Ladies and gentlemen, welcome to ServiceMaster's Second Quarter 2018 Earnings Call. Today's call is being recorded and broadcast on the Internet. Beginning today's call is Jesse Jenkins, ServiceMaster's Senior Director of Treasury and Investor Relations, and he will introduce the other speakers on the call. At this time, we’ll begin today's call. Please go ahead, Mr. Jenkins.

Thank you, Tia. Good morning and thank you for joining our second quarter 2018 earnings conference call. Before I review the agenda and introduce the other speakers, 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, July 31, 2018. The company undertakes no obligation to update any information discussed on today’s call. This morning, ServiceMaster issued a press release filed with the SEC on Form 8-K, highlighting our second quarter 2018 financial results. The press release and the related presentation can be found on the Investor Relations section of our website. We will reference certain non-GAAP financial measures throughout today's call, and we have included definitions of these terms in our press release, which is available on our website at www.servicemaster.com. We'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 to EBITDA are to adjusted EBITDA as 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. For those following along with the presentation available on our website, I’ll walk through the agenda items shown on Slide 3. Nik will lead off by providing second quarter 2018 highlights. We will then provide an update on the American Home Shield separation and progress on the Terminix business transformation. Tony will follow and summarize our consolidated second quarter 2018 financial results, review the individual business unit results, provide more details in regard to our financial statements and then speak to the updated full-year 2018 outlook. We will then open the line to allow questions. I'll now turn the call over to ServiceMaster's CEO, Nik Varty for opening comments. Nik?

Thanks Jesse. Thank you all for joining us today and your interest in our company. I will start with our highlights on the quarter on Slide 4. We were pleased by the strong revenue growth across our businesses in the second quarter. Our transformation efforts at Terminix are on track and beginning to drive improved NPS scores, revenue growth and profitability. While the expansion of our presence in the commercial disaster restoration business and the strengthening of the commercial cleaning business drove improved results at the Franchise Services Group or FSG. We reported an 8% year-over-year revenue increase to $874 million in the quarter with organic growth in all our segments highlighted by 9% growth in American Home Shield or AHS and 14% in the franchise services group. This topline growth continued to the bottom line with adjusted net income of $108 million up $15 million year-over-year and adjusted EPS of $0.11 per share to $0.79 per share or 16% higher over the same quarter last year. Free cash flow generation continues to be a trend of the company, as we generated $119 million in the second quarter, which is 110% of adjusted net income. We are continuing to focus on acquisitions that add strategic value to our business. We delivered $25 million of growth to Copesan and four additional pest control companies we acquired in the second quarter. The acquisition of Cooper Pest Control will significantly enhance our expertise and capabilities to deliver bedbug solutions, and we can leverage these across our entire customer base. We are making meaningful strides in other areas of the Terminix transformation with a focus on enhancing our service delivery to drive customer satisfaction to new levels. We are also driving empowerment towards the organization with keen focus on providing our technicians and local…

Thanks, Nik, and good morning, everyone. Before I begin, I would like to take this opportunity to personally congratulate Brian Turcotte on his new appointment as CFO of the American Home Shield business. He has been a valued member of my finance team, and I know he will do a tremendous job in his new role. I would also like to recognize Jesse Jenkins on his well-deserved promotion and look forward to working with him in his new role. Turning to Slide 8, total company revenue grew $67 million or 8% compared to the prior year. Our results were driven by continued strong organic revenue growth of 9% at AHS, predominantly driven by unit growth and price realization and 14% at FSG driven by continued janitorial national accounts growth and higher disaster restoration royalty fee. Terminix revenue is up over 6% mostly due to the acquisition growth for Copesan. Adjusted EBITDA for the quarter is now $2 million or 1% compared to the prior year. As we previously released, the decrease was driven primarily by the $22 million increase in year-over-year claims cost at American Home Shield. The claims cost increase was predominantly driven by an increase in appliance replacements versus repairs that we will discuss in more detail in a moment. Higher claims costs were offset by higher revenue conversion in all of our segments and Terminix business productivity. Our adjusted net income for the second quarter was $108 million, a $50 million increase versus prior year. Adjusted diluted earnings per share of $0.79 was up 60% versus prior year. The increase on the bottom line was primarily driven by a lower effective income tax rate as we continue to realize the benefits of the Tax Cuts and Jobs Act of 2017. Turning to Slide 9, I will detail…

Thanks Tony. 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 questions, so that we can get to everyone in the allotted time. Tia, let’s open up the line for questions.

[Operator Instructions] And our first question comes from the line of Judah Sokel with JPMorgan. Please proceed with your question.

I just wanted to ask a quick question, a housekeeping, could you tell us the NPS scores or the retention rates how those trended in the quarter? You've been kind enough to provide those in the last couple of quarters and it’s really key for assessing how that turnaround is going at Terminix.

We don't give out the absolute numbers. As you know, we get to a trend on how we perform. And as you - as I mentioned earlier, our test NPS scores are up 5% and termite NPS scores are up 9%, which is an encouraging sign given the amount of work we have to do to turn around performance issues and all that we've faced in the past. And what I've seen are extremely encouraging trends in terms of behavior, in terms of the motivation. And if look at that, we did register 0.5% organic growth this quarter which is very much in line with our expectations. As we focus on the quality of revenue, we are trying to generate a reasonably challenging quarter last year which had a conversion to bait stations which has a onetime effect. Barring that, we would've been closer to 1% growth rate. So, I think, all in all, on the residential side, we've seen some significant improvements on the pest side. We're starting to see some improvements on the termite side because our first focus was passed. And I'm pretty encouraged with what I'm seeing and see for the rest of the year. On the commercial side, as you know, we started that work fairly late in the game. Our first focus was residential when Kelly coming on board about four, five months ago. And we're starting to see some improvement given our efforts with Copesan. But that's going to take a little while to turn compared to the residential side as well.

And just from my follow-up question, I was hoping to dig a little bit more into the issue in AHS of parts availability. I'm just trying to understand a little bit what is going on to drive that dynamic. Did anything change in terms of the vendors, perhaps, mergers or anything changing your relationships with those vendors, have input costs for those parts gone up and there? And this is simply a case of the vendors putting it through to you guys. Maybe you could just discuss a little bit about what's driving that dynamic. Thank you.

You did notice this is a trend, and we look at it. This is across the industry, so it's not just American Home Shield, but we've seen across the whole industry that appliance placement rates are going up and parts availability being a major issue. Now, we're working being one of the largest players, and we are working very systematically with a lot of our vendors to improve that situation and curtail that. So, this is not – the costs haven't gone up per se. The issue is just the availability of parts.

Our next question comes from the line of Ian Zaffino with Oppenheimer. Please proceed with your question.

Just a quick question on the AHS side. What sort of the market's tolerance for maybe price increases there, or maybe you could give us an idea of what you've done historically when situations like this have happened in the past. How long does it take you to recoup any of the lost margin, et cetera? Thanks.

In this market, typically, we have been able to raise prices anywhere from 1% to 2% and also being able - very successfully with that because we match with the industry trends. And typically, we are much better able to anticipate these and get the pricing in place. We've seen typically – we've been able to counter inflation. As you've seen, we’ve generated steady margins or consistent margins over the past few years. We have seen replacement rates actually jump about 200% - 200 basis points compared to last year, which is a much larger uptick than you've seen in the past, which is closer to the 100% increase. And there are several different reasons why that is happening, as I mentioned earlier. So, it’s an ability. I think one other thing we’re doing, Ian is we have improved our systems and our capabilities or visibility to anticipate some of these changes in a better way. For example, we are putting in not only visibility but people who will be looking at this on a daily basis. So, we see the trend uptick and we can react much quicker than we did in this instance. The other thing we're looking at is an upgrade in our system to do dynamic pricing. What I mean by dynamic pricing is rather than having across the board consistent pricing we're looking at now via zip code and what the price elasticity is and there are certain customers who were able to bear more pricing or we know that these - the profiles in certain areas is much more severe in terms of cost and the customers are actually willing to pay that kind of pricing to go in. The question is improving our capability to match that going into the business while we take these accounts rather than react to it like we're doing at this stage.

Our next question comes from the line of Andrew Wittmann with Baird. Please proceed with your question.

I wanted to dig into the AHS claims costs and its impact on guidance. Not so much on 2018 but as you - first of all, thank you for the detail on slide 12. When we look at this the line that draws the most attention to me is the higher appliance replacement rates in 2008 which is a $12 million variance from your prior look. So, I guess I just want to confirm that’s basically a three-quarter adjustment of $12 million or an average about $4 million per quarter implying potential $16 million annual headwind. Tony, is that the right way to think about how the replacement issues are affecting the business net of any remedial actions that you're taking?

Yes. I think it's more like $3 million a quarter on an ongoing basis rather than $4 million. I would use that $12 million a year or $3 million a quarter.

And how do we think about the replacement thing? It seems like this is going to have been an issue that's going to carry on. You've got the mitigating factors. When do you think that your actions could take effect? And how do you consider the weather that's happened this year? Is it unusually hot versus averages, or how should we factor in the weather impact as we think out into next year?

There's a couple of questions there, Andy. If you look at summer, this particular May was, in the last 124 years that weather has been measured, was the hottest May in history almost by an average of 5 degrees across most states, which is a significant increase. So, this is an anomaly. Weather has always been up or down, but over time, you see that kind of even out as we see. It was a hot May, but we're going to see some normalization in some months. And we don't normally try to play and predict weather. So, we typically in our estimates predict the normalized impact as we keep calculating. But May was a huge anomaly for this year across all practically every state in the U.S. On the other questions on replacement rates, there's a couple things we’re doing. Number one important thing to me always is about people. And by putting in not only Rex at a C-suite but a very capable team under him, we believe that there's a team that is much more capable combined with the visibility we’re putting in the systems and early warning system that this team is able to take accountability and rapid actions to match that. This whole concept of dynamic pricing which is fairly new and being installed in place will also allow us to anticipate the nature of business by zip code. As I mentioned, knowing specific elasticities of different markets that we’re able to price these based on anticipated trends rather than reactionary trends. So, why we are deeply disappointed with what happened here especially from the timing, not the replacement rates because that's a trend, the key is how quickly can you anticipate and react to these trends. What I'm really interested about is, how well Rex and the team reacted to this situation and how rapidly they have put some action plans in place already starting to raise prices. Over two-thirds of the business is already sort of in the bank, it's hard to cycle that through in less than a year. But going forward, I think this is - what's really good about this is I can - I have a strong conviction that this situation won't happen or it’s highly unlikely to happen again or creep up on us because we have good people, good prophecies, good systems, good visibility, matching pricing. So we're putting all the ingredients in place to run this incredibly strong business going forward.

If I can, I wanted to dig into the impact of your contractor network as well, specifically, your usage of preferred contractors. Anybody who's read the pros press or owns a house knows that it's hard to find these specialty contractors today. Are you guys having to go out of network or use less preferred contractors? And how much of a factor is that into the AHS cost headwinds that we've seen so far this year, if at all?

Yes, Andy. I’ll take that one. That is not an issue this time. We’re still running roughly 80% of our cost through preferred contractors. So, that was not the issue as we strictly repair – replace versus repair this time around. So, we're doing a good job of maintaining our contractor network, our preferred percentage all in line with our expectations and goals.

Our next question comes from the line of Tim Mulrooney with William Blair. Please proceed with your question.

Just piggybacking on Andy's question with the weather related issues that AHS, in your preliminary results statement you said that the revised outlook for 2018 included an annualized $12 million from ongoing contract claim costs and $18 million from increased number of claims due to weather. I didn't hear you guys mentioned this $18 million figure in your press release today or in your comments today. Is this still a relevant number?

Yes. This is Jesse. That $18 million is not an accurate number. We shouldn’t use the new guidance that we had provided based on weather. So, only $3 million of that actually impacts the guidance going forward the rest of the year.

And that's the $3 million that we saw in the second quarter because mostly the unusually hot May.

So, if I'm thinking about 2019 would it be fair to just assume a normalized rate I would add back that $3 million to get a base number and then and then add back 30% incremental operating margins on your organic growth rate? Is that a good way to think about AHS margins moving forward?

I think so – I mean the way I look at it is the ongoing impact of the replacement versus repair issue is $3 million a quarter or roughly $12 million, whether it's going to – we think over time EBITDA some years will be hotter than normal, some years will be colder than normal or less weather impact than normal. So I look at it as $12 million of higher cost in our operating base going forward because of this issue we're facing with appliance parts.

But we would have in tandem pricing that is reflecting that increase, so we can take care of that and help our margins going forward.

It’s high that we’ll offset that with actions, pricing and supply chain actions.

And that will allow us to get back to the historical margin levels.

Yes.

Okay.

So, whether we don’t normally - we will never predict whether, so we usually take the history and use that as a normalized pattern of what will happen next year.

That's more simple way of looking at it. Thank you. That's very clear now. And then shifting gears to Terminix, your pest control revenue growth of 11% was quite a bit stronger than what we've seen recently. Were there any onetime items to think about here or are we really starting to see the impact from the turnaround effort?

Apart from the residential improvements that we’ve seen, the bulk of it really came from actually the acquisition of Copesan and some of the smaller acquisitions we made, but mainly Copesan. One of the reasons you see a guidance bump is not only that new acquisitions, but our retention rates at Copesan were way higher than what we had anticipated because we've been able to pretty much retain all customers with the with the combination. And as I mentioned in my remarks earlier, Copesan actually grew at higher than market or 6.5% year-over-year organic growth. We don't count that in organic today because Copesan is an acquisition. So, that shows up in our inorganic growth, but Copesan registered a very sizable growth this quarter for us.

Got it. Thank you.

This is a great sign for us. It’s a real – again, a reaffirmation that we did the right thing, and the execution of the integration is – the team has done a great job.

Just to add to that, Copesan will add significant capabilities all throughout our commercial business, so we're very in line in that acquisition.

Our next question comes from the line of Michael Hoffman with Stifel. Please proceed with your question.

Thank you very much for taking the question. You answered this earlier. I just didn't hear it very well. Sorry. I apologize for asking it again. How did you frame the retention in the quarter by residential versus commercial – pest control? Sorry.

We have started breaking out residential versus commercial. But what I said is we've seen an overall NPS for improvement of 5% on pest and about 9% on termite, which is the strongest correlation of future organic growth for us. Now, what I mentioned between residential and commercial is we started the efforts on residential of bringing in a new leader, completely resetting the team and focusing very hard on our transformation effect as one of the first pillars outright during the company almost a year-to-date ago. And so, we’ve seen much improvement in that because we've been more into that game. On the commercial side, we brought in a leader in Kelly four or five months ago. He's been building our team. We had acquired Copesan and a couple of others. So, we’re very strongly focused in that business where we were number 4 with $300 million today, number 3 with about $375 plus million. We are making progress but it will take us some more time to get to the same level of improvement we're already seeing in residential and we'll continue to see. So, I would say that I'm pretty encouraged with the progress we've made on the residential side on the pest, and on the commercial side I’m seeing good signs, the number 1 is putting in the people, learning from the Copesan practices, combining our national account teams with each other. So there are some good things going on which will bode well towards the end of the year or going into next year.

Well, to sort of stretch that further than underlying residential growth of the markets 1% to 2%, you're not growing in line with that, that means your retention is still hampering that. When do you see getting back in line with the underlying market growth?

As I've mentioned, when we took over this we are doing a lot of improvements in terms of what we've done is moved away from a complete centralized model to a smart central and much of a more decentralized given the business back into the branches. So, resetting the metrics from 40 to 45 fluctuating metrics or seven key metrics which I reiterated in my script today, changing the pace structure of our technicians which is bearing dividends already So, a lot of these things take a while. Any recurring business, a significant portion of that is in our - already in our numbers and we've still seen struggles on retention but we're starting to see some noticeable improvements and we will continue to see that as we go forward in the next quarter. And on the presidential side and we're still improving in the commercial. And as I've mentioned before, we have guided the whole year to be 1% to 2% given the knowledge of the underlying issues we have and the fix we have because what we want to come to, Michael, eventually is a business that can sustainably grow without impacts on one-timers and all is really on a sustainable basis that we are able to deliver at or above market growth going forward and that takes the hard work we have to do which we continue to see a lot of progress on.

And then one housekeeping question, when can we expect to see the Form 10, so we can be prepared from a standpoint of depth of data we're going to get from that?

In the next couple days - coming days.

And our next question comes from the line of Toni Kaplan with Morgan Stanley. Please proceed with your question.

The amount of dis-synergies that you're projecting in 2019 is a fair amount lower than what we were previously thinking. And so, just trying to understand, are there any other costs that could be potentially incurred annually that might be higher than if you were keeping the companies together? Just trying to understand if there are some factors that could drive the dis-synergies higher. Thanks.

We think we're okay with that. I think our estimates are pretty strong. We've been working really hard to ensure we're minimizing those going in, but making sure we're not cutting any corners. We are making sure we’re at help setting two independent companies for success. So I think the $9 million forecast we’re giving for the year, we're standing by it and we believe that should be fine for this year. The annualized impact, as I mentioned, next year for the full year would be around $20 million. And that includes not only duplication of functions like finance, HR, IT, legal and others that necessary for two public companies but also some of the stranded costs that remain at ServiceMaster which we have to continue to that.

And I will add to that, our goal over time is to drive productivity to offset as much of these as we can. So, that will keep testing that as we go through in the future.

And in terms of the inorganic contribution in the Terminix business from Copesan and the other acquisitions, would you be able to provide a split for us of how much was Copesan? Just trying to understand if there's, like, basically the seasonality by quarter for Copesan. And you mentioned the 6% growth in that business. How does that compare to what it was growing at before you acquired it? And I guess how fast are the other acquired businesses growing? Thanks.

Well, the global growth that we delivered to our acquisitions including organic growth over there with the growth last year was $25 million for the quarter. Now, it's hard for you to estimate what the other four were because there were quite different parts during the year. And we've given some of the upgraded guidance for the rest of the year. We're not getting into the details of exactly which acquisitions delivering how much, I mean…

In Q2, Copesan is the vast majority of the increase. And so – and then I will say on the growth in the second quarter, Copesan grew –we had a very strong growth rate of over 6.5%. Again, just to reiterate, we're not counting that as organic even though it's occurring after the acquisition per year. We'll count that as inorganic. So, Copesan did have a good quarter, and we're really excited about Copesan going forward

And is there a seasonality in that business like a higher amount in fourth quarter than another quarter or something like that?

I think in all of our businesses there's always some element of seasonality in the second and third quarter being higher than the first and fourth quarter being lower. So, that always has to be taken into account for any of our past differences.

And our final question comes from the line of Jamie Clement with Buckingham Research. Please proceed with your question.

Nik, did you say pro forma for Copesan and commercial pest control is about 375 on an annual run rate basis. Is that right?

Yes. Annualized.

And now that you’re on the business for a couple of months, as you look to share best practices and those kinds of things, obviously, great growth from them. What do you think you all can learn from the folks of Copesan to help build your commercial business over time?

Well, number one is the consistency in the delivery of their service and how closely they are aligned to every single customer whether they understand the needs. All those needs are baked into the tech practices. And they have an incredibly strong quality assurance system which is something we can strongly benefit from. And as I’ve mentioned earlier, we are in the process of combining our national accounts, so even if we acquire Copesan, Copesan is our brand. We're very proud of it and we're combining our Terminix commercial national accounts into Copesan directly. And we’ve appointed a leader from Copesan to drive those accounts for us. So, we will soon start seeing some of those benefits in our systems as well. Now, our Chief Transformation Officer is very deeply tied with them and we're working extremely closely not only to use some of their best practices, like I said, customer - deep understanding of customers' specific requirements, baking them into our protocols, almost like a pack having a clean recipe book on what exactly you do. There's independent quality assurance built into that system, good communications with the customer. So, all those will benefit, not only the national accounts at Terminix going forward, but also other commercial customer accounts that we have. And we are learning these best practices not only from the Copesan from a front-end perspective, but also the partners who help deliver the service today. We're partnering very strongly with them and it's been incredibly open and fruitful relationship for us.

Thank you, all, 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 1 hour from now. We look forward to speaking with you on the third quarter earnings call currently scheduled for October 30. Thank you.

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