Serve Robotics Inc
NASDAQ:SERV
If you don’t study any companies, you have the same success buying stocks as you do in a poker game if you bet without looking at your cards.
Utilize notes to systematically review your investment decisions. By reflecting on past outcomes, you can discern effective strategies and identify those that underperformed. This continuous feedback loop enables you to adapt and refine your approach, optimizing for future success.
Each note serves as a learning point, offering insights into your decision-making processes. Over time, you'll accumulate a personalized database of knowledge, enhancing your ability to make informed decisions quickly and effectively.
With a comprehensive record of your investment history at your fingertips, you can compare current opportunities against past experiences. This not only bolsters your confidence but also ensures that each decision is grounded in a well-documented rationale.
Do you really want to delete this note?
This action cannot be undone.
| 52 Week Range |
1.82
25
|
| Price Target |
|
We'll email you a reminder when the closing price reaches USD.
Choose the stock you wish to monitor with a price alert.
This alert will be permanently deleted.
Serve Robotics Inc
You don't have any saved screeners yet
Ladies and gentlemen, welcome to ServiceMaster’s Third Quarter 2019 Earnings Call. Today’s call is being recorded and broadcast on the internet. Beginning today’s call is Jesse Jenkins, ServiceMaster’s Vice President of Investor Relations and Treasurer.
I will now turn the call over to Mr. Jenkins, who will introduce the other speakers on the call.
Thank you, Searcy. Good morning and welcome to our third quarter 2019 earnings conference call. Before we begin, I’d like to remind you that throughout today’s call, management may make forward-looking statements to assist you in understanding the company’s strategies and operating performance.
As stated on Slide 2, all forward-looking statements are subject to the forward-looking statement legends contained in our public filings with the SEC. 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 5th, 2019. The company undertakes no obligation to update any information discussed on today’s call. This morning ServiceMaster issued a press release filed with the SEC on Form 8-K, highlighting our third quarter 2019 financial results. The press release and the related presentation can be found on the investor relations section of our website at servicemaster.com.
We will reference certain non-GAAP financial measures throughout today’s call and we have included definitions of these terms in our press release. We’ve also included reconciliations of these non-GAAP financial measures to the most comparable GAAP financial measures in our press release in the appendix of this presentation in order to better assist you in understanding our financial performance. All references on the call to EBITDA or to adjusted EBITDA is defined in our press release.
Joining me on today’s call are ServiceMaster’s Chief Executive Officer, Nik Varty; and Chief Financial Officer, Tony DiLucente. Slide 3 of the presentation posted on the investor relations section of our website shows the agenda we will cover today.
I’ll now turn the call over to ServiceMaster’s CEO, Nik Varty. Nick?
Thanks, Jesse and thank you all for your time today. I will start with the Q3 performance highlights on Slide 4. As we have shared with you over prior quarters, we are under determined journey to become the best and most customer-centric pest control, home and commercial services company in our industry.
We understood that there will be challenges and some ups and downs as we make progress on this journey. We had to upgrade our people and much of our capabilities and investments needed to be made ahead of the profits that to come from these investments.
We have also been focused on effectively managing legacy risks and issues such as termite damage claims and fumigation services. Despite these issues, we are convinced that we continue to make significant progress on our journey.
My team and I are absolutely committed to do what is needed to return our company to market leading growth with sustainable margin improvements. We are determined to do this in a smart, deliberate and focused manner, and to do it the right way to sustain these improvements. We will continue to focus on and prioritize our core business until we reach our goals.
We will also aggressively and thoroughly address these hurdles quickly and decisively, both management issues and legacy issues. There will certainly be other setbacks along this journey. But we are improving visibility and management focus across all of our businesses that will allow us to address future issues in a faster and more efficient manner, providing increased performance consistency to our shareholders.
ServiceMaster delivered 7% revenue growth in the third quarter as we continue to make progress on our strategic initiatives. Organic growth at Terminix was 2%, despite the comparison against strong prior year organic growth rates, driven by improvements in stock rates and completion rates.
Acquisitions in Terminix accounted for 5% of the revenue growth in the quarter, as we strategically added tuck-ins in the residential business, and through the continued strong performance of Assured Environments and our urban strategy in New York City.
ServiceMaster Brands also had a strong quarter, posting 5% revenue growth as initiatives to grow commercial and national accounts, and healthcare cleaning and disinfection gained traction. We remain focused on reimagining the customer experience in Terminix to drive better service levels.
NPS scores in the Terminix business are up across all of our service lines to the hard work of our customer-facing technicians to improve our service delivery. These improvements lowered daily cancel rates and increased retention, excluding the impact of termite renewals in the Mobile, Alabama region.
Terminix Commercial continues to build on a strong foundation of quality assurance processes leveraged from Copesan to drive retention improvements of over 300 basis points versus prior year. Initiatives focused on consistent customer communications, quality audits and engaging with the customer during on-time appointments are driving better customer satisfaction that is translating to organic growth.
Greg Rutherford and his team have done a tremendous job in a very short time in setting the business on a growth trajectory. Through investments in the sales team, including a new VP of Sales, we can drive new customers at a higher pace into our improved service delivery network.
Terminix Commercial also recently added significant capabilities and talent to the recent acquisitions of two Copesan partners, McCloud Services and Gregory Pest Control, each add unique capabilities in high-value verticals that will add to the depth of our commercial business.
The leaders and technicians we added share our common culture of serving our customers, caring for our people and delivering results and they will be a valuable addition to the team. And finally, we are closing on refinancing of our Term Loan book today, that will allow us to take advantage of a strong debt market to improve our interest rates and extend our debt maturities into the future.
Turning to Slide 5, our value creation strategy focuses on three priorities. First, we are fully committed to continuing our progress on building the core of our strong businesses, which have high brand awareness and large segmented and growing markets. While we continue to make progress, our Q3 EBITDA performance is the reminder that we still have more work to do.
We also are continuing to expand our addressable markets through new geographies, innovative products and expanded service offerings. M&A remains a vital part of our longer-term strategy. Underlying and supporting all of these initiatives, is the critical progress we are making to reimagine the customer experience. Better service levels are the basis of our company mission, where we start with serving our customers.
We are making progress on a customer-first culture change that will realign every person in the organization to think about how we are making things cleaner, healthier and safer for all of our customers. Culture changes take time, and there are many milestones along the way. But we are prioritizing this important aspect of our strategy and beginning to show meaningful results that are gaining traction.
Turning to Slide 6, I would like to highlight the progress we are making on improving our service levels and what we are building to take this even further into the future. In Residential Pest, continued execution on the basics of customer service are driving improvements in the base business.
Continued progress on our initiatives to never miss an appointment, speaking with customers before and after every service visit, and improvement of our service delivery and effectiveness have helped drive a 3% year-over-year improvement in both daily cancellation rate and NPS scores in the quarter. We still have a long way to go to achieve our goal of best-in-class service levels and delivery. But it is nice to see continued progress in these areas.
Commercial Pest continues to show dramatic year-over-year improvements as well. We are communicating more consistently with our customers and striving for on-time delivery of service and best-in-class responsiveness. Our initiatives are being well received by our customers as evidenced by NPS ratings at a 4% higher score year-over-year. These improvements are translating quickly to customer retention. As again, trailing 12-month retention is up over 300 basis points from a low base with the prior year.
Despite the recent challenges in our termite business in the Mobile, Alabama region, the remainder of our termite business continues to grow. Excluding this region, our daily cancel rates have improved 6% year-over-year. Our NPS scores driven by customer service and quality actions we’re taking have improved 2% year-over-year.
Through a clean sheet initiative, a completely revamped service delivery model has been developed that focuses on improving process capabilities at every customer touchpoint. This ultimately will provide a much better customer experience and improve termite protection.
The findings from this initiative and the completed validations are being used as the basis for our Salesforce implementation. Labor efficiencies, improved customer and employee retention and digitized workflow are a few of the many benefits that will come from the Salesforce initiatives.
One particular area of importance to us, that we will be monitoring closely in the pilot branches In Arizona are improved documentation capabilities. A vital aspect of our service is the ability to document the work performed. With Salesforce all the information on prior services, customer signatures and chemical applications will be digitized and at the fingertips of everyone across our company.
Turning to Slide 7, Terminix has long enjoyed a leading market position in the termite business. A key part of the value proposition to our customers is the best-in-class warranty against damages, which has allowed us to build that position.
The profitability levels of the business have historically included spending approximately 4% to 4.5% of termite revenue annually in the settlement of these termite damage claims nationally. And the base of our business outside of the Mobile, Alabama area continues to operate at these historical levels. Most of these claims are handled directly with the customer and involve relatively minor repairs, but a few occasionally involved litigation and the payment of damages.
In the past few years, we have seen an increase in the number and average cost of termite damage claims in the Mobile, Alabama area related to Formosan termite activity. We also have seen an increase in the number of termite damage claims in that region that involves litigation.
These two trends have increased our termite damage claim costs as a percentage of termite revenue between 7% and 8%. Given the increased volume we have seen, we expect additional cost increases in 2020 before our mitigating actions only take effect, and we begin to gradually return them to historical norms.
I’d like to reiterate that the cost increases above the historical trend are attributed almost exclusively to Formosan termite activity in the Mobile, Alabama area. We are not seeing trends of this kind in any other geography, even those with Formosan termite activity. We have been focused on managing damage claims since January of 2018 and the mitigating actions we are taking are showing positive signs.
Consistent with our larger business initiatives, we began with improvements across the board in our customer service levels. This includes better training of our technicians on application of chemicals, and a rigorous new customer inspection process.
At the beginning of 2019, we began a pricing initiative in the Mobile, Alabama area to better align the cost we change – we charge for termite customers with the actual cost we incur to provide services in the area. We anticipated some customer reductions as a result of the pricing change, but they have accelerated faster than we originally projected, and as a result are impacting termite renewal revenue and profitability in the short-term. As these customers renew their contracts, we conduct a detailed inspection and when necessary, retreat their properties.
We have added a dedicated quality assurance team that is solely devoted to these inspections and retreatments. Another key initiative was to increase awareness of these issues in the area and train technicians more effectively on inspection methods to identify and document aspects of Formosan termite activity that are different from subterranean termites.
The inspection and documentation process is vital to ensure we set customer expectations regarding property damage, that may predate our treatment and conducive conditions that may limit our treatments’ effectiveness. Another action we have taken is to improve our claims management process through a third-party administrator. This administrator helps us settle any new claims that may arise at a faster pace than our historical norms.
In the long run, we believe these actions will help us return what historical damage claim norms. However, as we actively inspect properties, retreat at risk properties and resolve claims faster than our historical base, they are impacting us negatively in the short-term.
Our termite services work effectively on Formosan termites, and we have a list of initiatives we have been driving to limit our legacy risk exposure. Unfortunately, this issue will take us time to fully resolve, but the mitigating actions we are taking are aimed at returning us to our normal profit levels in termite over time. The termite business remains attractive with strong value propositions to our end customers and strong profitability.
Turning to Slide 8, I will touch on the difficulties we have had in our outsourcing of fumigation services and what we are doing to resolve that. In order to resolve potential legacy risks related to fumigation operations, the company outsource completion services to a third-party provider. This common industry arrangement allowed the company to maintain its position with customers as a full service pest control provider.
In our attempt to rapidly address these risks, we experienced execution missteps which resulted in a higher than expected outsourcing costs which impacted our bottom line. We are implementing the correction plan to improve performance to better subcontractor management, and negotiation of better pricing with our service providers to ensure that the business have attractive economics going forward.
And before I turn it over to Tony to go over the financials, I will briefly touch on the European market expansion strategy on Slide 9. Our Nomor acquisition will contribute approximately $60 million in revenue and $14 million of EBITDA and strategically position us as the number four player in the European pest market, which is the second largest pest market in the world.
Europe is a roughly $3.8 billion market growing faster than GDP that exhibits many of the same attractive dynamics for the US market. It’s a highly fragmented market with the top four providers, accounting for less than 50% of the market, and the remaining portion consisting of approximately 8,000 businesses. We have an opportunity to expand on our global account presence into Europe to existing relationships we have in place at Terminix Commercial and Copesan.
Svein Olav Stolen and his highly experienced team know the market and the underlying dynamics, and have a history of both organic and inorganic growth in the European pest industry. We plan to work from the strong foothold we have in the Nordics to expand our presence over time into the broader EU.
In addition, we acquired a smaller global accounts focused business in the UK to help us build foundational capabilities to serve Europe-based global accounts. It was very important for us to separate the management and reporting of these businesses so as not to slow down the progress we’re making in the transformation of Terminix.
Dion Persson will take ownership of the European operations and help Svein and his team worked an independent group strategy in the region. There will be more to come, but I’m excited about the attractive opportunities in front of us.
And with that, I will turn it over to Tony.
Thanks, Nik and good morning everyone. Turning to Slide 10, let’s start with the Q3 consolidated financial summary. Revenue grew $32 million or 7% to $528 million. Terminix grew organically $9 million or 2%, excluding $3 million of year-over-year revenue decline from the previously discussed divested fumigation services lines.
Revenue from acquired businesses at Terminix added $20 million or 5% growth in the quarter, predominantly through tuck-in acquisitions in Residential Pest and the Assured Environments acquisition in Commercial Pest. ServiceMaster Brands added $3 million or 5% in the quarter, including strong growth in key focus areas of the business, commercial and national accounts and healthcare cleaning.
We also saw approximately $4 million in revenue in the period from the September 6th acquisition of Nomor Holding AB in Sweden and Norway. As a reminder, Nomor will be reported in the corporate and other operations area of our financials to allow clear visibility at the base Terminix business and better align with the management structure of the business.
Excluding the $11 million in the prior period for historically allocated American Home Shield costs, EBITDA in Q3 would have been down $9 million year-over-year. EBITDA was lower in the period primarily due to increased investments in the Terminix business, low revenue flow through due to termite renewals, the fumigation issues previously described by Nik and increases in termite damage claims.
Turning the Slide 11, I’ll discuss the Terminix revenue growth by channel. Overall Terminix delivered revenue growth in all channels, starting with the Termite & Home Services column on the left side of the chart, revenue increased 3% in the quarter, 2% of which was organic. Termite renewals were down $1 million or 1% in the quarter, predominantly due to higher than expected customer cancellations in the Mobile, Alabama area of the country. We expect this trend to continue into the fourth quarter.
These termite renewals convert EBITDA at a higher level and I’ll discuss the impact of this in the next slide. In the fourth quarter, we will be lapping a $2 million one-time acceleration of revenue related to an accounting methods change for a bundled pest and termite services offering that we made in order to comply with new revenue recognition standards. We currently expect to see a decline in termite renewals in the fourth quarter due to both of these issues.
Termite Completions & Home Services were up 8% in the quarter, including 6% organically based on pricing realization and unit growth in both core Termite & Home Services driven by accelerated marketing spend in the quarter, approximately 47% of the $71 million in termite completions is related to the core termite sales, which were up 4% year-over-year.
Home Services completions, which include attic installation, wildlife exclusion and crawl space encapsulation represent 53% of the revenue in this category and were up 10%. The strong performance in termite completions coupled with our improved customer service levels sets us up for renewal growth in 2020.
Residential Pest Control services were up 6% in the third quarter of the prior year, including 2% organically. Organic growth in Residential Pest Control was driven by price realization in the quarter and improvements in daily cancellation rates. This growth came despite lapping a strong prior year organic growth quarter driven by one-time accelerations of start and completion rates that are difficult to meaningfully improve beyond certain levels.
Commercial Pest Control revenue is up 30% versus prior year, including 1% organically. Organic growth in Commercial Pest was driven by the 300 basis point improvement in retention rates, offset by lower one-time sales, predominantly at bed bug services, which have been soft all year.
Acquisition revenue contributed the remaining 12% growth in the quarter, predominantly from the Assured Environments out of New York City. The new additions of McCloud and Gregory will ensure that acquisition revenue growth continues into 2020 as we grow our size and capabilities in Commercial Pest Control.
I would also like to note strong year-over-year growth of 8% or $2 million in our product sales business. We have seen strong results this year in products sales driven by a concerted effort to grow this channel. However, it’s important to note that these sales flow through to EBITDA at approximately 10% and have a much different profitability profile than our base Terminix businesses.
Overall, Terminix revenue grew 7% in the quarter, including 2% organically as we continued our focus on improving service levels and driving organic growth. We expect to see organic growth to Terminix between 2.5% and 3% for the full year. Just like the third quarter, we will be lapping start and completion rate improvements in Residential, as well as the $2 million accounting method change in termite renewals.
Turning to Slide 12, adjusted EBITDA for the third quarter decreased $9 million or 11% to $72 million, reflecting a margin of 15.7% below original company expectations. Working across the bridge on the bottom of the slide, you can see organic revenue growth at $6 million converted to $2 million in the quarter.
This includes the lower margin flow through the product sales, as well as the impact of lower termite renewals in the Mobile, Alabama area. This mix shift particularly as it relates to termite renewals was more severe than expected and factors into our [difficult] [ph] quarter.
As Nik discussed earlier, we had a $4 million in profitability erosion related to the execution of the outsourcing of fumigation services. The outsource cost of fumigation completions were higher than anticipated. Price increases attempting to recover the cost increase caused volumes to decline significantly.
This resulted in decreased volume and lower margins combining to drive this $4 million miss. We expect continued declines in the fourth quarter that have a focused action plan that will soften the margin declines and improve volumes as we headed into next year.
Acquired revenue growth of $20 million contributed $4 million to EBITDA or a margin of 20% in the quarter. Excluding our European pest acquisition, which is reported in corporate and other operations, we expect more than $25 million from acquisition revenue in the fourth quarter to contribute approximately 20% EBITDA margins.
We had $6 million of investment in growth and productivity in the quarter, including $2 million increased sales and marketing, which produced higher new units in core Termite & Home Services, $2 million in investments in our customer experience platform with Salesforce technology and $2 million to optimize our Commercial Pest business. This represents an increase from prior guidance, predominantly in marketing spend to drive new leads.
There was also $2 million in increased damage claims expense due to the increase Formosan termite activity in the Mobile, Alabama area in the country. Termite damage claims particularly claims that involve litigation are difficult to estimate at both size and timing, but currently we expect a year-over-year increase from damage claims of approximately $4 million in the fourth quarter.
Original estimates at termite damage claims expense improving the back half of the year through the mitigation actions we implemented in prior periods. These results were below our expectations for the quarter, with profitability impacted by revenue mix shift, in addition to the larger than expected effects of damage claims and fumigation outsourcing. As Nik has discussed, we are actively addressing these issues and we are confident we can return to the levels we are expecting in this business.
Let’s move to Slide 30 to talk about ServiceMaster Brands’ Q3 performance. ServiceMaster Brands delivered a strong quarter with revenue increases of 5% or $3 million to $63 million. The increase was driven by our initiatives to grow commercial and national accounts up again this quarter by 7%. We are also gaining traction on our expansion at healthcare cleaning and disinfection, which was up 13% on the year. In total, we saw a 3% growth in royalty revenue in the period, converting to EBITDA at a high margin.
Adjusted EBITDA was up $2 billion or 7% in the period, primarily due to the flow through of royalty revenue growth. The brand and the team continues to focus on improving its ability to support our franchisees through Centers of Excellence in key verticals and geographies, including healthcare and reconstruction. As we anticipate the fourth quarter, it is important to note that we will be lapping the benefits we received in 2018 from Hurricane Florence and Michael.
Moving to Slide 14, I’ll discuss our cash flow for the quarter. Free cash flow of $191 million year-to-date, improved $22 million or 30% year-over-year and free cash flow conversion improved over 300 basis points to 57%.
Reduced cash interest driven by debt reduction after the frontdoor share monetization and a reduction in property additions as we cycle construction related costs from the move of our global service center to Downtown Memphis were the primary drivers of the improvement.
Looking to the uses of our cash, you can see we continue to invest in strategic acquisitions and have spent $345 million year-to-date excluding both Gregory and McCloud that we closed in early October. We ended the period with $140 million of available cash.
Cash generation at 57% of adjusted EBITDA continues to be a strong story for the company. Our continued focus on working capital improvements and EBITDA conversion remained priorities for the businesses. We remain diligent in the use – uses of the generated capital ensuring all investments we make provide returns for investors and rates well in excess of our cost of capital.
Let’s move to Slide 15, to look at another way we are adding value through our recent refinancing. We will be closing on a debt refinancing that will enable us to take advantage of a very receptive debt market to refinance $441 million in secured debt with the new $600 million Term Loan B. This loan extends our maturity by approximately three years, while also lowering our interest rate by 75 basis points.
On the right side of the slide, you will see our capital structure post this refinancing. Our total net debt leverage ratio after the transaction is approximately 3.5 times. As we have long discussed, we have the cash flow and flexibility to extend our debt levels in a responsible manner for the right opportunities. That being said, we are still targeting a net debt level of between 2.5 and 3.0 times. After the refinancing, we expect the run rate of cash interest to be roughly equivalent to today, while reducing our blended interest rate to below 5%.
Looking ahead, we now expect total ServiceMaster revenue for the full year 2019 of between $2.070 billion and $2.085 billion or growth of 9% to 10%. The $25 million increase from previous guidance is primarily by acquisition contributions from our European pest operations as well as the recent McCloud and Gregory acquisitions in Commercial Pest. We now expect acquisition revenue of approximately $130 million for the year, including over $40 million in the fourth quarter.
Adjusted EBITDA is now expected between $415 million and $425 million for a ServiceMaster EBITDA margin of approximately 20%. The $20 million reduction from prior guidance includes approximately $10 million in damage claim expense from prior expectations. The previous damage claim expectation included year-over-year favorability from mitigation actions that are taking longer than expected to show results in the Mobile, Alabama area of the country.
It also includes a $10 million reduction from the combined impact of fumigation outsourcing execution issues and termite renewal reductions in Mobile, Alabama. We also spent an additional $5 million on growth initiatives, primarily additional marketing in Q3 that helped to accelerate new units in Termite completions & Home Services.
These increases were offset partially by approximately $5 million of EBITDA contribution from new acquisitions. And Terminix we expect organic growth rates for the full year between 2.5% to 3% when normalized for the impact of our fumigation divestiture. In the fourth quarter, we expect more than $25 million in revenue from acquisitions.
Adjusted EBITDA in Q4 is expected to be impacted by the previously discussed damage claims expense and fumigation services offset by conversion of continued organic and acquired revenue growth.
At ServiceMaster Brands, we expect mid single-digit growth and slight margin pressure as we grow EBITDA dollars by expanding our commercial cleaning national accounts business and driving active initiatives to generate value for our franchisees and customers. ServiceMaster Brands will also be lapping the area-wide hurricane weather events of Florence and Michael from the fourth quarter of 2018.
At corporate and other operations, we expect over $50 million in revenue from our European pest operations. We expect the full year effective tax rate to be between 21% and 23% given the tax regained from the monetization of our frontdoor shares.
That said, the Q4 effective tax rate is expected to range between 26% and 28% as the rates normalize post the monetization. And given the refinancing, we expect cash interest to be between $80 million and $90 million annually going forward.
And with that, I’ll turn it back over to Nik for final comments. Nick?
Thanks, Tony. We are fortunate to have an incredible pest business in a wonderful industry, with an outstanding brand, leadership position and strong customer relationships led by our devoted frontline associates. As we complete year two of a complete transformation of this business to address its underperformance, I remain encouraged and confident in our business fundamentals and in our ability to continue on our journey to build from the strong foundation we have developed over the past two years.
Over the last two years, we have improved our NPS scores and are starting to see consistent traction in our retention numbers as well highlighted by the recent rapid gains in our commercial business. We have added much needed commercial capabilities in high-value verticals to our targeted acquisitions. We have also made improvements in our field operations by focusing on the fundamentals, improving our safety records, on-time services, customer communication cadence, service and inspection protocols, as well as start and completion rates.
Even though we have accomplished a lot in the first two years of our transformation, a lot remains to be done. As we are reminded by our underperformance this quarter, we have identified and are rapidly addressing the three key items that caused this underperformance, which are legacy termite damage claims subpar execution of our outsourcing of our legacy residential fumigation business and a much lower conversion from our revenue mix, largely driven by lower termite renewals.
These items emphasize that we must and will focus on our – on improving our execution of both current and legacy initiatives and work towards setting and meeting achievable expectations with improved analytics and project management cadence.
Our underperformance this quarter also reinforces our need for commitment to our cultural transformation which we have started rolling out this year. We are focusing on improving our problem-solving project management and analytical capabilities. We are investing in a much needed Salesforce operating system, which will create a major upgrade in our industry – in our ability to serve our customers and make the jobs of our frontline easier.
We are working on a clean sheet initiative in our termite journey and are targeting 2020 for the role off. This frontline led transformation is a breakthrough opportunity that can differentiate our ability to serve our customers. These commitments will ensure that we will be positioned to drive continued and sustainable profitable growth and allow us to regain on profitable growth leadership in pest.
Let me also address our change in leadership in our Residential Pest business. Matt Stevenson was a strong contributor to the actions needed in the first two years of our transformation journey. His ability to focus on and drive improvements in our fundamentals was critical to turning the tide for this business and he was responsible for the early successes we have seen in return to organic growth and improving customer metrics.
As we move to the next phase of our transformation journey, we felt a change needed to be made as we looked at the items we now need to address, primarily sustainable operational excellence backed by a strong operating system. I remain confident in the progress we’re making on our journey and our ability to continue to drive sustainable and profitable growth and appreciate your support and patience as we continue on this challenging and rewarding transformation.
I will now turn the call back over to Jesse to lead us through a Q&A session.
Thanks, Nik. As a reminder, during the Q&A session, we encourage you to ask any questions that you may have. But please note that guidance is limited to the outlook we provided in our press release and webcast presentation. Additionally, since the queue is long this morning, please limit yourself to a single question so that we can get to everyone in the allotted time. Searcy, let’s open up the line for questions.
Thank you. [Operator Instructions] And our first question comes from Michael Hoffman of Stifel. Please go ahead.
One question, seemingly crickets that go like 20s. So I guess I’m going to focus on retention and I’m trying to figure out the messaging that retention not improved in residential, but it did in commercial. And if it didn’t improve, what are you doing to get it restarted to improve again?
Retention, Michael good morning. The retention improved across all our product lines in Residential Pest, in termite as well as in Commercial Pest. In Commercial Pest, we saw a significant improvement of 300 basis points, so as you know for quite a few years, this business was in decline and we’ve been supporting it with great talent being build up, carving it out as a separate business unit and bringing in some incredible capabilities with some of our partnerships with Copesan and some verticals that we’ve acquired since then like Assured.
On the Residential side, we did see improvements in termite, that were almost flattish, but positive if you exclude the losses we faced in the Mobile, Alabama area, which was a result of you know finally trying to match our pricing with a cost to serve in that area. But we do see continued improvement.
We’ve seen quite a substantial improvement over the last three quarters of retention on Residential Pest. And it’s, you know, like we said, we have to continue to work on sustainable practices so we’ve improved the underlying basics, much better on-time performance, better completion, we continue to maintain a high level of start rates, but we have to continue do you know do that 75,000 times a day that we knock on doors of all our customers.
Thank you. Our next question comes from Tim Mulrooney of William Blair. Please go ahead.
Good morning.
Good morning, Tim.
So if I only have one question, it’s this Nik. Why should investors have confidence that other cities outside of Mobile won’t also become more litigious?
That’s a good question, Tim. As we’ve seen with Formosan Termites Day is a possibility of them existing and we’ve seen them below the 35th north latitude in non-desert like conditions. But we’ve seen much more aggressive activity where the soil composition and certain conditions exist like the River Delta’s in Mobile, Alabama area and predominantly we’ve also seen in New Orleans. Now in New Orleans, we do not serve customers directly there. So that doesn’t impact us.
But we’ve seen the activity significantly in other areas Formosans doing exist. But over the years since we’ve seen the spike in claims in the Mobile, Alabama area, we have not seen any similar trend in other areas. As you know, since starting 2018, we have put significant improvements in service quality, in terms of documentation, in terms of inspection, training, retreatment, better inspection, so we don’t inherit pre-existing conditions.
And we also, you know are working directly with our customers to settle, you know, any of their issues directly with them rather than it becoming costly litigations in the future. But as I said, you know, we – first of all, I think, you know, we got to understand that we did offer – we do offer a differentiated warranty sort of – you know, offering which has allowed us to become the market leader in the past, because the primary, you know, concern for people is the value of the home.
Now, that – allowing that we’ve seen about 4% to 4.5% as a termite damage claim cost across the nation in you know, whether it’s Formosan termites or otherwise. And the increase is almost exclusively related to Formosan termite activities, as you know, being very invasive in that area. But we have not seen that trend at all in other areas at all so.
Thank you. Our next question comes from Toni Kaplan of Morgan Stanley. Please go ahead.
Hey, this is Jeff Goldstein on for Toni. I’m just going to follow-up on that last question, if I can. So just on this termite liability that is out there, could you help us understand what is the maximum liability you could face in terms of $1 figure?
So I know 2% of Formosan activities in the Mobile, Alabama area, but I think you just mentioned some other cities that like possibly be, and so just given like the litigation that’s out there and maybe theoretically if all the homes that were in the Mobile, Alabama area, filed some type of damage claims just in terms of $1 figure, how should investors be thinking about the liability that exists? Thanks.
Yeah, I think the best – this is Tony DiLucente. I think the best way to look at this is that across the country our termite damage claims expenses are running about 4% of revenue. They’re running higher in the Mobile, Alabama area, and that drove our percentage up to 7% to 7.5% this year.
The – it’s – it appears that this is really isolated to this one area for us, where we have these unique soil conditions, kind of close to a River Delta. We don’t see the exposure, you know, anywhere, you know, like this anywhere else at this time. It’s hard for us to predict with any certainty, you know what – what’s going to happen in the future, but that’s our best estimate right now.
And if you’ve seen the 7% to 7.5% kind of rate starting in 2000, early 2017 and there were discussions, you know, in Q1 of 2017 around this. So we pretty much been able to manage within that range. And, you know, we believe given the actions that we put in with the consistency and strength which we’ve been operating, you know, in those – in this area, we believe either at least in the future that we will be able to return to the historical norms as we see these things, you know, continue to be managed better.
Thank you. Our next question comes from Ian Zaffino of Oppenheimer. Please go ahead.
Hi, great. Thank you very much. You know I also wanted to ask on the termite damage claims side, you know, how are you thinking about price and retention levels and trying to match basically the pricing with the cost to serve? And then also basically, how do you think about pricing versus kind of cost mitigation as each other store kind of the termite damage claims to historical levels? Thanks.
Good morning, Ian. So as you know in this area since January of 2018, you know right after I was able to you know completely assess the situation and we’ve been putting some you know strong practices in place.
And we realized that in order to serve this particular area of the activity we had, we had to you know, use several methods such as much – more stringent inspection regimen, we had to retreat certain areas, we had to, you know, power down on what we call dual defend with depending on [indiscernible] in some houses.
So, we have to enhance the pricing in this area to match you know, with the cost to serve. And we’ve seen some, you know, we had kind of expected, but it was – we saw a much larger than expected decline in customers in this area.
So as customers continue to renew with us, we obviously do reinspections and retreats and you know, much, much more improved documentation as we go forward on these cases, but we’ve seen that at least we’re now pricing these in line with what we believe the cost of service and continue do, you know, match that and increase that as we see the service levels being increased.
Thank you. Our next question comes from Gary Bisbee, Bank of America Merrill Lynch. Please go ahead.
Thanks. Sadly I’ll continue on the same line of questioning. So I guess my question a little different though. You alluded to this, you know, continuing for a while, I think, Nik you said into 2020. Can you give us just a sense as to how you think this impacts next year what part of the cost? Is it just higher claims? Is it cleaning up all the litigation?
And as part of that also I’d like to understand how much revenue you expect you’re going to lose the bridge that you gave for the change in full year guidance lumped in renewal reductions and the fumigation. That’s not real helpful as a $10 million. Can you tell us how much is the revenue reduction? And how much was the fumigation? And really what matters to next year is what I’m getting at?
Yeah. Good morning, Gary. I’ll answer the first part of it and I let Tony, you know, give you the bridge answer on that one. As I mentioned earlier that, you know, we’ve seen across the country, our normal cost of doing business in termite is about 4% to 4.5% on different kinds of damage claims you know, that we based on a warranty that we serve, and we still see an incredible value proposition in this business, and highly profitable, you know, including that cost.
We’ve seen overall and that’s in ‘17 [ph], that that costs have gone up, you know, to 7% to 8%, right, 7% to 7.5% right now. And we’ve seen the volume increase from our mitigation actions, you know, so this issue is, we’ve seen – so we started working more directly with customers. So you know, that obviously resulted in some non-litigated claims. But for a claim that helps us better with a dialogue with the customers the need becoming expensive litigations in the future.
We are expecting, as we mentioned – as Tony mentioned earlier, this cost to go up slightly in the fourth quarter. And we see that continued, you know, marginal increase into 2020. So we believe it should be right around that range to slightly higher in 2020 as we – as our actions eventually start, you know, bearing fruit and reducing, you know, litigated claims, reducing even issues and claims we have with better documentation and better service as we go forward. That allowing us, you know, we believe that we can get back to the historical 4% to 4.5% range in the future.
Yeah and Gary, you bring up a good point. You know, obviously, the – this will have some impact in 2020. Our estimates are roughly, you know, $2 million in renewable revenue. But I think we have to stay focused on the fact that it’s important that we take into effect with the cost to serve is in these regions and adjust our pricing accordingly for that, and we’re you know, so for the long run, it’s definitely the right move, but it will have some impact in 2020.
Thank you. Our next question comes from Seth Weber, RBC Capital Markets. Please go ahead.
Hey, good morning guys. I kind of want to take another stab at this termite cost question. I think you said it was an incremental $2 million in the third quarter going and then it’s going to an $8 million incremental in the fourth quarter, which sounds like it is a $4 million swing year-over-year. But is there something in this fourth quarter number? Is there a kind of an accrual or is there some sort of big lump sum settlement or something? I’m just trying to understand why it’s such a big jump from 3Q to 4Q?
And then, you know, I think we’re all trying to understand really what the jumping off point into next year is going to be, is it this fourth quarter kind of run rate? If you could give us the full impact, I guess for ’19 maybe that would be a helpful number to have and then kind of use that as a starting point for ’20 you know, any additional color there? Thanks.
Yeah, this is Tony. I’ll take that one. So in Q3, termite damage claims were roughly $2 million higher year-over-year. If they’re going to be $4 million higher year-over-year in Q4, that brings you the $6 million.
The other $4 million relates to the fact that it was our expectation that we would actually have a reduction in termite damage costs in the year. We’ve seen higher volumes of non-litigated claims, which is – which in some ways is good for the long-term, because we’re aggressively working those in the right way.
And so that also is a little bit contributed to some high claims that we’re working on the litigated side. So that’s what really drove that $4 million. Why we didn’t realize that $4 million lower than expectation. So that’s the bridge to the $10 million.
Thank you. Our next question comes from Judah Sokel of JPMorgan. Please go ahead.
Hi, good morning. How are you?
Good morning, Judah.
Good morning. You referenced the fact that it can take years to fully settle the claims that come out of the termite practice, but the one in 3Q arising from a 2016 claim. So how long do you expect that to take until we’ve cycled through all potential claims from policies that were underwritten before you started your mitigating activities, your mitigating actions in 2018? Thanks.
Judah there were practices in place where, you know these teams were served well as you see you know, given the nature of the case, there are some homes that, you know, we haven’t sort of seen you know, materialized fully, but as these go by, there’s a lot of discussion but more and more as the settle non-litigated claims treat better and the legal part of this is really tougher time especially, you know, both in terms of timing and severity.
But the more our practices take, you know, more houses we inspect, more retreatments we do and the more we continue to settle these at reasonable with our customers on the non-litigated way, it continues to mitigate our future risk. So it’s difficult to predict but we believe you know, we are continuing to improve the future, you know, exposure within the limits.
Thank you. Our next question comes from Jamie Clement, Buckingham Research. Please go ahead.
Hi. Good morning, gentlemen. Just changing gears a little bit you know, it seems when you announce Nomor, you know, platform acquisition and obviously your longer-term leverage target is maybe a little less than where you are today. How high would you take leverage in the short run, the tax and businesses on to Nomor?
Yeah, thanks, Jamie. You know, like we said all along, our target is 2.5% to 3%, no doubt about that. We set for the right opportunity, we would – you know, we would go over that and you know, for a period of time and with our strong cash flow, eventually bring that back into the 2.5% to 3% range.
So how much higher would we go above the 3.5%? We don’t really have any plans right now to go any higher. And you know, obviously I think we’re, you know, we’re pretty comfortable going up to the 3.5%, but going any higher than that probably not in the short-term.
And Jamie, you know, we are pretty, you know, we generate significant cash not only from our base business, but also, we look at, you know, the targets that we bring in are pretty cash flow rich as well in terms of the kind of business we have.
We – and we’ve spent two years really building in line with our strategy where we wanted to boost our commercial business which drove the acquisitions of things like Copesan, Assured, Gregory and McCloud. We believe we’ve added not only revenue, which was not the primary reason for doing this, the primary reason was adding the much needed capabilities to become one of the strongest commercial business in the future.
And as we can see, that has benefited us significantly in terms of you know, continued improved retention rates and finally starting to see positive growth and, you know, stringing quarter-by-quarter positive numbers. We have you know, we’ve brought in a new VP of Sales in this business, we are you know, strengthening the sales function there to add and continue new sales you know, in addition to the retention that we’re driving.
So I'm – so these have paid the dividends, and I believe, you know, we’ve got some – a lot of the capabilities we actually needed. We don’t have anything, you know, sort of large in the future not in the horizon at this stage. But that doesn’t preclude us if opportunities come on play. We’ll continue to focus in the future on very, you know, smart tuck-in type opportunities that give us you know, strong density going forward. But these are maybe, you know, much smaller in size, larger numbers, that doesn’t really impact in a big way, how we look at our leverage ratios.
Thank you. Our next question comes from George Tong, Goldman Sachs. Please go ahead.
Hi, thanks. Good morning. I wanted to go back to the termite claims activity. You’ve previously indicated that visibility into claims can be somewhat limited. Can you discuss what initiatives you have to improve visibility into claims costs and provide more clarity into how you expect claims costs to basically go back to 4% of revenues from 7.5% to-date?
Yeah, the best way, George, we can – we address this as we, you know, the customers that we serve, we have gone back into the high risk areas, we continue to reinspect, we understand the situation a lot better, we continue to retreat as needed, we continue to have conversations with our customers.
And that’s how we – and one of the big things we’ve done is, you know, so handling the process in-house, we’ve engaged about a year ago, a little less than a year ago with a third-party administrator who has brought a lot of professional cadence and discipline in how we approach these customers and address you know, any open issues before they become, you know, a sizable by nature.
So it’s better to understand those treat builds on time and move forward. And that’s one of the reasons why it gives us confidence that you know – and we’ve seen some, you know, incredible results from the actions we’ve taken so that these things take time to materialize.
Thank you. Our next question comes from Andy Wittmann of Baird. Please go ahead.
Oh, great. I guess my question is for Tony and it’s actually focused on the third quarter a little bit more. I wanted to understand the EBITDA bridge, I guess it’s kind of based on Slide number 12. And specifically like a lot of the items that are listed in the page, you guys knew about when you gave your guidance for the year, you know, growth investments in particular the synergies are two of the larger buckets on this list. So and the fumigation kind of offsets the acquisition EBITDA impact.
So when I look at all of this and look at kind of how the quarter came in, it feels like there are other things in the quarter which negatively impacted EBITDA. And I was wondering if you could go through some of those factors that maybe were also in the EBITDA results for the quarter that maybe aren’t bridged here or could have been reasons for a little bit of the shortfall that we saw in the results?
Yeah, you know, that’s a good question. I think the you know, the one thing you know, that I wanted to mention was on the organic revenue conversion that’s a little bit lighter than we expected, mainly because we saw a different mix, you know, that we were expecting. We had a large increase in product sales and we had the, you know, the lower termite renewals that we’ve already talked about and given the, you know, the profitability of termite renewals, that is a very significant part of the other miss, I guess in the expectations.
Well mainly the termite – if you look at the renewals and the bulk of those are a huge majority of those were customers that we ended up losing in the Mobile, Alabama area, which is, you know, where we did not have those in the world. So in the short-term, it was much faster, more accelerated than we had expected. But, you know, in the long-term, this should be, you know, helping our cost as we continue to manage the situation.
Thank you. At this time, I’d like to turn the call back over to our host for any closing remarks.
Thank you again for your participation in today’s conference call and webcast. As a reminder, a replay of the call will be available on our website in about an hour from now. Thank you for your continued interest in our company.
That does conclude the conference call for today. We thank you for your participation and ask that you please disconnect your lines. Thank you and have a good day.