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

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UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

 

 

FORM 10-Q

 

 

 

For the quarterly period ended June 30, 2014

 

or

 

 

For the transition period from                    to                    

 

Commission file number 001-36507

 

 

ServiceMaster Global Holdings, Inc.

(Exact name of registrant as specified in its charter)

 

 

Commission file number 001-14762

 

 

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.

 

ServiceMaster Global Holdings, Inc.	Yes  o  No  x
The ServiceMaster Company, LLC	Yes  o  No  x

 

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).

 

ServiceMaster Global Holdings, Inc.	Yes  x  No  o
The ServiceMaster Company, LLC	Yes  x  No  o

 

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.

 

ServiceMaster Global Holdings, Inc.
Large accelerated filer o	Accelerated filer o	Non-accelerated filer x	Smaller reporting company o
		(Do not check if a smaller reporting company)
The ServiceMaster Company, LLC
Large accelerated filer o	Accelerated filer o	Non-accelerated filer x	Smaller reporting company o
		(Do not check if a smaller reporting company)

 

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

 

ServiceMaster Global Holdings, Inc.	Yes  o  No  x
The ServiceMaster Company, LLC	Yes  o  No  x

 

The number of shares of the registrant’s common stock outstanding as of August 5, 2014:

 

ServiceMaster Global Holdings, Inc.

91,914,159 shares of common stock, par value $0.01 per share

 

The ServiceMaster Company, LLC is a privately held limited liability company, and its membership interests are not publicly traded. At August 5, 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

 

	Page No.
Part I. Financial Information
Item 1. Financial Statements (Unaudited)
Condensed Consolidated Statements of Operations and Comprehensive Income (Loss)	4
Condensed Consolidated Statements of Financial Position	6
Condensed Consolidated Statements of Cash Flows	7
Notes to Condensed Consolidated Financial Statements	8
Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations	36
Item 3. Quantitative and Qualitative Disclosures About Market Risk	55
Item 4. Controls and Procedures	55
Part II. Other Information	56
Item 1. Legal Proceedings	56
Item 1A. Risk Factors	56
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds	57
Item 6. Exhibits	58
Signature	60

 

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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)

 

		Holdings						SvM
		Three months ended June 30,						Three months ended June 30,
		2014			2013			2014			2013
Revenue		$	683		$	631		$	683		$	631
Cost of services rendered and products sold		351			329			351			329
Selling and administrative expenses		178			188			177			188
Amortization expense		14			13			14			13
Impairment of software and other related costs		(1		)	—			(1		)	—
Restructuring charges		1			—			1			—
Interest expense		61			63			61			63
Interest and net investment income		(1		)	(2		)	(1		)	(2		)
Income from Continuing Operations before Income Taxes		80			40			81			40
Provision for income taxes		38			25			38			25
Income from Continuing Operations		42			15			43			15
Loss from discontinued operations, net of income taxes		(2		)	(525		)	(2		)	(525		)
Net Income (Loss)		$	40		$	(510	)	$	41		$	(510	)
Total Comprehensive Income (Loss)		$	42		$	(514	)	$	43		$	(514	)
Weighted-average common shares outstanding - Basic		92			92
Weighted-average common shares outstanding - Diluted		92			92
Basic Earnings (Loss) Per Share:
Income from continuing operations		$	0.46		$	0.16
Loss from discontinued operations, net of income taxes		(0.02		)	(5.73		)
Net income (loss)		0.44			(5.57		)
Diluted Earnings (Loss) Per Share:
Income from continuing operations		$	0.46		$	0.16
Loss from discontinued operations, net of income taxes		(0.02		)	(5.68		)
Net income (loss)		0.44			(5.52		)

 

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)

 

		Holdings						SvM
		Six months ended June 30,						Six months ended June 30,
		2014			2013			2014			2013
Revenue		$	1,216		$	1,145		$	1,216		$	1,145
Cost of services rendered and products sold		639			599			639			599
Selling and administrative expenses		329			346			328			346
Amortization expense		27			26			27			26
Impairment of software and other related costs		47			—			47			—
Restructuring charges		6			3			6			3
Interest expense		122			123			122			123
Interest and net investment income		(7		)	(4		)	(7		)	(4		)
Income from Continuing Operations before Income Taxes		53			52			54			52
Provision for income taxes		29			31			29			31
Income from Continuing Operations		24			21			25			21
Loss from discontinued operations, net of income taxes		(97		)	(554		)	(97		)	(554		)
Net Loss		$	(73	)	$	(533	)	$	(72	)	$	(533	)
Total Comprehensive Loss		$	(74	)	$	(534	)	$	(74	)	$	(534	)
Weighted-average common shares outstanding - Basic		92			92
Weighted-average common shares outstanding - Diluted		92			93
Basic Earnings (Loss) Per Share:
Income from continuing operations		$	0.26		$	0.23
Loss from discontinued operations, net of income taxes		(1.06		)	(6.04		)
Net loss		(0.79		)	(5.81		)
Diluted Earnings (Loss) Per Share:
Income from continuing operations		$	0.26		$	0.23
Loss from discontinued operations, net of income taxes		(1.05		)	(5.97		)
Net loss		(0.79		)	(5.74		)

 

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)

 

		Holdings						SvM
		As of June 30, 2014			As of December 31, 2013			As of June 30, 2014			As of December 31, 2013
Assets:
Current Assets:
Cash and cash equivalents		$	528		$	484		$	515		$	476
Marketable securities		23			27			23			27
Receivables, less allowances of $27 and $26, respectively		447			394			451			394
Inventories		39			39			39			39
Prepaid expenses and other assets		62			56			56			56
Deferred customer acquisition costs		34			30			34			30
Deferred taxes		105			107			105			107
Assets of discontinued operations		—			76			—			76
Total Current Assets		1,238			1,213			1,223			1,205
Property and Equipment:
At cost		362			381			362			381
Less: accumulated depreciation		(223		)	(204		)	(223		)	(204		)
Net Property and Equipment		139			177			139			177
Other Assets:
Goodwill		2,060			2,018			2,060			2,018
Intangible assets, primarily trade names, service marks and trademarks, net		1,716			1,721			1,716			1,721
Notes receivable		23			22			40			37
Long-term marketable securities		91			122			91			122
Other assets		48			49			48			49
Debt issuance costs		36			41			36			41
Assets of discontinued operations		—			542			—			542
Total Assets		$	5,351		$	5,905		$	5,353		$	5,912
Liabilities and Shareholder’s (Deficit) Equity:
Current Liabilities:
Accounts payable		$	99		$	92		$	99		$	92
Accrued liabilities:
Payroll and related expenses		62			70			62			70
Self-insured claims and related expenses		109			78			109			78
Accrued interest payable		47			51			47			51
Other		62			55			59			55
Deferred revenue		502			448			502			448
Liabilities of discontinued operations		8			139			8			139
Current portion of long-term debt		42			39			42			39
Total Current Liabilities		931			972			928			972
Long-Term Debt		3,859			3,867			3,859			3,867
Other Long-Term Liabilities:
Deferred taxes		742			712			720			690
Liabilities of discontinued operations		—			162			—			162
Other long-term obligations, primarily self-insured claims		144			169			144			169
Total Other Long-Term Liabilities		886			1,043			864			1,021
Commitments and Contingencies (See Note 4)
Shareholder’s (Deficit) Equity:
Common stock $0.01 par value (authorized 2,000,000,000 shares with 99,512,954 shares issued and 91,903,152 outstanding at June 30, 2014 and 98,915,432 shares issued and 91,669,470 outstanding at December 31, 2013)		1			1			—			—
Membership interest		—			—			—			—
Additional paid-in capital		1,532			1,523			1,478			1,475
Retained deficit		(1,741		)	(1,390		)	(1,780		)	(1,430		)
Accumulated other comprehensive income		4			7			4			7
Less common stock held in treasury, at cost (7,609,802 shares at June 30, 2014 and 7,245,962 shares at December 31, 2013)		(121		)	(118		)	—			—
Total Shareholder’s (Deficit) Equity		(325		)	23			(298		)	52
Total Liabilities and Shareholder’s (Deficit) Equity		$	5,351		$	5,905		$	5,353		$	5,912

 

See accompanying Notes to the unaudited Condensed Consolidated Financial Statements

 

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Condensed Consolidated Statements of Cash Flows (Unaudited)

 

(In millions)

 

		Holdings						SvM
		Six months ended June 30,						Six months ended June 30,
		2014			2013			2014			2013
Cash and Cash Equivalents at Beginning of Period		$	484		$	418		$	476		$	412
Cash Flows from Operating Activities from Continuing Operations:
Net Loss		(73		)	(533		)	(72		)	(533		)
Adjustments to reconcile net loss to net cash provided from operating activities:
Loss from discontinued operations, net of income taxes		97			554			97			554
Depreciation expense		24			24			24			24
Amortization expense		27			26			27			26
Amortization of debt issuance costs		5			5			5			5
Impairment of software and other related costs		47			—			47			—
Deferred income tax provision		22			28			23			28
Stock-based compensation expense		3			1			3			1
Restructuring charges		6			3			6			3
Cash payments related to restructuring charges		(5		)	(5		)	(5		)	(5		)
Change in working capital, net of acquisitions:
Current income taxes		(3		)	(8		)	(3		)	(8		)
Receivables		(29		)	(25		)	(32		)	(22		)
Inventories and other current assets		(14		)	(19		)	(9		)	(19		)
Accounts payable		14			21			14			21
Deferred revenue		27			24			27			24
Accrued liabilities		12			29			9			29
Other, net		(11		)	(2		)	(12		)	(2		)
Net Cash Provided from Operating Activities from Continuing Operations		149			123			149			126
Cash Flows from Investing Activities from Continuing Operations:
Property additions		(26		)	(23		)	(26		)	(23		)
Sale of equipment and other assets		1			1			1			1
Other business acquisitions, net of cash acquired		(41		)	(5		)	(41		)	(5		)
Notes receivable, financial investments and securities, net		30			(18		)	30			(18		)
Notes receivable from affiliate		—			—			(2		)	(10		)
Net Cash Used For Investing Activities from Continuing Operations		(36		)	(45		)	(38		)	(55		)
Cash Flows from Financing Activities from Continuing Operations:
Borrowings of debt		—			1			—			1
Payments of debt		(22		)	(22		)	(22		)	(22		)
Repurchase of common stock and RSU vesting		(4		)	(12		)	—			—
Issuance of common stock		7			—			—			—
Discount paid on issuance of debt		—			(12		)	—			(12		)
Debt issuance costs paid		—			(6		)	—			(6		)
Contribution to TruGreen Holding Corporation		(35		)	—			(35		)	—
Net Cash Used For Financing Activities from Continuing Operations		(54		)	(51		)	(57		)	(39		)
Cash Flows from Discontinued Operations:
Cash used for operating activities		(10		)	(46		)	(10		)	(46		)
Cash used for investing activities		(2		)	(16		)	(2		)	(16		)
Cash used for financing activities		(3		)	(6		)	(3		)	(6		)
Net Cash Used for Discontinued Operations		(15		)	(68		)	(15		)	(68		)
Cash Increase (Decrease) During the Period		44			(41		)	39			(36		)
Cash and Cash Equivalents at End of Period		$	528		$	377		$	515		$	376

 

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 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 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.

 

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.

 

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.

 

Note 2. Recent Developments

 

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:

 

(In millions)
Net Proceeds
Gross proceeds		$	702
Underwriting discounts and commissions		(35		)
Offering expenses		(6		)
Net Proceeds		$	661

 

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(In millions)
Use of Proceeds
Partial redemption of 8% 2020 Notes(1)		$	234
Partial redemption of 7% 2020 Notes(1)		288
Principal payment of Existing Term Facilities(1)		118
Consulting agreement termination fees(2)		21
Use of Proceeds		$	661

 

(1)                                 See “—Refinancing of Indebtedness” below for further details of the total debt reduction of $835 million in July 2014.

(2)                                 See Note 16 for further details on the termination of the consulting agreements.

 

Refinancing of Indebtedness

 

On July 1, 2014, in connection with the initial public offering, SvM terminated its existing credit agreements governing its existing term loan facility, the pre-funded letter of credit facility (together, the “Existing Term Facilities”) and the existing Revolving Credit Facility (together with the Existing Term Facilities, the “Existing Credit Facilities”) and entered into a new credit 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 $244 million of available cash and $118 million of net proceeds of the initial public offering, were used to repay in full the $2,187 million outstanding under the Existing Term Facilities.  In addition, $41 million of available cash was used to pay debt issuance costs of $23 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 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 Existing Term Facilities, we expect to record a loss on extinguishment of debt of approximately $65 million in the third quarter of 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 approximately $30 million of debt issuance costs.

 

Note 3. 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; 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

 

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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 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 $19 million and $18 million for the three months ended June 30, 2014 and 2013, respectively, and $36 million and $33 million for the six months ended June 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 $502 million and $448 million of deferred revenue as of June 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 $34 million and $30 million as of June 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

 

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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 for each of the three months ended June 30, 2014 and 2013, and $24 million for each of the six months ended June 30, 2014 and 2013.

 

The Company recorded an impairment charge of $47 million ($28 million, net of tax) in the first six months of 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 17 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 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 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 shares 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

 

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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.

 

Note 4. Restructuring Charges

 

The Company incurred restructuring charges of $1 million ($1 million, net of tax) for the three months ended June 30, 2014. Restructuring charges for the three months ended June 30, 2013 were less than $1 million. The Company incurred restructuring charges of $6 million ($3 million, net of tax) and $3 million ($2 million, net of tax) for the six months ended June 30, 2014 and 2013, respectively. Restructuring charges were comprised of the following:

 

		Three months ended June 30,						Six months ended June 30,
(In millions)		2014			2013			2014			2013
Terminix branch optimization(1)		$	1		$	—		$	2		$	1
Centers of excellence initiative(2)		—			—			4			2
Total restructuring charges		$	1		$	—		$	6		$	3

 

(1)                                 For the three months ended June 30, 2014, these charges included lease termination costs. For the six months ended June 30, 2014, these charges included lease termination and severance costs. For the six months ended June 30, 2013, these charges included lease termination costs.

 

(2)                                 Represents restructuring charges related to an initiative to enhance capabilities and reduce costs in the Company’s headquarters functions that provide Company-wide administrative services for our operations that we refer to as centers of excellence. For the six months ended June 30, 2014, these charges included professional fees of $1 million and severance and other costs of $3 million. For the six months ended June 30, 2013, these charges included professional fees of $1 million and severance and other costs of $1 million.

 

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:

 

(In millions)		Accrued Restructuring Charges
Balance as of December 31, 2013		$	1
Costs incurred		6
Costs paid or otherwise settled		(5		)
Balance as of June 30, 2014		$	2

 

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Note 5. 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:

 

(In millions)		Accrued Self-insured Claims, Net
Balance as of December 31, 2013		$	101
Provision for self-insured claims		36
Cash payments		(31		)
Balance as of June 30, 2014		$	106
Balance as of December 31, 2012		$	103
Provision for self-insured claims		30
Cash payments		(24		)
Balance as of June 30, 2013		$	109

 

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 6. 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 six months ended June 30, 2014 and 2013.

 

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

 

(In millions)		Terminix			American Home Shield			Franchise Services Group			Total
Balance as of December 31, 2013		$	1,480		$	348		$	190		$	2,018
Acquisitions		7			34			1			42
Balance as of June 30, 2014		$	1,487		$	382		$	191		$	2,060

 

There were no accumulated impairment losses recorded in continuing operations as of June 30, 2014.

 

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

 

		Estimated Remaining Useful		As of June 30, 2014									As of December 31, 2013
(In millions)		Lives (Years)		Gross			Accumulated Amortization			Net			Gross			Accumulated Amortization			Net
Trade names(1)		N/A		$	1,608		$	—		$	1,608		$	1,608		$	—		$	1,608
Customer relationships		3 - 10		531			(469		)	62			512			(447		)	65
Franchise agreements		20 - 25		88			(56		)	32			88			(54		)	34
Other		4 - 30		44			(30		)	14			41			(27		)	14
Total				$	2,271		$	(555	)	$	1,716		$	2,249		$	(528	)	$	1,721

(1)                                 Not subject to amortization.

 

In the six months ended June 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 three and six months ended June 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 7. 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 existing 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 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.

 

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For the three months ended June 30, 2014, the Company recognized stock-based compensation expense of $1 million ($1 million, net of tax). Stock-based compensation expense for the three months ended June 30, 2013 was less than $1 million. For the six months ended June 30, 2014 and 2013, the Company recognized stock-based compensation expense of $3 million ($2 million, net of tax) and $1 million ($1 million, net of tax), respectively. As of June 30, 2014, there was $18 million of total unrecognized compensation costs related to non-vested stock options and restricted share units 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 2.97 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 no grants as of June 30, 2014. Upon adoption of the 2014 Omnibus Incentive Plan, the Company froze the MSIP and will make no further grants thereunder.

 

Note 8. 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.

 

(In millions)		Unrealized Gains on Derivatives			Unrealized Gains on Available -for-Sale Securities			Foreign Currency Translation			Total
Balance as of December 31, 2013		$	—		$	7		$	—		$	7
Other comprehensive income before reclassifications:
Pre-tax amount		—			3			—			3
Tax provision		—			1			—			1
After tax amount		—			2			—			2
Amounts reclassified from accumulated other comprehensive income (loss)(1)		—			(3		)	—			(3		)
Net current period other comprehensive (loss) income		—			(1		)	—			(1		)
Spin-off of the TruGreen Business		—			—			(2		)	(2		)
Balance as of June 30, 2014		$	—		$	6		$	(2	)	$	4
Balance as of December 31, 2012		$	(2	)	$	5		$	4		$	7
Other comprehensive (loss) income before reclassifications:
Pre-tax amount		(1		)	2			(3		)	(2		)
Tax (benefit) provision		(1		)	1			—			—
After tax amount		—			1			(3		)	(2		)
Amounts reclassified from accumulated other comprehensive (loss) income(1)		2			(1		)	—			1
Net current period other comprehensive income (loss)		2			—			(3		)	(1		)
Balance as of June 30, 2013		$	—		$	5		$	1		$	6

(1)                                 Amounts are net of tax. See reclassifications out of accumulated other comprehensive income below for further details.

 

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