ServiceMaster Global's (SERV) CEO Robert Gillette on Q2 2016 Results - Earnings Call Transcript

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ServiceMaster Global (NASDAQ:SERV) Q2 2016 Earnings Conference Call July 28, 2016 9:00 AM ET


James Shields - VP, IR and Treasurer

Robert Gillette - CEO

Alan Haughie - SVP, Finance and CFO


George Tong - Piper Jaffray

Andy Whitman - Robert W. Baird

Jay Hanam - RBC Capital Markets

Anj Singh - Credit Suisse

Sara Gubins - Bank of America, Merrill Lynch

Jeff Goldstein - Morgan Stanley


Ladies and gentlemen, welcome to ServiceMaster's Second Quarter 2016 Earnings Conference Call. Today's call is being recorded and broadcasted on the Internet. Beginning today's call is Jim Shields, ServiceMaster's Vice President of Investor Relations and Treasurer. He will introduce the other speakers on the call.

At this time, we’ll begin today's call. Please go ahead, Mr. Shields.

James Shields

Thank you, Operator. Good morning and thank you for joining our second quarter 2016 earnings conference call. Today, you will hear from ServiceMaster's Chief Executive Officer, Rob Gillette, and Chief Financial Officer, Alan Haughie.

For those of you who haven't had a chance to download the investor presentation from our Web site, I'll walk you through the agenda items shown on slide two. Rob will lead off by providing some opening remarks and then provide a summary of our second quarter consolidated results. Alan will then review performance by segment and provide more details of our consolidated results, as well as providing an update on our 2016 full-year guidance. Rob will then provide summary comments before opening the call to your questions.

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 three, all forward-looking statements are subject to the forward-looking 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 July 28, 2016.

The Company undertakes no obligation to update any information discussed on today's call. This morning, ServiceMaster issued a press release, filed with the SEC on Form 8-K, highlighting our second quarter 2016 financial results. And we have posted a related presentation, both of which can be found on the investor relations section of our Web site. We will reference certain non-GAAP financial measures throughout today's call, and we have included definitions of these terms in our press release, which is available on our Web site.

We have also included reconciliations of these non-GAAP financial measures to the most comparable GAAP financial measures in our press release and presentation in order to better assist you in understanding our financial performance. All references on the call to EBITDA are to adjusted EBITDA as defined in our press release.

I'll now turn the call over to ServiceMaster's CEO, Rob Gillette for opening comments. Rob?

Robert Gillette

Thanks, Jim, and thanks to all of you for joining our 2016 second quarter earnings call. While many of you on the call today either attended our Investor Day held in New York on May 17th or had the opportunity to view the video on our Web site. At that event, we introduced ServSmart our approach to how we engage our customers, employees, and business partners to provide the best service possible in an efficient way.

ServSmart is the foundation of our plans to improve our business processes and enable customers to research, buy, and schedule home services. Our team gave an overview of our approach in how we are transforming our Company through technologies. For our Company, ServSmart is more than just an initiative. It is how we will tackle process improvements across brands and functions, and simplify the tools we use to deliver services on time for customers.

Our ultimate goal is to provide a world class experience from the time customer begins to search for a service provider to the time they take for those services. We want to serve our customers when, where, and how they want to be served. By leveraging technology to make it easier and more convenient for customers and our associates, ServiceMaster aims to be top of line for consumers when they select services for their homes.

We operate in large and attractive markets with favorable consumer trends. Estimates take the overall addressable market size for home services to be between $250 billion and $400 billion. The industry is incredibly fragmented with the reputation for poor and inconsistent customer service. Many lead generation companies have struggled with the thin margins after decades of investments, and new entrants have failed to gain traction.

ServiceMaster is in an excellent position to capture increasing share of this market. We had three of the largest and most profitable home service brands in the industry with a record of solid service delivery across all of our brands. We visit 75,000 homes and businesses each day. And in the process, our trusted professionals delivered quality of service through an unmatched network of employees, contractors, and franchisees.

As we shared with you on our Investor Day, we are now capitalizing on our size and scale by investing in technology to take our service to next level. Through technology, we are transforming the customer experience and building a reputation for delivering quality service.

Now, before I walk you through our second quarter financial results, I would like to address the charge we took this quarter related to the incident in the U.S. Virgin Islands. The Company has reached a tentative agreement to settle the civil claims of the family injured from the fumigation incident at U.S. Virgin Islands resort serviced by a local Terminix branch. This incident was tragic, and we deeply regret that it happened. Under the tentative settlement, in addition to the payment from our insurance carriers, we will pay $90 million, representing non-insurance amounts. We had previously recovered a charge of $3 million, which was an amount equal to the Company's insurance deductible under its applicable insurance program.

With regard to criminal proceedings on this matter, on July 21st, the Company entered into a new plea agreement with the Department of Justice. The plea agreement supersedes the previous plea agreement entered with the Department of Justice in March of this year, which has been rejected by the U.S. District Court of the U.S. Virgin Islands. The Company had previously taken a $10 million charge associated with this criminal matter. Under the new plea agreement, the Company does not anticipate taking any additional charges. The new plea agreement is subject to the approval of the court. The court hearing is anticipated to be held in August of 2016. And if the new plea agreement is approved, it will resolve the Federal Criminal Department of Justice Investigation.

As a Company, we continue to improve and make significant investments in our health and safety programs, and our goal is to be the best in the industry. Over the past year, we have made great strides towards that goal. We will continue to invest in technology, personnel, and training, to continually improve our processes.

Now turning to results, ServiceMaster revenue grew 4%, compared to the prior year, or 6% if we exclude the conversion of Merry Maids' branches to franchises. Revenue growth was driven by American Home Shield through the increase in a number of our direct-to-consumer and real-estate customers, and at Terminix by the acquisition of Alterra, which occurred in November of last year. In addition, at the end of the second quarter, American Home Shield acquired OneGuard Home Warranties. The acquisition is important to our growth strategy and expands American Home Shields’ footprint in three highly competitive and important states; Texas, Arizona, and Nevada.

Based in Phoenix, Arizona, OneGuard was named in the 2015 Inc. magazine 5,000 list of America’s Fastest-Growing Private Companies. We are excited about OneGuard being part of our team and the talent they bring to ServiceMaster. OneGuard will continue in the market with its current brand identity and product offerings. We look forward to learning from their success and having them as part of our team.

With regard to our Terminix business, our targeted marketing, couponing, and bundling strategies have resulted in the third straight quarter where we’ve experienced a year-over-year increase in sales. As Alan mentioned last quarter, Terminix customers have one of the highest lifetime values in the ServiceMaster portfolio. The increase in Terminix sales is a good sign for future revenue as these new customers renew their subscription in subsequent years.

With regard to pest control, we are pleased with the integration and performance of our Alterra acquisition, and continue to invest in our core pest control business. Our organic pest control growth in the quarter was disappointing, but we are focused on developing new strategies to improve execution and growth in the future.

Adjusted EBITDA increased $12 million or 6% this quarter compared to the prior year. The increase reflects $21 million from the conversion of higher revenue, offset by an increase of approximately $6 million in technology cost related to ServSmart and a $3 million reduction in investment income. We also incurred $2 million in additional marketing spends this quarter compared to Q2 of 2015.

As we discussed last quarter, the increase in technology investments this year represents a step change, which we expect to remain at approximately the same level in 2017. Adjusted net income improved this quarter, largely driven by the increase in adjusted EBITDA. Second quarter adjusted net income was $93 million, an improvement of $11 million compared to prior year. Second quarter adjusted diluted earnings per share of $0.67 increased $0.07 versus prior year. The improvement was driven by an increase in adjusted net income, partially offset by higher weighted average diluted common shares outstanding.

As approved under our share repurchase program during the quarter, the Company used $17 million in cash to purchase 461,000 shares at an average price of $36.04. Now let me turn it over to Alan to discuss the detailed segment results, Alan.

Alan Haughie

Thanks Rob. Good morning, everybody. As Rob mentioned, we had another solid operating quarter with revenue growing 6%, excluding the conversion of Merry Maids branches with EBITDA margin expanding by 50 basis points. More importantly, and I’ve highlighted on Investor Day, our businesses continue to generate strong gross margins with both Terminix and American Home Shield consistently delivering annual gross margins in the high 40% to low 50% range. So this quarter was no exception. With gross margin expanded 30 basis points year-over-year. As a result of these strong fundamental margins, we are able to invest in technology and marketing to fuel future growth, while still delivering strong bottom line results.

And just as in the first quarter, we increased year-over-year technology spending on our ServSmart platform by $6 million, but this time also expanded our EBITDA margin. So, let's begin by discussing the breakdown of Terminix revenue shared on slide six. Revenue increased year-over-year by $19 million or 5%. Now revenue grew by $21 million or 6% if we exclude the product sales which were in line item labeled products in the Terminix segment table in the press release. These products are low margin and tend to vary widely for the year.

So of the $21 million in non-product growth, $17 million was driven by acquisitions, most of which was on the acquisition of Alterra completed in November of last year. And again, we’re very pleased with this acquisition. Its performance and integration are both ahead of our internal plans and we are beginning to cross sell other services such as mosquito control to these customers. And historically, acquisitions have played an important role in Terminix's growth and Alterra is a great example of how acquisitions through synergies and cross-selling opportunities add value.

Pest control revenue of $226 million increased by 10% or $21 million over the prior year with residential pest growing 14% and commercial pest growing about 3%. Now excluding Alterra and other acquisitions, our pest control business grew 2% with residential pest growing 3% and commercial pest growing 1%. And although we were pleased with the performance of certain service lines, such as bed bug, which increased 24% and mosquito which increased 42%, our organic growth in pest control did not meet our expectations this quarter.

Now revenue from termite and other services of $168 million was flat to prior year, good completion revenue down $1 million at $88 million and renewal revenue up $1 million to $80 million. But despite revenue being essentially flat, we are actually pleased with some of the recent developments in our core termite business. As Rob mentioned, this is the third quarter in a row in which we have increased year-over-year sales. And as a reminder, purchase sales, or termite completions as we call them, are a key source of future profitable revenue.

In a business where retention rates are as high as 85% acquiring such customers results in very profitable multiyear revenue stream that highlights and add value. Our bundling targeted marketing and couponing strategy has proven to be a success. New services revenue, excluding mosquito, was flat this quarter, largely driven by low demand for insulation services. And once again, our recent dedication of more sales and marketing resources to repositioning our core termite services was the principle driver.

Turning to slide seven, and Terminix's segment results, the conversion of revenue to gross profit was very healthy with $10 million of additional gross profit generated from the $19 million of additional revenue. As a result, the gross margin rose by 30 basis points to 47.6%. Terminix EBITDA increased by $11 million this quarter. But as we can plainly see, the improvement came from the $10 million of increased gross profit with a modest net $1 million reduction in SG&A. And as discussed on the first quarter call and our Investor Day, we continue to incur $4 million of additional year-over-year technology costs. But these were more than offset by savings in other areas of expense.

However, most of this SG&A improvement is simply timing within the first half of the year. You may recall that we had, in the first quarter, a year-over-year increase in SG&A of about $5 million due to a host of small items. And so, while we are reporting for second quarter very healthy 58% conversion of incremental revenues into EBITDA, when we look at it on a year-to-date basis, Terminix have increased EBITDA by $17 million on a revenue increase of $47 million, and conversion of 36%, consistent with the longer-term conversion rates we have been discussing. So overall, for Terminix, healthy gross margin, good operating leverage, strong total revenue growth driven by acquisitions with challenging top line organic growth.

So, let's turn to slide eight and discuss the American Home Shield’s second quarter performance. Overall, American Home Shield had a strong quarter with good top line revenue growth and strong gross margins, while continuing to invest in marketing and technology. Claims costs have returned to more normal levels as we have expanded our contracted network to better align capacity with demand. In addition, we acquired OneGuard at the end of the quarter. And as Rob mentioned, this is a significant acquisition for us. Its strong record of growth and entrepreneurial customer focus and mind set makes OneGuard a perfect fit with American Home Shield and with ServiceMaster.

And for the sake of transparency, we paid about $65 million for OneGuard and expect it to contribute roughly $15 million, and little over $2 million in EBITDA for 2016. However, for the second quarter, American Home Shield's results include no impact from the OneGuard acquisition, with no revenue or EBITDA recognized in the quarter.

So for Home Shield, the year-over-year revenue growth for the second quarter was 8% or $21 million, of which roughly $6 million was from pricing. For the second quarter, we had about 50% flow-through, as you should expect with increase in volume to gross profit. And of course the higher pricing flows through the gross profit of 100%, naturally.

These two positive items have been partly offset by $4 million of higher non-volume related claims costs. Of which about $3 million can be attributed to inflationary pressures, and the remaining $1 million through the impact of the growth in first year direct to consumer customers, which historically have one additional claim in their first year in the average customers. And so the second quarter gross margin percentage of 49.6% is about six tens of a point lower than the same quarter last year.

Shifting our attention to EBITDA, the higher gross profit of $9 million was partly offset by higher selling and marketing costs of $3 million, and higher technology costs of $2 million. And of course we maintained our investment in ServSmart technology at roughly the same levels as the first quarter. And as I mentioned last quarter, incremental selling and marketing costs are largely front loaded this year.

In the second half of the year, we anticipate selling and marketing costs to be roughly flat to last year. And also the year-over-year step-up in technology costs of $2 million per quarter should continue through the third and fourth quarters. In 2017, we expect our technology costs to be flat compared with 2016, and the same comment actually applies to Terminix too.

We did report another investment income of $3 million as we actually have $3 million in investment gains this quarter compared to $6 million in gains a year ago. Now these gains are the result of sales and securities held by American Home Shield as part of its regulatory obligations. The term of the securities is the result of our strategy to sell all equity and long dated fixed income securities held by American Home Shield in order to de-risk its portfolio. And with the sale of securities this quarter, American Home Shield’s portfolio has largely been restructured, and we can now anticipate any additional gains for the foreseeable future.

So, for the remainder of 2016, American Home Shield will not have the marketing or investment gains headwinds. The business is on track to achieve about 10% of organic growth for the year. And with the inclusion of OneGuard for the second half, we expect to grow the American Home Shield top line between 11% and 12% in total. Our claims costs are under control, and we’ll continue to invest in growing the business. So, as mentioned on Investor Day, American Home Shield is very well positioned for a strong second half of the year.

Slide nine shows FSG’s performance. The revenue decline of $10 million or 17% is almost entirely related to the Merry Maids’ business. The vast majority of which is of course due to the ongoing conversion of the branches in different franchises. As of right now, we are in the process of divesting our one remaining branch. Actually, we are maintaining our branch and emphasis is best to chose. And I can show you that I check this regularly every week.

Once again, we’ve largely maintained our EBITDA by driving cost reductions on pace with the branch conversions, which has the impact of rate in the gross margin of this segment by 3 percentage points year-over-year to 58%. And the EBITDA margin by 5% to 8% [ph].

So let's turn now to the full P&L account on page 10, and look at the business in its entirety. The year-over-year revenue increase of over 4% or $31 million includes $23 million or 3 points of net organic growth. The remaining $8 million of revenue increase comprises $17 million due to acquisitions of Terminix, all the excess cost by $9 million of revenue divested due to conversion of Merry Maids tranches to franchises. Gross margin as a percentage of revenue increased by three tens of a point to 49.3%, that’s actually due to the fact that growth in American Home Shield and in Terminix, and Home Shield has a higher gross margin than Terminix.

The year-over-year SG&A increase of $5 million largely reflects the higher technology costs combined with general overhead efficiency, so this don’t result in SG&A, as a percentage of revenue, improving by four tens of a point to 25%. Now, we’ve recorded a $23 million charge referred to as an insurance reserve adjustment. Annually, during the second quarter, our actuary performed a retrospective review of loss development factors in relation to our self-insured reserves for workers’ comp also in generally liability.

So over the past several years, we’ve experienced significant adverse developments on many of the older claims for which we have satisfied with those. Many of these claims were older than five years and some older than 10 years, and they rose at entities only similar to our other entities that the company has since divested. Exacerbating the problem is that many of these claims in emerging years which the Company have high deductibles, but they does not in such greater exposure.

As such, the Company has determined in consultation with its actuaries that an increase in their balance sheet reserve of $23 million is appropriate. And of this $23 million charge, about $10 million actually related to these previously divested entities. Now this charge is test deductible, so one of the impacts of reducing this year’s cash taxes by about $8 million. And there is no relationship between this $23 million charge and $88 million charge that we are taking for, what I’ll describe as fumigation related matters.

So, even with these charges in our results, we generated pretax income of $23 million compared to $109 million over the same period last year. And so, net income for the quarter is $16 million compared to $67 million last year. And of course to aid comparability, we also report adjusted net income, which I will reconcile in a moment, and this increased by $11 million to $93 million.

So, Slide 11 provides our standard two reconciliations. First, we work our segment performance measure, adjusted EBITDA down to net income and then what the reconciliation back up to the adjusted net income. And of course, we’ve excluded the charges for fumigation related matters and the insurance reserve adjustments from both EBITDA and adjusted net income. And I think the other [23.00] are self explanatory or immaterial, so we’ll move on to cash flow, which is shown on Slide 12 where we show the second quarter and the year-to-date simplified cash flow statements.

In the second quarter, we generated $123 million of free cash flow, some $29 million less than over the same period last year. However, as outlined on prior calls, we have become a federal tax payer in 2016, and so the primary source of the change is the $29 million increase in cash taxes. And I’ll say more on cash taxes in a moment.

Moving down to cash flow statements, the $17 million of acquisition payments includes the cash paid in the quarter for OneGuard. And then during the quarter we also placed $95 million of cash in a collateralized trust for the benefit of Zurich, our primary insurance provider. The purpose of the trust is to secure our self insured claims. Previously, the Company provided Zurich a letter of credit to secure the claims. And by using a trust structure, secured by cash, the Company avoids over $3 million in letters and credit fees. This change has no impact on our liquidity since the reduction in cash balances is matched by an equivalent opposite increase in our availability -- the availability under our revolver.

The $47 million of cash realized from the sale of securities related to the de-risking of the American Home Shield portfolio, that I mentioned earlier, and this is simply a transfer for more long-term marketable securities to cash, and it does not affected the amount of restricted cash or restricted net assets. And of course as Rob mentioned also during the second quarter, we spent $17 million purchasing 461,000 shares of common stock at an average price of $36.40.

Now with regard to our full year free cash flow projections, the $23 million insurances reserve adjustment is not expected to have a material cash impact in 2016. Although, it will reduce cash taxes by $8 million, as I mentioned a moment ago. This benefit, in combination with other tax planning initiatives, reduces our expected cash taxes to about $125 million compared to the $145 million investments on Investor Day and on prior calls. However, we do expect to pay the $88 million for few mitigation related matters in 2016, so this will also before the cash tax deductible when settled, so the net cash impact of this one-time settlement will be an outflow of around $53 million.

So all other things being equal, our full year free cash flow projection has been reduced by about $33 million, that is a $20 million reduction in cash taxes, more than offset by the net $53 million outflow for the fumigation related matters. So we’re revising our free cash flow projection for the full year, so at $272 million to $290 million range. Please note that a full reconciliation from the U.S. GAAP cash flow statements to free cash flow is provided in the appendix and in the press release. And actually, we are maintaining our long-term leverage targets to 2.5 to 3 times EBITDA.

And now, with respect to our full year guidance, shown on Slide 13, as I mentioned previously, American Home Shield continues to perform well. We expect organic growth revenue at Home Shield to continue to be approximately 10%. And with the addition of the OneGuard acquisition, total revenue growth for Home Shield should be between 11% and 12%. As for Terminix, our outlook for revenue growth is now in the mid single-digits, down from mid to high single digits as organic growth has disappointed us. As such, we’ll revise our full year outlook for revenue down by about $20 million.

As for EBITDA, given the strength of our margins, our capacity for operating leverage, the investment gains and the OneGuard acquisition, we are maintaining our previously reported full year EBITDA range. I should say previous provided full year EBITDA range. However, on that note, I’ll turn the call back over to Rob for closing comments.

Robert Gillette

Okay, thanks, Alan. Just to wrap things up. Our business remained strong. We continue to see revenue and customer account growth at American Home Shield, with OneGuard acquisition, American Home Shield has added the Company with its strong record of growth and entrepreneurial customer focused mindset. We continue to be the leader in the home warranty market and OneGuard strengthens our position.

At Terminix, in the integration and performance of the Alterra is ahead of plan, and we’re pleased with the sales in the core termite business. Most importantly, our business model remains strong with resilient margins and cash flow. We’re focused on a customer first culture and enabling our associates to perform essential services in high quality and reliable way. Our investment in ServSmart will empower our team to deliver these services efficiently, which frees them to connect with customers and provide a superior experience.

Thank you for joining our call. And now I’ll turn it over to Jim for Q&A, Jim?

James Shields

Thanks Rob. As a reminder, during the question-and-answer session, we encourage you to ask any questions that you may have. But please note that guidance is limited to the outlook we provided in our press release and webcast presentation. Additionally, since the queue is long this morning, please limit yourself to one follow-up question, so that we can get everyone in on the allotted time. Let’s open up the line for questions operator.

Question-and-Answer Session


Thank you [Operator Instructions]. And our first question comes from the line of George Tong with Piper Jaffray. Please proceed with your question.

George Tong

Can you comment on inflationary costs that you’re seeing in the American Home Shield business, specifically how rapidly contractor rates are increasing? And any factors in the market that may change this going forward?

Robert Gillette

Not that we’re seeing. I mean the $3 million I quoted is, if you think about it given the contracted costs, represent about half of our revenue in American Home Shield. The rate of inflationary increase that they’re giving to our contractors is not that similar to the rate of price increases that the tax includes to our customers. And so that level is about the level that helps us maintain our EBITDA margin -- gross margin as it's been that we’ve seen in revenue and Home Shield and the claims.

So given the -- let's call it renewed focus on making sure that we have a broad enough contracted capacity. At this point in time, we’re not seeing any significant headwinds in terms of the behavior of the contractors. And I think bear in mind, and we say it often, that being the market leader actually does mean some things. And so, the level of volumes that we can give to our contractors, we still believe gives us a pre-eminent position to, let's say to have those contractors in our network as opposed to any of our competitor’s network.

George Tong

And sticking with American Home Shield. Can you provide an update on how much you’ve increased your, in-network contractor base by, in the quarter and thoughts on what level of contractor growth is appropriate to support high single low double-digit revenue growth in the segment?

Robert Gillette

Sure. I am not going to comment on the number of contractors that we’ve added. But there has been a significant inflow of contractors into the network, I can assure you that. So, the pipeline remained strong. We still believe that the way we are managing and the signals we see from contractors don’t provide any significant tailwinds to the level of, let's call it, mid to high single-digit volume growth that we are projecting for this business.


Our next question comes from the line of Andy Whitman with Robert W. Baird. Please proceed with your question.

Andy Whitman

On the insurance accrual adjustment, I just want to recognize that those are mostly for prior periods. But what does it say about your current accrual rate, and maybe just to put some in context. Was there an adjustment last year also? And is there an implication on margins that you might need to accrue more aggressively, or take more expense, so that we don’t have more of this in the future?

Alan Haughie

No, I don’t believe so. I mean, our 26 -- so all of the assessments are actuary at the rates of which we’re accruing in 2016 are more than adequate. So it's not that those as a foregoing expense. If you think about Rob’s comments, particularly around safety as well, I think in the last 18 to 24 months, our process of handling claims as they come in has improved significantly. And so no I don’t actually see an issue with ongoing expense for this. This is an actuary reappraisal of a long tail of claims that preceded most of us in the company today.

Andy Whitman

Then just on the Terminix business and the organic trends there. It sounded like you guys were generally happy with the Terminix -- termite side, but the pest side, where you saw some of the disappointment. I guess, when you break it down, was it the couponing that weighed on that top line or competitive factors there? Or were you seeing just volume weakness from the market? I guess a little bit more context for why you saw some of the weaker trends on the pest side, would be helpful.

Robert Gillette

I think it's kind of both. I think in terms of activity, there is clearly activity but not significant core organic growth in terms of activity in the marketplace. And I think we’re, as we’ve talked about before, we’re trying different approaches to provide value to customers in different ways. So combining services, whether it's termite or pest or other things and innovative ways to get value to customers, so I think part of it is has been learning experience. And I think part of it is our execution over the period.

And I feel good about the position we’re taking now and the improvements that we’ve made to some of what Alan alluded to in his safety and other things. And we’re making sure that we put the tools in place to do all those things consistently. So, we just call it out because we’d like to see obviously more organic growth to the business. And the Alterra acquisition has done really well, but we still want the core market to continue to grow. So, I think we’ve learned a lot and we continue to implement changes that will pay off in the future.


Our next question comes from the line of Gary Bisbee with RBC Capital Markets. Please proceed with your questions.

Jay Hanam

This is actually Jay Hanam on the line for Gary today. I noticed that in OneGuard service offerings, several that don’t fall under the typical Terminix HS product line umbrella. How should we think about this? So they all be retained, or is this maybe an attempt that some product expansion?

Robert Gillette

As I said, we’re going to continue the business and the brand as it is. We think they’ve taken some really innovative approach to the real-estate side of the equation. So, people that buy homes and then adding services and more importantly reinforcing the relationship and the coverages that they do have, so we’re going to maintain and try and learn from them and maybe see if there is opportunities for us to expand that offering. So, they’ve done a really great job in growth, and delivering to customers. So I think there is opportunities for us to learn from them.


Our next question comes from the line of Anj Singh with Credit Suisse. Please proceed with your question.

Anj Singh

I wanted to touch first on the termite part of Temrinix. It seems over the past year and half or so that growth there continues to slow. I realized you guys are -- you sound optimistic about your efforts there. But it seems to still be flattish completions and other services down slightly, renewals up slightly. And your competitors continue to seemingly grow faster than the rates you’re seeing. So could you just talk about what’s driving that? And I think you had expressed some optimism on the termite transfer the later part of the year. So, are you less optimistic now? If could just help us understand those things. Thanks.

Robert Gillette

Sure. I think, as we know the market itself is not growing a lot in the last two years, two to three years. So, that’s part of the equation. I think that some of the approaches we’re taking to providing multiple services to the same customer have an impact that makes it a little less transparent on the outside. Remember when we say core termite is one part that we’re happy with and the growth. And when we report termite, in general, there is all the other services tied to it.

And in number, you can’t just look it as termite solely. But I do think that we’ve positioned the product and the service that we have in positive that will increase growth in the future. So we feel pretty good about it. We’d always like it to be more. And as we mentioned, the lifetime value of that business is critical and probably one of our best, similar to DTC and American Home Shield. So, growing the base and expanding the services to more customers is our focus.

Anj Singh

And for my second question, I was hoping you could talk a little bit about the marketing expense as it relate to Terminix and more broadly. It seems like Terminix more getting expense is basically flat for the first half of ’16 versus the last year. I guess, first, have you pulled back on your marketing expense plans for Terminix, are you proceeding in line with your initial expectations? And then more broadly, are you no longer anticipating, going forward, some marketing expense from 2016?

Robert Gillette

I guess I’ll take the last part first. It depends on where we are and what opportunities we see. So we still look at, as we talked about in the prior call, the potential of moving some of those expenses in, whether it's IT investment or marketing. So, we continue to do that. Collectively, you saw that we spend more on marketing in Q2 of this year versus last year. So, we’re up somewhat.

I would say a lot of the work that’s been done in marketing in Terminix has been focused on translating some of the digital capabilities that we have in American Home Shield through the new marketing organization and focusing on lead generation in different ways. So, versus the classical TV advertising and other things that we’ve done, there is much more element of digital, email, and other types of media that we’re using to create leads. So it's more of a mix shift and a change in how we’re going to market, but no real reduction in how we’re spending to grow the Terminix business.


Our next question comes from the line of Sara Gubins with Bank of America, Merrill Lynch. Please proceed with your question.

Sara Gubins

First, given the improving termite sales, should we see completion revenue grow in the back half of the year on a year-over-year basis?

Alan Haughie

I think the increase in -- not necessarily, no. I wouldn’t -- we’re certainly not banking on that, and which is we’d like to see it. The increase in completion revenue dollars will generate renewal revenue on the anniversary of those sales that we’re seeing, that’s the real thrust of where the ultimate growth comes from by virtue of having these additional completions. So we won’t see a flow through into revenue of those additional sales of any significance until 2017.

Sara Gubins

Okay and then turning to AHS. Could you talk about how we should think about margins for AHS in the back half of the year? And comment about the investment revenue hit to the quarter, given that you’ve now de-risked that. Is that actually going to be a drag on margins for the next couple of quarters?

Alan Haughie

Well, we certainly won’t be getting any more investments gains in American Home Shield. So, if you look at it from that perspective, from quarter-to-quarter, year-over-year of course it wouldn’t have any impact. Comparing second half to first-half, we will see a huge margin increase in American Home Shield from the second half to the first-half. As I said on earlier, the marketing spend was front loaded and that was year-over-year increase of about $10 million and we won’t see that in the second half of the year.

The third quarter in American Home Shield is our highest revenue quarter in the year. We have the acquisition of OneGuard and we have the massive tailwind from the fourth quarter claims expense that was from last year. So, there will be a significant margin improvement in the second half of the year.


And our next question is from the line of Jeff Goldstein with Morgan Stanley. Please proceed with your question.

Jeff Goldstein

You touched on this a little earlier. But with the recent acquisition of OneGuard, they offer services beyond just your typical home warranty, like pest control and carpet cleaning. I was just thinking, is this something you’re contemplating, doing within American Home Shield as well and maybe cross-selling with your other segments. If you could just talk about any opportunity there, that’d be helpful.

Robert Gillette

I think if you look at the way they’ve gone to market, they do it in concert with other companies as well, so not as similar to what we would do in other pieces of business. But there is also the lot changing side of it and other things. I think the real, the way to look at it is, it's an innovative way on the real-estate channel to create more stickiness from a customer perspective and improve retention in first year and beyond.

So, we think it's pretty creative in making sure you touch the customer, and it just isn’t a line item on the closing statement. But it's real. And if you go and look at people who acquire home in the first six to eight months spend more to either improve the home or make modifications to their liking or other things than they do over five years, typically.

So there is an opportunity to sell the other services that we provide in ServiceMaster as well. So we like the way they’ve approached it, and I think its additive to the way we felt with the real-estate market and how we could potentially grow.

Jeff Goldstein

And then just on the $90 million settlement, that’s related to the Virgin Islands case. Could you just talk about any measures you’ve taken to prevent the similar situation from reoccurring again in the future?

Robert Gillette

I mentioned the investment in the environmental practices and safety practices that we’re making. And we continue to do that and continue to look at improving our processes in general. So, I think that we have the right process and disciplines in place to prevent that type of thing happening in the future and we are certainly focused on it in a big way.


Mr. Shields, I’ll turn the call back to you for your closing remarks.

James Shields

Thank you again for participating in today’s conference call and webcast. As a reminder, a replay of the call will be available on our Web site in about one hour. We look forward to speaking with you. Thank you, Operator.


Ladies and gentlemen, that does conclude the conference call for today. We thank you for your participation and ask that you please disconnect your lines.

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