience. Higher organic revenue growth this quarter is the end result of considerable the hard work by our empowered people. The underlying indicators for organic growth continued to improve as well as the top line. Year-over-year trailing 12-month NPS rates are up 11% in pest and 14% in termite. This is the third consecutive quarter of improvement in NPS scores. Starting more jobs on time and completing more work as scheduled is allowing us to improve our customer engagement scores, which is translating to strong growth. We are holding technicians and branch managers accountable and continue to simplify daily duties through the use of technology. We have also aligned compensation to our overall goals and are seeing meaningful progress as a result. Incentive compensation is up for both our technicians and branch managements as we share the results of our strong revenue gains this quarter. Sharing in our successes is an important way that we continue to empower our teams to deliver exceptional customer service.
We have said all along that this journey is not a straight line. And while these results are justification of progress, the journey is far from over. This is a march towards sustainable growth rates that will ultimately be driven by improved customer retention. Our focus on rebuilding a strong commercial pest control business also remains a high priority. While we started the transformation in the residential pest area, there are many learnings that can be shared with the commercial business. One particular area of opportunity is the digital mobile technology platform, we currently use as the foundation for many initiatives in the residential business. Expanding this across the commercial technicians would add a layer of connectivity between leadership and the field that they have never enjoyed. Protocols and procedures are a key part of commercial service delivery and an integrated platform with that information could be accessed in real time would be a powerful step in increasing service levels across the board.
Copesan continues to give the business an example of best-in-class customer service levels, and we continue to incorporate these best practices across the entire commercial business. Our Lean Six Sigma approach is crucially important going forward as there are still many opportunities to invest in these businesses. Paying for those investments through business productivity gains is the focus of Pratip Dastidar's Transformation Office. Detailed reviews are currently underway to better understand our service delivery model and how to improve it. We are examining all aspects of the business from things as simple as how to best park a truck at a customer's stop to more complex issues like the ideal branch size and structure. This mindset of continuous improvement in all we do is critical as a means to differentiate ourselves and fund the additional investment needed to improve the customer experience and continue to grow organically.
Turning to Slide 7. We are committed to growing a strong commercial platform that can be leveraged by all of our businesses. As our commercial strategy has evolved over the last few months, it has become apparent that sophisticated commercial jobs and national accounts are a broader opportunity for us going forward. Leveraging our strong brands, our improving expertise and nationwide footprint is the distinct competitive advantage in this highly contested market. The acquisition of Copesan increased our commercial revenue split at Terminix to approximately 23% and gave us a tremendous opportunity to leverage a leader that has grown 4% predominantly through focused expansion of sophisticated national account work. Deni Naumann not only gives us a dynamic leader with infectious energy and passion, but also enables us to expand on the terrific model that Copesan already has in place.
Over the last few months, Deni and our commercial team have integrated the national accounts sales teams at Terminix Commercial and Copesan. By better understanding the strengths of each brand, we have identified opportunities to leverage the expertise, each brand brings to different verticals from national accounts. The Terminix Commercial brand is strongest in the property management and hospitality verticals while Copesan has the leading position in food processing, food service, and retail food. Because of the value these different brands bring to the respective areas of strength, we have decided to maintain both brand names and leverage the strong commercial platform and service model of Copesan to expand the reach of each going forward.
An exceptional customer experience remains at the forefront of the Copesan business model, and it has served them well with year-over-year revenue growth this quarter of 6%. We have a potential opportunity to leverage our strong relationships with sophisticated, commercial and national account customers across our pest control, clean and restoration businesses. We have just started scratching the surface by piloting a combined offering of clean and pest control services at one national account. Invaluable learnings from this pilot will position us better serve these customers' needs in the future with outstanding value propositions focused on providing cleaner, safer and healthier business environments.
Apart from broadening our customer base and leveraging adjacent spaces in growth-oriented markets providing strong recurring revenue potential, we can significantly benefit from synergies driven by commercial and national accounts management capabilities and improved operational management talent.
Our business strategy focused on enhancing our pest control, restoration and cleaning businesses as well as other high-growth areas of a broader commercial and business service sector is something we will share in more detail at our Investor Day next month. I will now turn the call over to Tony, who will cover our third quarter 2018 results in more detail. Tony?
Thanks, Nik, and good morning, everyone. Turning to Slide 8, Terminix and FSG revenue grew $46 million or 10% compared to the prior year. Organic growth in residential pest control, as Nik previously mentioned, was 7.8% and ServiceMaster Clean national accounts revenue grew organically 15%. Additionally, our 2018 acquisitions are showing solid revenue growth, highlighted by 6% growth in Copesan. Adjusted EBITDA increased by $1 million year-over-year. EBITDA was positively impacted by a $4 million reduction in automobile, general and workers' compensation liability claims trends driven by improved claims management processes. The favorable impact of these reserve reduction was recorded in Corporate. Earnings also reflect continued investment in sales and marketing at Terminix to drive growth and lower royalty fees at ServiceMaster Restore driven by a reduction in large weather events year-over-year.
Turning to Slide 9, I will discuss Terminix starting with the revenue growth by channel. As Jesse mentioned previously, we have broken out organic and acquisition revenue by channel this quarter to better align with how management views the business. Starting with the Termite and All Other column on the left side of the chart, termite completions, which includes new termite sales and related services were up 5% as new unit sales were particularly strong during the quarter. Approximately 50% of this $76 million in termite completions is related to core termite sales, which were up 6% year-over-year.
Termite renewals were down $5 million or 6% in the third quarter. It is important to remember that we are cycling an initiative to upgrade bait station monitoring devices for a subset of our customers that caused approximately half of the decrease this quarter. We are addressing how we can more rapidly improve growth at our termite segment, including looking at enhanced preventative termite offerings as well as driving higher retention by continuing to upgrade the customer experience. The $22 million in other revenue for the quarter is comprised of revenue from product sales as well as royalty fees of $94 million of franchise revenue earned during the quarter. The $94 million in franchise-level revenue is up over 3% from the same quarter in the previous year. In total, termite and other revenue was down 1% year-over-year, mostly due to lower termite renewals. When adjusted for the previously mentioned bait station monitoring device upgrades, termite would have increased 0.5% versus prior year. Residential pest control services were up 11% in the third quarter over prior year, including 7.8% organically, driven by the previously discussed operational improvements in new sales start and route completion rates as well as strong new unit sales for the quarter, which were up 17% year-over-year. Included in the residential pest control our mosquito services, which saw another strong quarter performance up 24% in the third quarter and 19% year-to-date. Mosquito is still relatively small base of business but sales have been strong, and we see this as a growth avenue going forward. I would also note that the quarter included a tailwind of approximately $4 million in revenue from 53 branches that were closed for portions of Q3 in 2017 due to the hurricanes, which predominantly impacted residential pest control revenue. Commercial pest control revenue of $90 million was up 37% versus prior year, driven by the acquisition revenue predominantly from Copesan which increased 6% year-over-year. All of our recent acquisitions continue to perform well after being acquired and are growing faster than the base business. There is tremendous opportunity to leverage the talents and service capabilities of all of these acquisitions as we move forward and execute on our plan to grow the commercial business. Overall Terminix revenue grew over 10% in the quarter, including 2.6% organically. When adjusted for the previously mentioned hurricane impact and bait station monitoring conversions, organic revenue growth would have been 2.3% for the quarter. We still have considerable work to do to improve customer service levels that will ultimately increase retention rates, but we are encouraged by our progress, especially as it relates to residential pest control. The transformation is far from complete, but we are confident we are on the right path for long-term sustainable growth.
Turning to Slide 10. Adjusted EBITDA for the third quarter decreased $2 million or 3% to $80 million. We again were able to drive $4 million of business productivity, including $2 million in bad debt expense reductions and $2 million of sourcing savings in our chemicals and materials spec. We also saw $4 million increase in production labor resulting from higher technician incentive pay due to more work orders than anticipated in the quarter driven in part by initiatives to increase route completion, higher sales and improved sales start rates. Although selling and marketing expenses were up $6 million year-over-year, we continue to see strong returns in our increased investment in marketing spend as proven by increased new sales and lease in the third quarter. We are also optimizing the way we utilize our marketing dollars by enhancing our strategic advertising partnerships and investing in search engine optimization and reenergizing our field sales teams. We will continue to make these marketing investments as long as they deliver substantial growth.
Slide 11 shows the third quarter performance of FSG. Revenue increased by $5 million year-over-year or 9%. The increase was driven organically by $2 million of higher janitorial national account revenue offset by $1 million less disaster royalty fees due to the cycling of Hurricane Harvey and Irma in the prior year. Revenue also increased by $4 million related to the adoption of a new accounting rule regarding revenue recognition that took effect on January 1. As we discussed in the previous quarters, we now record franchisee contributions to the national advertising fund as revenue rather than as the reduction in advertising expense. This accounting change has no impact on EBITDA and is simply a reclassification of how we report franchisee contributions to the national advertising fund. We expect the fourth quarter revenue impact from this accounting rule change to be approximately $3 million with no impact to EBITDA. Excluding the impact of prior hurricanes and the accounting rule change, revenue would have increased by approximately 4% in the quarter.
Third quarter adjusted EBITDA was down $1 million or 3% versus prior year due to the previously mentioned cycling of hurricanes in 2017. Excluding the impact of the hurricanes, adjusted EBITDA would have increased $0.5 million or 2% versus prior year. At FSG, we are exploring opportunities in related and adjacent spaces and as Nik discussed earlier, we will continue to expand our presence in national accounts.
The full year 2018 updated outlook is shown on Slide 12. We now expect revenue to range between $1.885 billion and $1.9 billion for the full year. The $10 million increase in guidance at the midpoint is related to improved growth of our acquisitions, primarily Copesan. Our revenue guidance continues to assume Terminix achieves organic revenue growth between 1% and 2% and mid-single digit organic growth at FSG.
The adjusted EBITDA guidance remains in the range of $425 million to $435 million or approximately 23% margins. We expect Terminix margins to stay relatively flat, excluding the impact of acquisitions and approximately $4 million of dissynergies. FSG-adjusted EBITDA will continue to be impacted by the cycling of large weather events into the fourth quarter. Given our new debt structure after completion of the spin-off, the annualized run rate for interest expense will now be between $90 million and $100 million. I will now turn it back to Nik for closing remarks
Thanks, Tony. Overall, we feel good and our team should feel proud, proud over the progress that we are making. Terminix' organic growth rate is improving through focused investments in marketing and improvements in field operations. Our acquisitions have added talent and capabilities and expanded reach for our businesses. And we are seeing nice growth in national accounts, both in pest control and ServiceMaster Clean. We have a lot more work to do and systematic investments to make in improving our customer experience, which will enhance customer retention and improve our organic growth. This is an exciting journey. But to make it sustainable in the long run, we must continue to pursue it with passion, deliver consistently exceptional customer experience and execute flawlessly when we knock on 50,000 doors every single day. I will now turn the call back over to Jesse to lead us through a Q&A session.
Thanks, Nik. [Operator Instructions]. Lt's open up the line for questions.
[Operator Instructions]. Our first question comes from the line of Ian Zaffino with Oppenheimer & Company.
First question would be on the retention levels. I didn't hear you guys mentioning retention level. I know you talked about NPS scores, but are you seeing now the NPS growth trends leading to better retention or are there any numbers you could give us around it?
As you've seen, we've made some great strides in our residential pest efforts where we started the focus of our transformation, and we are in the -- we've already begun the journey on the commercial side pest and also for termites. We have started to see -- this is the third quarter in a row we've seen an improvement in our NPS scores about 11% in pests and 14% in termite. We have yet to see a meaningful translation of that in retentions. And we understand it takes our lot more than just gaining customers to continue to retain them and -- but we fully understand the issues that are faced there. And we are addressing it on two prongs: One is day-to-day continuous improvement identifying these issues. I mean, bear in mind, we are knocking on 50,000 doors on every single day and to -- we are working to translate that into an enriched customer experience.
So we've invested in the mobile digital technology, we're reinvesting in training, we are reinvesting in lot of things that really are fundamental to delivering the rich experience that our customers fully deserve and that entails us to keep them longer term. So while we're encouraged with the NPS scores, we still believe there is a lot of work for us to do to continue with the retention. And this is why I believe it's -- I've been saying very consistently, it's a slow and steady journey. It's a matter of investing in the right places in the business and I know one thing I should mention, it's also a lot of our talent and having the right management and the right branch level people to drive this change. The second prong we're looking at is transformational change. And as I mentioned in my earlier comments, that what we're looking is really breaking down into fine detail.
What goes on from the time a customer or a prospective customer calls us and through the whole service journey until we renew them for the next year, and we are completely questioning everything, like I said, the simple things like how we do we park the truck in front of the customer from a safety perspective, knock on the door or greet the customer, we're actually questioning the branch side and structure and the definitions behind it. We're starting to see some incredibly great learning opportunities from that and how we fall short sometimes from giving the customer what they deserve. So I think getting all that in order is what encourages me that as we continue on this journey we're going to see a big uptick in retention as we go forward. Because -- but for me if we want to deliver that sustainable growth, that is the fundamental is to start seeing the translational in retention.
Okay. And then I'm sorry, go on.
Yes, go ahead.
Okay. So the other question would be on Copesan keeping that branding out there. Is there anything we should read into that? Are we still on pace to roll that in-house on the same time line that you have originally laid out for us? And also does that mean now, you have more confidence in the commercial business that you want to make this a much bigger piece of your business or what can be read in sort of your original comments on Copesan?
Good question, Ian. Commercial is an extremely critical part of our equation. I believe in that very strongly. And as we are noticing with our acquisition of Copesan and the integration, the way we've orchestrated it, I mean, first thing to be clear, the Copesan business is 100% owned by us so the customer relationships are owned by us. We get the work outsourced today in most cases, but we are on track and -- as we've committed that within three years we would roll that back in and that still -- we're still committed to that. The key is to do it systematically so we are learning from the fantastic experience and the high NPS scores that Copesan garners and enjoy a high retention rates.
So how do you translate that into the Terminix branches is extremely crucial. There is a lot of work going on behind that. What we've done is rather than integrate Copesan into the Terminix national accounts, we've actually integrated the Terminix national accounts with Copesan. And the reason for the dual branding, Ian, is because what -- when we did the analytics, Copesan is focused on very specific verticals like food service and food specialty, whereas, you see Terminix commercial accounts are focused on different verticals like hospitality. So there wasn't much of an overlap, and we both customers we see that prefer the branding they've been used to and the kind of service they've been provided. So we will continue to go down that dual path. Now we have about a bit north of $100 million in national accounts, which is the third of our commercial business and this is something we're going to continue to heavily invest in. As Tony mentioned earlier, we are putting a mobile digital technology platform that we had invested even in commercial, and we will start seeing the enrichment of the experience our customers get. But we're doing similar things, learning a lot more from residential space and then bring it back. So there is 3-year plan to migrate the operations into Terminix as we continue to build further relationships.
Our next question comes from the line of Judah Sokel from JPMorgan.
Just the first question is a quick housekeeping question. I was wondering, if we could get the organic revenue growth rates for residential pest and commercial pest for last year just so that we can dimension -- the very appreciated disclosure that you guys started giving this quarter, and we can think about it on a year-over-year basis from last year.
So on the -- Judah on the Investor Day, we're going to give you all those trends going back to 2017. So obviously, we are pretty happy to see the 7.8% organic growth in residential pest and the overall 2.6% organic growth. But rather than itemizing out the prior years now, I prefer to do that during our Investor Day.
And needless to say Judah, the trend is upwards in both. We like I said the residential pest is something we started focusing on as soon as Matt Stevenson came on board and started the leadership of that business. We are seeing -- it's a lot of work that the team has put in, and we're starting to see traction and this was a great quarter for residential pest. And even if you back out the hurricane issues we had last year, we saw 5%-plus gain in the residential pest area, which is pretty encouraging.
Residential pest is up significantly. And I don't have the exact numbers of what they were in 2017 handy, but we'll give you that. And of course, the 2.6% is solid performance that we feel good about.
Got it, okay, great. And then just a second question on Copesan. Clearly commercial is a key part strategy and buying Copesan should facilitate accomplishing that strategy. My question is, because of the dimensions in vertical focus between Copesan and Terminix historical legacy commercial and also the difference in just national accounts versus, I guess, traditional commercial accounts, is there any risk as far as being able to part over some of those best practices from Copesan into Terminix's more traditional vertical and traditional commercial account?
Well, I don't see those as risks. I see those as opportunities where we can learn their quality assurance process, how they fully understand their customer's needs and translate those into systematic practices and performance. I mean, the ability for them to deliver a very well-defined standard and consistent experience to the customer is priceless. And this is why we are able to achieve significantly high NPS scores and a very high retention rate, which is something we are working systematically to put into our branch structures as we serve from a Terminix perspective as well. I mean, having Deni -- Deni was heading the national accounts combination anyway, but currently giving us her leadership for the broader commercial businesses is also helping that journey. I mean, I give Deni a lot of credit, but we also got to give credit to a lot of those leaders that are in that team that work tirelessly towards continuing to rebuild the business. And bear in mind, in the past Terminix was much heavier focused on its residential space without as much focus on commercial, and we have given it one of the high priorities. So it is going to be a major vector for us going forward.
Got it. So everything that may do well in the food vertical you think is very transferable to healthcare and property management and et cetera?
Absolutely.
Our next question comes from the line of Jamie Clement with BRG.
Nik, earlier this year, there was some concern in your industry that the tightening labor market might trigger a little bit of an uptick in technician churn, technician departures. And if that in turn might cause a little bit of an uptick in customer churns, that appears to have not happened to you. Do you think that's a function of changes in compensation structure, more reinvestment in training. Can you talk about the tighter labor market in general, and steps that you've taken and why that has not been a problem for you?
I mean, like any other industry and business, we have to be cognizant that these issues exist in our industry, and we have to watch these dynamics. The key is to be the best-in-class company, and we apart from improving pay structures, we are continuing to learn, first of all, learn how to listen to our technicians, make them a bigger part of the journey. We are giving them a lot of empowerment in making decisions in how they handle their customers, which has enriched the energy level. And we are seeing our attrition rates on technicians are pretty much in line with the industries. So we haven't seen that go up, Jamie or down. We are working on how to improve that because one thing we want to do is make sure that we're giving them not only the benefits and the ability to succeed when the company succeeds. So there is a win-win situation rewarding them, but we're also starting to hold them must more accountable for their performance, but also at the same time giving them the tools and all the training that they need to succeed, so that relationship is strengthening. And I think happier and more -- employees who are more engaged. I don't just use the word happiness, but for me engaging employees truly as part of the journey for success is what's helping us keep these employees even more engaged or more enthusiastic about delivering a better experience for our customers and thereby it will help us offset some of the industry trends. The other thing is bear in mind most of our labor is variable. So having them tied to and creating a structure that allows them to gain while the company gains is also a major incentive for them because they feel like they're part of delivering that success story.
Okay. And then thematically similar question on the sales force you've now entered seasonally a slower period of time. I think there was some discussion that there maybe some tweaks in sales force incentive comp and that sort of thing. How are you thinking of that process?
We are following the same disciplined process that we did with tax. So we've had quite a lot of face-to-face with the key salespeople, their managers. We worked with the teams, focused groups to help us redesign their pay restructure. And we are in the process of piloting those in the residential space right now. As I mentioned that we are going to wait till the peak season is over so it's timely right now, we're starting to rollout the pilots, and we expect to have those plans in place sometime early next year.
Our next question comes from the line of Tim Mulrooney with William Blair.
I'm am trying to gauge where we are in the reset in terms of decentralizing certain branch functions, investing in the technicians, investing in sales and marketing. Is it fair to say that we are close to level set in terms of an investment run rate and what you are planning to spend on the turn around or is there any reason we might see another step-up in investments in the coming quarters that may impact EBITDA margins?
As I kept mentioning, this is a little long-term journey, and we will do whatever it takes to get the company to sustainable growth rates and sustainable growth rates can only be achieved once we are able to get our retention rates to highly respectable and above industry marks. So we're going to continue to invest -- and this is a fact of whether you start your marathon at the start line or you are starting it behind the start line. So we are not going to be shy of investing in those, but as we've mentioned repeatedly, we will be very disciplined in our approach. So it's not like just throwing money at things, we are taking it very systematically, prioritizing, piloting things, testing things, ensuring that our people are completely engaged in any of the changes we make. So these become more sustainable because people believe that the frontline should believe that they're leading our transformation because we are actually listening to their feedback in how what their customers really feel and incorporating those in our changes.
So it is a long-term journey. I don't think we are anywhere close to the finish of it. And even once we get to the market growth rates, the question is, how do you continue to put in continuous improvement. This has always going to be a game of growth and productivity and our ability to continuously balance it. There are going to be times that we see something that is incredibly exciting that we need to invest in, it can give us some rapid pull, We will talk to investors about it in a timely manner before we trigger anything of that magnitude. But until then, it's going to be continuous, slow and steady grind. It's not a straight line. I wish it was, but it's not -- I promise you, it's not going to be. And -- but we have to take -- I mean, we have to make sure we don't repeat some of the mistakes we've made in the past and just become a company that is very cognizant of customer -- changing customer requirements, competitive dynamics. Our competitors are not static either. So we have to keep looking at that and then ensure that we keep our people just the most important asset. In fact, the product we really sell to our customers is our people. And we have to make sure that this is the most engaged and the most capable workforce that we put out there. And we reward them amply rather than just focusing on EBITDA -- temporary EBITDA improvements.
Okay. Got it, thanks for all the color, Nick, that's helpful on how you're thinking about the business. If I could shift gears for a second to the termite business. I was down in the PestWorld, I think that was a couple of weeks ago. Now, there was a lot of talk about termites in general. How do you guys think about the long-term growth in this market? I know pest is 4% to 5%, is that where termite is as well in your mind or should this be somewhat lower, given the higher competitive pressures on the switch to bait stations? And secondly, are there plenty of M&A targets or are you primarily focused on pest?
Great question. Let me if I were to say that in just a few words, termite growth definitely is lower than I would say pest, both residential and commercial pest would have going forward. However, it's still a great market. It's still a great market. It's still something we are pretty much a leader in. What we are doing is as we started the journey down the pest -- residential pest area, we have kicked off the journey in termites as well, so putting a lot of focus and better understanding. And we are looking in -- and we could share more on Investor Day of what we're looking at for going forward, and we are -- so we've been pretty good at curative markets, but we've not seen a lot of uptick in the market space for curative. And we are very strongly pushing on preventative products and solutions for our customers. And that's something we have to look at in terms of your peer product solutions. And its a still -- it may not be a high-growth rates as pest, but it's still a high-margin product. And as far as acquisitions go, we are going to continue to look for the best-in-class in terms of what kind of capabilities we can bolt-on to our existing businesses. I don't want to do acquisitions just to bolster our revenue, buying revenues is expensive. And I think what we need to do is look at what kind of synergies we can bring in, what kind of product capabilities, what kind of density. So we're going to continue to look at and be acquisitive in the market space when the right opportunities, we'll bring them on board.
Our next question comes from the line of Dan Dolev with Nomura.
We were very positively surprised by the 5% organic growth in residential. And my question is, kind of one, what was the main culprit for that step function from like flattish growth to 5%? 2, is that what should expect going forward? And three, how much of that came from kind of a Alterra running off, right? So if I remember correctly, Alterra was about $4 million drag in the third quarter of '17, so that's like another couple of points. I am just want to make sure that this 5% is real because it looks really good?
Well, the growth number was 7.8%, but you can say the real if you back out the hurricane affects and all closer to the 5% number, so that's a real. And Alterra even though it was a '16 to '17 comparison, you can't really say that '17 to '18, it has a positive or negative impact, it has no impact in my mind there. Some small bid of sale, but it's negligible, not we're talking about. So as far as the growth goes there were a few factors here, Dan, which are important to understand. So what we call start rates, so when we -- so when we have our marketing efforts, we get customers calling in. When we sign up a customer, if you can start that customer within 24 hours, that signifies -- that's a great relationship to start within the customer. In the past, we were not able to do that systematically. And Matt Stevenson, Augusto and his team they've done incredible job to improve that start rates.
So we improved that about, I think, 9 basis points -- 9 percentage points, where it's been -- we've been able to start those in less than 24 hours. So first of all we started the customer the right and we don't lose them because many of these times if you're not able to start within a few days, you actually lose the customer you just put a lot of money and effort to gain in the first place. So that's a good uptick. The second one is the completion rates. So we saw 240 basis point improvement in -- 290 basis points improvement in completion rates. Completion rates are -- we give the path to our technicians to complete a certain level of jobs, and the ability to finish all those tasks. So it's really not standing on customers for basic things, right? But we put a lot of effort in helping improving our routing scheduling, our tooling, our tools that we give to our technicians so they were able to do a lot better. Now, some of these, you kind of plateau after a while. You can get as close to 100% completion rates, and you don't have that lever anymore to the pull of. So that something -- but something was necessary because it's a fundamental. If you don't show up to your customer, you're going to lose them.
So this also will help us in the retention going forward. The key to the success if you want to continue at these rates, Dan, is just going to be how fast we can impact our retention. So believe -- for me, the #1 priority that is for our entire team, not only at Terminix, where we incorporate to support them, is getting that retention rate up. So we understand -- also we understand what we're falling short. We can't fix everything overnight. It's a step-by-step improvement that we have to continue to drive and sharp the system. But I'm pretty confident given the behavior this team has displayed, the marketing efforts that Matt Loos who works for Matt Stephenson's group, his team has done a phenomenal job in better leveraging our marketing spend and dollars going forward. So we've seen a higher return on the spend. So all these things are just the foundation stones of building a better story and a more sustainable story for the future.
I appreciate it. So if you still think about following that such good results 5% would end up happening as people's models tend to kind of just flat line that growth, is that a fair assumption going forward?
I don't think so. I think you got a look at it like I said, completion rates. You got to look at a broader picture in terms of retention and new sales growth. I mean, we can pump the engine only so much on completion rates. Like I mentioned, you can take them closer to -- as close to 100%, and you don't have a year-over-year impact, but you still have -- you're capturing what you have to really drive that year-over-year or that level, we've got to get the retention rate space, I mean, I think, Tony had a comment to add as well on this.
I look at this as a full year rather than a quarter. And if you look at our full year guidance for organic growth, I think that's a better launching pad as we look forward to with what we can do next year and beyond. Again, slow, steady progress every year is what we are shooting for. Doing it the right way, building our recurring revenue base, improving through retention going forward. I think that's how we are really looking at this journey, and it's going to be variable from quarter to quarter a little bit. But there's a lot of factors like hurricanes and other things that really impact us. But we feel we're on a nice, strong -- slow steady space for getting there in the future.
Our next question comes from the line of Andy Wittmann with Baird.
So you touched a little bit earlier on the termite business but maybe I just trying to get a little bit more color out of you guys. The business has been showing better growth in the innovative services in this quarter again, the retention revenues were a little bit softer. You guys talked about kind of the tough comp on some liquid, I guess, last year's bait station programs that you ran. How much of the business headwinds on the renewal business is just driven by the fact that maybe you guys are still running off that kind of legacy business that you guys had, really good share with that liquid solution versus and then transition to bait versus just kind of what you said core service functionality?
Andy, I think, you're asking about the termite renewal portion of our segment performance. Well half of that was really the bait station change that we made it last year. When we change the monitoring bait stations. We had a one-time benefit in 2017, that obviously cycles in 2018. So that's about half of the client termite renewals. And I think that was roughly $2.4 million in total. So -- and as far as the -- I think, that's what you meant, right, the conversion to the bait station initiative.
I guess, I'm trying to get at is how much of a headwind is the fact that technology has moved towards baits rather than liquids maybe not just on the tough comps from last year, but how much a headwind is that to your overall termite business is I'm really trying to get at?
Got you. So look, back, I guess, it started in earnestly about 5 or 6 years ago. There was a conversion over to the bait stations versus the liquid treatment. And obviously, that's had some impact on us over the last 5 years. I think that impact for us is diminishing as time goes by. We're -- our new termite completions are mainly bait at this point in time. So I think yes, it had an impact for us, but I think we're recycling through that impact now. And our key going forward is really improving the retention through better customer service and may be more focused initiatives around the preventative side of termite treatment as opposed to the curative side. I think that's our approach going forward to kind of jump start our improvements in the termite area.
Andy, we've seen very coordinated approach and strategy that the team has put together. As I mentioned, our initial focus was residential pest where we had quite a month's head start on the residential pest side. We are using a lot of that learning obviously in the termite, but also there's some uniqueness to the termite story. So I'm pretty encouraged that as we keep putting these investments and the right training and the right customer experience levels buildup, we'll start seeing that, but the fundamental thing is also for us to really add a lot of spark to our preventative product strategy going forward. I will be sharing more of that. Matt will personally that at the Investor Day as well. So we can add more color to show exactly how we are planning 2019 and going forward.
Thanks for that. If I could just do a quick follow-up here just on cash flow since you haven't really talked about it. The results because of the spin you guys report the full cash flow from the quarter, but maybe we can do some math with the Frontdoor results from last night. But Tony, can you just talk about kind of how you evaluated your quarter on ServiceMaster's specific cash flow and how you saw that come in? How you're looking at the year and maybe more importantly on a normalized basis, how we should thinking about free cash flow out of this business, maybe as it relates to EBITDA or net income?
Yes, so obviously, the year-to-date results on cash flow are good. They do include American Home Shield for the first 9 months obviously as well too. Both businesses as we reported in the past have good dynamics for cash flow generation. Ours will continue in that vein going forward. So I think, that if you looked at our conversion on the termite -- on the ServiceMaster side, we're still going to be roughly in the 50% to 60% conversion to EBITDA to cash flow. That dynamic has been a pretty much hold going forward. Of course, we got some benefit this year. That will be on going from tax reform so a little bit better in that regard. So I think the same strong cash flow dynamics will hold forward on the ServiceMaster's side.
Our next question comes from the line of Michael Hoffman with Stifel.
This is actually Brian Butler on for Michael. Just on the Terminix business when you think about the trade-off between future organic growth and margins, how should we think about that the spending on the investments that you're making and the spending on sales, kind of going out further? Is that still a low single-digit growth and margins kind of flat or do they really -- we start to get to see some margin improvement as those sales -- the investments in sales kind of compound. I'm just trying to understand that kind of longer-term trend.
First off, I wouldn't call it a trade-off between long-term growth and investment. I think it's a precursor having the right investments, having the right structure to systematically build a growth rate at or above market is what our goal is and that has been and we've been continuously saying that. While we're not going to sit here and guide at this stage for what 2019 is going to look like, and we'll do that at the right time as we always do. It's needless to stay that we -- our prime focus as a company is going to be achieving those at or above market organic growth rates. And we will do -- we will continue to invest. But as we said earlier albeit very systematically in a disciplined approach, we'll take our highest priorities. We'll make sure we are fixing things like incredible talent, technology upgrades that help us. And bear in mind, a lot of these things when you try to bring down the people, when you have the right level of technology, better engagement with customers, these not only help your sales growth by retaining customers with a better experience, these also in a way help improve elimination of waste in our system and improving our EBITDA. The key is are we going to continue to reinvest that. And I think until we get to sustainable market growth rates, we're not going to take the foot off pedal on that, but we're going to be disciplined.
Right. The investments we're making this year benefit future years, and it is critical that we build up the recurring customer base and organic growth is going to continue to be the prime priority for us in this transition -- transformation. But we are certainly focused on productivity as well. We will continue that. More to come on this when we get our 2019 guidance out there, but I think that is where we're at right now.
Okay. And then 1 quick one on the balance sheet. Can you give a little color on what the split is between fixed versus variable and kind of what that target might be post monetization of the FTDR shares?
I didn't understand the question, I'm sorry?
I was just looking at how much is fixed versus variable debt and then what that might actually look like once you pay down additional debt once you sell the shares in Frontdoor?
Okay. I didn't realize your term about debt. Okay, it had to be 100% fixed.
Our next question comes from the line of Paul Fanelli with G Research.
So you called out high rate of new starts. And I just wanted to get -- see if you could give any color around how long those starts will take to achieve sort of run rate levels of profitability and what the pacing on that looks like?
Let me probably explain to you the concept because -- pardon me, maybe I didn't understand the question correctly. I mean, start rates are -- so we're continuously everyday marketing our brand and marketing our service to our customers through various channels. And when we get these incoming leads and we sign them up, there is a lag between the time we sign them up and our technician can show up at the doorstep. Our target is to achieve that within 24 hours in every case. And we've not been very successful in the past in many cases. And what happens is, you end up actually losing those customers because they need the service -- they need instant gratification and we're not able to provide that. So we have significantly improved that in this quarter, but that's journey. We still have some room to improve. But once we get to a certain level, that's you kind of -- you can't get a year-over-year click on that.
Plus, we have other things that we need to do in this transformation to get to solid organic growth rates. We're going to be really concentrated going forward on what can we do specifically on retention. How can we make a bigger, faster dent in that particular metric, because that's the key, I think, going forward.
Okay. I guess, Just -- the way I'm thinking about is that the first time you make a stop when you make that first start is going to be -- it's going to cost more than the sixth visit that you make. And I was just trying to get a sense of how long that ramp takes to become more profitable?
I think maybe perhaps what you are asking is when do we get start seeing margin improvements. Is that what you really are asking?
Yes, that's right, that's right.
Right now, we're in a transformation. We're taking focused investments to improve our organic growth. We're really focusing on building that recurring customer base up. A lot of the expenditures we're making this year is going to benefit future years. At some point, we're going to get the operating leverage from that growth as we realize it in the future and at that point our long-term incremental margins will kick back in. That's kind of how we look at it. Right now, we're more or less in it and that's been more to improve our service offering.
And bear in mind, we are delivering reasonable best-in-class margins at this stage as well if you compare to the rest of the industry. And we're not -- what we don't want to do is repeat the mistakes of the past as to just raise the margin rates as we are bound and sacrifice our service levels, our branch contents or engagement of our people to just artificially drive those up. We have to do that very systematically. So this is a story to redo some of the things that we did invest in, in the last few years, and we have to systematically invest in that before we starting it. As I have mentioned, the day we feel like we're getting to those -- and you will see the growth rates because a great quarter in my mind is a great step forward for us. But if you look at when we get to those at-market to above-market growth rates in a sustainable way, then as Tony mentioned, we'll returning back to those 30% to 35% type incremental margins.
Okay. Thanks, and then just 1 quick follow-up. I didn't hear you guys talked about pricing at all. Can you just maybe give a little bit detail on how you're thinking about, maybe offsetting some of the inflationary -- some of the inflation in the market and how that's come through and you sort of -- in pricing?
Yes. I mean, our pricing results are pretty much in line with what they've been in those quarter, maybe perhaps a tad bit lower this quarter, but still pretty solid. In this business, you can get a reasonable amount of price, and we continue on that focus every quarter.
All right, that will do it for today's call. Thank you, again, for your participation. 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 later at our Investor Day on December 11 in New York City. Thank you.
Thank you. Ladies and gentlemen, that does conclude the conference call for today. We thank you for your participation, and ask that you please disconnect your lines.