TERMINIX GLOBAL HOLDINGS INC - Quarter Report: 2014 September (Form 10-Q)

 

 

 

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

 

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FORM 10-Q

 

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For the quarterly period ended September 30, 2014

 

or

 

For the transition period from                    to                    

 

Commission file number 001-36507

 

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ServiceMaster Global Holdings, Inc.

(Exact name of registrant as specified in its charter)

 

Commission file number 001-14762

 

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The ServiceMaster Company, LLC

(Exact name of registrant as specified in its charter)

 

860 Ridge Lake Boulevard, Memphis, Tennessee 38120

(Address of principal executive offices) (Zip Code)

901-597-1400

(Registrant’s telephone number, including area code)

 

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.

 

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).

 

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See definitions of “large accelerated filer,” “accelerated filer,” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.

 

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).

 

The number of shares of the registrant’s common stock outstanding as of November 3, 2014:

The ServiceMaster Company, LLC is a privately held limited liability company, and its membership interests are not publicly traded. At November 3, 2014, all of the registrant’s membership interests were owned by CDRSVM Holding, LLC. 

 

 

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EXPLANATORY NOTE

 

This Form 10-Q is a combined quarterly report being filed separately by two registrants: ServiceMaster Global Holdings, Inc. and The ServiceMaster Company, LLC. Unless the context indicates otherwise, any reference in this report to “Holdings” refers to ServiceMaster Global Holdings, Inc., any reference to “SvM” refers to The ServiceMaster Company, LLC, the indirect wholly-owned subsidiary of Holdings, and any references to the “Company,” “we,” “us,” and “our” refer to ServiceMaster Global Holdings, Inc. together with its direct and indirect subsidiaries, including SvM. Each registrant hereto is filing on its own behalf all of the information contained in this quarterly report that relates to such registrant. Each registrant hereto is not filing any information that does not relate to such registrant, and therefore makes no representation as to any such information. 

 

 

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TABLE OF CONTENTS

 

 

 

 

 

 

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PART I. FINANCIAL INFORMATION

 

ITEM 1. FINANCIAL STATEMENTS

 

Condensed Consolidated Statements of Operations and Comprehensive Income (Loss) (Unaudited)

(In millions, except per share data)

 

 

 

See accompanying Notes to the unaudited Condensed Consolidated Financial Statements

 

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Condensed Consolidated Statements of Operations and Comprehensive Loss (Unaudited)

(In millions, except per share data)

 

 

 

See accompanying Notes to the unaudited Condensed Consolidated Financial Statements

 

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Condensed Consolidated Statements of Financial Position (Unaudited)

(In millions, except per share data)

 

 

See accompanying Notes to the unaudited Condensed Consolidated Financial Statements

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Condensed Consolidated Statements of Cash Flows (Unaudited)

(In millions)

 

 

See accompanying Notes to the unaudited Condensed Consolidated Financial Statements

 

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SERVICEMASTER GLOBAL HOLDINGS, INC. AND THE SERVICEMASTER COMPANY, LLC

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(UNAUDITED)

 

Note 1. Basis of Presentation

The unaudited condensed consolidated financial statements of ServiceMaster Global Holdings, Inc. include the accounts of ServiceMaster Global Holdings, Inc. (“Holdings”) and its majority-owned subsidiary partnerships, limited liability companies and corporations (collectively, the “Company,” “we,” “us, and “our”), including The ServiceMaster Company, LLC (“SvM”). The unaudited condensed consolidated financial statements of The ServiceMaster Company, LLC include the accounts of SvM and its majority-owned subsidiary partnerships, limited liability companies and corporations. All consolidated Company subsidiaries are wholly-owned. Intercompany transactions and balances have been eliminated.

The Company is a leading provider of essential residential and commercial services. The Company’s services include termite and pest control, home warranties, disaster restoration, janitorial, residential cleaning, furniture repair and home inspection. The Company provides these services through an extensive service network of company-owned, franchised and licensed locations operating primarily under the following leading brands: Terminix, American Home Shield, ServiceMaster Restore, ServiceMaster Clean, Merry Maids, Furniture Medic and AmeriSpec.

The unaudited condensed consolidated financial statements have been prepared by the Company in accordance with generally accepted accounting principles in the United States (“GAAP”) and pursuant to the rules and regulations of the U.S. Securities and Exchange Commission (“SEC”). The Company recommends that the quarterly unaudited condensed consolidated financial statements of Holdings be read in conjunction with the audited consolidated financial statements and the notes thereto included in Holdings’ Registration Statement on Form S-1 (File No. 333-194772), as amended (the “2014 Form S-1”), and the unaudited quarterly condensed consolidated financial statements of SvM be read in conjunction with the audited consolidated financial statements and the notes thereto included in SvM’s Annual Report on Form 10-K for the year ended December 31, 2013, as filed with the SEC (the “2013 Form 10-K”). The unaudited condensed consolidated financial statements reflect all normal and recurring adjustments that are, in the opinion of management, necessary for the fair presentation of the financial position, results of operations and cash flows for the interim periods presented. The results of operations for any interim period are not indicative of the results that might be achieved for a full year.

TruGreen Spin-off

On January 14, 2014, the Company completed a separation transaction (the “TruGreen Spin-off”) resulting in the spin-off of the assets and certain liabilities of the business that comprise the lawn, tree and shrub care services previously conducted by the Company primarily under the TruGreen brand name (collectively, the “TruGreen Business”) through a tax-free, pro rata dividend to the stockholders of Holdings. As a result of the completion of the TruGreen Spin-off, TruGreen Holding Corporation (“New TruGreen”) operates the TruGreen Business as a private independent company. The historical results of the TruGreen Business, including the results of operations, cash flows and related assets and liabilities, are reported as discontinued operations for all periods presented herein.

Reverse Stock Split

On June 13, 2014, Holdings effected a 2-for-3 reverse stock split of its common stock. Holdings’ accompanying unaudited condensed consolidated financial statements and notes thereto give retroactive effect to the reverse stock split for all periods presented. 

Initial Public Offering

On June 25, 2014, Holdings’ registration statement on Form S-1 was declared effective by the SEC for an initial public offering of its common stock. Holdings registered the offering and sale of 35,900,000 shares of its common stock and an additional 5,385,000 shares of its common stock sold to the underwriters pursuant to an option to purchase additional shares. On July 1, 2014, Holdings completed the offering of 41,285,000 shares of its common stock at a price of $17.00 per share. The net proceeds and use of proceeds in connection with the offering are summarized in the table below:

 

 

 

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Note 2. Significant Accounting Policies

Summary:  The preparation of the unaudited condensed consolidated financial statements requires management to make certain estimates and assumptions required under GAAP which may differ from actual results. The more significant areas requiring the use of management estimates relate to revenue recognition; the allowance for uncollectible receivables; accruals for self-insured retention limits related to medical, workers’ compensation, auto and general liability insurance claims; accruals for home warranties and termite damage claims; the possible outcome of outstanding litigation; accruals for income tax liabilities as well as deferred tax accounts; the deferral and amortization of customer acquisition costs; share based compensation; useful lives for depreciation and amortization expense; the valuation of marketable securities; and the valuation of tangible and intangible assets. In 2014, there have been no changes in the significant areas that require estimates or in the underlying methodologies used in determining the amounts of these associated estimates.

The allowance for receivables is developed based on several factors including overall customer credit quality, historical write-off experience and specific account analyses that project the ultimate collectability of the outstanding balances. As such, these factors may change over time causing the reserve level to vary.

The Company carries insurance policies on insurable risks at levels which it believes to be appropriate, including workers’ compensation, auto and general liability risks. The Company purchases insurance from third-party insurance carriers. These policies typically incorporate significant deductibles or self-insured retentions. The Company is responsible for all claims that fall within the retention limits. In determining the Company’s accrual for self-insured claims, the Company uses historical claims experience to establish both the current year accrual and the underlying provision for future losses. This actuarially determined provision and related accrual include both known claims, as well as incurred but not reported claims. The Company adjusts its estimate of accrued self-insured claims when required to reflect changes based on factors such as changes in health care costs, accident frequency and claim severity.

The Company seeks to reduce the potential amount of loss arising from self-insured claims by insuring certain levels of risk. While insurance agreements are designed to limit the Company’s losses from large exposure and permit recovery of a portion of direct unpaid losses, insurance does not relieve the Company of its ultimate liability. Accordingly, the accruals for insured claims represent the Company’s total unpaid gross losses. Insurance recoverables, which are reported within Prepaid expenses and other assets and Other assets, relate to estimated insurance recoveries on the insured claims reserves.

Accruals for home warranty claims in the American Home Shield business are made based on the Company’s claims experience and actuarial projections. Termite damage claim accruals in the Terminix business are recorded based on both the historical rates of claims incurred within a contract year and the cost per claim. Current activity could differ causing a change in estimates. The Company has certain liabilities with respect to existing or potential claims, lawsuits, and other proceedings. The Company accrues for these liabilities when it is probable that future costs will be incurred and such costs can be reasonably estimated. Any resulting adjustments, which could be material, are recorded in the period identified.

The Company records deferred income tax balances based on the net tax effects of temporary differences between the carrying value of assets and liabilities for financial reporting purposes and income tax purposes. The Company records its deferred tax items based on the estimated value of the tax basis. The Company adjusts tax estimates when required to reflect changes based on factors such as changes in tax laws, relevant court decisions, results of tax authority reviews and statutes of limitations. The Company records a liability for unrecognized tax benefits resulting from uncertain tax positions taken or expected to be taken in a tax return. The Company recognizes potential interest and penalties related to its uncertain tax positions in income tax expense.

Revenue.  Revenues from pest control services, as well as liquid and fumigation termite applications, are recognized as the services are provided. The Company eradicates termites through the use of non-baiting methods (e.g., fumigation or liquid treatments) and baiting systems. Termite services using baiting systems and termite inspection and protection contracts are frequently sold through annual contracts. Service costs for these contracts are expensed as incurred. The Company recognizes revenue over the life of these contracts in proportion to the expected direct costs. Those costs bear a direct relationship to the fulfillment of the Company’s obligations under the contracts and are representative of the relative value provided to the customer (proportional performance

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method). The Company regularly reviews its estimates of direct costs for its termite bait contracts and termite inspection and protection contracts and adjusts the estimates when appropriate.

Home warranty contracts are typically one year in duration. Home warranty claims costs are expensed as incurred. The Company recognizes revenue over the life of these contracts in proportion to the expected direct costs. Those costs bear a direct relationship to the fulfillment of the Company’s obligations under the contracts and are representative of the relative value provided to the customer (proportional performance method). The Company regularly reviews its estimates of claims costs and adjusts the estimates when appropriate.

The Company has franchise agreements in its Terminix, ServiceMaster Restore, ServiceMaster Clean, Merry Maids, Furniture Medic and AmeriSpec businesses. Franchise revenue (which in the aggregate represents approximately six percent of annual consolidated revenue from continuing operations in 2013) consists principally of continuing monthly fees based upon the franchisee’s customer-level revenue. Monthly fee revenue is recognized when the related customer-level revenue generating activity is performed by the franchisee and collectability is reasonably assured. Franchise revenue also includes initial fees resulting from the sale of a franchise or a license. These initial franchise or license fees are pre-established fixed amounts and are recognized as revenue when collectability is reasonably assured and all material services or conditions relating to the sale have been substantially performed. Total profits from the franchised operations were $18 million for each of the three month periods ended September 30, 2014 and 2013, and $54 million and $51 million for the nine months ended September 30, 2014 and 2013, respectively. The portion of total franchise fee income related to initial fees received from the sale of franchises was immaterial to the Company’s unaudited condensed consolidated financial statements for all periods.

Revenues are presented net of sales taxes collected and remitted to government taxing authorities on the unaudited condensed consolidated statements of operations and comprehensive income (loss).

The Company had $511 million and $448 million of deferred revenue as of September 30, 2014 and December 31, 2013, respectively. Deferred revenue consists primarily of payments received for annual contracts relating to home warranties, termite baiting, termite inspection and pest control services.

Deferred Customer Acquisition Costs:  Customer acquisition costs, which are incremental and direct costs of obtaining a customer, are deferred and amortized over the life of the related contract in proportion to revenue recognized. These costs include sales commissions and direct selling costs which can be shown to have resulted in a successful sale. Deferred customer acquisition costs amounted to $38 million and $30 million as of September 30, 2014 and December 31, 2013, respectively.

Advertising:  On an interim basis, certain advertising costs are deferred and recognized approximately in proportion to the revenue over the year and are not deferred beyond the calendar year-end. Certain other advertising costs are expensed when the advertising occurs. The cost of direct-response advertising at Terminix, consisting primarily of direct-mail promotions, is capitalized and amortized over its expected period of future benefits. Deferred advertising costs are included in prepaid expenses and other assets on the unaudited condensed consolidated statements of financial position.

Inventory:  Inventories are recorded at the lower of cost (primarily on a weighted average cost basis) or market. The Company’s inventory primarily consists of finished goods to be used on the customers’ premises or sold to franchisees.

Property and Equipment and Intangible Assets: Fixed assets and intangible assets with finite lives are depreciated and amortized on a straight-line basis over their estimated useful lives. These lives are based on the Company’s previous experience for similar assets, potential market obsolescence and other industry and business data. As required by accounting standards for the impairment or disposal of long-lived assets, the Company’s long-lived assets, including fixed assets and intangible assets (other than goodwill), are tested for recoverability whenever events or changes in circumstances indicate that their carrying amounts may not be recoverable. If the carrying value is no longer recoverable based upon the undiscounted future cash flows of the asset, an impairment loss would be recognized equal to the difference between the carrying amount and the fair value of the asset. Changes in the estimated useful lives or in the asset values could cause the Company to adjust its book value or future expense accordingly.

Depreciation of property and equipment, including depreciation of assets held under capital leases, was $12 million and $11 million for the three months ended September 30, 2014 and 2013, respectively, and $36 and $35 million for the nine months ended September 30, 2014 and 2013, respectively.

The Company recorded an impairment charge of $47 million ($28 million, net of tax) in the nine months ended September 30, 2014 relating to its decision in the first quarter of 2014 to abandon its efforts to deploy a new operating system at American Home Shield. Included in this charge are the impairment of the capitalized software of $45 million and the recognition of the remaining liabilities associated with the termination of lease, maintenance and hosting agreements totaling $2 million. This impairment represented an adjustment of the carrying value of the asset to its estimated fair value of zero on a non-recurring basis.

Fair Value of Financial Instruments and Credit Risk:  See Note 16 for information relating to the fair value of financial instruments.

Financial instruments, which potentially subject the Company to financial and credit risk, consist principally of investments and receivables. Investments consist primarily of publicly traded debt and common equity securities. The Company periodically reviews its portfolio of investments to determine whether there has been an other than temporary decline in the value of the

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investments from factors such as deterioration in the financial condition of the issuer or the market(s) in which it competes. The majority of the Company’s receivables have little concentration of credit risk due to the large number of customers with relatively small balances and their dispersion across geographical areas. The Company maintains an allowance for losses based upon the expected collectability of receivables.

Income Taxes:  The Company and its subsidiaries file consolidated U.S. federal income tax returns. State and local returns are filed both on a separate company basis and on a combined unitary basis with the Company. Current and deferred income taxes are provided for on a separate company basis. The Company accounts for income taxes using an asset and liability approach for the expected future tax consequences of events that have been recognized in the Company’s financial statements or tax returns. Deferred income taxes are provided to reflect the differences between the tax bases of assets and liabilities and their reported amounts in the financial statements. Valuation allowances are established when necessary to reduce deferred income tax assets to the amounts expected to be realized.

The Company records a liability for unrecognized tax benefits resulting from uncertain tax positions taken or expected to be taken in its tax return. The Company recognizes potential interest and penalties related to its uncertain tax positions in income tax expense.

Stock-Based Compensation:  The Company accounts for stock-based compensation under accounting standards for share based payments, which require that stock options, restricted stock units and restricted share grants be measured at fair value and this value is recognized as compensation expense over the vesting period.

Earnings Per Share:  Basic earnings (loss) per share is computed by dividing net income (loss) by the weighted average number of shares of common stock outstanding. Diluted earnings (loss) per share is computed by dividing net income (loss) by the weighted-average number of shares of common stock outstanding during the period, increased to include the number of shares of common stock that would have been outstanding had potential dilutive shares of common stock been issued. The dilutive effect of stock options, restricted stock units and restricted share grants are reflected in diluted net income (loss) per share by applying the treasury stock method.

Newly Issued Accounting Statements and Positions:  In July 2013, the Financial Accounting Standards Board (“FASB”) issued Accounting Standards Update (“ASU”) 2013-11, “Presentation of an Unrecognized Tax Benefit When a Net Operating Loss Carryforward, a Similar Tax Loss, or Tax Credit Carryforward Exists” to eliminate the diversity in practice associated with the presentation of unrecognized tax benefits in instances where a net operating loss carryforward, a similar tax loss, or a tax credit carryforward exists. ASU 2013-11 generally requires an unrecognized tax benefit, or a portion of an unrecognized tax benefit, to be presented in the financial statements as a reduction to a deferred tax asset for a net operating loss carryforward, a similar tax loss, or a tax credit carryforward, except in certain circumstances. The amendments in ASU 2013-11 are effective for fiscal years, and interim periods within those years, beginning after December 15, 2013. The adoption of this standard did not have a material impact on the Company’s condensed consolidated financial statements.

 

In April 2014, the FASB issued ASU 2014-08, “Reporting Discontinued Operations and Disclosure of Disposals of Components of an Entity” to change the criteria for reporting discontinued operations and enhance the convergence of the FASB’s and the International Standard Board’s reporting requirements for discontinued operations. The changes in ASU 2014-08 amend the definition of discontinued operations by limiting discontinued operations reporting to disposals of components of an entity that represent strategic shifts that have or will have a major effect on an entity’s operations and financial results. ASU 2014-08 requires expanded disclosures for discontinued operations and also requires an entity to disclose the pretax profit or loss of an individually significant component of an entity that does not qualify for discontinued operations reporting. The amendments in ASU 2014-08 are effective for fiscal years, and interim periods within those years, beginning after December 15, 2014. The Company anticipates the adoption of this standard will not have a material impact on the Company’s unaudited condensed consolidated financial statements.

In May 2014, the FASB issued ASU 2014-09, “Revenue from Contracts with Customers” to provide a single comprehensive model for entities to use in accounting for revenue arising from contracts with customers. This model supersedes most current revenue recognition guidance, including industry-specific guidance. The core principle of the revenue model is that “an entity recognizes revenue to depict the transfer of promised goods or services to customers in an amount that reflects the consideration to which the entity expects to be entitled in exchange for those goods or services.” Entities have the option of using either a full retrospective or modified approach to adopt the guidance. The amendments in ASU 2014-09 are effective for fiscal years, and interim periods within those years, beginning after December 15, 2016. The Company is currently evaluating the impact of adopting ASU 2014-09.

In August 2014, the FASB issued ASU 2014-15, “Presentation of Financial Statements—Going Concern” to require management to evaluate whether there are conditions or events that raise substantial doubt about a company’s ability to continue as a going concern within one year from the date the financial statements are issued. The amendments in ASU 2014-15 are effective for annual periods ending after December 15, 2016, and for annual and interim periods thereafter. The Company anticipates the adoption of this standard will not have a material impact on the Company’s unaudited condensed consolidated financial statements. 

 

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Note 3. Restructuring Charges

The Company incurred restructuring charges of $1 million ($1 million, net of tax) and $1 million ($0 million, net of tax) for the three months ended September 30, 2014 and 2013, respectively. The Company incurred restructuring charges of $7 million ($4 million, net of tax) and $4 million ($2 million, net of tax) for the nine months ended September 30, 2014 and 2013, respectively. Restructuring charges were comprised of the following:

 

 

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The pretax charges discussed above are reported in Restructuring charges in the unaudited condensed consolidated statements of operations and comprehensive income (loss).

A reconciliation of the beginning and ending balances of accrued restructuring charges, which are included in Accrued liabilities—Other on the unaudited condensed consolidated statements of financial position, is presented as follows:

 

 

 

 

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Note 4. Commitments and Contingencies

The Company carries insurance policies on insurable risks at levels that it believes to be appropriate, including workers’ compensation, auto and general liability risks. The Company purchases insurance policies from third-party insurance carriers, which typically incorporate significant deductibles or self-insured retentions. The Company is responsible for all claims that fall below the retention limits. In determining the Company’s accrual for self-insured claims, the Company uses historical claims experience to establish both the current year accrual and the underlying provision for future losses. This actuarially determined provision and related accrual includes known claims, as well as incurred but not reported claims. The Company adjusts its estimate of accrued self-insured claims when required to reflect changes based on factors such as changes in health care costs, accident frequency and claim severity.

A reconciliation of beginning and ending accrued self-insured claims, which are included in Accrued liabilities—Self-insured claims and related expenses and Other long-term obligations, primarily self-insured claims on the unaudited condensed consolidated statements of financial position, net of reinsurance recoverables, which are included in Prepaid expenses and other assets and Other assets on the unaudited condensed consolidated statements of financial position, is presented as follows:

 

 

Accruals for home warranty claims in the American Home Shield business are made based on the Company’s claims experience and actuarial projections. Termite damage claim accruals in the Terminix business are recorded based on both the historical rates of claims incurred within a contract year and the cost per claim. Current activity could differ causing a change in estimates. The Company has certain liabilities with respect to existing or potential claims, lawsuits and other proceedings. The Company accrues for these liabilities when it is probable that future costs will be incurred and such costs can be reasonably estimated. Any resulting adjustments, which could be material, are recorded in the period the adjustments are identified.

In the ordinary course of conducting business activities, the Company and its subsidiaries become involved in judicial, administrative and regulatory proceedings involving both private parties and governmental authorities. These proceedings include insured and uninsured matters that are brought on an individual, collective, representative and class action basis, or other proceedings involving regulatory, employment, general and commercial liability, automobile liability, wage and hour, environmental and other matters. The Company has entered into settlement agreements in certain cases, including with respect to putative collective and class actions, which are subject to court or other approvals. If one or more of the Company’s settlements are not finally approved, the Company could have additional or different exposure, which could be material. At this time, the Company does not expect any of these proceedings to have a material effect on its reputation, business, financial position, results of operations or cash flows; however, the Company can give no assurance that the results of any such proceedings will not materially affect its reputation, business, financial position, results of operations and cash flows. 

 

 

Note 5. Goodwill and Intangible Assets

Goodwill and intangible assets that are not amortized are subject to assessment for impairment by applying a fair-value based test on an annual basis or more frequently if circumstances indicate a potential impairment. The Company’s annual assessment date is October 1. There were no goodwill or trade name impairment charges recorded in continuing operations in the three and nine months ended September 30, 2014 and 2013. There were no accumulated impairment losses recorded in continuing operations as of September 30, 2014.

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The table below summarizes the goodwill balances for continuing operations by reportable segment and for Other Operations and Headquarters:

 

 

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The table below summarizes the other intangible asset balances for continuing operations:

 

 

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In the nine months ended September 30, 2014, the TruGreen Business recorded a pre-tax non-cash trade name impairment charge of $139 million ($84 million, net of tax) in discontinued operations, net of income taxes. In the nine months ended September 30, 2013, the TruGreen Business recorded a pre-tax non-cash goodwill and trade name impairment charge of $673 million ($521 million, net of tax) in discontinued operations, net of income taxes. 

 

 

Note 6. Stock-Based Compensation

In connection with the TruGreen Spin-off, on January 14, 2014, we distributed all of New TruGreen’s common stock to our stockholders. Following the distribution, our employees held equity incentive awards covering shares of New TruGreen common stock as well as equity incentive awards covering shares of our common stock, and employees who transferred to New TruGreen held equity incentive awards covering shares of our common stock as well as equity incentive awards covering shares of New TruGreen common stock.

To align the interests of our continuing employees and the interests of New TruGreen’s employees with their respective employers, on February 14, 2014, we and New TruGreen extended offers to each other’s employees to allow them to tender their equity awards covering shares of their non-employing entity to the respective issuer and subsequently to apply the proceeds of any such tendered equity awards to subscribe for equity awards in their respective employers at the then-current fair market value ($12.00, in the case of our common stock, and $3.75, in the case of New TruGreen common stock). As a result of this program, on March 18, 2014, we accepted tenders of 199,075 shares of our common stock and DSUs from New TruGreen employees and issued 237,762 shares of our common stock and DSUs to our continuing employees. There was also a small number of RSUs exchanged.

In connection with the TruGreen Spin-off, we adjusted the exercise price of options held by our employees to reflect the fair market value of our common stock after giving effect to the TruGreen Spin-off by multiplying the exercise price of such options immediately prior to the TruGreen Spin-off by a fraction, the numerator of which was the fair market value of a share of our common stock immediately following the TruGreen Spin-off ($12.00 per share) and the denominator of which was the fair market value of a share of our common stock immediately prior to the TruGreen Spin-off ($15.75 per share), or the “Option Conversion Ratio.”

To allow our employees to retain the intrinsic value of their stock options prior to the TruGreen Spin-off, we also adjusted the number of shares underlying the options of such employees. The number of shares underlying the options was adjusted by dividing the number of shares underlying the options held by each employee by the Option Conversion Ratio. We refer to these adjustments collectively as the “Option Conversion.” The change in the number of shares underlying options and the adjustment of the exercise price pursuant to the Option Conversion represent modifications to our share based compensation awards. As a result of the Option

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Conversion we compared the fair value of the awards following the TruGreen Spin-off with the fair value of the original awards. The comparison did not yield incremental value. Accordingly, we did not record any incremental compensation expense as a result of the Option Conversion.

For each of the three month periods ended September 30, 2014 and 2013, the Company recognized stock-based compensation expense of $2 million ($1 million, net of tax). For the nine months ended September 30, 2014 and 2013, the Company recognized stock-based compensation expense of $5 million ($3 million, net of tax) and $3 million ($2 million, net of tax), respectively. As of September 30, 2014, there was $17 million of total unrecognized compensation costs related to non-vested stock options, restricted share units and restricted shares granted under the Amended and Restated ServiceMaster Global Holdings, Inc. Stock Incentive Plan (“MSIP”). These remaining costs are expected to be recognized over a weighted-average period of 2.79 years.

On June 13, 2014, the Company formally adopted the 2014 Omnibus Incentive Plan to provide for the grants of long-term incentive compensation to our directors, officers and associates, for which there were grants of 5,784 restricted shares as of September 30, 2014. Upon adoption of the 2014 Omnibus Incentive Plan, the Company froze the MSIP and will make no further grants thereunder. 

 

Note 7. Comprehensive Income (Loss)

Comprehensive income (loss), which primarily includes net income (loss), unrealized gain (loss) on marketable securities, unrealized gain (loss) on derivative instruments and the effect of foreign currency translation is disclosed in the unaudited condensed consolidated statements of operations and comprehensive income (loss).

The following tables summarize the activity in other comprehensive income (loss), net of the related tax effects.

 

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Reclassifications out of accumulated other comprehensive income (loss) included the following components for the periods indicated.

 

 

 

 

Note 8. Supplemental Cash Flow Information

Supplemental information relating to the unaudited condensed consolidated statements of cash flows is presented in the following table:

 

 

The Company acquired $12 million and $21 million of property and equipment through capital leases and other non-cash financing transactions in the nine months ended September 30, 2014 and 2013 months, respectively, which have been excluded from the unaudited condensed consolidated statements of cash flows as non-cash investing and financing activities. 

 

 

Note 9. Cash and Marketable Securities

Cash, money market funds and certificates of deposits with maturities of three months or less when purchased are included in Cash and cash equivalents on the unaudited condensed consolidated statements of financial position. As of September 30, 2014 and December 31, 2013, the Company’s investments consisted primarily of domestic publicly traded debt and certificates of deposit (“Debt securities”) and common equity securities (“Equity securities”). The amortized cost, fair value and gross unrealized gains and losses of the Company’s short- and long-term investments in Debt and Equity securities as of September 30, 2014 and December 31, 2013 were as follows:

 

 

Unrealized losses which had been in a loss position for more than one year as of September 30, 2014 were less than $1 million. There were no unrealized losses which had been in a loss position for more than one year as of December 31, 2013. The

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aggregate fair value of the investments with unrealized losses was $17 million and $30 million as of September 30, 2014 and December 31, 2013, respectively.

Gains and losses on sales of investments, as determined on a specific identification basis, are included in investment income in the period they are realized. The Company periodically reviews its portfolio of investments to determine whether there has been an other than temporary decline in the value of the investments from factors such as deterioration in the financial condition of the issuer or the market(s) in which the issuer competes. The table below summarizes proceeds, gross realized gains, and gross realized losses resulting from sales of available-for-sale securities. There were no impairment charges due to other than temporary declines in the value of certain investments for the three and nine months ended September 30, 2014 and 2013.

 

 

 

 

 

Note 10. Long-Term Debt

Long-term debt as of September 30, 2014 and December 31, 2013 is summarized in the following table:

 

 

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Refinancing of Indebtedness

On July 1, 2014, in connection with Holdings’ initial public offering, SvM terminated its existing credit agreements governing its then existing term loan facility, the pre-funded letter of credit facility (together, the “Old Term Facilities”) and the then existing revolving credit facility (together with the Old Term Facilities, the “Old Credit Facilities”) and entered into a new credit

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agreement with respect to a new $1,825 million term loan facility maturing 2021 (the “New Term Loan Facility”) and a new $300 million revolving credit facility maturing 2019 (the “New Revolving Credit Facility,” and, together with the New Term Loan Facility, the “New Credit Facilities”), with JPMorgan Chase Bank, N.A. as administrative agent, collateral agent and issuing bank, and a syndicate of lenders party thereto from time to time.  Borrowings under the New Term Loan Facility, together with $243 million of available cash and $120 million of net proceeds of the initial public offering, were used to repay in full the $2,187 million outstanding under the Old Term Facilities.  In addition, $42 million of available cash was used to pay debt issuance costs of $24 million and to pay original issue discount of $18 million in connection with the New Term Loan Facility.

On July 16, 2014, SvM used proceeds from Holdings’ initial public offering to redeem $210 million of its outstanding 8 percent senior notes due 2020 (the “8% 2020 Notes”) and $263 million of its outstanding 7 percent senior notes due 2020 (the “7% 2020 Notes”). In connection with the redemption of the 8% 2020 Notes and the 7% 2020 Notes, SvM was required to pay a pre-payment premium of $17 million and $18 million, respectively, and accrued interest of $7 million and $8 million, respectively.

In connection with the partial redemption of the 8% 2020 Notes and 7% 2020 Notes and the repayment of the Old Term Facilities, we recorded a loss on extinguishment of debt of $65 million in the three and nine months ended September 30, 2014, which includes the pre-payment premiums on the 8% 2020 Notes and 7% 2020 Notes of $17 million and $18 million, respectively, and the write-off of $30 million of debt issuance costs.

Interest Rate Swaps

On July 23, 2014, SvM entered into two four-year interest rate swap agreements effective August 1, 2014. The aggregate notional amount of the agreements was $300 million. Under the terms of the agreements, SvM will pay a weighted-average fixed rate of interest of 1.786 percent on the $300 million notional amount, and SvM will receive a floating rate of interest (based on one-month LIBOR) on the notional amount. Therefore, during the term of the agreements, the effective interest rate on $300 million of the New Term Loan Facility is fixed at a rate of 1.786 percent, plus the incremental borrowing margin of 3.25 percent.

 

On July 23, 2014, SvM entered into three forty-one month interest rate swap agreements effective March 1, 2015. The aggregate notional amount of the agreements was $400 million. Under the terms of the agreements, SvM will pay a weighted-average fixed rate of interest of 1.927 percent on the $400 million notional amount, and SvM will receive a floating rate of interest (based on one-month LIBOR) on the notional amount. Therefore, during the term of the agreements, the effective interest rate on $400 million of the New Term Loan Facility is fixed at a rate of 1.927 percent, plus the incremental borrowing margin of 3.25 percent. 

 

 

Note 11. Acquisitions

Acquisitions have been accounted for using the acquisition method and, accordingly, the results of operations of the acquired businesses have been included in the Company’s unaudited condensed consolidated financial statements since their dates of acquisition. The assets and liabilities of these businesses were recorded in the financial statements at their estimated fair values as of the acquisition dates.

On February 28, 2014, the Company acquired Home Security of America, Inc. (“HSA”), based in Madison, Wisconsin. The total net purchase price for this acquisition was $32 million. The Company recorded goodwill of $34 million and other intangibles of $18 million related to this acquisition.

During the nine months ended September 30, 2014, the Company completed several pest control, termite and franchise acquisitions. The total net purchase price for these acquisitions was $25 million. The Company recorded goodwill of $16 million and other intangibles of $7 million related to these acquisitions.

During the nine months ended September 30, 2013, the Company completed several pest control, termite and franchise acquisitions, along with the purchase of a distributor license agreement with the Franchise Services Group. The total net purchase price for these acquisitions was $28 million. The Company recorded goodwill of $21 million and other intangibles of $6 million related to these acquisitions.

Supplemental cash flow information regarding the Company’s acquisitions is as follows:

 

 

 

 

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Note 12. Discontinued Operations

TruGreen Spin-off

On January 14, 2014, the Company completed the TruGreen Spin-off resulting in the spin-off of the assets and certain liabilities of the TruGreen Business through a tax-free, pro rata dividend to the Company’s stockholders. As a result of the completion of the TruGreen Spin-off, New TruGreen operates the TruGreen Business as a private independent company.

The TruGreen Business experienced a significant downturn in recent years. From 2011 through 2013, the TruGreen Business lost 400,000 customers, or 19 percent of its customer base. The TruGreen Business’s operating margins also eroded during this time frame due to production inefficiencies, higher chemical costs and inflationary pressures, compounded by lower fixed cost leverage as falling customer counts drove revenue down. The TruGreen Business experienced revenue and Adjusted EBITDA declines of 18.6 percent and 87.6 percent, respectively, from 2011 to 2013. In light of these developments, the Company made the decision to effect the TruGreen Spin-off and enable its management to increase its focus on Terminix, American Home Shield and the Franchise Services Group segments while providing New TruGreen, as an independently-operated, private company, the time and focus required to execute a turnaround.

As a result of the TruGreen Spin-off, the Company was required to perform an interim impairment analysis as of January 14, 2014 on the TruGreen trade name. The assumptions were developed with the view of the TruGreen Business as a stand-alone company, resulting in an increase in the assumed discount rate of 350 basis points, or “bps,” as compared to the discount rate used in the October 1, 2013 impairment test for the TruGreen trade name. This interim impairment analysis resulted in a pre-tax non-cash trade name impairment charge of $139 million ($84 million, net of tax) to reduce the carrying value of the TruGreen trade name to its estimated fair value. This impairment charge was recorded in Loss from discontinued operations, net of income taxes, in the nine months ended September 30, 2014. The impairment of the TruGreen trade name represented an adjustment of the carrying value of the asset to its estimated fair value on a non-recurring basis using significant unobservable inputs on the date of the TruGreen Spin-off.

The following is a summary of the assets and liabilities distributed to New TruGreen as part of the TruGreen spin-off on January 14, 2014:

 

 

The historical results of the TruGreen Business, including the results of operations, cash flows and related assets and liabilities, are reported as discontinued operations for all periods presented herein.

In connection with the TruGreen Spin-off, the Company and TruGreen Limited Partnership (“TGLP”), an indirect wholly owned subsidiary of New TruGreen, entered into a transition services agreement pursuant to which the Company and its subsidiaries provide TGLP with specified communications, public relations, finance and accounting, tax, treasury, internal audit, human resources operations and benefits, risk management and insurance, supply management, real estate management, marketing, facilities, information technology and other support services. The charges for the transition services allow the Company to fully recover the allocated direct costs of providing the services, plus specified margins and any out-of-pocket costs and expenses. The services provided under the transition services agreement will terminate at various specified times, and in no event later than January 14, 2016 (except certain information technology services, which the Company expects to provide to TGLP beyond the two-year period). TGLP may terminate the transition services agreement (or certain services under the transition services agreement) for convenience upon 90 days written notice, in which case TGLP will be required to reimburse the Company for early termination costs.

Under this transition services agreement, in the three and nine months ended September 30, 2014, the Company recorded $8 million and $27 million, respectively, of fees due from TGLP, which is included, net of costs incurred, in Selling and administrative expenses in the unaudited condensed consolidated statement of operations and comprehensive income (loss). As of September 30, 2014, all amounts owed by TGLP under this agreement have been paid.

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During the nine months ended September 30, 2014, the Company processed certain of TGLP’s accounts payable transactions. Through this process, in the nine months ended September 30, 2014, $96 million was paid on TGLP’s behalf, of which $94 million was repaid by TGLP. As of September 30, 2014, the Company recorded a $2 million receivable due from TGLP, which is included in Receivables on the unaudited condensed consolidated statement of financial position.

In addition, the Company, New TruGreen and TGLP entered into (1) a separation and distribution agreement containing key provisions relating to the separation of the TruGreen Business and the distribution of New TruGreen common stock to the Company’s stockholders (including relating to specified TruGreen legal matters with respect to which we have agreed to retain liability, as well as insurance coverage, non-competition, indemnification and other matters), (2) an employee matters agreement allocating liabilities and responsibilities relating to employee benefit plans and programs and other related matters and (3) a tax matters agreement governing the respective rights, responsibilities and obligations of the parties thereto with respect to taxes, including allocating liabilities for income taxes attributable to New TruGreen and its subsidiaries generally to the Company for tax periods (or portions thereof) ending on or before January 14, 2014 and generally to New TruGreen for tax periods (or portions thereof) beginning after that date.

 

Financial Information for Discontinued Operations

(Loss) income from discontinued operations, net of income taxes, for all periods presented includes the operating results of the TruGreen Business and previously sold businesses.

The operating results of discontinued operations are as follows:

 

 

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Assets and liabilities of discontinued operations are summarized below:

 

 

 

At September 30, 2014, the liabilities of discontinued operations relate primarily to accruals for legal and other reserves. At December 31, 2013, these balances also reflect the historical assets and liabilities of the TruGreen Business, which was spun off in the nine months ended September 30, 2014. 

 

Note 13. Income Taxes

As of September 30, 2014 and December 31, 2013, the Company had $8 million of tax benefits primarily reflected in state tax returns that have not been recognized for financial reporting purposes (“unrecognized tax benefits”). The Company currently

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estimates that, as a result of pending tax settlements and expiration of statutes of limitations, the amount of unrecognized tax benefits could be reduced by approximately $1 million during the next 12 months.

As required by Accounting Standard Codification (“ASC”) 740, “Income Taxes,” the Company computes interim period income taxes by applying an anticipated annual effective tax rate to our year-to-date income or loss from continuing operations before income taxes, except for significant unusual or infrequently occurring items. The Company’s estimated tax rate is adjusted each quarter in accordance with ASC 740.

The effective tax rate on (loss) income from continuing operations at Holdings was 56.5 percent for the three months ended September 30, 2014 compared to 34.4 percent for the three months ended September 30, 2013. The effective tax rate on (loss) income from continuing operations at SvM was 59.4 percent for the three months ended September 30, 2014 compared to 33.7 percent for the three months ended September 30, 2014. The effective tax rate on loss from continuing operations for the three months ended September 30, 2014 was affected by a cumulative adjustment for tax expense for prior quarters arising from a revision in the anticipated annual effective tax rate during the three months ended September 30, 2014.

The effective tax rate on income from continuing operations at Holdings was 54.3 percent for the nine months ended September 30, 2014 compared to 49.3 percent for the nine months ended September 30, 2013. The effective tax rate on income from continuing operations at SvM was 53.7 percent for the nine months ended September 30, 2014 compared to 48.9 percent for the nine months ended September 30, 2013. The effective tax rate on income from continuing operations for the nine months ended September 30, 2014 was affected by various discrete events, including an adjustment to deferred state taxes resulting from a change in the Company’s state apportionment factors primarily attributable to the TruGreen Spin-off. The effective tax rate on income from continuing operations for the nine months ended September 30, 2013 was affected by the reclassification of the TruGreen Business to discontinued operations and the resulting impact on the allocation of the full year effective tax rate on income from continuing operations to interim periods. 

 

Note 14. Business Segment Reporting

The business of the Company is conducted through three reportable segments: Terminix, American Home Shield and Franchise Services Group.

In accordance with accounting standards for segments, the Company’s reportable segments are strategic business units that offer different services. The Terminix segment provides termite and pest control services to residential and commercial customers and distributes pest control products. The American Home Shield segment provides home warranties for household systems and appliances. The Franchise Services Group segment provides residential and commercial disaster restoration, janitorial and cleaning services through franchises primarily under the ServiceMaster, ServiceMaster Restore and ServiceMaster Clean brand names, home cleaning services through franchises and Company-owned locations primarily under the Merry Maids brand name, on-site wood furniture repair and restoration services primarily under the Furniture Medic brand name and home inspection services primarily under the AmeriSpec brand name. Other Operations and Headquarters includes The ServiceMaster Acceptance Company Limited Partnership (“SMAC”), our financing subsidiary exclusively dedicated to providing financing to our franchisees and retail customers of our operating units, and the Company’s headquarters operations (substantially all of which costs are allocated to the Company’s reportable segments), which provide various technology, marketing, finance, legal and other support services to the reportable segments. The composition of our reportable segments is consistent with that used by our chief operating decision maker (the “CODM”) to evaluate performance and allocate resources.

Information regarding the accounting policies used by the Company is described in Note 2. The Company derives substantially all of its revenue from customers and franchisees in the United States with less than two percent generated in foreign markets. Operating expenses of the business units consist of direct costs and indirect costs allocated from Other Operations and Headquarters. In periods prior to the TruGreen Spin-off, expenses which were allocated to TruGreen but are not reflected in discontinued operations are included in Other Operations and Headquarters. Such expenses amounted to $9 million and $29 million in the three and nine months ended September 30, 2014, respectively.

The Company uses Reportable Segment Adjusted EBITDA as its measure of segment profitability. Accordingly, the CODM evaluates performance and allocates resources based primarily on Reportable Segment Adjusted EBITDA. Reportable Segment Adjusted EBITDA is defined as net income (loss) before: unallocated corporate expenses; income (loss) from discontinued operations, net of income taxes; provision (benefit) for income taxes; gain (loss) on extinguishment of debt; interest expense; depreciation and amortization expense; non-cash goodwill and trade name impairment; non-cash impairment of software and other related costs; non-cash impairment of property and equipment; non-cash stock-based compensation expense; restructuring charges; management and consulting fees; consulting agreement termination fees; non-cash effects attributable to the application of purchase accounting; and other non-operating expenses. The Company’s definition of Reportable Segment Adjusted EBITDA may not be calculated or comparable to similarly titled measures of other companies. We believe Reportable Segment Adjusted EBITDA is useful for investors, analysts and other interested parties as it facilitates company-to-company operating performance comparisons by excluding potential differences caused by variations in capital structures, taxation, the age and book depreciation of facilities and equipment, restructuring initiatives, consulting agreements and equity-based, long-term incentive plans.

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Information for continuing operations for each reportable segment and Other Operations and Headquarters is presented below:

 

 

 

 

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___________________________________

 

 

 

Note 15. Related Party Transactions

On July 24, 2007, the Company was acquired pursuant to a merger transaction (the “2007 Merger”), and, immediately following the completion of the 2007 Merger, all of our outstanding common stock was owned by investment funds managed by, or affiliated with, Clayton, Dubilier & Rice, LLC (“CD&R”), or the “CD&R Funds,” Citigroup Private Equity LP, or “Citigroup,” BAS Capital Funding Corporation, or “BAS,” and JPMorgan Chase Funding Inc., or “JPMorgan.” On September 30, 2010, Citigroup transferred the management responsibility for certain investment funds that owned shares of our common stock to StepStone Group LP, or “StepStone,” and the investment funds managed by StepStone Group, the “StepStone Funds.” As of December 22, 2011, we purchased from BAS 5 million shares of our common stock. On March 30, 2012, an affiliate of BAS sold 5 million shares of our common stock to Ridgemont Partners Secondary Fund I, L.P, or “Ridgemont.” On July 24, 2012, BACSVM-A L.P., an affiliate of BAS, distributed 1,666,666 shares of our common stock to Charlotte Investor IV, L.P., its sole limited partner, (together with the CD&R Funds, the StepStone Funds, JPMorgan, Citigroup Capital Partners II Employee Master Fund, L.P., an affiliate of Citigroup, and BACSVM-A, L.P., an affiliate of BAS, the “Equity Sponsors”).

Upon completion of Holdings’ initial public offering on July 1, 2014, the Equity Sponsors continued to hold approximately 65 percent of Holdings’ common stock.

Consulting Agreements

The Company was a party to a consulting agreement with CD&R under which CD&R provided the Company with ongoing consulting and management advisory services. The annual consulting fee payable under the consulting agreement with CD&R was $6 million. Under this agreement, the Company recorded consulting fees of $2 million in the three months ended September 30, 2013 and $3 million and $5 million in the nine months ended September 30, 2014 and 2013, respectively, which is included in Selling and administrative expenses in the unaudited condensed consolidated statements of operations and comprehensive income (loss). There were no consulting fees recorded in the three months ended September 30, 2014.

The Company was also a party to consulting agreements with StepStone, JPMorgan and Ridgemont (and formerly with BAS). Pursuant to the consulting agreements, the Company was required to pay aggregate annual consulting fees of $1 million to StepStone, JPMorgan and Ridgemont (formerly payable to BAS), respectively.

On July 1, 2014, in connection with the completion of Holdings’ initial public offering, the Company paid the Equity Sponsors aggregate fees of $21 million in connection with the termination of the consulting agreements, which is recorded in the three and nine months ended September 30, 2014 in Consulting agreement termination fees in the unaudited condensed consolidated statements of operations and comprehensive income (loss).

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Revolving Promissory Note

On April 19, 2013, SvM entered into a revolving promissory note with Holdings with a maximum borrowing capacity of $25 million that was scheduled to mature on April 18, 2018. Amounts outstanding under this agreement bore interest at the rate of 5.0 percent per annum. As of December 31, 2013, the amount due to SvM by Holdings under this note was $14 million. The funds borrowed under this note were used by Holdings to repurchase shares of its common stock from associates who have left the Company. On July 1, 2014, Holdings used a portion of the proceeds from the initial public offering to repay in full this inter-company loan. 

 

Note 16. Fair Value Measurements

The period-end carrying amounts of receivables, accounts payable and accrued liabilities approximate fair value because of the short maturity of these instruments. The period-end carrying amounts of long-term notes receivable approximate fair value as the effective interest rates for these instruments are comparable to period-end market rates. The period-end carrying amounts of short- and long-term marketable securities also approximate fair value, with unrealized gains and losses reported net of tax as a component of accumulated other comprehensive income (loss) on the unaudited condensed consolidated statements of financial position, or, for certain unrealized losses, reported in interest and net investment income in the unaudited condensed consolidated statements of operations and comprehensive income (loss) if the decline in value is other than temporary. The carrying amount of total debt was $3,059 million and $3,906 million and the estimated fair value was $3,170 million and $3,906 million as of September 30, 2014 and December 31, 2013, respectively. The fair value of the Company’s debt is estimated based on available market prices for the same or similar instruments which are considered significant other observable inputs (Level 2) within the fair value hierarchy. The fair values presented reflect the amounts that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date (exit price). The fair value estimates presented in this report are based on information available to the Company as of September 30, 2014 and December 31, 2013.

The Company has estimated the fair value of its financial instruments measured at fair value on a recurring basis using the market and income approaches. For investments in marketable securities, deferred compensation trust assets and derivative contracts, which are carried at their fair values, the Company’s fair value estimates incorporate quoted market prices, other observable inputs (for example, forward interest rates) and unobservable inputs (for example, forward commodity prices) at the balance sheet date.

Interest rate swap contracts are valued using forward interest rate curves obtained from third-party market data providers. The fair value of each contract is the sum of the expected future settlements between the contract counterparties, discounted to present value. The expected future settlements are determined by comparing the contract interest rate to the expected forward interest rate as of each settlement date and applying the difference between the two rates to the notional amount of debt in the interest rate swap contracts.

Fuel swap contracts are valued using forward fuel price curves obtained from third-party market data providers. The fair value of each contract is the sum of the expected future settlements between the contract counterparties, discounted to present value. The expected future settlements are determined by comparing the contract fuel price to the expected forward fuel price as of each settlement date and applying the difference between the contract and expected prices to the notional gallons in the fuel swap contracts. The Company regularly reviews the forward price curves obtained from third-party market data providers and related changes in fair value for reasonableness utilizing information available to the Company from other published sources.

The Company has not changed its valuation techniques for measuring the fair value of any financial assets and liabilities during the year. Transfers between levels, if any, are recognized at the end of the reporting period. There were no significant transfers between levels during each of the nine month periods ended September 30, 2014 and 2013.

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The carrying amount and estimated fair value of the Company’s financial instruments that are recorded at fair value on a recurring basis for the periods presented are as follows:

 

 

 

 

 

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A reconciliation of the beginning and ending fair values of financial instruments valued using significant unobservable inputs (Level 3) on a recurring basis is presented as follows:

 

 

The following tables present information relating to the significant unobservable inputs of our Level 3 financial instruments:

 

 

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The Company uses derivative financial instruments to manage risks associated with changes in fuel prices and interest rates. The Company does not hold or issue derivative financial instruments for trading or speculative purposes. In designating its derivative financial instruments as hedging instruments under accounting standards for derivative instruments, the Company formally documents the relationship between the hedging instrument and the hedged item, as well as the risk management objective and strategy for the use of the hedging instrument. This documentation includes linking the derivatives to forecasted transactions. The Company assesses at the time a derivative contract is entered into, and at least quarterly thereafter, whether the derivative item is effective in offsetting the projected changes in cash flows of the associated forecasted transactions. All of the Company’s designated hedging instruments are classified as cash flow hedges.

The Company has historically hedged a significant portion of its annual fuel consumption. The Company has also historically hedged the interest payments on a portion of its variable rate debt through the use of interest rate swap agreements. All of the Company’s fuel swap contracts and interest rate swap contracts are classified as cash flow hedges, and, as such, the hedging instruments are recorded on the unaudited condensed consolidated statements of financial position as either an asset or liability at fair value, with the effective portion of changes in the fair value attributable to the hedged risks recorded in accumulated other comprehensive income (loss). Any change in the fair value of the hedging instrument resulting from ineffectiveness, as defined by accounting standards, is recognized in current period earnings. Cash flows related to fuel and interest rate derivatives are classified as operating activities in the unaudited condensed consolidated statements of cash flows.

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The effect of derivative instruments on the unaudited condensed consolidated statements of operations and comprehensive income (loss) and accumulated other comprehensive income (loss) on the unaudited condensed consolidated statements of financial position is presented as follows:

 

 

Ineffective portions of derivative instruments designated in accordance with accounting standards as cash flow hedge relationships were insignificant during the nine months ended September 30, 2014. As of September 30, 2014, the Company had fuel swap contracts to pay fixed prices for fuel with an aggregate notional amount of $22 million, maturing through 2015. Under the terms of its fuel swap contracts, the Company is required to post collateral in the event that the fair value of the contracts exceeds a certain agreed upon liability level and in other circumstances required by the counterparty. As of September 30, 2014, the Company had posted $1 million in letters of credit as collateral under its fuel hedging program, none of which were posted under the Company’s New Revolving Credit Facility.

The effective portion of the gain or loss on derivative instruments designated and qualifying as cash flow hedging instruments is recorded in accumulated other comprehensive income (loss). These amounts are reclassified into earnings in the same period or periods during which the hedged forecasted debt interest settlement or the fuel settlement affects earnings. The amount expected to be reclassified into earnings during the next 12 months includes unrealized gains and losses related to open fuel hedges and interest rate swaps. Specifically, as the underlying forecasted transactions occur during the next 12 months, the hedging gains and losses in accumulated other comprehensive income (loss) expected to be recognized in earnings is a loss of $3 million, net of tax, as of September 30, 2014. The amounts that are ultimately reclassified into earnings will be based on actual interest rates and fuel prices at the time the positions are settled and may differ materially from the amount noted above. 

 

 

 

Note 17. Earnings Per Share

Basic earnings (loss) per share is computed by dividing net income (loss) by the weighted average number of shares of common stock outstanding. Diluted earnings (loss) per share is computed by dividing net income (loss) by the weighted-average number of shares of common stock outstanding during the period, increased to include the number of shares of common stock that would have been outstanding had potential dilutive shares of common stock been issued. The dilutive effect of stock options and restricted stock units are reflected in diluted net income (loss) per share by applying the treasury stock method.

A reconciliation of the amounts included in the computation of basic earnings per share from continuing operations and diluted earnings per share from continuing operations is as follows:

 

 

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On June 25, 2014, Holdings’ registration statement on Form S-1 was declared effective by the SEC for an initial public offering of its common stock, and, on July 1, 2014, Holdings completed the offering of 41,285,000 shares of its common stock. For further details, see Note 1. 

 

 

 

Note 18. Condensed Consolidating Financial Statements of The ServiceMaster Company, LLC and Subsidiaries

The following condensed consolidating financial statements of SvM and its subsidiaries have been prepared pursuant to Rule 3-10 of Regulation S-X. These condensed consolidating financial statements have been prepared from SvM’s financial information on the same basis of accounting as the unaudited condensed consolidated financial statements. Goodwill and other intangible assets have been allocated to all of SvM’s subsidiaries based on management’s estimates. ServiceMaster Global Holdings, Inc. is not an obligor, nor guarantor, to the 8% 2020 Notes and the 7% 2020 Notes (collectively, the “2020 Notes”), or the New Credit Facilities.

The payment obligations of SvM under the 2020 Notes are jointly and severally guaranteed on a senior unsecured basis by SvM’s domestic subsidiaries that guarantee our indebtedness under the New Credit Facilities (the “Guarantors”). Each of the Guarantors is wholly owned, directly or indirectly, by SvM, and all guarantees are full and unconditional. SvM’s non-U.S. subsidiaries, SvM’s subsidiaries subject to regulation as an insurance, home warranty, service contract or similar company, and certain other subsidiaries of SvM (the “Non-Guarantors”) do not guarantee the 2020 Notes. A Guarantor will be released from its obligations under its guarantee under certain customary circumstances, including, (i) the sale or disposition of the Guarantor, (ii) the release of the Guarantor from all of its obligations under all guarantees related to any indebtedness of SvM, (iii) the merger or consolidation of the Guarantor as specified in the indenture governing the 2020 Notes, (iv) the Guarantor becomes an unrestricted subsidiary under the indenture governing the 2020 Notes, (v) the defeasance of SvM’s obligations under the indenture governing the 2020 Notes or (vi) the payment in full of the principal amount of the 2020 Notes.

Effective July 1, 2014, commensurate with entering the New Term Loan Facility, SvM began recording interest expense at the Guarantors pursuant to the New Term Loan Facility and the 2020 Notes. For the three months ended September 30, 2014, interest expense recorded by the Guarantors was $38 million.

 

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THE SERVICEMASTER COMPANY, LLC AND SUBSIDIARIES

Condensed Consolidating Statement of Operations and Comprehensive Income

For the Three Months Ended September 30, 2014 (Unaudited)

(In millions)

 

 

 

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THE SERVICEMASTER COMPANY, LLC AND SUBSIDIARIES

Condensed Consolidating Statement of Operations and Comprehensive Loss

For the Three Months Ended September 30, 2013 (Unaudited)

(In millions)

 

 

 

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THE SERVICEMASTER COMPANY, LLC AND SUBSIDIARIES

Condensed Consolidating Statement of Operations and Comprehensive Loss

For the Nine Months Ended September 30, 2014 (Unaudited)

(In millions)

 

 

 

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THE SERVICEMASTER COMPANY, LLC AND SUBSIDIARIES

Condensed Consolidating Statement of Operations and Comprehensive Loss

For the Nine Months Ended September 30, 2013 (Unaudited)

(In millions)

 

 

 

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THE SERVICEMASTER COMPANY, LLC AND SUBSIDIARIES

Condensed Consolidating Statement of Financial Position (Unaudited)

As of September 30, 2014

(In millions)

 

 

 

 

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THE SERVICEMASTER COMPANY, LLC AND SUBSIDIARIES

Condensed Consolidating Statement of Financial Position (Unaudited)

As of December 31, 2013

(In millions)

 

 

 

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THE SERVICEMASTER COMPANY, LLC AND SUBSIDIARIES

Condensed Consolidating Statement of Cash Flows (Unaudited)

For the Nine Months Ended September 30, 2014

(In millions)

 

 

 

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THE SERVICEMASTER COMPANY, LLC AND SUBSIDIARIES

Condensed Consolidating Statement of Cash Flows (Unaudited)

For the Nine Months Ended September 30, 2013

(In millions)

 

 

 

 

 

 

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ITEM 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

The following information should be read in conjunction with the unaudited condensed consolidated financial statements and related notes included in this report. The following discussion may contain forward-looking statements that reflect our plans, estimates and beliefs. Our actual results could differ materially from those discussed in these forward- looking statements. Factors that could cause or contribute to these differences include those factors discussed below and elsewhere in this report, particularly in “—Information Regarding Forward-Looking Statements” and the section entitled “Risk Factors” in the 2014 Form S-1.

Overview

This Management’s Discussion and Analysis of Financial Condition and Results of Operations is combined for two registrants: ServiceMaster Global Holdings, Inc. and The ServiceMaster Company, LLC. Unless the context indicates otherwise, any reference in this discussion and analysis to “Holdings” refers to ServiceMaster Global Holdings, Inc., any reference to “SvM” refers to The ServiceMaster Company, LLC, the indirect wholly-owned subsidiary of Holdings, and any references to the “Company,” “we,” “us,” and “our” refer to ServiceMaster Global Holdings, Inc. together with its direct and indirect subsidiaries, including SvM.

Our core services include termite and pest control, home warranties, disaster restoration, janitorial, residential cleaning, furniture repair and home inspection under the following leading brands: Terminix, American Home Shield, ServiceMaster Restore, ServiceMaster Clean, Merry Maids, Furniture Medic and AmeriSpec. Our operations for the periods presented in this report are organized into three reportable segments:  Terminix, American Home Shield and Franchise Services Group.

Key Business Metrics

We focus on a variety of indicators and key operating and financial metrics to monitor the financial condition and performance of the continuing operations of our businesses. These metrics include:

 

 

 

 

 

 

 

To the extent applicable, these measures are evaluated with and without impairment, restructuring and other charges that management believes are not indicative of the earnings capabilities of our businesses. We also focus on measures designed to optimize cash flow, including the management of working capital and capital expenditures.

Customer Retention Rates and Customer Counts Growth.  We report our customer retention rates and growth in customer counts for our two largest revenue generating businesses in order to track the performance of those businesses. Customer counts represent our recurring customer base and include customers with active contracts for recurring services. At Terminix, these services are primarily delivered on an annual, quarterly or monthly frequency. Retention rates are calculated as the ratio of ending customer counts to the sum of beginning customer counts, new sales and acquired accounts for the applicable period. These measures are presented on a rolling, twelve-month basis in order to avoid seasonal anomalies. See “—Segment Review.”

Revenue.  Our revenue results are primarily a function of the volume and pricing of the services and products provided to our customers by our businesses as well as the mix of services and products provided across our businesses. The volume of our revenue in Terminix and American Home Shield, and in our company-owned branches in the Franchise Services Group, is impacted by new unit sales, the retention of our existing customers and tuck-in acquisitions. We expect to continue our tuck-in acquisition program at Terminix in 2014 at levels consistent with prior periods. Revenue results in the remainder of our Franchise Services Group are driven principally by royalty fees earned from our franchisees. We serve both residential and commercial customers, principally in the United States.

Operating Expenses.  In addition to the impact of changes in our revenue results, our operating results are affected by, among other things, the level of our operating expenses. A number of our operating expenses are subject to inflationary pressures, such as fuel, chemicals, raw materials, wages and salaries, employee benefits and health care, vehicles, self-insurance costs and other insurance premiums, as well as various regulatory compliance costs.

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Adjusted EBITDA.  We evaluate performance and allocate resources based primarily on Adjusted EBITDA. We define Adjusted EBITDA as net income (loss) before: income (loss) from discontinued operations, net of income taxes; provision (benefit) for income taxes; gain (loss) on extinguishment of debt; interest expense; depreciation and amortization expense; non-cash goodwill and trade name impairment; non-cash impairment of software and other related costs; non-cash impairment of property and equipment; non-cash stock-based compensation expense; restructuring charges; management and consulting fees; consulting agreement termination fees; non-cash effects attributable to the application of purchase accounting; and other non-operating expenses. We believe Adjusted EBITDA is useful for investors, analysts and other interested parties as it facilitates company-to-company operating performance comparisons by excluding potential differences caused by variations in capital structures, taxation, the age and book depreciation of facilities and equipment, restructuring initiatives, consulting agreements and equity-based, long-term incentive plans.

Net Income (Loss)and Earnings (Loss) Per Share.  Basic earnings (loss) per share is computed by dividing net income (loss) by the weighted average number of shares of common stock outstanding. Diluted earnings (loss) per share is computed by dividing net income (loss) by the weighted-average number of shares of common stock outstanding during the period, increased to include the number of shares of common stock that would have been outstanding had potential dilutive shares of common stock been issued. The dilutive effect of stock options and restricted stock units are reflected in diluted net income (loss) per share by applying the treasury stock method. The presentation of net income (loss) and earnings (loss) per share provides GAAP measures of performance which are useful for investors, analysts and other interested parties in company-to-company operating performance comparisons.

Seasonality

We have seasonality in our business, which drives fluctuations in revenue and Adjusted EBITDA for interim periods. In 2013, approximately 22 percent, 28 percent, 27 percent and 23 percent of our revenue and approximately 23 percent, 29 percent, 28 percent and 20 percent of our Adjusted EBITDA was recognized in the first, second, third and fourth quarters, respectively.

Effect of Weather Conditions

The demand for our services and our results of operations are also affected by weather conditions, including the seasonal nature of our termite and pest control services, home inspection services and disaster restoration services. Weather conditions which have a potentially unfavorable impact to our business include cooler temperatures or droughts which can impede the development of termite swarms and lead to lower demand for our termite control services; severe winter storms which can impact our home cleaning business if we cannot travel to service locations due to hazardous road conditions; and extreme temperatures which can lead to an increase in service requests related to household systems and appliances, resulting in higher claim frequency and costs. Weather conditions which have a potentially favorable impact to our business include mild winters which can lead to higher demand for termite and pest control services; mild winters or summers which can lead to lower household systems and appliance claim frequency; and severe storms which can lead to an increase in demand for disaster restoration services.

We believe colder weather conditions in early 2014 adversely affected our traditional termite revenue in the nine months ended September 30, 2014. Conversely, contract claims expense in our American Home Shield segment decreased in the three and nine months ended September 30, 2014, as compared to the three and nine months ended September 30, 2013, in part, we believe, due to cooler temperatures in 2014 as compared to 2013.

Initial Public Offering

On June 25, 2014, Holdings’ registration statement on Form S-1 was declared effective by the SEC for an initial public offering of its common stock. Holdings registered the offering and sale of 35,900,000 shares of its common stock and an additional 5,385,000 shares of its common stock sold to the underwriters pursuant to an option to purchase additional shares. On July 1, 2014, Holdings completed the offering of 41,285,000 shares of its common stock at a price of $17.00 per share. The net proceeds and use of proceeds in connection with the offering are summarized in the table below:

 

 

 

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Refinancing of Indebtedness

On July 1, 2014, in connection with Holdings’ initial public offering, SvM terminated its then existing credit agreements governing its Old Credit Facilities and entered into a new credit agreement with respect to a $1,825 million New Term Loan Facility maturing 2021 and a $300 million New Revolving Credit Facility maturing 2019.  Borrowings under the New Term Loan Facility, together with $243 million of available cash and $120 million of net proceeds of the initial public offering, were used to repay in full the $2,187 million outstanding under the Old Term Facilities. In addition, $42 million of available cash was used to pay debt issuance costs of $24 million and to pay original issue discount of $18 million in connection with the New Term Loan Facility.

On July 16, 2014, SvM used proceeds from the initial public offering to redeem $210 million of its outstanding 8% 2020 Notes and $263 million of its 7% 2020 Notes. In connection with the redemption of the 8% 2020 Notes and the 7% 2020 Notes, SvM was required to pay a pre-payment premium of $17 million and $18 million, respectively, and accrued interest of $7 million and $8 million, respectively.

In connection with the partial redemption of the 8% 2020 Notes and 7% 2020 Notes and the repayment of the Old Term Facilities, we recorded a loss on extinguishment of debt of $65 million in the three and nine months ended September 30, 2014, which included the pre-payment premiums on the 8% 2020 Notes and 7% 2020 Notes of $17 million and $18 million, respectively, and the write-off of $30 million of debt issuance costs.

TruGreen Spin-off

On January 14, 2014, we completed the TruGreen Spin-off. As a result of the completion of the TruGreen Spin-off, New TruGreen operates the TruGreen Business as a private independent company. In connection with the TruGreen Spin-off, SvM and TGLP, entered into a transition services agreement pursuant to which SvM and its subsidiaries provide TGLP with specified communications, public relations, finance and accounting, tax, treasury, internal audit, human resources operations and benefits, risk management and insurance, supply management, real estate management, marketing, facilities, information technology and other support services. The charges for the transition services allow us to fully recover the allocated direct costs of providing the services, plus specified margins and any out-of-pocket costs and expenses. The services provided under the transition services agreement will terminate at various specified times, and in no event later than January 14, 2016 (except for certain information technology services, which SvM expects to provide to TGLP beyond the two-year period). TGLP may terminate the transition services agreement (or certain services under the transition services agreement) for convenience upon 90 days written notice, in which case TGLP will be required to reimburse SvM for early termination costs.

Beginning with the TruGreen Spin-off, where it was practicable, employees who historically provided such services to the TruGreen Business were separated from us and transferred to New TruGreen as of the date of the TruGreen Spin-off. For certain support services for which it was not practicable to separate employees and transfer them to New TruGreen beginning with the TruGreen Spin-off, a transition services agreement was entered into pursuant to which SvM and its subsidiaries provide specified services to New TruGreen while an orderly transition of employees and other support arrangements from SvM to New TruGreen is executed. As a result of the transfer of employees to New TruGreen, in combination with the fees we expect to receive under the transition services agreement, we expect an approximate $25 million reduction in annual costs.

In addition, we, SvM, New TruGreen and TGLP entered into (1) a separation and distribution agreement containing key provisions relating to the separation of the TruGreen Business and the distribution of New TruGreen common stock to our stockholders (including relating to specified TruGreen legal matters with respect to which we have agreed to retain liability, as well as insurance coverage, non-competition, indemnification and other matters), (2) an employee matters agreement allocating liabilities and responsibilities relating to employee benefit plans and programs and other related matters and (3) a tax matters agreement governing the respective rights, responsibilities and obligations of the parties thereto with respect to taxes, including allocating liabilities for income taxes attributable to New TruGreen and its subsidiaries generally to SvM for tax periods (or portions thereof) ending on or before January 14, 2014 and generally to New TruGreen for tax periods (or portions thereof) beginning after that date.

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Under this transition services agreement, in the three and nine months ended September 30, 2014, SvM recorded $8  million and $27 million, respectively, of fees due from TGLP, which is included, net of costs incurred, in Selling and administrative expenses in the unaudited condensed consolidated statement of operations and comprehensive income (loss). As of September 30, 2014, all amounts owed by TGLP under this agreement have been paid.

During the nine months ended September 30, 2014, SvM processed certain of TGLP’s accounts payable transactions. Through this process, in the nine months ended September 30, 2014, $96 million was paid on TGLP’s behalf, of which $94 million was repaid by TGLP. As of September 30, 2014, SvM recorded a $2 million receivable due from TGLP, which is included in Receivables on the unaudited condensed consolidated statement of financial position. 

 

 

Results of Operations

Three and Nine Months Ended September 30, 2014 and 2013

 

 

 

 

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*     not meaningful

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Revenue

We reported revenue of $664 million and $615 million for the three months ended September 30, 2014 and 2013, respectively, and $1,880 million and $1,760 million for the nine months ended September 30, 2014 and 2013, respectively. A summary of changes in revenue for each of our reportable segments and Other Operations and Headquarters is included in the tables below. See “—Segment Review” for a discussion of the drivers of the year-over-year changes.

 

 

 

 

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Cost of Services Rendered and Products Sold

We reported cost of services rendered and products sold of $344 million and $324 million for the three months ended September 30, 2014 and 2013, respectively, and $983 million and $924 million for the nine months ended September 30, 2014 and 2013, respectively. The following tables provide a summary of changes in cost of services rendered and products sold for each of our reportable segments and Other Operations and Headquarters:

 

 

 

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The increase in damage claims at Terminix was primarily driven by higher claim payments. The decrease in contract claims at American Home Shield was primarily driven by lower claims costs due, in part, to an increase in the service fee charged to our customers for service visits and, to a lesser extent, mild weather conditions.

 

 

The increase in damage claims at Terminix was primarily driven by higher claim payments. The decrease in contract claims at American Home Shield was primarily driven by lower claims costs due, in part, to an increase in the service fee charged to our customers for service visits and, to a lesser extent, mild weather conditions, offset, in part, by the impact of favorable adjustments to reserves for prior year contract claims of $1 million and $5 million in the nine months ended September 30, 2014 and 2013, respectively. The increased expense in our automobile, general liability and workers’ compensation insurance program was driven by adverse claims trends.

Selling and Administrative Expenses

We reported selling and administrative expenses of $176 million and $181 million for the three months ended September 30, 2014 and 2013, respectively, and $505 million and $527 million for the nine months ended September 30, 2014 and 2013, respectively. For the three months ended September 30, 2014 and 2013, selling and administrative expenses comprised general and administrative expenses of $65 million and $78 million, respectively, and selling and marketing expenses of $111 million and $103 million, respectively. For the nine months ended September 30, 2014 and 2013, selling and administrative expenses comprised general and administrative expenses of $205 million and $241 million, respectively, and selling and marketing expenses of $300 million and $286 million, respectively. The following tables provide a summary of changes in selling and administrative expenses for each of our reportable segments and Other Operations and Headquarters:

 

 

 

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The increase in selling and administrative expenses at Terminix was driven by higher sales costs, offset, in part, by a reduction in key executive transition charges. The increase in selling and administrative expenses at American Home Shield primarily included the addition of administrative costs as a result of the HSA acquisition and incremental marketing investments in our direct to consumer channel, offset, in part, by lower technology costs driven by the decision in the first quarter of 2014 to abandon its efforts to deploy a new operating system.

The decrease in selling and administrative expenses at Other Operations and Headquarters primarily included decreased costs in our centers of excellence driven by the transition of certain costs to New TruGreen, cost reductions pursuant to the termination of consulting agreements with our equity sponsors and other cost reductions achieved in the three months ended September 30, 2014.

 

 

The decrease in selling and administrative expenses at Terminix was driven by overhead cost reductions achieved in the nine months ended September 30, 2014 and a reduction in key executive transition charges, offset, in part, by higher sales costs. The increase in selling and administrative expenses at American Home Shield primarily included the addition of administrative costs as a result of the HSA acquisition and incremental marketing investments in our direct to consumer channel, offset, in part, by lower technology costs driven by the decision in the first quarter of 2014 to abandon its efforts to deploy a new operating system and a reduction in key executive separation charges.  Additionally, a $3 million reduction in tax-related reserves was recorded at American Home Shield in the nine months ended September 30, 2013 for which there was no similar adjustment recorded in the nine months ended September 30, 2014.

The decrease in selling and administrative expenses at Other Operations and Headquarters primarily included decreased costs in our centers of excellence driven by the transition of certain costs to New TruGreen, cost reductions pursuant to the termination of consulting agreements with our equity sponsors and other cost reductions achieved in the nine months ended September 30, 2014, offset, in part, by an increase in stock-based compensation expense driven by grants of options and RSUs.

Amortization Expense

During the nine months ended September 30, 2014, our portfolio of intangible assets has remained relatively stable, and, as a result, amortization expense was $13 million in each of the three month periods ended September 30, 2014 and 2013, and $39 million and $38 million in the nine months ended September 30, 2014 and 2013, respectively.

Impairment of Software and Other Related Costs

We recorded an impairment charge of $47 million in the nine months ended September 30, 2014 relating to American Home Shield’s decision, in the first quarter of 2014, to abandon its efforts to deploy a new operating system. This decision will allow us to more effectively focus our energy and resources on driving growth and serving our customers. Included in this charge are the impairment of the capitalized software of $45 million and the recognition of the remaining liabilities associated with the termination of lease, maintenance and hosting agreements totaling $2 million.

Consulting Agreement Termination Fees

On July 1, 2014, in connection with the completion of Holdings’ initial public offering, the Company paid the Equity Sponsors aggregate fees of $21 million in connection with the termination of the consulting agreements, which was recorded in the three and nine months ended September 30, 2014. See Note 15 to the unaudited condensed consolidated financial statements for more details.

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Restructuring Charges

We incurred restructuring charges of $1 million for each of the three month periods ended September 30, 2014 and 2013, and $7 million and $4 million for the nine months ended September 30, 2014 and 2013, respectively. Restructuring charges were comprised of the following:

 

 

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Interest Expense

Interest expense was $49 million and $63 million for the three months ended September 30, 2014 and 2013, respectively, and $171 million and $186 million for the nine months ended September 30, 2014 and 2013, respectively. The decrease in interest expense was driven by the refinancing of the Old Term Facilities on July 1, 2014 and the partial redemption of the 8% 2020 Notes and the 7% 2020 Notes on July 16, 2014. See Note 10 to the unaudited condensed consolidated financial statements for more details.

Interest and Net Investment Income

Interest and net investment income was less than $1 million and $2 million for the three months ended September 30, 2014 and 2013, respectively, and  $7 million and $6 million for the nine months ended September 30, 2014 and 2013, respectively, and was comprised of the following:

 

 

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Loss on Extinguishment of Debt

A loss on extinguishment of debt of $65 million was recorded in the three and nine months ended September 30, 2014 related to the partial redemption of the 8% 2020 Notes and the 7% 2020 Notes on July 16, 2014. See Note 10 to the unaudited condensed consolidated financial statements for more details.

 

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Income from Continuing Operations before Income Taxes

Loss from continuing operations before income taxes was $5 million for the three months ended September 30, 2014, and income from continuing operations before income taxes was $35 million for the three months ended September 30, 2013. Income from continuing operations before income taxes was $48 million and $88 million for the nine months ended September 30, 2014 and 2013, respectively. The decrease in income from continuing operations before income taxes primarily reflects the net effect of year-over-year changes in the following items:

 

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Provision for Income Taxes

The effective tax rate on (loss) income from continuing operations was 56.5 percent for the three months ended September 30, 2014 compared to 34.4 percent for the three months ended September 30, 2013.  The effective tax rate on loss from continuing operations for the three months ended September 30, 2014 was affected by a cumulative adjustment for tax expense for prior quarters arising from a revision in the anticipated annual effective tax rate during the three months ended September 30, 2014.  

The effective tax rate on income from continuing operations was 54.3 percent for the nine months ended September 30, 2014 compared to 49.3 percent for the nine months ended September 30, 2013. The effective tax rate on income from continuing operations for the nine months ended September 30, 2014 was affected by various discrete events, including an adjustment to deferred state taxes resulting from a change in our state apportionment factors primarily attributable to the TruGreen Spin-off. The effective tax rate on income from continuing operations for the nine months ended September 30, 2013 was affected by the reclassification of the TruGreen Business to discontinued operations and the resulting impact on the allocation of the full year effective tax rate on income from continuing operations to interim periods.

Net Income (Loss)

Net loss was $4 million for the three months ended September 30, 2014 compared to net income of $45 million for the three months ended September 30, 2013. The $49 million decrease in net income was primarily driven by a $23 million reduction in income from discontinued operations, net of tax, and a $40 million decrease in income from continuing operations before income taxes, offset, in part, by a $15 million decrease in provision for income taxes.

Net loss was $76 million for the nine months ended September 30, 2014 compared to a net loss of $489 million for the nine months ended September 30, 2013. The $413 million reduction in net loss was primarily driven by a $435 million reduction in loss from discontinued operations, net of tax, and a  $17 million reduction in provision for income taxes, offset, in part, by a  $40 million decrease in income from continuing operations before income taxes.

Segment Review

The following business segment reviews should be read in conjunction with the required footnote disclosures presented in the notes to the unaudited condensed consolidated financial statements included in this report.

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Revenue and Adjusted EBITDA by reportable segment and for Other Operations and Headquarters are as follows:

 

 

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The table below presents selected operating metrics related to customer counts and customer retention for our Terminix and American Home Shield segments.

 

 

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Terminix Segment

Three Months Ended September 30, 2014 compared to Three Months Ended September 30, 2013

The Terminix segment, which provides termite and pest control services to residential and commercial customers and distributes pest control products, reported a 5.8 percent increase in revenue and an 18.3 percent increase in Adjusted EBITDA for the three months ended September 30, 2014 compared to the three months ended September 30, 2013.

Revenue

Revenue by service line is as follows:

 

 

Pest control revenue increased 5.1 percent compared to the three months ended September 30, 2013, reflecting improved price realization, the introduction of a new mosquito service and a favorable product mix. Pest control customer counts as of September 30, 2014 increased slightly compared to September 30, 2013,  driven by a decrease in new unit sales, offset by an 80 bps increase in the customer retention rate and an increase in acquisitions.

Termite revenue, including the wildlife exclusion, crawl space encapsulation and attic insulation products which are managed as a component of our termite line of business, increased 9.2 percent compared to the three months ended September 30, 2013. Termite renewal revenue comprised 50 percent of total termite revenue, while the remainder consisted of termite new unit revenue. The increase in termite revenue reflects introductions of new products (wildlife exclusion and crawlspace encapsulation), increased sales of attic insulation and improved price realization, offset, in part, by a decrease in traditional termite sales driven by mild weather conditions. Termite customer counts decreased 2.6 percent compared to September 30, 2013, driven by a decrease in traditional new unit sales and acquisitions and an 60 bps decrease in the customer retention rate, offset, in part, by the introduction of new products.

As of September 30, 2014, mosquito, wildlife exclusion and crawl space encapsulation are being offered in substantially all geographic markets in which such services are essential.  We are now focusing our efforts on increasing our market share in these product lines.

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Adjusted EBITDA

The following table provides a summary of changes in the segment’s Adjusted EBITDA for the three months ended September 30, 2014 compared to the three months ended September 30, 2013:

 

 

The increase in damage claims was primarily driven by higher claim payments. The increase in selling and administrative expenses was driven by higher sales costs, offset, in part, by a reduction in key executive transition charges.

Nine Months Ended September 30, 2014 compared to Nine Months Ended September 30, 2013

The Terminix segment reported a 3.7 percent increase in revenue and a 10.9 percent increase in Adjusted EBITDA for the nine months ended September 30, 2014 compared to the nine months ended September 30, 2013.

Revenue

Revenue by service line is as follows:

 

 

Pest control revenue increased 3.6 percent compared to the nine months ended September 30, 2013, reflecting improved price realization, the introduction of a new mosquito service and a  favorable product mix.  Pest control customer counts as of September 30, 2014 were comparable to September 30, 2013, driven by a decrease in new unit sales, offset by an 80 bps increase in the customer retention rate and an increase in acquisitions.

Termite revenue, including the wildlife exclusion, crawl space encapsulation and attic insulation products which are managed as a component of our termite line of business, increased 4.8 percent compared to the nine months ended September 30, 2013. Termite renewal revenue comprised 53 percent of total termite revenue, while the remainder consisted of termite new unit revenue. The increase in termite revenue reflects introductions of new products (wildlife exclusion and crawlspace encapsulation), increased sales of attic insulation and improved price realization, offset, in part, by a decrease in traditional termite sales driven by mild weather conditions. Termite customer counts decreased 2.6 percent compared to September 30, 2013, driven by a decrease in traditional new unit sales and acquisitions and an 60 bps decrease in the customer retention rate, offset, in part, by the introduction of new products.

Adjusted EBITDA

The following table provides a summary of changes in the segment’s Adjusted EBITDA for the nine months ended September 30, 2014 compared to the nine months ended September 30, 2013:

 

 

 

The increase in damage claims was primarily driven by higher claim payments. The decrease in selling and administrative expenses was driven by overhead cost reductions achieved in the nine months ended September 30, 2014 and a reduction in key executive transition charges, offset, in part, by higher sales costs. 

 

 

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American Home Shield Segment

Three Months Ended September 30, 2014 compared to Three Months Ended September 30, 2013

The American Home Shield segment, which provides home warranties for household systems and appliances, reported a 12.0 percent increase in revenue and a 13.2 percent increase in Adjusted EBITDA for the three months ended September 30, 2014 compared to the three months ended September 30, 2013. On February 28, 2014, we acquired HSA, a company with 2013 revenue of approximately $62 million.  The HSA acquisition contributed approximately $18 million in revenue in the three months ended September 30, 2014.

Revenue

As of September 30, 2014 compared to September 30, 2013, customer counts increased 13.4 percent, and the customer retention rate increased 140 bps. Excluding HSA, for the same period, customer counts increased 3.4 percent, and the customer retention rate increased 170 bps. The revenue results reflect the impact of the HSA acquisition, the 3.4 percent increase in customer counts and a favorable product mix. 

Adjusted EBITDA

The following table provides a summary of changes in the segment’s Adjusted EBITDA for the three months ended September 30, 2014 compared to the three months ended September 30, 2013:

 

 

The decrease in contract claims was primarily driven by lower claims costs due, in part, to an increase in the service fee charged to our customers for service visits and, to a lesser extent, mild weather conditions. The increase in selling and administrative expenses primarily included the addition of administrative costs as a result of the acquisition of HSA and incremental marketing investments in our direct to consumer channel, offset, in part, by lower technology costs driven by the decision in the first quarter of 2014 to abandon efforts to deploy a new operating system.

In the three months ended September 30, 2013, the segment’s Adjusted EBITDA included interest and net investment income from the American Home Shield investment portfolio of $1 million for which there was no similar amount recorded in the three months ended September 30, 2014.

Nine Months Ended September 30, 2014 compared to Nine Months Ended September 30, 2013

The American Home Shield segment reported a 12.2 percent increase in revenue and a 26.0 percent increase in Adjusted EBITDA for the nine months ended September 30, 2014 compared to the nine months ended September 30, 2013. The HSA acquisition contributed approximately $41 million in revenue in the nine months ended September 30, 2014.

Revenue

As of September 30, 2014 compared to September 30, 2013, customer counts increased 13.4 percent, and the customer retention rate increased 140 bps. Excluding HSA, for the same period, customer counts increased 3.4 percent, and the customer retention rate increased 170 bps. The revenue results reflect the impact of the HSA acquisition, the 3.4 percent increase in customer counts, a favorable product mix and an increase due to differences between years in the expected timing of contract claims. American Home Shield recognizes revenue over the contract period in proportion to expected direct costs.

Adjusted EBITDA

The following table provides a summary of changes in the segment’s Adjusted EBITDA for the nine months ended September 30, 2014 compared to the nine months ended September 30, 2013:

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The decrease in contract claims was primarily driven by lower claims costs due, in part, to an increase in the service fee charged to our customers for service visits and, to a lesser extent, mild weather conditions, offset, in part, by the impact of favorable adjustments to reserves for prior year contract claims of $1 million and $5 million in the nine months ended September 30, 2014 and 2013, respectively. The increase in selling and administrative expenses primarily included the addition of administrative costs as a result of the acquisition of HSA and incremental marketing investments in our direct to consumer channel, offset, in part, by lower technology costs driven by the decision in the first quarter of 2014 to abandon efforts to deploy a new operating system and a reduction in key executive transition charges.

In the nine months ended September 30, 2014 and 2013, the segment’s Adjusted EBITDA included interest and net investment income from the American Home Shield investment portfolio of $6 million and $4 million, respectively. Additionally, a $3 million reduction in tax-related reserves was recorded in the nine months ended September 30, 2013 for which there was no similar adjustment recorded in the nine months ended September 30, 2014.

Impairment of Software and Other Related Costs

In February 2014, American Home Shield made the decision to abandon its efforts to deploy a new operating system. This decision will allow us to more effectively focus our energy and resources on driving growth and serving our customers. Important factors that led to this decision include:

 

 

 

 

We recorded an impairment charge of $47 million in the nine months ended September 30, 2014 relating to this decision. 

 

 

Franchise Services Group Segment

Three Months Ended September 30, 2014 compared to Three Months Ended September 30, 2013

The Franchise Services Group segment, which consists of the ServiceMaster Restore (disaster restoration), ServiceMaster Clean (janitorial), Merry Maids (residential cleaning), Furniture Medic (furniture repair) and AmeriSpec (home inspection) businesses, reported a 6.2 percent increase in revenue and a 3.4 percent decrease in Adjusted EBITDA for the three months ended September 30, 2014 compared to the three months ended September 30, 2013.

Revenue

Revenue by service line is as follows:

 

 

Royalty fees and sales of products to franchisees were comparable to the three months ended September 30, 2013. Revenue from company-owned Merry Maids branches was comparable to the three months ended September 30, 2013 with customer counts

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down 5.9 percent compared to September 30, 2013. Revenue from janitorial national accounts increased 72.9 percent compared to the three months ended September 30, 2013, driven by strong sales activity.

Adjusted EBITDA

The following table provides a summary of changes in the segment’s Adjusted EBITDA for the three months ended September 30, 2014 compared to the three months ended September 30, 2013:

 

 

The nominal impact of the increase in revenue on Adjusted EBITDA was a result of increases in relatively low margin revenue from janitorial national accounts.

Nine Months Ended September 30, 2014 compared to Nine Months Ended September 30, 2013

The Franchise Services Group segment reported an 8.0 percent increase in revenue and a 1.5 percent increase in Adjusted EBITDA for the nine months ended September 30, 2014 compared to the nine months ended September 30, 2013.

Revenue

Revenue by service line is as follows:

 

 

Royalty fees increased 4.4 percent compared to the nine months ended September 30, 2013, primarily driven by increases in disaster restoration services. Revenue from company-owned Merry Maids branches decreased 1.5 percent compared to the nine months ended September 30, 2013 with customer counts down 5.9 percent compared to September 30, 2013. Revenue from janitorial national accounts increased 51.2 percent compared to the nine months ended September 30, 2013, driven by strong sales activity. Sales of products to franchisees increased 6.3 percent compared to the nine months ended September 30, 2013, driven by high franchisee demand for equipment.

Adjusted EBITDA

The following table provides a summary of changes in the segment’s Adjusted EBITDA for the nine months ended September 30, 2014 compared to the nine months ended September 30, 2013:

 

 

The nominal impact of the increase in revenue on Adjusted EBITDA was a result of increases in relatively low margin revenue from janitorial national accounts and sales of products. 

  

 

Other Operations and Headquarters

Three Months Ended September 30, 2014 compared to Three Months Ended September 30, 2013

The following section discusses results for our Other Operations and Headquarters functions, which includes SMAC and our headquarters functions. Other Operations and Headquarters reported a $10 million increase in Adjusted EBITDA for the three months ended September 30, 2014 compared to the three months ended September 30, 2013.

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Adjusted EBITDA

The following table provides a summary of changes in Other Operations and Headquarters’ Adjusted EBITDA for the three months ended September 30, 2014 compared to the three months ended September 30, 2013:

 

 

 The decrease in selling and administrative expenses primarily included decreased costs in our centers of excellence driven by the transfer of employees to New TruGreen in combination with fees received under the transition services agreement with New TruGreen and other cost reductions achieved in the three months ended September 30, 2014.

Nine Months Ended September 30, 2014 compared to Nine Months Ended September 30, 2013

Other Operations and Headquarters reported a $27 million increase in Adjusted EBITDA for the nine months ended September 30, 2014 compared to the nine months ended September 30, 2013.

Adjusted EBITDA

The following table provides a summary of changes in Other Operations and Headquarters’ Adjusted EBITDA for the nine months ended September 30, 2014 compared to the nine months ended September 30, 2013:

 

 

The increased expense in our automobile, general liability and workers’ compensation insurance program was driven by adverse claims trends. The decrease in selling and administrative expenses primarily included decreased costs in our centers of excellence driven by the transfer of employees to New TruGreen in combination with fees received under the transition services agreement with New TruGreen and other cost reductions achieved in the nine months ended September 30, 2014. 

 

 

Discontinued Operations

TruGreen Spin-off

On January 14, 2014, we completed the TruGreen Spin-off resulting in the spin-off of the TruGreen Business through a tax-free, pro rata dividend to our stockholders. As a result of the completion of the TruGreen Spin-off, New TruGreen operates the TruGreen Business as a private independent company.

The TruGreen Business experienced a significant downturn in recent years. From 2011 to 2013, the TruGreen Business lost 400,000 customers, or 19 percent of its customer base. The TruGreen Business’s operating margins also eroded during this time frame due to production inefficiencies, higher chemical costs and inflationary pressures, compounded by lower fixed cost leverage as falling customer counts drove revenue down. The TruGreen Business experienced revenue and Adjusted EBITDA declines of 18.6 percent and 87.6 percent, respectively, from 2011 to 2013. In light of these developments, we made the decision to effect the TruGreen Spin-off and enable our management to increase its focus on the Terminix, American Home Shield and Franchise Services Group segments, while providing New TruGreen, as an independently-operated, private company, the time and focus required to execute a turnaround. In addition, the TruGreen Spin-off was effected to enhance our ability to complete an initial public offering of our common stock and use the net proceeds primarily to reduce our indebtedness.

As a result of the TruGreen Spin-off, we were required to perform an interim impairment analysis as of January 14, 2014 on the TruGreen trade name. The assumptions were developed with the view of the TruGreen Business as a stand-alone company, resulting in an increase in the assumed discount rate of 350 bps as compared to the discount rate used in the October 1, 2013 impairment test for the TruGreen trade name. This interim impairment analysis resulted in a pre-tax non-cash trade name impairment charge of $139 million ($84 million, net of tax) to reduce the carrying value of the TruGreen trade name to its estimated fair value. This impairment charge was recorded in Loss from discontinued operations, net of income taxes, in the nine months ended September 30, 2014.

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Financial Information of Discontinued Operations

(Loss) income from discontinued operations, net of income taxes, for all periods presented includes the operating results of the TruGreen Business and the previously sold businesses described in the 2014 Form S-1.

The operating results of discontinued operations are as follows:

 

 

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Liquidity and Capital Resources

Liquidity

We are highly leveraged, and a substantial portion of our liquidity needs are due to service requirements on our significant indebtedness. The agreements governing the 2020 Notes and the New Credit Facilities contain covenants that limit or restrict the ability of SvM and certain of its subsidiaries to incur additional indebtedness, repurchase debt, incur liens, sell assets, make certain payments (including dividends) and enter into transactions with affiliates. As of September 30, 2014, SvM was in compliance with the covenants under the agreements that were in effect on such date.

Our ongoing liquidity needs are expected to be funded by cash on hand, net cash provided by operating activities and, as required, borrowings under our credit facilities. We expect that cash provided from operations and available capacity under the New Revolving Credit Facility will provide sufficient funds to operate our business, make expected capital expenditures and meet our liquidity requirements for the following 12 months, including payment of interest and principal on our debt. On July 1, 2014, in connection with Holdings’ initial public offering, SvM terminated its then existing credit agreements governing its then existing revolving credit facility and entered into a $300 million New Revolving Credit Facility maturing 2019. As of September 30, 2014, SvM had $300 million of remaining capacity available under the New Revolving Credit Facility.

Cash and short- and long-term marketable securities totaled $387 million as of September 30, 2014, compared with $633 million as of December 31, 2013. As described below, on July 1, 2014, $243 million of available cash, together with borrowings under the New Term Loan Facility and $120 million of net proceeds from Holdings’ initial public offering, was used to repay in full the $2,187 million outstanding under the Old Term Facilities, and $42 million of available cash was used to pay debt issuance costs of $24 million and to pay original issue discount of $18 million in connection with the New Term Loan Facility.  In addition, on July 16, 2014, SvM used proceeds from Holdings’ initial public offering to redeem $210 million of the 8% 2020 Notes and $263 million of the 7% 2020 Notes. In connection with the redemption of the 8% 2020 Notes and the 7% 2020 Notes, SvM was required to pay a pre-payment premium of $17 million and $18 million, respectively, and accrued interest of $7 million and $8 million, respectively. 

Cash and short- and long-term marketable securities include balances associated with regulatory requirements at American Home Shield. See “—Limitations on Distributions and Dividends by Subsidiaries.” American Home Shield’s investment portfolio has been invested in a combination of high-quality, short-duration fixed-income securities and equities. We closely monitor the performance of the investments. From time to time, we review the statutory reserve requirements to which our regulated entities are subject and any changes to such requirements. These reviews may result in identifying current reserve levels above or below minimum statutory reserve requirements, in which case we may adjust our reserves. The reviews may also identify opportunities to satisfy certain regulatory reserve requirements through alternate financial vehicles.

Under the terms of our fuel swap contracts, we are required to post collateral in the event that the fair value of the contracts exceeds a certain agreed upon liability level and in other circumstances when required by the counterparty. As of September 30, 2014, the estimated fair value of our fuel swap contracts was a net liability of $1 million, and we had posted $1 million in letters of credit as collateral under our fuel hedging program, none of which were issued under SvM’s New Revolving Credit Facility. The continued use of letters of credit for this purpose in the future could limit SvM’s ability to post letters of credit for other purposes and could limit SvM’s borrowing availability under its revolving credit facilities. However, we do not expect the fair value of the outstanding fuel swap contracts to materially impact our financial position or liquidity.

We may from time to time repurchase or otherwise retire or extend our debt and/or take other steps to reduce our debt or otherwise improve our financial position. These actions may include open market debt repurchases, negotiated repurchases, other

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retirements of outstanding debt and/or opportunistic refinancing of debt. The amount of debt that may be repurchased or otherwise retired or refinanced, if any, will depend on market conditions, trading levels of our debt, our cash position, compliance with debt covenants and other considerations.

Term Loan Facility

On July 1, 2014, in connection with Holdings’ initial public offering, SvM terminated its then existing credit agreements governing its Old Term Facilities and entered into a $1,825 million New Term Loan Facility maturing 2021. Borrowings under the New Term Loan Facility, together with $243 million of available cash and $120 million of net proceeds of the initial public offering, were used to repay in full the $2,187 million outstanding under the Old Term Facilities. In addition, $42 million of available cash was used to pay debt issuance costs of $24 million and to pay original issue discount of $18 million in connection with the New Term Loan Facility.

On July 23, 2014, SvM entered into two four-year interest rate swap agreements effective August 1, 2014. The aggregate notional amount of the agreements was $300 million. Under the terms of the agreements, SvM will pay a weighted-average fixed rate of interest of 1.786 percent on the $300 million notional amount, and SvM will receive a floating rate of interest (based on one-month LIBOR) on the notional amount. Therefore, during the term of the agreements, the effective interest rate on $300 million of the New Term Loan Facility is fixed at a rate of 1.786 percent, plus the incremental borrowing margin of 3.25 percent.

On July 23, 2014, SvM entered into three forty-one month interest rate swap agreements effective March 1, 2015. The aggregate notional amount of the agreements was $400 million. Under the terms of the agreements, SvM will pay a weighted-average fixed rate of interest of 1.927 percent on the $400 million notional amount, and SvM will receive a floating rate of interest (based on one-month LIBOR) on the notional amount. Therefore, during the term of the agreements, the effective interest rate on $400 million of the New Term Loan Facility is fixed at a rate of 1.927 percent, plus the incremental borrowing margin of 3.25 percent.

Senior Notes

On July 16, 2014, SvM used proceeds from Holdings’ initial public offering to redeem $210 million of its outstanding 8% 2020 Notes and $263 million of its 7% 2020 Notes. In connection with the redemption of the 8% 2020 Notes and the 7% 2020 Notes, SvM was required to pay a pre-payment premium of $17 million and $18 million, respectively, and accrued interest of $7 million and $8 million, respectively.

Fleet and Equipment Financing Arrangements

SvM has entered into the Fleet Agreement which, among other things, allows us to obtain fleet vehicles through a leasing program. We expect to fulfill substantially all of our vehicle fleet needs in 2014 through the leasing program under the Fleet Agreement. For the nine months ended September 30, 2014, we acquired $12 million of vehicles under the Fleet Agreement leasing program. All leases under the Fleet Agreement are capital leases for accounting purposes. The lease rental payments include an interest component calculated using a variable rate based on one-month LIBOR plus other contractual adjustments and a borrowing margin totaling 2.45 percent. We have no minimum commitment for the number of vehicles to be obtained under the Fleet Agreement. We anticipate that new lease financings under the Fleet Agreement for the full year 2014 will range from approximately $15 million to $20 million.

Limitations on Distributions and Dividends by Subsidiaries

Holdings and SvM are each holding companies, and as such have no independent operations or material assets other than ownership of equity interests in their respective subsidiaries. We depend on our respective subsidiaries to distribute funds to us so that we may pay obligations and expenses, including satisfying obligations with respect to indebtedness. The ability of our subsidiaries to make distributions and dividends to us depends on their operating results, cash requirements and financial condition and general business conditions, as well as restrictions under the laws of our subsidiaries’ jurisdictions.

The terms of the indenture governing the 2020 Notes and the agreements governing the New Credit Facilities significantly restrict the ability of our subsidiaries, including SvM, to pay dividends, make loans or otherwise transfer assets to us. Further, SvM’s subsidiaries are permitted under the terms of the New Credit Facilities and other indebtedness to incur additional indebtedness that may restrict or prohibit the making of distributions, the payment of dividends or the making of loans by such subsidiaries to SvM and, in turn, to us.

Furthermore, there are third-party restrictions on the ability of certain of our subsidiaries to transfer funds to us. These restrictions are related to regulatory requirements at American Home Shield and to a subsidiary borrowing arrangement at SMAC. The payment of ordinary and extraordinary dividends by our home warranty and similar subsidiaries (through which we conduct our American Home Shield business) are subject to significant regulatory restrictions under the laws and regulations of the states in which they operate. Among other things, such laws and regulations require certain such subsidiaries to maintain minimum capital and net worth requirements and may limit the amount of ordinary and extraordinary dividends and other payments that these subsidiaries can pay to us. As of September 30, 2014, the total net assets subject to these third-party restrictions was $184 million. We expect that such limitations will be in effect through the end of 2014. None of our subsidiaries are obligated to make funds available to us through the payment of dividends.

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We consider undistributed earnings of our foreign subsidiaries as of September 30, 2014 to be indefinitely reinvested and, accordingly, no U.S. income taxes have been provided thereon. The amount of cash associated with indefinitely reinvested foreign earnings was approximately $22 million and $14 million as of September 30, 2014 and December 31, 2013, respectively. We have not repatriated, nor do we anticipate the need to repatriate, funds to the United States to satisfy domestic liquidity needs arising in the ordinary course of business, including liquidity needs associated with our domestic debt service requirements.

Cash Flows

Cash flows from operating, investing and financing activities, as reflected in the accompanying condensed consolidated statements of cash flows, are summarized in the following table.

 

 

Operating Activities

Net cash provided from operating activities from continuing operations increased $5 million to $132 million the nine months ended September 30, 2014  compared to $127 million for the nine months ended September 30, 2013.

Net cash provided from operating activities for the nine months ended September 30, 2014 was comprised of $203 million in earnings adjusted for non-cash charges, offset, in part, by a $72 million increase in cash required for working capital  (a  $27 million increase excluding the working capital impact of accrued interest, restructuring and taxes). Working capital requirements for the nine months ended September 30, 2014 were negatively impacted by the timing of interest payments on the 2020 Notes, payments of accrued interest attributable to the principal pay down of debt, payments related to settlements of certain legal related matters and normal seasonal activity.

Net cash provided from operating activities for the nine months ended September 30, 2013 was comprised of $164 million in earnings adjusted for non-cash charges, offset, in part, by a $37 million increase in cash required for working capital  (a  $2 million increase excluding the working capital impact of accrued interest, restructuring and taxes). Working capital requirements for the nine months ended September 30, 2013 were impacted by normal seasonal activity, offset, in part, by the impact of improved payment terms with certain of our vendors and increased accruals for compensation and insurance related payments.  In addition, working capital requirements were negatively impacted by the timing of interest payments on the 2020 Notes.

Investing Activities

Net cash used for investing activities from continuing operations was $51 million for the nine months ended September 30, 2014 compared to $81 million for the nine months ended September 30, 2013.

Capital expenditures decreased to $29 million for the nine months ended September 30, 2014 from $38 million in the nine months ended September 30, 2013 and included recurring capital needs and information technology projects. We anticipate that capital expenditures for the full year 2014 will range from approximately $40 million to $50 million, reflecting recurring needs and the continuation of investments in information systems and productivity enhancing technology. We expect to fulfill our ongoing vehicle fleet needs through vehicle capital leases. The Company has no additional material capital commitments at this time.

Cash payments for acquisitions for the nine months ended September 30, 2014 totaled $52 million, compared with $22 million for the nine months ended September 30, 2013. On February 28, 2014, we acquired HSA, based in Madison, Wisconsin, for cash consideration of $32 million. Consideration paid for tuck-in acquisitions consisted of cash payments and debt payable to sellers. We expect to continue our tuck-in acquisition program at levels consistent with prior periods. 

Cash flows provided from notes receivable, financial investments and securities, net, for the nine months ended September 30, 2014 were $30 million and were primarily driven by the sale of marketable securities at American Home Shield. Cash flows used for notes receivable, financial investments and securities, net, for the nine months ended September 30, 2013 were $22 million and were primarily driven by increased investments in marketable securities at American Home Shield.

Cash flows provided by notes receivable from affiliate at SvM of $14 million and used for notes receivable from affiliate at SvM of $12 million for the nine months ended September 30, 2014 and 2013, respectively, reflect amounts provided under the revolving promissory note with Holdings. See Note 15 to the unaudited condensed consolidated financial statements for further details.

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Financing Activities

Net cash used for financing activities from continuing operations was $274 million for the nine months ended September 30, 2014 compared to $60 million for the nine months ended September 30, 2013.

On July 1, 2014, Holdings completed the offering of 41,285,000 shares of its common stock at a price of $17.00 per share, and SvM terminated its existing credit agreements governing its Old Term Facilities and entered into a New Term Loan Facility. The net proceeds and use of proceeds in connection with the offering and related refinancing, which are included in financing activities from continuing operations during the nine months ended September 30, 2014, are as follows:

 

In addition to the aforementioned financing activities in connection with Holdings’ initial public offering, during the nine months ended September 30, 2014, SvM made scheduled principal payments on long-term debt of $27 million and contributed $35 million to New TruGreen in connection with the TruGreen Spin-off. Additionally, Holdings paid $5 million for the purchase of common stock and restricted stock units or “RSUs” and received $8 million from the issuance of common stock during the nine months ended September 30, 2014.

During the nine months ended September 30, 2013, SvM made scheduled principal payments on long-term debt of $28 million and made payments on other long-term financing obligations of $4 million, paid $12 million in original issue discount, paid debt issuance costs of $6 million and borrowed an incremental $1 million. Additionally, Holdings paid $14 million for the purchase of common stock and RSUs and received $4 million from the issuance of common stock during the nine months ended September 30, 2013.

Contractual Obligations

SvM’s 2013 Form 10-K and Holdings’ 2014 Form S-1 include disclosures of our contractual obligations and commitments as of December 31, 2013. We continue to make the contractually required payments, and, therefore, the 2014 obligations and commitments as listed in SvM’s 2013 Form 10-K and Holdings’ 2014 Form S-1 have been reduced by the required payments. Additionally, the TruGreen Spin-off has reduced our contractual obligations and commitments as reported as of December 31, 2013. While contractual obligations relating to principal repayments, estimated interest payments, non-cancelable operating leases and other long-term liabilities of the TruGreen Business are separately identifiable and were transferred to New TruGreen pursuant to the separation and distribution agreement, purchase obligations generally relate to Company-wide spend and commitments of multiple business segments and, therefore, the obligations which were transferred to New TruGreen are more difficult to separately identify and are included in costs under the transition services agreement. We are in the process of negotiating the transfers of these contractual obligations to New TruGreen. The impact of the TruGreen Spin-off was the only material change in our previously disclosed contractual obligations and commitments during the nine months ended September 30, 2014.  Immediately following Holdings’ initial public offering, SvM terminated its Old Term Facilities, entered into the New Credit Facilities and, on July 16, 2014 redeemed $210 million of the 8% 2020 Notes and $263 million of the 7% 2020 Notes. See “—Term Loan Facility” and “—Senior Notes” above for details on debt payments made during July 2014.

Off-Balance Sheet Arrangements

As of September 30, 2014, we did not have any significant off-balance sheet arrangements.

We do not have any relationships with unconsolidated entities or financial partnerships, such as entities often referred to as structured finance or special purpose entities, established for the purpose of facilitating off- balance sheet arrangements or other contractually narrow or limited purposes. Accordingly, we are not materially exposed to any financing, liquidity, market or credit risk that could arise if we had engaged in such relationships. 

 

 

Regulatory Matters

In April 2014, the Bureau of Consumer Financial Protection (the “CFPB”) issued a Civil Investigative Demand to American Home Shield seeking documents and information to determine whether home warranty providers or other unnamed persons have engaged or are engaging in unlawful acts and practices in connection with referral arrangements and relationships in violation of the Real Estate Settlement Procedures Act and its implementing regulation (“RESPA”) and other laws enforceable by the CFPB. American Home Shield believes that it has complied with RESPA and other laws applicable to American Home Shield’s home

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warranty business. If the CFPB determines to bring an enforcement action, it could include demands for money penalties, changes to certain of American Home Shield’s business practices and customer restitution or disgorgement. 

 

Information Regarding Forward-Looking Statements

This report contains forward-looking statements and cautionary statements. Some of the forward-looking statements can be identified by the use of forward-looking terms such as “believes,” “expects,” “may,” “will,” “shall,” “should,” “would,” “could,” “seeks,” “aims,” “projects,” “is optimistic,” “intends,” “plans,” “estimates,” “anticipates” or other comparable terms. Forward-looking statements include, without limitation, all matters that are not historical facts. They appear in a number of places throughout this report and include, without limitation, statements regarding our intentions, beliefs, assumptions or current expectations concerning, among other things, financial position; results of operations; cash flows; prospects; growth strategies or expectations; customer retention; the continuation of acquisitions, including the integration of any acquired company and risks relating to any such acquired company; fuel prices; attraction and retention of key personnel; the impact of fuel swaps; the valuation of marketable securities; estimates of accruals for self-insured claims related to workers’ compensation, auto and general liability risks; estimates of accruals for home warranty claims; estimates of future payments under operating and capital leases; the outcome (by judgment or settlement) and costs of legal or administrative proceedings, including, without limitation, collective, representative or class action litigation; and the impact of prevailing economic conditions.

Forward-looking statements are subject to known and unknown risks and uncertainties, many of which may be beyond our control. We caution you that forward-looking statements are not guarantees of future performance or outcomes and that actual performance and outcomes, including, without limitation, our actual results of operations, financial condition and liquidity, and the development of the market segments in which we operate, may differ materially from those made in or suggested by the forward-looking statements contained in this report. In addition, even if our results of operations, financial condition and cash flows, and the development of the market segments in which we operate, are consistent with the forward-looking statements contained in this report, those results or developments may not be indicative of results or developments in subsequent periods. A number of important factors, including, without limitation, the risks and uncertainties discussed in “Risk Factors” in the 2014 Form S-1, could cause actual results and outcomes to differ materially from those reflected in the forward-looking statements. Additional factors that could cause actual results and outcomes to differ from those reflected in forward-looking statements include, without limitation:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

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You should read this report completely and with the understanding that actual future results may be materially different from expectations. All forward-looking statements made in this report are qualified by these cautionary statements. These forward-looking statements are made only as of the date of this report, and we do not undertake any obligation, other than as may be required by law, to update or revise any forward-looking or cautionary statements to reflect changes in assumptions, the occurrence of events, unanticipated or otherwise, and changes in future operating results over time or otherwise.

Comparisons of results for current and any prior periods are not intended to express any future trends, or indications of future performance, unless expressed as such, and should only be viewed as historical data. 

 

ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

The economy and its impact on discretionary consumer spending, labor wages, fuel prices and other material costs, home resales, unemployment rates, insurance costs and medical costs could have a material adverse impact on future results of operations.

We do not hold or issue derivative financial instruments for trading or speculative purposes. We have entered into specific financial arrangements, primarily fuel swap agreements and interest rate swap agreements, in the normal course of business to manage certain market risks, with a policy of matching positions and limiting the terms of contracts to relatively short durations. The effect of derivative financial instrument transactions could have a material impact on our financial statements.

Interest Rate Risk

We are exposed to the impact of interest rate changes and manage this exposure through the use of variable-rate and fixed-rate debt and by utilizing interest rate swaps. In our opinion, the market risk associated with debt obligations and other significant instruments as of September 30, 2014 has not materially changed from December 31, 2013 (see Item 7A of the 2013 Form 10-K).

Fuel Price Risk

We are exposed to market risk for changes in fuel prices through the consumption of fuel by our vehicle fleet in the delivery of services to our customers. We expect to use approximately 12 million gallons of fuel in 2014. As of September 30, 2014, a ten percent change in fuel prices would result in a change of approximately $4 million in our annual fuel cost before considering the impact of fuel swap contracts. Our exposure to changes in fuel prices has not significantly changed our per gallon fuel costs since December 31, 2013.

We use fuel swap contracts to mitigate the financial impact of fluctuations in fuel prices. As of September 30, 2014, we had fuel swap contracts to pay fixed prices for fuel with an aggregate notional amount of $22 million, maturing through 2015. The estimated fair value of these contracts as of September 30, 2014 was a net liability of $1 million. These fuel swap contracts provide a fixed price for approximately 66 and 38 percent of our estimated fuel usage for the remainder of 2014 and 2015, respectively. 

 

ITEM 4. CONTROLS AND PROCEDURES

(a) Evaluation of disclosure controls and procedures

ServiceMaster Global Holdings, Inc.

Holdings’ Chief Executive Officer, Robert J. Gillette, and Holdings’ Senior Vice President and Chief Financial Officer, Alan J. M. Haughie, have evaluated Holdings’ disclosure controls and procedures (as defined in Rule 13a-15(e) and Rule 15d-15(e) under the Exchange Act) as of the end of the period covered by this Quarterly Report on Form 10-Q as required by Rule 13a-15(b) and Rule 15d-15(b) under the Exchange Act. Messrs. Gillette and Haughie have concluded that both the design and operation of Holdings’ disclosure controls and procedures were effective as of September 30, 2014.

The ServiceMaster Company, LLC

SvM’s Chief Executive Officer, Robert J. Gillette, and SvM’s Senior Vice President and Chief Financial Officer, Alan J. M. Haughie, have evaluated SvM’s disclosure controls and procedures (as defined in Rule 13a-15(e) and Rule 15d-15(e) under the Exchange Act) as of the end of the period covered by this Quarterly Report on Form 10-Q as required by Rule 13a-15(b) and Rule 15d-15(b) under the Exchange Act. Messrs. Gillette and Haughie have concluded that both the design and operation of SvM’s disclosure controls and procedures were effective as of September 30, 2014.

(b) Changes in internal control over financial reporting

No changes in Holdings’ or SvM’s internal control over financial reporting, as defined in Rule 13a-15(f) or Rule 15d-15(f) under the Exchange Act, occurred during the third quarter of fiscal 2014 that has materially affected, or is reasonably likely to materially affect, Holdings’ or SvM’s internal control over financial reporting. 

 

 

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PART II. OTHER INFORMATION

ITEM 1. LEGAL PROCEEDINGS

In the ordinary course of conducting business activities, the Company and its subsidiaries become involved in judicial, administrative and regulatory proceedings involving both private parties and governmental authorities. These proceedings include insured and uninsured matters that are brought on an individual, collective, representative and class action basis, or other proceedings involving regulatory, employment, general and commercial liability, automobile liability, wage and hour, environmental and other matters. We have entered into settlement agreements in certain cases, including with respect to putative collective and class actions, which are subject to court or other approvals. If one or more of our settlements are not finally approved, we could have additional or different exposure, which could be material. At this time, we do not expect any of these proceedings to have a material effect on our reputation, business, financial position, results of operations or cash flows; however, we can give no assurance that the results of any such proceedings will not materially affect our reputation, business, financial position, results of operations and cash flows.

 

ITEM 1A. RISK FACTORS

We discuss in the 2014 Form S-1 and our and SvM’s other filings with the SEC various risks that may materially affect our business. There have been no material changes to the risk factors disclosed in the 2014 Form S-1.  The materialization of any risks and uncertainties identified in Forward-Looking Statements contained in this report, together with those previously disclosed in the 2014 Form S-1 and our and SvM’s other filings with the SEC or those that are presently unforeseen could result in significant adverse effects on our financial condition, results of operations and cash flows.  See “Information Regarding Forward-Looking Statements” above. 

 

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ITEM 2.  UNREGISTERED SALES OF REGISTERED SECURITIES AND USE OF PROCEEDS

Issuer Purchases of Equity Securities

 

 

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ITEM 5.  OTHER INFORMATION

 

Executive Compensation

 

On October 29, 2014 and effective as of October 31, 2014, the Compensation Committee approved the award of 45,872 restricted stock units (“RSUs”) and the grant of 92,670 options to acquire shares of common stock (“Options”) of the Company (such Options having an exercise price of $23.98 per share) to Mark J. Barry in connection with his new duties and responsibilities as Group President, American Home Shield & Franchise Services Group. The RSUs will vest in three equal installments on the first three anniversaries of the grant date, subject to Mr. Barry’s continued employment with the Company.  The Options will vest in four equal installments on the first four anniversaries of the grant date, subject to Mr. Barry’s continued employment with the Company. 

 

Shareholder Proposals

 

We intend to hold our first Annual Meeting of Shareholders (the “Annual Meeting”) no earlier than April 20, 2015 and no later than June 1, 2015, with the exact date, time and location to be determined and specified in our proxy statement related to the Annual Meeting.

 

Under the Securities and Exchange Commission’s proxy rules, we have set the deadline for submission of proposals to be included in our proxy materials for the Annual Meeting as the close of business on February 1, 2015, assuming the outer date of June 1, 2015.   Accordingly, in order for a shareholder proposal to be considered for inclusion in our proxy materials for the Annual Meeting, the proposal must be received by our Corporate Secretary, ServiceMaster Global Holdings, Inc., 860 Ridge Lake Boulevard, Memphis, Tennessee 38120, on or before the close of business on February 1, 2015, and must comply with the procedures and requirements set forth in Rule 14a-8 under the Securities Exchange Act of 1934, as amended.

 

In accordance with the advance notice requirements contained in our second amended and restated bylaws, for director nominations or other business to be brought before the Annual Meeting by a shareholder, other than Rule 14a-8 proposals described above, written notice must be delivered no earlier than on January 15, 2015, and no later than the close of business on February 14, 2015, to our Corporate Secretary, ServiceMaster Global Holdings, Inc., 860 Ridge Lake Boulevard, Memphis, Tennessee 38120. These shareholder notices also must comply with the requirements of our second amended and restated bylaws and will not be effective otherwise.

 

 

 

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ITEM 6. EXHIBITS

 

 

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# Filed herewith. 

 

 

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SIGNATURE

 

Pursuant to the requirements of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.

 

Date: November 3, 2014

 

 

 

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