Serve Robotics Inc
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Serve Robotics Inc
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Ladies and gentlemen, welcome to ServiceMaster's Fourth Quarter and Full Year 2019 Earnings Call. Today's call is being recorded and broadcast on the Internet. Beginning today's call is Jesse Jenkins, ServiceMaster's Vice President of Investor Relations and Treasurer.
I will now turn it over to Mr. Jenkins, who will introduce the other speakers on the call.
Thank you, Frank. Good morning, and welcome. Before we begin, I'd like to remind you that throughout today's call, management may make forward-looking statements to assist you in understanding the company's strategies and operating performance. As stated on Slide 2, all forward-looking statements are subject to the forward-looking statement legends contained in our public filings with the Securities and Exchange Commission. These forward-looking statements are not guarantees of performance and are subject to the risk factors contained in our public filings that may cause actual results to vary materially from those contemplated in the forward-looking statements. Information discussed on today's call speaks only as of today, February 27, 2020. The company undertakes no obligation to update any information discussed on today's call.
This morning, ServiceMaster issued a press release filed with the SEC on Form 8-K, highlighting our 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 and the appendix of this presentation in order to better assist you in understanding our financial performance. All references on the call are to EBITDA – all references on the call to EBITDA are to adjusted EBITDA as defined in our press release.
Joining me on today's call are ServiceMaster's Chairman and Interim CEO, Naren Gursahaney; and our Chief Financial Officer, Tony DiLucente.
Slide 3 of the presentation posted on the Investor Relations section of our website shows the agenda we will cover today.
Before I turn it over to Naren, I would like to remind you, effective January 1, 2020, in conjunction with the strategic alternatives review of ServiceMaster Brands, all operating results of ServiceMaster Brands will move to discontinued operations. All forward-looking statements on today's call, including 2020 guidance, will focus on continuing operations.
I will now turn it over to Naren Gursahaney. Naren?
Thanks, Jesse, and thank you all for joining our call today. I'll start with Slide 4. Before I cover our financial results, I'd like to make a few comments on our decision to explore strategic alternatives for our ServiceMaster Brands business. As part of our annual strategic planning process, management completed a portfolio review of our businesses. This review included an assessment of the markets we compete in as well as the strategic plans developed for each of our businesses and the capital we had to deploy in support of these strategies. As a result of this review, management and the Board agreed that we should explore strategic alternatives, including a possible sale of our ServiceMaster Brands business.
We feel that we have two great businesses, each with exciting opportunities to deploy capital in order to grow the business and create value for our shareholders. In addition, based on other recent transactions in the markets where ServiceMaster Brands competes, we felt now was a good time to explore our options. Depending on the outcome of this process, we expect to be in a position whereby both businesses will be able to pursue the exciting opportunities they see in front of them. While we're still early in the process, we're very pleased with the enthusiastic response are seeing from potential suitors.
Moving on to our financial results. 2019 was another year of solid progress against our strategic priorities. Our focus on improving the fundamentals drove improvements in the customer experience, as reflected by increases in customer retention and Net Promoter Scores and declines in cancel rates across all of our business lines.
We delivered $2.077 billion of revenue, an increase of over 9% year-over-year, including 2.6% organic growth in Terminix. Organic growth accelerated over 2018 levels, and we met our increased 2019 guidance of 2.5% to 34%. We also delivered $417 million of adjusted EBITDA, with strong free cash flow generation of $216 million. In the fourth quarter of 2019, we strengthened our leadership team with the addition of Kim Scott to lead our Terminix residential business. Kim has extensive experience in industrial and service businesses and has built customer-centric teams wherever she has been. Her track record of executing safety and efficiency programs across large dispersed service network and employee base fits well with our strategic plan for the Terminix business.
Kim also has a background in environmental engineering, and her experience and knowledge in this area has played a major role in accelerating our termite damage claims mitigation program. We've made substantial investments in our infrastructure, which will help us more efficiently run our day-to-day business and enable us to drive more and faster synergies from the strategic acquisitions we pursue. While we're still early – in the early phases of these efforts, we're excited by what we're seeing so far. We went live with the pilot of our new customer experience platform, powered by Salesforce technology, in a call center in two Phoenix area branches. This deployment was the culmination of one of the largest cross-functional endeavors in company history involving over 200 employees, from field technicians to executive team members.
Our users are excited and feel empowered, with better and more accessible information to do their jobs and serve our customers more effectively. Our reimagined field standard operating procedures, or project clean sheet, has been completed for our termite business, and the results are very encouraging. Although the results reflect only one location, we are pleased that metrics like Net Promoter Score, cancel rate, close rates and employee retention are improving.
We're planning to roll out key aspects of this program to our remaining branches, and are excited to have modern and efficient standard operating procedures that can be replicated and scaled easily across the network.
While we're pleased with our progress for the year, our Q4 results show that we still have work to do to improve our consistency. Organic growth at Terminix dipped to 1%, as Tony will discuss in more detail in a moment. We also made several acquisitions in Europe that put short-term pressure on our margins. We're excited about the platform these acquisitions bring us, which will significantly enhance our ability to effectively support global commercial customers. Once we complete our integration work and optimization, we are confident we'll reach our longer-term margin expectations.
Margins were also negatively impacted by impacted by year-over-year growth in termite damage claims. This impacted both the fourth quarter and the full year results, and we are laser-focused on addressing the issue for our customers and our shareholders. Before we move our attention to termite damage claims, I'd like to discuss our strategic priorities for 2020, as seen on Slide 5. As we look to 2020, we're excited about the market opportunities we see and our ability to continue to make progress against each of our strategic priorities. The market continues to be attractive, with industry growth rates above GDP in both our residential and commercial service lines.
Our Terminix brand continues to have very strong awareness and customer satisfaction, as validated by independent third-party studies. And the fragmented nature of the pest control industry creates opportunities for us to continue to grow, both organically and via strategic and tuck-in acquisitions. With this as a backdrop, our strategic priorities for 2020 remain focused on familiar objectives.
First, we're committed to reducing employee turnover, especially within our frontline teams through our revamped onboarding process, improved training, better tools for our frontline employees and a continued focus on employee safety. Second, we'll improve customer retention through better employee engagement and improved customer analytics that will provide a deeper understanding of the drivers of customer cancellations.
Third, we'll enhance our profit margins across all lines of business using the new tools and procedures we're developing to our frontline employees, including the customer experience platform and termite clean sheet initiative, along with better prioritization and alignment on our key business initiatives. Cost productivity, marketing optimization and better labor management will be the better labor management will be the key margin enhancement drivers in 2020.
And the final pillar of our strategy focuses on revitalizing our termite business. We'll continue to roll out our clean sheet standard operating procedures for termite, enhance our product offering to better align with customer purchasing preferences and accelerate our mitigation program in the Mobile Bay Area.
Turning to Slide 6, you'll find more detail on our termite damage claim mitigation program. Over the past three years, we've seen a steady increase in our expenses related to termite damage claims. As Tony will discuss in more detail, virtually all of the increased claims have been isolated to the Mobile Bay Area of Alabama and attributable to damage caused by Formosan termites. We've analyzed these claims and associated trends to better understand the drivers and how we can address that.
In addition to our own analysis, we engaged a third party to help validate our findings with deeper statistical analysis. The global valuation consulting firm we engaged has over 50 years of experience in a wide range of complex legal liability issues, and many of the largest companies in the world leverage their economic and financial expertise. They confirmed our analysis of the geographic distribution of risk areas and have helped us better understand drivers of high-cost claims.
In addition, we've spoken to several entomologists and service providers in geographies we have limited claims history. All appear to confirm and validate our conclusions that our primary risk is limited to the Mobile Bay Area, which is why our mitigation plan initially focuses on this geography. We will continue to evaluate our claims activity and consult with these industry and subject matter experts and modify our mitigation plan as needed.
We focused our initial efforts on stopping additional termite damage by accelerating the pace of our previously discussed supplemental treatment program. This will ensure that we've treated all 15,000 mobile Bay Area customers with a supplemental treatment before the end of 2020. We've already completed approximately 2,500 supplemental treatments, of which many were for our customers who have chosen our dual-defend paste and liquid solution. While this initiative will depress our margin in 2020, we believe it's the right thing to do for both our customers and our shareholders.
We're taking these aggressive steps out of an abundance of caution to make sure that we get to the root cause of the issue, stopping further termite damage and ensuring that we're providing the best possible termite protection for our customers. We continue to make improvements in our reinspection and quality assurance processes using best practices and tools from our clean sheet efforts.
We're supporting our reinspection efforts with better scheduling procedures to improve access to the home for a thorough examinations. Improved inspection tools and techniques will help us identify potential damage earlier, improving customer satisfaction and mitigating higher costs from prolonged infestations. We're also expanding the size of our quality assurance teams. These teams lead our training efforts and also review the effectiveness and quality of inspections and treatments. By adding supplemental resources to these teams, we are able to better maintain our improved quality standards and ensure consistent delivery of services, leaving our customers better protected and minimizing the likelihood of future infestations.
The third prong of our strategy focuses on continuing to strengthen our claims management and contracting processes. We will continue to engage with our third-party claims management firm to centrally manage the claims process and accelerate the pace of claims resolution. Even though this pulls forward costs, efforts to solve these problems earlier – in the earlier phases of claims resolution will improve customer satisfaction and ultimately reduce our total expense. We are also making changes to our contracts with customers to better align terms and pricing with what we've learned about the real cost to serve.
As we've seen from the experience of others in the industry, this is certainly an issue that can be managed effectively, and we are fully committed to doing the right thing for our customers and our shareholders. I'm confident the execution of this mitigation plan will pay dividends for years to come.
I'll now turn it over to Tony to discuss the financial impact we've seen from termite damage claims, our 2019 financial results and our financial outlook for 2020. Tony?
Thanks, Naren, and good morning, everyone. Turning to Slide 7, let's start with a deeper look at termite damage claims in 2019. This view breaks out the Mobile Bay Area versus the rest of the country. It further breaks down litigated damage claims or those that end up in arbitration or a trial versus non-litigated damage claims or those that are settled directly with the customer.
I wanted to take a moment to explain the accounting change that we have made on litigated cases. According to the accounting guidelines for contingencies, reserves can only be recorded when the loss is probable and estimatable. Historically, this occurred if the filed cases move through discovery, and we eventually had enough information, including an outside counsel opinion, to make this determination.
In2019, we experienced an increase in the number of litigated claims and, assisted by our work with the third-party valuation firm, we can now use the specific attributes of these cases at the time of filing to make an initial estimate using statistical regression analysis. As a result, we recorded an additional liability of $45 million for pending cases, the bulk of which are attributable to the Mobile Bay Area.
The onetime adjustment we made for this change in estimation timing has been excluded from our non-GAAP measures in the current period. However, this change now becomes a normal part of our ongoing operations. This means that going into 2020, expenses will be recorded both when new litigated cases are filed as well as when case settlements differ from previously recorded reserves.
While the timing of when future cases will be filed will be difficult to predict, we do expect to see an increase in litigated cases filed in 2020.
Moving to non-litigated damage claims, you could see an incident rate of approximately 5% in the Mobile Bay Area. This rate is approximately 20 times higher than the base rate for the rest of our termite business. As a reminder, non-litigated claims are accrued based on warranty accounting principles, where we recorded initial estimated liability based on known claims and expected but not incurred damage claims for all contracts through their next renewal date. We also had a change in estimation technique for non-litigated claims of $8 million to take into account both the expected geographic distribution of claims as well as the variation in the cost per claim in those geographies.
Our guidance for 2020 assumes approximately $70 million of termite damage claims expense, including $10 million for the mitigation program. On an adjusted EBITDA basis, this represents a $20 million increase over 2019. For clarity, I've also included on the chart our current $80 million balance sheet reserve for each of these categories. These balances include the year-end adjustment entries I spoke about earlier.
Turning to Slide 8. I'd like to talk about the process that we went through with an independent third-party to calculate our expected liability over the next 10 years for all of our one million-plus termite customers. In December, we provided our termite damage claims data from 2010 to 2019 to a third-party firm for actuarial statistical analysis. The firm reviewed thousands of damage claims that explored many customer attributes that could indicate the likelihood of future claims. They used these variables to develop a formula and statistical model to apply against our existing termite customer base and mitigation plans to estimate annual liability into the future, then extrapolated that formula over a 10-year time horizon.
The results of this robust study give us valuable analysis to better understand which customer attributes are the best leading indicator of future damage claims so we can improve our practices going forward.
In the chart on Slide 8, you could see our claims expense history and expectations, segmented into five-year buckets. This shows a clear divide between the historical norms in 2010 to 2014 bucket and the increases we have seen over the last five years. As you can see by the red bar, these increases are driven almost exclusively by the Mobile Bay Area. During the five-year period from 2015 to 2019, the company incurred approximately $230 million in total termite damage claims expense. The results of the study established an expectation of approximately $230 million for the years 2020 to 2024 before returning to historical levels of approximately 4% to 5% of termite and home services revenue in the last five years of the decade
In total, we expect incremental expenses above 4% of termite and home services revenue, to be between $130 million and $150 million over the next 10years. The majority of these incremental expenses will occur in the first few years as our mitigation program starts to take hold. Approximately $45 million or around 35% of these higher-than-normal termite damage claim expenses are expected to occur in 2020.
As we have seen from competitors in the industry, improving our historical damage claims expense rate is certainly possible and represents an additional opportunity for us as we move forward.
Turning to Slide 9. Our analysis also confirmed that the issue is largely isolated to one geographical area. As a part of the analysis, we examined all geographies for any additional costs at our customer base beyond our historical claims experience. While the analysis identified a few areas of moderate risk for Formosan termites in the adjacent Gulf Coast counties in Southeastern Hawaii, shown in yellow on the map, the overwhelming majority of the total increase is coming from the Mobile Bay Area.
The analysis reflected that no other areas of the country have significantly deviated from their historical patterns. Our analysis leads us to conclude that we're not likely to see an acceleration of claims in moderate risk areas over the next 10 years.
Turning to the results for the quarter on Slide 10, you could see the consolidated Q4 financial summary for the business, including ServiceMaster Brands. Revenue grew $50 million or 11% to $507 million. Adjusted EBITDA was roughly flat to prior year, while adjusted net income improved 12%, driven primarily by lower year-over-year tax expense in the quarter. ServiceMaster Brands' revenue grew 8% in the quarter through continued progress on commercial national account and health care cleaning and disinfection.
Adjusted EBITDA per branch was roughly flat year-over-year, with revenue growth coming from lower-margin national accounts, health care and owned branch operations. As Jesse mentioned earlier, going forward, ServiceMaster Brands will be classified as held for sale and will move to discontinued operations while we explore strategic alternatives for the business.
Our European pest operations reported $18 million in revenue in the quarter, primarily from our 2019 acquisitions of Nomor, which operates in Sweden and Norway; and Terminix UK. As a reminder, our European pest operations are reported in the Corporate and Other Operations area of our financials to allow clear visibility to the base Terminix business and provide better alignment with management structure of the European pest business.
Adjusted EBITDA contribution from Nomor operations was offset by ongoing integration and carve-out expenses and optimization efforts in Terminix UK. The Terminix UK business is a national accounts-only carve-out of the former Mitie Pest Control business.
Optimization efforts include revenue rightsizing as we add additional accounts to the business that will add density to the existing national accounts portfolio. Early results are encouraging, and we are excited about the opportunity to grow this valuable global platform, but margins will be pressured at the beginning of 2020 while we work through these operational and system improvements.
Turning to Slide 11, I'll discuss the Terminix Q4 revenue growth by channel. Overall, Terminix delivered revenue growth of $30 million or 8%, with $27 million of growth coming from acquisitions. Starting with the termite and home services column on the left side of the chart, revenue declined 1% in the quarter. Organic decline of 2% was partially offset by acquisition growth of 2%. As expected and discussed in the Q3 earnings call, termite renewals were down $2 million or 3% in the quarter, driven primarily by lapping a $2 million onetime acceleration of revenue related to an accounting method's change for a bundled pest and termite services offering that we made in order to comply with new revenue recognition standards in 2018.
We also experienced continued slight revenue decline in the Mobile Bay Area from customer attrition. Termite completions and home services were up 1% in the quarter, driven by acquisition growth. As Naren discussed earlier, revitalizing our termite business is a key priority for 2020, and we're excited about the rollout of a new monthly-pay termite offering during the year.
Residential pest control grew 5% in the quarter over prior year, including 4% organically. Organic growth in residential pest control was driven by price realization in the quarter and unit growth in mosquito services, which were up 13% for the full year. Growth in residential pest was delivered despite lapping a 7% prior year organic growth quarter that was driven by onetime accelerations of start and completion rates that are difficult to meaningfully improve beyond the levels we achieved. Commercial pest control revenue was up 26% versus prior year, including 2% organically. Organic growth in the commercial pest was driven by a 2% improvement in retention rates, offset by lower onetime sales.
Acquisition revenue contributed the remaining 24% growth in the quarter, predominantly from assured environments, which moves to organic in Q1 of 2020 as well as the October acquisitions of Gregory and McCloud.
Turning to Slide 12. Adjusted EBITDA for the fourth quarter increased $2 million or 4% to $58 million, reflecting a margin of 13.7%. I'll highlight a few of the items across the bridge on the bottom of the slide. Revenue growth contributed $6 million of adjusted EBITDA, mainly from the impact of 2019 acquisitions.
We delivered $5 million of sourcing productivity through better pricing on chemicals and supplies. This was partially offset by $4 million of additional production labor as improved hiring processes and lower employee turnover have allowed us to staff up with trained employees in advance of the peak pest season. We expect the trend of higher production labor costs to continue into the first quarter, but this will normalize over the course of the year.
As Naren mentioned earlier As Naren mentioned earlier, reducing employee turnover is one of our four strategic priorities in 2020 as this will improve customer service and eventually retention.
Fumigation expense increased $2 million as we continue to work through the margin and volume reductions from outsourcing this high-risk service. We expect an additional $5 million of increased expenses year-over-year from this outsourcing in Q1 of 2020 before fully lapping the initiative by Q2.
Sales and marketing was up $4 million in the quarter, primarily driven by increased sales commission from higher summer sales in 2019, which contributed to the increase in pest growth I mentioned earlier. These increased expenses were offset by a $9 million reduction in incentive compensation due reduction in incentive compensation due to our full year 2019 financial performance.
Turning to guidance on Slide 13. We expect 2020 to be another solid year of progress on our Terminix transformation journey. As a reminder, guidance addresses continued operations only and excludes any financial impact from ServiceMaster Brands as we continue to explore strategic alternatives. We expect revenue will grow in total between 9% and 10% and range between $1.98 billion and $2 billion. We expect adjusted EBITDA in total will range between $320 million and $335 million, with margins of between 16% and 17%.
Turning to the Terminix segment. We expect organic revenue growth will range between 3% and 4%, with acquisition growth of approximately $60 million carrying into 2020. Normalized organic incremental margins are expected to be approximately 25%, but are offset by $10 million in incremental termite damage claims expense, $10 million in termite damage mitigation program and $5 million related to fumigation outsourcing.
Adjusted EBITDA contributions from primarily commercial acquisitions of Gregory and McCloud are expected at rates in the mid- to high teens as we focus our efforts on integration and capturing synergies in those businesses during 2020. Terminix adjusted EBITDA margins will be pressured in the first quarter, primarily due to the impact of the fumigation outsourcing. We'll lap the fumigation outsourcing initiative after Q1.
On Slide 14, you'll see some additional details on guidance for damage claims expense as well as the European pest business. In 2020, we expect termite damage claims expense to increase to $70 million, including an increase of $10 million in claims costs and $10 million related to the previously discussed termite damage claim mitigation program. As I mentioned earlier, litigated damage claims will now be expensed at the time the case is filed, making them difficult to predict on a period-to-period basis. Our guidance is our best estimate, given our litigated claims history in predictive analytics from our third-party actuarial and economic valuation firm.
For European pest operations, we expect to see approximately $75 million of revenue, with margins in the low to mid-teens. High teens to low 20s percent margins in the Nomor business will be offset by our ongoing efforts to integrate and rebuild the revenue base of the primarily national accounts business of Terminix UK. The European pest business will start the year below the full year margin expectation and improve through the year as these efforts take hold. Additional modeling details for the full year 2020 included expected book tax rate of between 27% to 29%, with a lower cash tax rate of 12% to 14%, as we benefit from a large refund in 2020 for a prior period net operating loss carryforward before returning to our midterm expected cash tax rate of approximately 20%.
We expect CapEx to continue to be less than 2% of revenue or below $40 million.
And with that, I'll turn it back over to Naren for final comments. Naren?
Thanks, Tony. Spending the last month with many of the key leaders in the field and in our corporate office has reinforced my strong conviction that we have a great business. The talent and passion I see that provide excellent customer service permeates the entire organization. A clear focus and better prioritization and alignment on our four key business initiatives will continue to allow us to execute on our strategic goals.
Our strategy remains focused on reducing employee turnover, which will help us continue to drive improved customer retention and ultimately lead to better financial returns. Our focus on returning our termite business to the core of our success will also support our delivery of these goals. I'm confident in our strategy and look forward to updating you on our progress in the future.
Before I turn things back over to Jesse and open up the line for questions, I wanted to spend a minute on our CEO search. We've engaged a leading executive search firm to help us with this search, and we're already beginning to bring potential candidates. Over the past few weeks, I've received several questions regarding the search and what characteristics we're looking for in our next CEO. We're looking for somebody who is skilled, both commercially and operationally. Ideally, he or she will have experience leading large distributed organization and a demonstrated ability to create followership in this environment. And of course, we're looking for a customer-centric executive, who is familiar with recurring revenue businesses like ours; somebody with a keen eye for talent and a demonstrated ability to recruit, retain and develop diverse talent.
And finally, someone who embraces the servant leader model and understands the importance of enabling and empowering our frontline employees so that they can delight our customers. Continuity during the ServiceMaster Brands' strategic alternative review as well as the CEO search and leadership change is paramount. I'm thankful to be able to leverage Tony's experience and knowledge of the business during this time, and I'm happy to report that we've entered into a retention agreement to make sure he'll be available through these transitions.
So all in all, we're making good progress on a number of fronts across the company. We're excited about the future and focused on executing on all four prongs of our 2020 strategy to drive shareholder value.
Let me now turn the call back over to Jesse. To lead us through our Q&A Session.
Thanks Naren. With the queue being long this morning please limit yourself to a single question so that we can get to everyone in the allotted time. Frank let’s open the line for questions
Thank you. [Operator Instructions] Our first question comes from the line of Mario Cortellacci with Jefferies. Please proceed.
Hi, thank you guys so much for the time. Obviously, questions about the litigation and termite expense. So just could you give us a sense of the cadence for that $230 million over the next four years? Obviously, I think you said that a good chunk of that's going to be in 2020. But I guess, what's the cadence in the out years? And then, how much litigation is baked into that $230 million? And you guys had the $45 million in ligation reserve but, I guess, what are the odds of that going up? And again, how much of the litigation is baked into the $230 million?
Okay, hey Mario, thank you. This is Tony DiLucente. Obviously, in 2020, we signaled that that's going to be the peak of the termite damage claim expense, and then it's going to slowly trend down and get back to that 4% to 5% average in the last five-year period, the 2025 to 2029 period. So that's the general trend that we're seeing.
Your other question, I think, was around litigation.
Yes this is Naren. I would say that the cost that we put out there in that range, it really includes all of our costs. The mitigation plan costs, litigation costs as well as the actual claims settlement in there. So that should be the total impact of the termite damage claims.
Yes, thank you.
Thank you. Our next question comes from the line of Tim Mulrooney with William Blair. Please proceed.
Good morning.
Good morning Tim.
Good morning Tim.
Yes. So this question is unsurprisingly also on termite, but it's a broader question. I mean I know you're retreating all the homes down in Mobile, right? I think that's 15,000 customers. You've done a few thousand so far. Do you think there are other regions that will also require additional retreatments? I see that yellow other high-risk regions. With one million termite customers nationwide, how should we think about the implications to your termite margins over the next several years? Thank you.
Tim this is Naren. I’ll answer that. Based on this, the analysis that we've done, there's no indication that the problem or the concerns are outside of that mobile Bay Area. Clearly, we're going to continue to monitor the data and see if there are any new trends. But right now, we're very comfortable it is isolated to that Mobile Bay Area, and that's where our initial focus is.
Thank you. Our next question comes from the line of Judah Sokel with JPMorgan. Please proceed.
Hi, good morning. Thank you for taking my question. Just wanted to also thank you for providing that ring-fence assessment, very helpful. Maybe to just turn over the Q&A a little bit to organic revenue growth. I thought the 3% to 4% guidance that you put out was very encouraging. And so I was hoping that you could just provide a little bit of color by channel? Which areas of the business, commercial versus residential, termites versus pest, where do you really think that you're going to see that acceleration? Are there certain areas that you're going to see more or less? Thank you very much.
Thanks Judah. This is Tony. I really am encouraged with the commercial pest control business, in particular. The Q4 organic growth rate was 2%, but we're seeing nice improving trends in our retention rates that are, really, I think, it would give us some acceleration going into 2020. So that's probably the most significant changes that I'm seeing. We did have a strong residential pest control growth quarter as well, 4% organic growth. And if you will recall, we were lapping a 7% growth in Q4 of 2018. So I was really pleased to see the organic growth at that 4% level for this quarter. So those are the areas that I'm most encouraged.
Thank you. Our next question comes from the line of Toni Kaplan with Morgan Stanley. Please proceed.
Thank you. Just on the decision to explore alternatives for brands, any sense of timing of when we should expect an announcement? Like how quick you're expecting to complete that process? And how you're expecting to use the proceeds? And then just given that you're exploring alternatives with brands, would you also look to selling the entire business as well? Thank you.
A lot to unpack there, Toni. Let me start with kind of the timing of the process. I mean, clearly, in the process right now. And while we're very encouraged, we're not in a – we're not anxious to rush the process. We want to make sure we go through a thorough evaluation. And normally, what we've been told is kind of four to six months is kind of typical for these types of things. So that's kind of what we're working towards. But again, we're not going to push the schedule. We want to make sure that we find the right home and, probably, more importantly, get the right value for our shareholders. We think it's a great business. And fortunately, it looks like others do as well.
As far as the rest of the business, there's no intention there. I mean we are – the business is not for sale. We think we got a great business. We think we've got plenty of opportunities to drive both growth and operational improvement. And we're looking forward to driving those improvements and creating value.
And then finally as far as the use of the proceeds, I think we've talked about that in our press release. Clearly, we will pay down some debt to get our – get back to our target leverage ratio. We are losing some EBITDA with this. We think there'll be plenty more to continue to invest in the business for organic. And to the extent we see – continue to see opportunities for acquisitions out there, and if there's left over funds, we'll look at the opportunity to redeploy back to our shareholders in one fashion or another.
Our next question comes from the line of Andrew Wittmann with Baird. Please proceed.
Great, thanks. I guess, first off, I wanted to ask Tony on free cash flow here. If you could give us some help of what you're expecting here for 2020? Presumably, some of the $53 million reserve that you took on termite is going to be a cash cost this year, other factors between the EBITDA and cash flow as well. So if you could just kind of bound for us what you think the cash flow could come in at this year that would be helpful.
And also I wanted to get just a little bit more detail as it relates to the independent quality assurance teams and the third-party claims administrators, how those two items are – how they work and how they're going to help you better address the termite issues that you've had and are having?
Hey Andy thank you. As far as free cash flow conversion, we still see that mid-50% – 50-ish, 55-ish range for 2020. And there will not be any impact to that conversion based on the reserve we took for termite damage claims. We'll obviously pay claims as they go. So again, around the mid-50% range for the free cash flow conversion. And the second question was on Q&A and third party administrator.
Yes this is Naren, I’ll go ahead and take that. Yes, the QA teams really supplement our traditional operations people. The QA team provides the training for our techs, and they'll make sure that they're up-to-date with the latest – both inspection techniques as well as the supplemental treatment techniques using the work that we've come out of our clean sheet termite process. And they'll also be involved with doing quality control reviews of the work that we're doing. Again, initially, in that mobile Bay Area but, clearly, they'll continue to provide value across our entire network.
And then the third-party claims administrator. This was actually a change that was made over a year ago, to have a professional organization reviewing those claims. And really, with a goal of moving faster than we were able to move when the claims were being handled at the branch level. Clearly, our data and analysis shows the more quickly we can resolve these claims, the better customer satisfaction and the less likelihood there is of any type of continued damage, if there is an infestation. So speed is really important to us, and we want to make sure we have adequate resources to pursue that.
Our next question comes from the line of Gary Bisbee with Bank of America. Please proceed.
Hi, guys good morning. So appreciate all the incremental color on the termite claims. I guess I wanted to ask about what seems to me are two other key components of the termite business. So first, just the operating cost base. I guess you talked about the incremental mitigation expense in 2020, but how has that been trending? And how do you see that cost base, long-term, as you get through these? Are your operating costs higher than they would have been historically to manage claims back down to the level?
The second part of that is the $10 million sort of onetime in 2020 that incremental mitigation cost? Or do you expect that to continue? And then the third piece of other termite costs, I wonder if you could comment on is, obviously, renewals where you don't have an issue at the home is your highest margin business in Terminix. So how do we think about what you've lost from customer losses as you try to push higher price in other regions? How much is that impacting the forward profit outlook? I know there's a lot there. I apologize for that but really trying to understand this issue. Thank you.
So Gary let me address the termite piece first and that $10 million. That $10 million we view as a onetime cost to go back and provide the supplemental treating and the inspection for the 15,000 homes in the Mobile Bay Area. So that should truly be a onetime cost there. As far as the long-term margins, we still feel excited about the opportunity to continue to improve margins. I think we've seen some good progress. But as you're aware, we're making significant investments with the clean sheet work, the new customer experience platform. And we have a series of other productivity initiatives on the sourcing side, on the labor productivity and on the marketing efficiency side. So we continue to see opportunities to drive margin improvements as we move forward. Clearly, some of that will take investments, and we're making those investments.
On the renewal side, again, I think that when you look at the pricing, we did make some adjustments on pricing in the Mobile Bay Area, and that was really to align ourselves with the cost to serve, understanding better now what our real cost to serve there – what the real cost to serve is. When you look at our other pricing increases across the rest of the network, I think their normal type of price increases that are consistent with the way costs move on a normal basis. And we're always looking at retention and the trade-off between pricing and retention of those. And the good news is we're continuing to see improvement in our retention metrics or cancellation metrics. So we feel good about the trade-offs that we're making there.
Our next question comes from the line of Ian Zaffino with Oppenheimer. Please proceed.
Great. Question would be on the CEO search. You touched on some details. Maybe give us the sense of timing, whether you're looking for a public CEO or someone just at a larger company? And then also, you mentioned the servant-led culture. What has been kind of your experience so far trying to implement that? And is that the right way to go about this? Or where we might see a different type of strategy? Thanks.
Yes, so as far as the search goes, Ian, clearly, I think the timing will be based on our ability to attract and find the right candidate. My guess, again, based on what we're hearing from the executive recruiters is in that four to six-month time frame. I think, again, based on preliminary list we've seen, there's a lot of talented people out there with the skills and capabilities. Love to find somebody who has been a public company CEO and has the experience dealing with the external side. But it doesn't necessarily – that's not a hard requirement. It could be a CEO of a private company. Or it could be somebody the next level down in a public company, who's had that external exposure.
And the third piece of that was around the servant-leader model. Again, our customer experience is driven by our frontline people. They're the ones in the home, in the businesses every day, and that's what our customers see when they think of Terminix, especially. So I think it's very important. I think we've done a nice job over the past couple of years of kind of turning that around and putting ourselves in the position where we better serve them. We're making the investments in the technology platforms and the training. And I think, again, in this type of business, in a recurring revenue business where retention is so important, the customer experience is so important, having a leader who understands that model and the importance of supporting that frontline is absolutely critical.
Our next question comes from the line of Jamie Clement with Buckingham Research. Please proceed.
Hey good morning gentlemen. Tony, just on the termite study methodology, the term you guys used was customer attributes as being sort of like the factor being looked at. And I'm just kind of curious, methodologically, why not look at things like climate, prevalence of Formosans, soil conditions, or even like historical measures of your own service quality adds factors to figure that. And maybe those factors were considered and maybe I'm just trying to look for a little bit more on that methodology there.
Yes, Jamie, those other factors were definitely considered. We consulted with our own entomologists and an external entomologist and took into account things like soil conditions and weather and climate in the area. And obviously, we took into account the mitigation plan that Naren has talked about. So all of that was factored into the analysis. So you're seeing a complete – statistically based but also based on actions we're taking and other external considerations in the environment.
Yes. Jamie, I'll add a little bit to that. Remember, the data that was used was our entire claims history over the last 10 years. So clearly, all of that is embedded into the raw data. And so we're looking at ZIP codes of where the homes are, home value. So when you talk about customer characteristics, it's not necessarily income and things like that. It's the home characteristics, the size may – the size of the home, so more of that. And again, it's using all of our claims history of the last 10 years. So all of the service capabilities and everything are embedded in that raw data that was used to build the models.
Thank you. Our next question comes from the line of George Tong with Goldman Sachs. Please proceed.
Hi, thanks. Good morning. I'd like to go back to the termite claims costs you've provided, the $230 million ring-fence for termite claims for 2020 through 2024. Can you elaborate on what litigation incidence rates you're assuming in your outlook? And what gives you confidence that claims cost will revert back to 5% after 2025?
Yes, so again, we used the historical statistical data, the very granular level, taking into account some of the factors we just talked about, home size and so forth, to come up with the trends that we're seeing in litigated claims. Clearly, it shows that they spike in 2019, 2020, and then the trend starts to move down after that based on everything. And then including the supplemental treatments, the mitigation plans that we're doing all factor into that downward trend that you're seeing after those two years of spike.
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