TERMINIX GLOBAL HOLDINGS INC - Quarter Report: 2016 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, 2016



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)



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 October 21, 2016:  134,757,904  shares of common stock, par value $0.01 per share

 

 

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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 (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.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS 

(UNAUDITED)

Note 1. Basis of Presentation 

ServiceMaster Global Holdings, Inc. and its majority-owned subsidiary partnerships, limited liability companies and corporations (collectively, “ServiceMaster,” the “Company,” “we,” “us, and “our”) 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, on-site cabinet and wood 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. All consolidated Company subsidiaries are wholly-owned. Intercompany transactions and balances have been eliminated.

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 be read in conjunction with the audited consolidated financial statements and the notes thereto included in the Company’s Annual Report on Form 10-K for the year ended December 31, 2015, as filed with the SEC (the “2015 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.

 



Note 2. Significant Accounting Policies

The Company’s significant accounting policies are described in Note 2 to the audited consolidated financial statements included in the Company’s 2015 Form 10-K. Other than the addition below, there have been no material changes to the significant accounting policies for the three and nine months ended September 30, 2016.

Restricted Cash

Restricted cash consists of cash held in trust as collateral under the Company’s automobile, general liability and workers’ compensation insurance program.

Newly Issued Accounting Standards

In May 2014, the Financial Accounting Standards Board (“FASB”) issued Accounting Standards Update (“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. ASU 2014-09 is effective for fiscal years, and interim periods within those years, beginning after December 15, 2017. Early adoption is permitted for fiscal years, and interim period within those years, beginning after December 15, 2016. The Company is currently evaluating the impact of adopting ASU 2014-09.

In January 2016, the FASB issued ASU 2016-01, “Recognition and Measurement of Financial Assets and Financial Liabilities” to change how entities measure certain equity investments, to require the disclosure of changes in the fair value of financial liabilities measured under the fair value option that are attributable to a company’s own credit, and to change certain other disclosure requirements. The changes in ASU 2016-01 specifically require that the changes in fair value of all investments in equity securities be recognized in net income. The Company is impacted as unrealized gains or losses on the Company’s available-for-sale securities are currently recognized in other comprehensive income. The amendments in ASU 2016-01 are effective for fiscal years, and interim periods within those years, beginning after December 15, 2017, and will be adopted prospectively.

In February 2016, the FASB issued ASU 2016-02, “Leases (Topic 842),” which is the final standard on accounting for leases. While both lessees and lessors are affected by the new guidance, the effects on lessees are much more significant. The most significant change for lessees is the requirement under the new guidance to recognize right-of-use assets and lease liabilities for all leases not considered short-term leases. Entities are required to use a modified retrospective approach to adopt the guidance. The amendments in ASU 2016-02 are effective for fiscal years, and interim periods within those years, beginning after December 15, 2018. Early adoption is permitted. The Company is currently evaluating the impact of adopting ASU 2016-02.

In March 2016, the FASB issued ASU 2016-09, “Improvements to Employee Share-Based Payment Accounting” to require the recognition of the income tax effects of share-based awards in the income statement when the awards vest or are settled and the presentation of excess tax benefits as an operating activity on the statement of cash flows as part of the FASB’s simplification initiative. Under previous guidance, an entity generally recorded excess tax benefits and certain tax deficiencies in additional paid-in capital instead of through income tax expense or benefit in the income statement and presented excess tax benefits as a financing

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activity rather than an operating activity in the statement of cash flows. ASU 2016-09 is effective for fiscal years, and interim periods within those years, beginning after December 15, 2016. As allowed, the Company has elected to early adopt the amendments of ASU 2016-09. The adoption of ASU 2016-09 has been accounted for as a change in accounting principle prospectively for the income statement effect, as required, and retrospectively for the cash flow statement effect, as allowed. As a result of the implementation of ASU 2016-09, $12 million of excess tax benefits for the nine months ended September 30, 2015 were retrospectively presented as an operating activity within the condensed consolidated statements of cash flows.

In August 2016, the FASB issued ASU 2016-15, “Classification of Certain Cash Receipts and Cash Payments” to reduce the diversity in practice in how certain transactions are classified in the statement of cash flows. In particular, under previous guidance, debt prepayment or debt extinguishment costs paid by a borrower in connection with settling a debt financing arrangement before the maturity date were inconsistently classified in the statement of cash flows as either operating activities or financing activities by borrowers. The Company has historically presented debt prepayment costs as cash outflows for operating activities. ASU 2016-15 requires that cash payments for debt prepayment or extinguishment costs be classified as cash outflows for financing activities. ASU 2016-15 is effective for fiscal years, and interim periods within those years, beginning after December 15, 2017. As allowed, the Company has elected to early adopt the amendments of ASU 2016-15 and has applied the applicable amendments retrospectively as required. As a result of the implementation of ASU 2016-15, $49 million of call premium paid on retirement of debt for the nine months ended September 30, 2015 was retrospectively presented as a financing activity within the condensed consolidated statements of cash flows. ASU 2016-15 contains additional clarifications on the classification of certain transactions in the statement of cash flows, which the Company has applied prospectively, as applicable.



 

 



Note 3. Commitments and Contingencies 

The Company carries insurance policies on insurable risks at levels that it believes to be appropriate, including workers’ compensation, automobile 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, exceed our coverage limits or are otherwise not covered by our insurance policies. 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 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 condensed consolidated statements of financial position, net of insurance recoverables, which are included in Prepaid expenses and other assets and Other assets on the condensed consolidated statements of financial position, is presented as follows:





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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.

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In 2008, the Company amended its Profit Sharing and Retirement Plan, a tax qualified 401(k) defined contribution plan available to substantially all of its employees (the “401(k) Plan”), to implement a qualified automatic contribution arrangement (“QACA”) under the safe harbor provisions of the Internal Revenue Code of 1986, as amended (the “Code”). QACA plans, in general, require automatic enrollment of employees into the retirement plan absent an affirmative election that such employees do not wish to participate. Although the Company implemented processes to auto-enroll new hires after adopting the QACA plan in 2008, it discovered that it did not auto-enroll then existing employees who were not participating in the 401(k) Plan. In response, the Company implemented an auto-enrollment process for affected active employees and submitted to the Internal Revenue Service (the “IRS”) a voluntary correction proposal to remedy the issue for prior years. The Company’s current estimate of the cost of the correction ranges from $24 million to approximately $89 million. The Company has recorded in the condensed consolidated statement of operations and comprehensive income charges of $24 million, of which $1 million was recorded in the nine months ended September 30, 2016. However, there can be no assurances as to the ultimate cost of the correction.

In addition to the matter discussed above and the fumigation related matters discussed below, 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. Subject to the paragraphs below, 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. 

Fumigation Related Matters

As previously disclosed, on July 21, 2016, Terminix International USVI, LLC (“TMX USVI”) and The Terminix International Company Limited Partnership (“TMX LP”), each an indirect, wholly-owned subsidiary of the Company, entered into a superseding Plea Agreement (the “Superseding Plea Agreement”) in connection with the investigation initiated by the United States Department of Justice Environmental Crimes Section (the “DOJ”) into allegations that a local Terminix branch used methyl bromide as a fumigant at a resort in St. John, U.S. Virgin Islands. The Superseding Plea Agreement was intended to resolve four misdemeanor charges of violations of the Federal Insecticide, Fungicide, and Rodenticide Act related to improper applications of methyl bromide. Those charges were set forth in an Information, dated March 29, 2016, in the matter styled United States of America v. The Terminix International Company Limited Partnership and Terminix International USVI, LLC.  At a hearing held on August 25, 2016, the United States District Court of the U.S. Virgin Islands rejected the Superseding Plea Agreement.  On August 31, 2016, the DOJ requested that the charges be dismissed, reserving its right to re-file the charges, in light of ongoing discussions to resolve the matter, and the court has granted that request. The Company continues to cooperate with the DOJ in an effort to resolve the matter in a manner consistent with the terms and conditions of the Superseding Plea Agreement.  While the Superseding Plea Agreement, and any modifications thereto, would not bind any other federal, state or local authority, the EPA has stated that it does not intend to initiate any administrative enforcement action or refer the matter to the DOJ for any civil enforcement once an appropriate plea agreement is approved by the court. The Company has previously recorded in the condensed consolidated statement of operations and comprehensive income total charges of $10 million in connection with the terms of the Superseding Plea Agreement. 

The Superseding Plea Agreement and the payments contemplated thereunder would not resolve any civil or administrative claims for damages or other relief related to the U.S. Virgin Islands matter; however, the Company previously disclosed that it has formalized the terms of the settlement agreement, which includes customary releases and confidentiality provisions, and a civil court in Delaware has given the necessary approvals.  Accordingly, the civil claims for all four members of the Delaware family are resolved.  In the nine months ended September 30, 2016, the Company recorded within Fumigation related matters in the condensed consolidated statement of operations and comprehensive income a charge of $87 million in connection with the settlement agreement.  In the nine months ended September 30, 2015, the Company recorded within Cost of services rendered and products sold in the condensed consolidated statement of operations and comprehensive income a charge of $3 million related to the civil claims related to the U.S. Virgin Islands matter, which is an amount equal to the Company’s insurance deductible under its general liability insurance policies.

The amount and extent of any further potential penalties, fines, sanctions, costs and damages that the federal or other governmental authorities may yet impose, investigation or other costs and reputational harm, as well as the impact of any additional civil, criminal or other claims or judicial, administrative or regulatory proceedings resulting from or related to the U.S. Virgin Islands matter, which could be material, is not currently known or reasonably estimable, and any such further penalties, fines, sanctions, costs or damages would not be covered under the Company’s general liability insurance policies. 

As previously disclosed, on September 15, 2015, a lawsuit was filed in the Circuit Court of the 15th Judicial Circuit in and for Palm Beach County, Florida, styled Carl Robert McCaughey, et al. v. Terminix International Company Limited Partnership, Sunland Pest Control Services, Inc., et al. The lawsuit alleges that fumigation of a Florida family’s residence by Sunland, a subcontractor of TMX LP, resulted in serious injuries to one of the family’s children. The Company has recently formalized the terms

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of a settlement agreement, which includes customary releases and confidentiality provisions, and a civil court in Florida has given the necessary approvals. Accordingly, the civil claims of the affected family related to the Florida fumigation matter are now resolved, and the case has been dismissed. Under the terms of the settlement agreement, in addition to the amounts that the Company’s insurance carriers have agreed to pay to the family pursuant to our general liability insurance policies, the Company will pay $3 million, an amount equal to the Company’s insurance deductible under its general liability insurance policies. In the nine months ended September 30, 2016, the Company recorded within Cost of services rendered and products sold in the condensed consolidated statement of operations and comprehensive income a charge of $3 million in connection with civil claims related to the Florida fumigation matter. 

 



Note 4. Goodwill and Intangible Assets

Goodwill and indefinite-lived intangible assets are not amortized and 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 the three and nine months ended September 30, 2016 and 2015. There were no accumulated impairment losses recorded as of September 30, 2016. The table below summarizes the goodwill balances for continuing operations by reportable segment:



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



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For the existing intangible assets, the Company anticipates amortization expense for the remainder of 2016 and each of the next five years of $8  million, $23 million, $17 million, $12 million, $9 million and $6 million, respectively.

 



Note 5. Stock-Based Compensation 

For each of the three month periods ended September 30, 2016 and 2015, the Company recognized stock-based compensation expense of  $3 million ($2 million, net of tax). For the nine months ended September 30, 2016 and 2015, the Company recognized stock-based compensation expense of $10 million ($6 million, net of tax) and $8 million ($5 million, net of tax), respectively. These charges are recorded within Selling and administrative expenses in the condensed consolidated statements of operations and comprehensive income.  Additionally, for the three and nine months ended September 30, 2016, the Company recognized $3 million of stock-based compensation expense due to the modification of non-vested stock options and restricted stock units (“RSUs”) as part of the severance agreement with the former president of Terminix, which has been included in Restructuring charges in the condensed consolidated statements of operations and comprehensive income.  

As of September 30, 2016, there was $27 million of total unrecognized compensation costs related to non-vested stock options, RSUs and performance shares granted under the Amended and Restated ServiceMaster Global Holdings, Inc. Stock Incentive Plan (“MSIP”) and the Amended and Restated ServiceMaster Global Holdings, Inc. 2014 Omnibus Incentive Plan (the “Omnibus Incentive Plan”) and discounts associated with the ServiceMaster Global Holdings, Inc. Employee Stock Purchase Plan (the “Employee Stock Purchase Plan”).  These remaining costs are expected to be recognized over a weighted-average period of 2.32 years.

 

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Note 6. Comprehensive Income

Comprehensive income, 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 gain (loss), is disclosed in the condensed consolidated statements of operations and comprehensive income.

The following tables summarize the activity in accumulated 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.

 

 

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Note 7. Supplemental Cash Flow Information

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

The Company acquired $50 million and $22 million of property and equipment through capital leases and other non-cash  financing transactions in the nine months ended September 30, 2016 and 2015, respectively, which have been excluded from the condensed consolidated statements of cash flows as non-cash investing and financing activities. 

In the nine months ended September 30, 2016 and 2015, the Company converted certain company-owned Merry Maids branches to franchises for a total purchase price of $9 million and $12 million, respectively. In the nine months ended September 30, 2016 and 2015, the Company received cash of $6 million and $9 million, respectively, and provided financing of $2 million and $3 million, respectively. These financed amounts have been excluded from the condensed consolidated statements of cash flows as non-cash investing activities.

 



Note 8. 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 condensed consolidated statements of financial position. As of September 30, 2016 and December 31, 2015, the Company’s investments consisted primarily of treasury bills (“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 are as follows:



There were no unrealized losses which had been in a loss position for more than one year as of September 30, 2016 and December 31, 2015. The aggregate fair value of the investments with unrealized losses was $11 million and $23 million as of September 30, 2016 and December 31, 2015, 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 and gross realized gains resulting from sales of available-for-sale securities. There were no gross realized losses resulting from sales of available-for-sale securities or impairment charges due to other than temporary declines in the value of certain investments for the three and nine months ended September 30, 2016 and 2015.  





 









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Note 9. Long-Term Debt

Long-term debt is summarized in the following table:



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Refinancing of Indebtedness

On February 17, 2015, the Company redeemed $190 million in aggregate principal amount of its outstanding 8% senior notes due 2020 (the “8% 2020 Notes”) at a redemption price of 106.0% of the principal amount using available cash. In connection with the partial redemption, the Company recorded a loss on extinguishment of debt of $13 million in the first quarter of 2015, which included a pre-payment premium of $11 million and the write-off of $2 million of debt issuance costs. 

On April 1, 2015, the Company entered into a first amendment (the “First Term Loan Amendment”) which amends the agreement governing the Credit Facilities. The First Term Loan Amendment provides for incremental term loans (the “April Incremental Term Loans”) in an aggregate principal amount of $175 million. On April 1, 2015, the Company used the net proceeds from the April Incremental Term Loans, together with cash on hand, to redeem the remaining outstanding $200 million in aggregate principal amount of the 8% 2020 Notes at a redemption price of 106.0% of the principal amount. In connection with the redemption, the Company recorded a loss on extinguishment of debt of $14 million in the second quarter of 2015, which included a pre-payment premium of $12 million and the write-off of $2 million of debt issuance costs.

On August 17, 2015, the Company entered into a second amendment (the “Second Term Loan Amendment”) which amends the agreement governing the Credit Facilities. The Second Term Loan Amendment provides for incremental term loans (the “August Incremental Term Loans”) in an aggregate principal amount of $400 million. On August 17, 2015, the Company used the net proceeds from the August Incremental Term Loans, together with cash on hand, to redeem the remaining outstanding $488 million in aggregate principal amount of the 7% senior notes due 2020 (the “7% 2020 Notes”) (together with the 8% 2020 Notes, the “2020 Notes”) at a redemption price of 105.25% of the principal amount. In connection with the redemption, the Company recorded a loss on extinguishment of debt of $31 million in the third quarter of 2015, which included a pre-payment premium of $25 million and the write-off of $6 million of debt issuance costs

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Interest Rate Swaps

Interest rate swap agreements in effect as of September 30, 2016 are as follows:

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(1)Before the application of the applicable borrowing margin.

 



Note 10. 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 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 June 27, 2016, the Company acquired OneGuard Home Warranties (“OneGuard”) for a total purchase price of $61 million.  The Company recorded goodwill of $57 million and other intangibles, primarily customer relationships, of $15 million related to this acquisition. As of September 30, 2016, the purchase price allocation for this acquisition has not been finalized. In particular, the Company is still evaluating the fair value of certain intangible assets. As the Company finalizes the fair value of assets acquired and liabilities assumed, additional purchase price adjustments will be recorded during the measurement period in 2016.

During the nine months ended September 30, 2016, the Company completed several pest control and termite acquisitions. The total purchase price for these acquisitions was $43  million. The Company recorded goodwill of $34 million and other intangibles, primarily customer relationships, of $6 million related to these acquisitions.

During the nine months ended September 30, 2015, the Company completed several pest control and termite acquisitions. The total purchase price for these acquisitions was $37 million. The Company recorded goodwill of $26 million and other intangibles, primarily customer relationships, of $9 million related to these acquisitions.

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















Note 11. Income Taxes 

As of September 30, 2016 and December 31, 2015, the Company had $18 million and $16 million, respectively, of tax benefits primarily reflected in state tax returns that have not been recognized for financial reporting purposes (“unrecognized tax benefits”). Based on information currently available, it is reasonably possible that over the next 12 month period unrecognized tax benefits may decrease by $7 million as the result of settlements of ongoing audits, statute of limitation expirations or final settlements of uncertain tax positions in multiple jurisdictions.

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 the Company’s 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 income from continuing operations was 39.8 percent and 39.3 percent for the three months ended September 30, 2016 and 2015, respectively, and 37.9 percent and 38.6 percent for the nine months ended September 30, 2016 and 2015, respectively.

 



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Note 12. 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 cabinet and wood furniture repair and restoration services primarily under the Furniture Medic brand name and home inspection services primarily under the AmeriSpec brand name. Corporate includes SMAC, the Company’s financing subsidiary exclusively dedicated to providing financing to its franchisees and retail customers of its 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 the Company’s reportable segments is consistent with that used by the Company’s chief operating decision maker (the “CODM”) to evaluate performance and allocate resources.

Information regarding the accounting policies used by the Company is described in the Company’s 2015 Form 10-K. The Company derives substantially all of its revenue from customers and franchisees in the United States with approximately two percent generated in foreign markets. Operating expenses of the business units consist primarily of direct costs and indirect costs allocated from Corporate.

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 before: unallocated corporate expenses; loss from discontinued operations, net of income taxes; provision for income taxes; loss on extinguishment of debt; interest expense; depreciation and amortization expense; 401(k) Plan corrective contribution; fumigation related matters; insurance reserve adjustment; non-cash stock-based compensation expense; restructuring charges; gain on sale of Merry Maids branches; non-cash impairment of software and other related costs; 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. The Company believes 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 and equity-based, long-term incentive plans.

Information for continuing operations for each reportable segment and Corporate is presented below:



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Note 13. Related Party Transactions 

TruGreen Spin-off

In connection with the TruGreen spin-off on January 14, 2014, the Company entered into a transition services agreement with TruGreen Holding Corporation (“New TruGreen”) pursuant to which the Company provided New TruGreen 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 were designed to allow the Company to fully recover the 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 terminated at various specified times on or prior to January 14, 2016 (except certain information technology, human resources and accounts payable services, which the Company has continued to provide to New TruGreen beyond January 14, 2016). New TruGreen may terminate the transition services agreement (or certain services under the transition services agreement) for convenience upon 90 days written notice, in which case New TruGreen will be required to reimburse the Company for early termination costs.

Under this transition services agreement, the Company recorded $2 million and $6 million in the three months ended September 30, 2016 and 2015, respectively, and $6 and $21 million in the nine months ended September 30, 2016 and 2015, respectively, of fees from New TruGreen, which is included as a reduction in Selling and administrative expenses in the condensed

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consolidated statement of operations and comprehensive income. As of September 30, 2016, all amounts owed by New TruGreen under this agreement have been paid.

In addition, the Company, New TruGreen and TruGreen Limited Partnership, an indirectly wholly-owned subsidiary of New TruGreen, 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 the Company has 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.

 

Note 14. Fair Value Measurements

The period-end carrying amounts of cash and cash equivalents, receivables, restricted cash, 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 condensed consolidated statements of financial position, or, for certain unrealized losses, reported in interest and net investment income in the condensed consolidated statements of operations and comprehensive income if the decline in value is other than temporary. The carrying amount of total debt was $2,785 million and $2,752 million and the estimated fair value was $2,903 million and $2,813 million as of September 30, 2016 and December 31, 2015, 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, 2016 and December 31, 2015.

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, 2016 and 2015.

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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 the Company’s 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 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 condensed consolidated statements of cash flows.

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, 2016. As of September 30, 2016, the Company had fuel swap contracts to pay fixed prices for fuel with an aggregate notional amount of $38 million, maturing through 2018. 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, 2016, the Company had posted $3 million in letters of credit as collateral under its fuel hedging program, which were issued under the Revolving Credit Facility.

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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. See Note 6 to the condensed consolidated financial statements for the effective portion of the gain or loss on derivative instruments recorded in accumulated other comprehensive income (loss) and for the amounts reclassified out of accumulated other comprehensive income (loss) and into 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, 2016. The amounts that are ultimately reclassified into earnings will be based on actual fuel prices and interest rates at the time the positions are settled and may differ materially from the amount noted above.

 





Note 15. Earnings Per Share

Basic earnings per share is computed by dividing net income by the weighted average number of shares of common stock outstanding. Diluted earnings per share is computed by dividing net income 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, RSUs and performance shares are reflected in diluted net income 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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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 Item 1 of this Quarterly Report on Form 10-Q. 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.”

Overview

Our core services include termite and pest control, home warranties, disaster restoration, janitorial, residential cleaning, cabinet and wood 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 monitor cash flow, including net cash provided from operating activities from continuing operations and free cash flow.

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 is impacted by new unit sales, the retention of our existing customers and acquisitions. We expect to continue our tuck-in acquisition program at Terminix and to periodically evaluate other strategic acquisitions. Revenue results in the 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. In 2015, approximately 98 percent of our revenue was generated by sales 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, contractor costs, self-insurance costs and other insurance premiums, as well as various regulatory compliance costs.

Net Income and Earnings Per Share. Basic earnings per share is computed by dividing net income by the weighted-average number of shares of common stock outstanding. Diluted earnings per share is computed by dividing net income 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 RSUs are reflected in diluted net income per share by applying the treasury stock method. The presentation of net income and earnings per share provides GAAP measures of performance which are useful for investors, analysts and other interested parties in company-to-company operating performance comparisons.

Adjusted EBITDA. We evaluate performance and allocate resources based primarily on Adjusted EBITDA. We define Adjusted EBITDA as net income before: loss from discontinued operations, net of income taxes; provision for income taxes; loss on extinguishment of debt; interest expense; depreciation and amortization expense; 401(k) Plan corrective contribution; fumigation related matters; insurance reserve adjustment; non-cash impairment of software and other related costs; non-cash stock-based compensation expense; restructuring charges; gain on sale of Merry Maids branches; 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

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performance comparisons by excluding potential differences caused by variations in capital structures, taxation, the age and book depreciation of facilities and equipment, restructuring initiatives and equity-based, long-term incentive plans.

Organic Revenue Growth. We evaluate organic revenue growth to track performance of the business, including the impacts of sales, pricing, new service offerings and other growth initiatives. Organic revenue growth excludes revenue from acquired customers for 12 months following the acquisition date.

Customer Retention Rates and Customer Counts Growth. Where applicable, we report our customer retention rates and growth in customer counts in order to track the performance of the business. Customer counts represent our recurring customer base, which includes customers with active contracts for recurring services. 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, 12-month basis in order to avoid seasonal anomalies. See “—Segment Review.”

Seasonality

We have seasonality in our business, which drives fluctuations in revenue and Adjusted EBITDA for interim periods. In 2015, approximately 22 percent, 28 percent, 27 percent and 23 percent of our revenue and approximately 21 percent, 31 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 residential 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.  For example, in the third quarter of 2016, we experienced an increase in contract claims cost at American Home Shield driven by a higher number of HVAC work orders driven by high temperatures. 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 claim frequency; and severe storms which can lead to an increase in demand for disaster restoration services.

Franchises

Franchises are important to the Terminix, ServiceMaster Restore, ServiceMaster Clean, Merry Maids, Furniture Medic and AmeriSpec businesses. Total profits from our franchised operations were $23 million and $20 million for the three months ended September 30, 2016 and 2015, respectively, and $61 million and $56 million for the nine months ended September 30, 2016 and 2015, respectively. Nearly all of the franchise fees received by our Franchise Services Group segment are derived from the ServiceMaster Restore, ServiceMaster Clean and Merry Maids businesses. Franchise fees from our Terminix franchisees represented less than one percent of Terminix revenue for the three and nine months ended September 30, 2016. We evaluate the performance of our franchise businesses based primarily on operating profit before corporate general and administrative expenses, interest expense and amortization of intangible assets. Franchise agreements entered into in the course of these businesses are generally for a term of five to 10 years. The majority of these franchise agreements are renewed prior to expiration. Internationally, we have license agreements, whereby licensees provide services under our brand names that would ordinarily be provided by franchisees in the United States. The majority of international licenses are for 10‑year terms.



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 Results of Operations

















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*     not meaningful



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Revenue

We reported revenue of $758 million and $706 million for the three months ended September 30, 2016 and 2015, respectively, and revenue of $2,113 million and $1,993 million for the nine months ended September 30, 2016 and 2015, respectively. A summary of changes in revenue for each of our reportable segments and Corporate is included in the table 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 $400 million and $368 million for the three months ended September 30, 2016 and 2015, respectively,  and $1,104 million and $1,036 million for the nine months ended September 30, 2016 and 2015, respectively. The following table provides a summary of changes in cost of services rendered and products sold for each of our reportable segments and Corporate:

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The increase in contract claims cost at American Home Shield was driven by a higher number of HVAC work orders driven by high temperatures during the quarter and normal inflationary pressure on the underlying costs of repairs.

We realized a reduction in cost of sales of $7 million in the Franchise Services Group as a result of the branch conversions.



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The increase in contract claims cost at American Home Shield was driven by the increase in the average cost per service request associated with appliance repairs we experienced in the first quarter, a higher number of HVAC work orders driven by high temperatures during the third quarter and normal inflationary pressure on the underlying costs of repairs. 

We realized a reduction in cost of sales of $21 million in the Franchise Services Group as a result of the branch conversions.

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Selling and Administrative Expenses

We reported selling and administrative expenses of $185 million and $178 million for the three months ended September 30, 2016 and 2015, respectively, and $546 million and $512 million for the nine months ended September 30, 2016 and 2015, respectively. For the three months ended September 30, 2016 and 2015, selling and administrative expenses comprised general and administrative expenses of $70 million and $64 million, respectively, and selling and marketing expenses of $115 million and $114 million, respectively. For the nine months ended September 30, 2016 and 2015, selling and administrative expenses comprised general and administrative expenses of $215 million and $194 million, respectively, and selling and marketing expenses of $331 million and $318 million, respectively. The following table provides a summary of changes in selling and administrative expenses for each of our reportable segments and Corporate:



The increase in technology costs was primarily due to an acceleration of investments to transform our customers’ experiences through technology.

We realized an increase in selling and administrative expenses at American Home Shield as a result of the acquisition of OneGuard.

We realized a reduction in selling and administrative expenses of $1 million in the Franchise Services Group as a result of the branch conversions.



The increase in technology costs was primarily due to an acceleration of investments to transform our customers’ experiences through technology.

The increase in sales and marketing costs at American Home Shield was primarily driven by the shift in the timing of a holiday mail campaign from the fourth quarter of 2015 to the first quarter of 2016 and, to a lesser extent, an increase in sales commissions and a change in the timing of marketing spend within the year. We expect the shift in the holiday mail campaign to result in an increase to our full year marketing costs. We realized an increase in selling and administrative expenses at American Home Shield as a result of the acquisition of OneGuard. The increase in customer service costs at American Home Shield was due to higher labor costs resulting from an acceleration of pre-season hiring and training in preparation for the high-volume summer season.

We realized a reduction in selling and administrative expenses of $2 million in the Franchise Services Group as a result of the branch conversions.

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Amortization Expense

Amortization expense was $8 million and $7 million in the three months ended September 30, 2016 and 2015, respectively, and $24 million and $31 million in the nine months ended September 30, 2016 and 2015, respectively. The decrease in the nine months ended September 30, 2016 compared to prior year is a result of certain finite-lived intangible assets recorded in connection with the merger transaction by which the Company was taken private in 2007 being fully amortized.

401(k) Plan Corrective Contribution

We recorded a charge of $1 million in the nine months ended September 30, 2016 related to the 401(k) Plan. See Note 3 to the condensed consolidated financial statements for more details. There were no 401(k) Plan corrective contribution charges recorded in the three months ended September 30, 2016 and three and nine months ended September 30, 2015.

Fumigation Related Matters

We recorded charges of $1 and $92 million in the three and nine months ended September 30, 2016 for fumigation related matters.  See Note 3 to the condensed consolidated financial statements for more details.

Insurance Reserve Adjustment

We recorded a charge of $23 million in the nine months ended September 30, 2016 for an adjustment to the Company’s accrued self-insured claims related to automobile, general liability and workers’ compensation risks. The adjustment is based on the Company’s detailed annual assessment of this actuarially determined accrual, which the Company completes in the second quarter of each year. This adjustment relates to coverage periods of 2015 and prior.

Impairment of Software and Other Related Costs

We recorded an impairment charge of $1 million in the nine months ended September 30, 2016 relating to our decision to replace certain software pursuant to our ServSmart initiative. There were no impairments of software and other related costs recorded in the three months ended September 30, 2016 and three and nine months ended September 30, 2015.

Restructuring Charges

We incurred restructuring charges of $8 million and $2 million in the three months ended September 30, 2016 and 2015, respectively, and $13 million and $4 million in the nine months ended September 30, 2016 and 2015, respectively. Restructuring charges were comprised of the following:





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Gain on Sale of Merry Maids Branches 

We recorded a gain of $3 million in the three months ended September 30, 2015 and $2 million and $5 million in the nine months ended September 30, 2016 and 2015, respectively, associated with the branch conversions. There was no gain recorded in the three months ended September 30, 2016. As of October 10, 2016, the branch conversion process was complete.

Interest Expense

Interest expense was $39 million and $41 million for the three months ended September 30, 2016 and 2015, respectively, and $115 million and $128 million for the nine months ended September 30, 2016 and 2015, respectively. The decrease in interest expense was driven by the redemption of the 2020 Notes in 2015, offset, in part, by additional borrowings under the April and August Incremental Term Loans. See Note 9 to the condensed consolidated financial statements for more details.

Interest and Net Investment Income

Interest and net investment income was $1 million for the three months ended September 30, 2016 and $5 million and $8 million for the nine months ended September 30, 2016 and 2015, respectively, and comprised net investment gains and interest and dividend income realized on the American Home Shield investment portfolio and interest income on other cash balances. There was no interest and net investment income for the three months ended September 30, 2015.

Loss on Extinguishment of Debt

A loss on extinguishment of debt of $31 million and $58 million was recorded in the three and nine months ended September 30, 2015, respectively, related to the redemptions of the 8% 2020 Notes on February 17, 2015 and April 1, 2015 and the redemption of the 7% 2020 Notes on August 17, 2015. See Note 9 to the condensed consolidated financial statements for more details. There were no debt extinguishments in the three and nine months ended September 30, 2016.

Income from Continuing Operations before Income Taxes

Income from continuing operations before income taxes was $116 million and $83 million for the three months ended September 30, 2016 and 2015, respectively, and $200 million and $237 million for nine months ended September 30, 2016 and 2015, respectively. The change 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 income from continuing operations was 39.8 percent and 39.3 percent for the three months ended September 30, 2016 and 2015, respectively, and 37.9 percent and 38.6 percent for the nine months ended September 30, 2016 and 2015, respectively.

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Net Income

Net income was $70 million and $49 million for the three months ended September 30, 2016 and 2015, respectively. The $21 million increase was primarily driven by a $33 million increase in income from continuing operations before income taxes, offset, in part, by a $14 million increase in the provision for income taxes.

Net income was $124 million and $144 million for the nine months ended September 30, 2016 and 2015, respectively. The $20 million reduction was primarily driven by a $37 million decrease in income from continuing operations before income taxes, offset, in part, by a $15 million decrease in the provision for 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 condensed consolidated financial statements included in this report.

Revenue and Adjusted EBITDA by reportable segment and for Corporate are as follows:



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Terminix Segment

Three Months Ended September 30, 2016 Compared to Three Months Ended September 30, 2015

The Terminix segment, which provides termite and pest control services to residential and commercial customers and distributes pest control products, reported a six percent increase in revenue and a 12 percent increase in Adjusted EBITDA for the three months ended September 30, 2016 compared to the three months ended September 30, 2015.

Revenue

Revenue by service line is as follows:







Pest control revenue increased eight percent,  reflecting  improved price realization, the impact of the acquisition of Alterra Pest Control, LLC (“Alterra”) on November 10, 2015 and growth in mosquito and bed bug services.

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 four percent. Termite renewal revenue comprised 51 percent of total termite revenue, while the remainder consisted of termite new unit revenue. Termite revenue reflects an increase in core termite

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sales and increased sales of wildlife exclusion, crawlspace encapsulation and attic insulation, offset, by lower price realization driven by targeted offerings of bundled services. Termite activity is unpredictable in its nature. Factors that can impact termite activity include conducive weather conditions and consumer awareness of termite swarms.

Adjusted EBITDA

The following table provides a summary of changes in the segment’s Adjusted EBITDA:



The increase in technology costs was primarily due to an acceleration of investments to transform our customers’ experiences through technology.

We expect an acceleration of investment in Terminix’s field operations focused on improving safety, technician efficiency, customer service and retention in the fourth quarter of 2016 and continuing through the first half of 2017.

Nine Months Ended September 30, 2016 Compared to Nine Months Ended September 30, 2015

The Terminix segment reported a six percent increase in revenue and a 10 percent increase in Adjusted EBITDA for the nine months ended September 30, 2016 compared to the nine months ended September 30, 2015.

Revenue

Revenue by service line is as follows:





Pest control revenue increased 10 percent, reflecting improved price realization, the impact of the Altera acquisition and growth in mosquito and bed bug services.

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 two percent. Termite renewal revenue comprised 52 percent of total termite revenue, while the remainder consisted of termite new unit revenue. The increase in termite revenue reflects an increase in core termite sales, offset, in part, by lower price realization driven by targeted offerings of bundled services.

Adjusted EBITDA

The following table provides a summary of changes in the segment’s Adjusted EBITDA:



The increase in technology costs was primarily due to an acceleration of investments to transform our customers’ experiences through technology.

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American Home Shield Segment

Three Months Ended September 30, 2016 Compared to Three Months Ended September 30, 2015

The American Home Shield segment, which provides home warranties for household systems and appliances, reported a 12 percent increase in revenue and a seven percent increase in Adjusted EBITDA for the three months ended September 30, 2016 compared to the three months ended September 30, 2015.

The growth in renewable customer counts and customer retention are presented below.



Revenue

The revenue results reflect an increase in new unit sales, the impact of the OneGuard acquisition (an approximate $10 million increase as a result of the acquisition on June 27, 2016) and improved price realization.

Adjusted EBITDA

The following table provides a summary of changes in the segment’s Adjusted EBITDA: 

The increase in contract claims cost was driven by a higher number of HVAC work orders driven by high temperatures during the quarter and normal inflationary pressure on the underlying costs of repairs. The increase in technology costs was primarily due to an acceleration of investments to improve our customers’ experiences through technology. Additionally, we incurred incremental selling and administrative expenses as a result of the OneGuard acquisition.

Nine Months Ended September 30, 2016 Compared to Nine Months Ended September 30, 2015

The American Home Shield segment reported an 11 percent increase in revenue and a two percent decrease in Adjusted EBITDA for the nine months ended September 30, 2016 compared to the nine months ended September 30, 2015.

Revenue

The revenue results reflect an increase in new unit sales, the impact of the OneGuard acquisition (an approximate $10 million increase as a result of the acquisition on June 27, 2016) and improved price realization.



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Adjusted EBITDA

The following table provides summary of changes in the segment’s Adjusted EBITDA:



The increase in contract claims cost was driven by the increase in the average cost per service request associated with appliance repairs we experienced in the first quarter, a higher number of HVAC work orders driven by high temperatures during the third quarter and normal inflationary pressure on the underlying costs of repairs.  

The increase in sales and marketing costs was primarily driven by the shift in the timing of a holiday mail campaign from the fourth quarter of 2015 to the first quarter of 2016 and, to a lesser extent, an increase in sales commissions and a change in the timing of marketing spend within the year. We expect the shift in the holiday mail campaign to result in an increase to our full year marketing costs.

The increase in technology costs was primarily due to an acceleration of investments to improve our customers’ experiences through technology. Additionally, we incurred incremental selling and administrative expenses as a result of the OneGuard acquisition. The increase in customer service costs was due to higher labor costs resulting from an acceleration of pre-season hiring and training in preparation for the high-volume summer season.

In the nine months ended September 30, 2016 and 2015, the segment’s Adjusted EBITDA included interest and net investment income from the American Home Shield investment portfolio of $4 million and $7 million, respectively.

Franchise Services Group Segment

Three Months Ended September 30, 2016 Compared to Three Months Ended September 30, 2015 

The Franchise Services Group segment, which consists of the ServiceMaster Restore (disaster restoration), ServiceMaster Clean (janitorial), Merry Maids (residential cleaning), Furniture Medic (on-site cabinet and wood furniture repair) and AmeriSpec (home inspection) businesses, reported a 12 percent decrease in revenue and a five percent increase in Adjusted EBITDA for the three months ended September 30, 2016 compared to the three months ended September 30, 2015.

Revenue

Revenue by service line is as follows:



The increase in royalty fees was primarily driven by higher disaster restoration services in Canada. The $9 million decline in revenue from company-owned Merry Maids branches was attributable to the branch conversions. The increase in janitorial national accounts was driven by increased sales activity.

In 2014, we began converting company-owned Merry Maids branches to franchises. We expect the branch conversions completed through September 30, 2016 to result in further decreases in revenues from company-owned Merry Maids branches, which we expect will be offset, in part, by modest increases in royalty fees. During the nine months ended September 30, 2016, we converted 27 company-owned Merry Maids branches to franchises.  As of October 10, 2016, the branch conversion process was complete.

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Adjusted EBITDA

The following table provides a summary of changes in the segment’s Adjusted EBITDA:



We realized a reduction in Adjusted EBITDA of $1 million as a result of the branch conversions.

Nine Months Ended September 30, 2016 Compared to Nine Months September 30, 2015

The Franchise Services Group segment reported a 15 percent decrease in revenue and comparable Adjusted EBITDA for the nine months ended September 30, 2016 compared to the nine months ended September 30, 2015.

Revenue

Revenue by service line as follows:



The increase in royalty fees was primarily attributable to the branch conversions. Approximately $27 million of the decline in revenue from company-owned Merry Maids branches was attributable to the branch conversions with the remainder of the decline driven by a decrease in new unit sales. The increase in revenue from janitorial national accounts was driven by increased sales activity. The decrease in sales of products was driven by lower franchisee demand.

Adjusted EBITDA

The following table provides a summary of changes in the segment’s Adjusted EBITDA:



We realized a reduction in Adjusted EBITDA of $3 million as a result of the branch conversions.

Corporate

Three Months Ended September 30, 2016 Compared to Three Months Ended September 30, 2015

Adjusted EBITDA for Corporate for the three months ended September 30, 2016 increased $1 million compared to the three months ended September 30, 2015. The three months ended September 30, 2015 included increased reserves in our automobile, general liability and workers’ compensation insurance program of $2 million driven by unfavorable claims trends.

Nine Months Ended September 30, 2016 Compared to Nine Months Ended September 30, 2015

Adjusted EBITDA for Corporate for the nine months ended September 30, 2016 increased $3 million compared to the nine months ended September 30, 2015. The nine months ended September 30, 2016 and 2015 included increased reserves in our automobile, general liability and workers’ compensation insurance program of $4 million and $6 million, respectively, driven by unfavorable claims trends.  The nine months ended September 30, 2016 were impacted by a charge of $3 million in connection with civil claims related to an incident at a family’s residence in Palm Beach County, Florida, and the nine months ended September 30, 2015 were impacted by a charge of $3 million in connection with civil claims related to an incident at a resort in St. John in the U.S. Virgin Islands. Each of the  $3 million charges are amounts equal to our insurance deductibles under our general liability insurance program.









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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 Credit Facilities contain covenants that limit or restrict our ability, including the ability of certain of our 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, 2016, we were 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 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. Cash and short- and long-term marketable securities totaled $270 million as of September 30, 2016, compared with $377 million as of December 31, 2015. As of September 30, 2016, there were $35 million of letters of credit outstanding and $265 million of available borrowing capacity under the Revolving Credit Facility. The letters of credit are posted to satisfy collateral requirements under our automobile, general liability and workers’ compensation insurance program and fuel swap contracts. 

On October 25, 2016, we announced that we intend to refinance approximately $2.4 billion of debt outstanding under the Credit Facilities. We anticipate refinancing the Credit Facilities with the proceeds of an amended and restated $1.5 billion term loan facility due 2023 and $1 billion of unsecured debt expected to mature in 2024. We also intend to enter into an amended and restated $300 million revolving credit facility due 2021. Proceeds from the refinancing will also be used to pay related fees and expenses of the refinancing. The proposed refinancing is subject to market conditions, and there can be no assurances that the proposed refinancing will be completed. If the refinancing of the Credit Facilities is successful, we will record a loss on extinguishment of debt in the fourth quarter of 2016, which we expect to be material.

On February 23, 2016, our board of directors authorized a three-year share repurchase program, under which we may repurchase up to $300 million of outstanding shares of our common stock. As of September 30, 2016, we have purchased $52 million of outstanding shares, which is included in treasury stock on the condensed consolidated statements of financial position.

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 debt securities and equity securities. 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.

As of September 30, 2016, we had posted $31 million in letters of credit, which were issued under the Revolving Credit Facility, and $95 million of cash, which is included in Restricted cash on the condensed consolidated statements of financial position, as collateral under our automobile, general liability and workers’ compensation insurance program. This amount is not related to the payments made in connection with the U.S. Virgin Islands matter. We may from time to time change the amount of cash or marketable securities used to satisfy collateral requirements under our automobile, general liability and workers’ compensation insurance program.  The amount of cash or marketable securities utilized to satisfy these collateral requirements will depend on the relative cost of the issuance of letters of credit under the Revolving Credit Facility and our cash position.  Any change in cash or marketable securities used as collateral would result is a corresponding change in our available borrowing capacity under the Revolving Credit Facility.

Additionally, under the terms of our fuel swap contracts, we are required to post collateral in the event the fair value of the contracts exceeds a certain agreed upon liability level and in other circumstances required by the agreement with the counterparty. As of September 30, 2016, the estimated fair value of our fuel swap contracts was a net asset of $1 million, and we had posted $3 million in letters of credit as collateral under our fuel hedging program, which were also issued under the Revolving Credit Facility. The continued use of letters of credit for this purpose in the future could limit our ability to post letters of credit for other purposes and could limit our borrowing availability under the Revolving Credit Facility. 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, results of operations or cash flows. These actions may include open market debt repurchases, negotiated repurchases, other 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.

The Company has reached a settlement agreement to settle all civil claims of the affected family related to the U.S. Virgin Islands matter pursuant to which the Company paid $87 million in the third quarter of 2016.  The Company has also sought to settle

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all federal criminal consequences related to the U.S. Virgin Islands matter pursuant to which the Company expects to pay approximately $10 million. See Note 3 to the condensed consolidated financial statements for more details.

The Company has submitted to the IRS a voluntary correction proposal to remedy an administrative error related to its Profit Sharing and Retirement Plan. The Company’s current estimate of the cost of the correction ranges from $24 million to approximately $89 million. See Note 3 to the condensed consolidated financial statements for more details.

Fleet and Equipment Financing Arrangements

We have 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 through the leasing program under the Fleet Agreement. For the nine months ended September 30, 2016, we acquired $50 million of vehicles through the leasing program under the Fleet Agreement. 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 new lease financings for the full year 2016 will range from approximately $55 million to $65 million.

Limitations on Distributions and Dividends by Subsidiaries

We are a holding company, and as such have no independent operations or material assets other than ownership of equity interests in our subsidiaries. We depend on our 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 agreements governing the Credit Facilities restrict the ability of our subsidiaries to pay dividends, make loans or otherwise transfer assets to us. Further, our subsidiaries are permitted under the terms of the 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 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 payments 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, 2016, the total net assets subject to these third-party restrictions was $152 million. We expect that such limitations will be in effect for the foreseeable future. None of our subsidiaries are obligated to make funds available to us through the payment of dividends.

We consider undistributed earnings of our foreign subsidiaries as of September 30, 2016 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 $20 million and $17 million as of September 30, 2016 and December 31, 2015, 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.

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Operating Activities

Net cash provided from operating activities from continuing operations decreased $75 million to $215 million for the nine months ended September 30, 2016 compared to $290 million for the nine months ended September 30, 2015.

Net cash provided from operating activities for the nine months ended September 30, 2016 comprised $335 million in earnings adjusted for non-cash charges, offset, in part, by $90 million in payments related to fumigation matters and a $31 million increase in cash required for working capital (a $36 million increase excluding the working capital impact of accrued interest, restructuring and taxes). For the nine months ended September 30, 2016, working capital requirements were negatively impacted by seasonal activity and timing of payments related to self-insured claims.

Net cash provided from operating activities for the nine months ended September 30, 2015 comprised $317 million in earnings adjusted for non-cash charges, offset, in part, by a $27 million increase in cash required for working capital (a $5 million increase excluding the working capital impact of accrued interest, restructuring and taxes). For the nine months ended September 30, 2015, working capital requirements were negatively impacted by the timing of interest payments on the 2020 Notes and normal seasonal activity, offset, in part, by the timing of payments to vendors seasonal activity.

Investing Activities

Net cash used for investing activities from continuing operations was $185 million for the nine months ended September 30, 2016 compared to $34 million for the nine months ended September 30, 2015.

Capital expenditures increased to $45 million for the nine months ended September 30, 2016 from $30 million in the nine months ended September 30, 2015 and included recurring capital needs and information technology projects. We anticipate capital expenditures for the full year 2016 will range from approximately $50 million to $60 million, reflecting recurring capital 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. We have no additional material capital commitments at this time.

Proceeds from the sale of equipment and other assets was $7 million and $9 million for the nine months ended September 30, 2016 and 2015, respectively, primarily driven by the branch conversions at Merry Maids. The branches were sold for a total purchase price of $9 million and $12 million for which we received cash of $6 million and $9 million and provided financing of $2 million and $3 million in the nine months ended September 30, 2016 and 2015, respectively. As of October 10, 2016, the branch conversion process was complete. 

Cash payments for acquisitions for the nine months ended September 30, 2016 totaled $86 million, compared with $31 million for the nine months ended September 30, 2015. On June 27, 2016, we acquired OneGuard Home Warranties for $61 million consisting of net cash consideration of $52 million and deferred payments of $9 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 Terminix and to periodically evaluate other strategic acquisitions.

The increase in restricted cash of $95 million for the nine months ended September 30, 2016 represents cash held in trust as collateral under our automobile, general liability and workers’ compensation insurance program.

Cash flows provided from purchases, sales and maturities of securities, net, for the nine months ended September 30, 2016 and 2015 totaled $42 million and $25 million, respectively, and were driven by the maturity and sale of marketable securities at American Home Shield.

Cash flows used for notes receivable, net, for the nine months ended September 30, 2016 and 2015 totaled $5 million and $8 million, respectively, and were a result of a net increase in financing provided by SMAC to our franchisees and retail customers of our operating units.

Financing Activities

Net cash used for financing activities from continuing operations was $97 million for the nine months ended September 30, 2016 compared to $375 million for the nine months ended September 30, 2015.

During the nine months ended September 30, 2016, we made scheduled principal payments on long-term debt of $50 million, repurchased $52 million of common stock and received $6 million from the issuance of common stock upon the exercise of stock options.

During the nine months ended September 30, 2015, we borrowed an incremental $578 million, made scheduled principal payments on long-term debt of $33 million and redeemed $390 million and $488 million in aggregate principal amount of the 8% 2020 Notes and 7% 2020 Notes, respectively, at a redemption price of 106.0% and 105.25%, respectively, of the principal amounts using available cash and the April and August Incremental Term Loans. Additionally, we paid $2 million in original issue discount, paid $5 million in debt issuance costs, paid $49 million for the call premium paid on the retirement of debt and received $14 million from the issuance of common stock during the nine months ended September 30, 2015.

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Contractual Obligations

Our 2015 Form 10-K includes disclosures of our contractual obligations and commitments as of December 31, 2015. We continue to make the contractually required payments, and, therefore, the 2016 obligations and commitments as listed in our 2015 Form 10-K have been reduced by the required payments. On June 3, 2016, we entered into an office lease agreement with Peabody Place Centre GP that will result in the relocation of our headquarters to the former Peabody Place mall in downtown Memphis.  Rent payments are expected to commence on January 1, 2020 with a lease term of 15 years. The lease agreement contains a termination right to cancel the lease 10 years after the commencement of rent payments.  As such, this agreement resulted in future non-cancelable base operating lease payments of $4 million in 2020 and $40 million in the years thereafter (2021-2029).

Off-Balance Sheet Arrangements

As of September 30, 2016, 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

As previously disclosed, on July 21, 2016, TMX USVI and TMX LP, each an indirect, wholly-owned subsidiary of the Company, entered into the Superseding Plea Agreement in connection with the investigation initiated by DOJ into allegations that a local Terminix branch used methyl bromide as a fumigant at a resort in St. John, U.S. Virgin Islands. The Superseding Plea Agreement was intended to resolve four misdemeanor charges of violations of the Federal Insecticide, Fungicide, and Rodenticide Act related to improper applications of methyl bromide. Those charges were set forth in an Information, dated March 29, 2016, in the matter styled United States of America v. The Terminix International Company Limited Partnership and Terminix International USVI, LLC.  At a hearing held on August 25, 2016, the United States District Court of the U.S. Virgin Islands rejected the Superseding Plea Agreement.  On August 31, 2016, the DOJ requested that the charges be dismissed, reserving its right to re-file the charges, in light of ongoing discussions to resolve the matter, and the court has granted that request. We continue to cooperate with the DOJ in an effort to resolve the matter in a manner consistent with the terms and conditions of the Superseding Plea Agreement.  While the Superseding Plea Agreement, and any modifications thereto, would not bind any other federal, state or local authority, the EPA has stated that it does not intend to initiate any administrative enforcement action or refer the matter to the DOJ for any civil enforcement once an appropriate plea agreement is approved by the court. We have previously recorded in the condensed consolidated statement of operations and comprehensive income total charges of $10 million in connection with the terms of the Superseding Plea Agreement. 

The Superseding Plea Agreement and the payments contemplated thereunder would not resolve any civil or administrative claims for damages or other relief related to the U.S. Virgin Islands matter; however, we previously disclosed that we have formalized the terms of the settlement agreement, which includes customary releases and confidentiality provisions, and a civil court in Delaware has given the necessary approvals.  Accordingly, the civil claims for all four members of the Delaware family are resolved.  In the nine months ended September 30, 2016, we recorded within Fumigation related matters in the condensed consolidated statement of operations and comprehensive income a charge of $87 million in connection with the settlement agreement.  In the nine months ended September 30, 2015, we recorded within Cost of services rendered and products sold in the condensed consolidated statement of operations and comprehensive income a charge of $3 million related to the civil claims related to the U.S. Virgin Islands matter, which is an amount equal to the Company’s insurance deductible under its general liability insurance policies.

The amount and extent of any further potential penalties, fines, sanctions, costs and damages that the federal or other governmental authorities may yet impose, investigation or other costs and reputational harm, as well as the impact of any additional civil, criminal or other claims or judicial, administrative or regulatory proceedings resulting from or related to the U.S. Virgin Islands matter, which could be material, is not currently known or reasonably estimable, and any such further penalties, fines, sanctions, costs or damages would not be covered under our general liability insurance policies. 

As previously disclosed, on September 15, 2015, a lawsuit was filed in the Circuit Court of the 15th Judicial Circuit in and for Palm Beach County, Florida, styled Carl Robert McCaughey, et al. v. Terminix International Company Limited Partnership, Sunland Pest Control Services, Inc., et al. The lawsuit alleges that fumigation of a Florida family’s residence by Sunland, a subcontractor of TMX LP, resulted in serious injuries to one of the family’s children. We have recently formalized the terms of a settlement agreement, which includes customary releases and confidentiality provisions, and a civil court in Florida has given the necessary approvals. Accordingly, the civil claims of the affected family related to the Florida fumigation matter are now resolved, and the case has been dismissed. Under the terms of the settlement agreement, in addition to the amounts that the our insurance carriers have agreed to pay to the family pursuant to our general liability insurance policies, we will pay $3 million, an amount equal to the Company’s insurance deductible under its general liability insurance policies. In the nine months ended September 30, 2016, we recorded within Cost of services rendered and products sold in the condensed consolidated statement of operations and comprehensive income a charge of $3 million in connection with civil claims related to the Florida fumigation matter. 

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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; the ability to successfully complete the refinancing of the Credit Facilities; 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; estimates on current and deferred tax provisions; 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” below and “Management’s Discussion and Analysis of Financial Condition and Results of Operations” above, could cause actual results and outcomes to differ 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 ordinary 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, 2016 has not materially changed from December 31, 2015 (see Item 7A of the 2015 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 2016. As of September 30, 2016, a 10 percent change in fuel prices would result in a change of approximately $3  million in our annual fuel cost before considering the impact of fuel swap contracts.

We use fuel swap contracts to mitigate the financial impact of fluctuations in fuel prices. As of September 30, 2016, we had fuel swap contracts to pay fixed prices for fuel with an aggregate notional amount of $38 million, maturing through 2018. The estimated fair value of these contracts as of September 30, 2016 was a net asset of $1 million. These fuel swap contracts provide a fixed price for approximately 69 percent, 79 percent and 28 percent of our estimated fuel usage for the remainder of 2016, 2017 and 2018, respectively. 

 

ITEM 4. CONTROLS AND PROCEDURES 

Evaluation of disclosure controls and procedures

Our Chief Executive Officer, Robert J. Gillette, and Senior Vice President and Chief Financial Officer, Alan J. M. Haughie, have evaluated our 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 our disclosure controls and procedures were effective as of September 30, 2016.

Changes in internal control over financial reporting

No changes in our internal control over financial reporting, as defined in Rule 13a-15(f) or Rule 15d-15(f) under the Exchange Act, occurred during the three months ended September 30, 2016 that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting. 

 

PART II. OTHER INFORMATION

ITEM 1. LEGAL PROCEEDINGS 

As previously disclosed, on July 21, 2016, TMX USVI and TMX LP, each an indirect, wholly-owned subsidiary of the Company, entered into the Superseding Plea Agreement in connection with the investigation initiated by DOJ into allegations that a local Terminix branch used methyl bromide as a fumigant at a resort in St. John, U.S. Virgin Islands. The Superseding Plea Agreement was intended to resolve four misdemeanor charges of violations of the Federal Insecticide, Fungicide, and Rodenticide Act related to improper applications of methyl bromide. Those charges were set forth in an Information, dated March 29, 2016, in the matter styled United States of America v. The Terminix International Company Limited Partnership and Terminix International USVI,

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LLC.  At a hearing held on August 25, 2016, the United States District Court of the U.S. Virgin Islands rejected the Superseding Plea Agreement.  On August 31, 2016, the DOJ requested that the charges be dismissed, reserving its right to re-file the charges, in light of ongoing discussions to resolve the matter, and the court has granted that request. We continue to cooperate with the DOJ in an effort to resolve the matter in a manner consistent with the terms and conditions of the Superseding Plea Agreement.  While the Superseding Plea Agreement, and any modifications thereto, would not bind any other federal, state or local authority, the EPA has stated that it does not intend to initiate any administrative enforcement action or refer the matter to the DOJ for any civil enforcement once an appropriate plea agreement is approved by the court. We have previously recorded in the condensed consolidated statement of operations and comprehensive income total charges of $10 million in connection with the terms of the Superseding Plea Agreement. 

The Superseding Plea Agreement and the payments contemplated thereunder would not resolve any civil or administrative claims for damages or other relief related to the U.S. Virgin Islands matter; however, we previously disclosed that we have formalized the terms of the settlement agreement, which includes customary releases and confidentiality provisions, and a civil court in Delaware has given the necessary approvals.  Accordingly, the civil claims for all four members of the Delaware family are resolved.  In the nine months ended September 30, 2016, we recorded within Fumigation related matters in the condensed consolidated statement of operations and comprehensive income a charge of $87 million in connection with the settlement agreement.  In the nine months ended September 30, 2015, we recorded within Cost of services rendered and products sold in the condensed consolidated statement of operations and comprehensive income a charge of $3 million related to the civil claims related to the U.S. Virgin Islands matter, which is an amount equal to the Company’s insurance deductible under its general liability insurance policies.

The amount and extent of any further potential penalties, fines, sanctions, costs and damages that the federal or other governmental authorities may yet impose, investigation or other costs and reputational harm, as well as the impact of any additional civil, criminal or other claims or judicial, administrative or regulatory proceedings resulting from or related to the U.S. Virgin Islands matter, which could be material, is not currently known or reasonably estimable, and any such further penalties, fines, sanctions, costs or damages would not be covered under our general liability insurance policies. 

As previously disclosed, on September 15, 2015, a lawsuit was filed in the Circuit Court of the 15th Judicial Circuit in and for Palm Beach County, Florida, styled Carl Robert McCaughey, et al. v. Terminix International Company Limited Partnership, Sunland Pest Control Services, Inc., et al. The lawsuit alleges that fumigation of a Florida family’s residence by Sunland, a subcontractor of TMX LP, resulted in serious injuries to one of the family’s children. We have recently formalized the terms of a settlement agreement, which includes customary releases and confidentiality provisions, and a civil court in Florida has given the necessary approvals. Accordingly, the civil claims of the affected family related to the Florida fumigation matter are now resolved, and the case has been dismissed. Under the terms of the settlement agreement, in addition to the amounts that the our insurance carriers have agreed to pay to the family pursuant to our general liability insurance policies, we will pay $3 million, an amount equal to the Company’s insurance deductible under its general liability insurance policies. In the nine months ended September 30, 2016, we recorded within Cost of services rendered and products sold in the condensed consolidated statement of operations and comprehensive income a charge of $3 million in connection with civil claims related to the Florida fumigation matter. 

In addition to the matters discussed above, in the ordinary course of conducting business activities, we and our 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. Subject to the paragraphs above, 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. See Note 3 to the condensed consolidated financial statement for more details.

ITEM 1A. RISK FACTORS 

You should carefully consider the factors described below, in addition to the other information set forth in this Quarterly Report on Form 10-Q. These risk factors are important to understanding the contents of this Quarterly Report on Form 10-Q and of other reports. Our reputation, business, financial position, results of operations and cash flows are subject to various risks. The risks and uncertainties described below are not the only ones relevant to us. Additional risks and uncertainties not currently known to us or that we currently believe are immaterial may also adversely impact our reputation, business, financial position, results of operations and cash flows.

The materialization of any risks and uncertainties set forth below or identified in Forward-Looking Statements contained in this report and our 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 “Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations —  Information Regarding Forward-Looking Statements” above.



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Risks Related to Our Business and Our Industry

Weakening in general economic conditions, especially as they may affect home sales, unemployment or consumer confidence or spending levels, may adversely impact our business, financial position, results of operations and cash flows.

A substantial portion of our results of operations is dependent upon spending by consumers. Deterioration in general economic conditions and consumer confidence, particularly in California, Texas and Florida, which collectively represented approximately one-third of our revenue in 2015 in our Terminix and American Home Shield segments, could affect the demand for our services. Consumer spending and confidence tend to decline during times of declining economic conditions. A worsening of macroeconomic indicators, including weak home sales, higher home foreclosures, declining consumer confidence or rising unemployment rates, could adversely affect consumer spending levels, reduce the demand for our services and adversely impact our business, financial position, results of operations and cash flows. These factors could also negatively impact the timing or the ultimate collection of accounts receivable, which would adversely impact our business, financial position, results of operations and cash flows.

We may not successfully implement our business strategies, including achieving our growth objectives.

We may not be able to fully implement our business strategies or realize, in whole or in part within the expected time frames, the anticipated benefits of our various growth or other initiatives. Our various business strategies and initiatives, including growth of our customer base, introduction of new service offerings, geographic expansion, growth of our commercial business and enhancement of profitability, are subject to significant business, economic and competitive uncertainties and contingencies, many of which are beyond our control.

In addition, we may incur certain costs to achieve efficiency improvements and growth in our business and we may not meet anticipated implementation timetables or stay within budgeted costs. As these efficiency improvement and growth initiatives are undertaken, we may not fully achieve our expected cost savings and efficiency improvements or growth rates, or these initiatives could adversely impact our customer retention or our operations. Also, our business strategies may change from time to time in light of our ability to implement our new business initiatives, competitive pressures, economic uncertainties or developments, or other factors.

Adverse credit and financial market events and conditions could, among other things, impede access to or increase the cost of financing or cause our commercial and governmental customers to incur liquidity issues that could lead to some of our services not being purchased or being cancelled, or result in reduced revenue and lower Adjusted EBITDA, any of which could have an adverse impact on our business, financial position, results of operations and cash flows.

Disruptions in credit or financial markets could, among other things, lead to impairment charges, make it more difficult for us to obtain, or increase our cost of obtaining, financing for our operations or investments or to refinance our indebtedness, cause our lenders to depart from prior credit industry practice and not give technical or other waivers under the $2,356 million Term Loan Facility and the $300 million Revolving Credit Facility to the extent we may seek them in the future, thereby causing us to be in default under the Credit Facilities. These disruptions also could cause our commercial customers to encounter liquidity issues that could lead to some of our services being cancelled or reduced, or that could result in an increase in the time it takes our customers to pay us, or that could lead to a decrease in pricing for our services and products, any of which could adversely affect our accounts receivable, among other things, and, in turn, increase our working capital needs. Volatile swings in the commercial real estate segment could also impact the demand for our services as landlords cut back on services provided to their tenants. In addition, adverse developments at federal, state and local levels associated with budget deficits resulting from economic conditions could result in federal, state and local governments decreasing their purchasing of our products or services and/or increasing taxes or other fees on businesses, including us, to generate more tax revenues, which could negatively impact spending by commercial customers and municipalities on our services.

Our market segments are highly competitive. Competition could reduce our share of the market segments served by us and adversely impact our reputation, business, financial position, results of operations and cash flows.

We operate in highly competitive market segments. Changes in the source and intensity of competition in the market segments served by us impact the demand for our services and may also result in additional pricing pressures. The relatively low capital cost of entry into certain of our business categories has led to strong competitive market segments, including competition from smaller regional and local owner‑operated companies. Regional and local competitors operating in a limited geographic area may have lower labor, employee benefits and overhead costs. The principal methods of competition in our businesses include name recognition, quality and speed of service, customer satisfaction, reputation and pricing. We may be unable to compete successfully against current or future competitors, and the competitive pressures that we face may result in reduced market segment share, reduced pricing or adversely impact our reputation, business, financial position, results of operations and cash flows.

Weather conditions and seasonality affect the demand for our services and our results of operations and cash flows.

The demand for our services and our results of operations are affected by weather conditions, including, without limitation, potential impacts, if any, from climate change, known and unknown, and by the seasonal nature of our termite and pest control services, home inspection services, home warranties and disaster restoration services. Adverse weather conditions (e.g., cooler temperatures or droughts), whether created by climate change factors or otherwise, can impede the development of the termite swarm and lead to lower demand for our termite remediation services. Severe winter storms can also impact our home cleaning business if

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personnel cannot travel to service locations due to hazardous road conditions. In addition, extreme temperatures can lead to an increase in service requests related to household systems and appliances in our American Home Shield business, resulting in higher claim frequency and costs and lower profitability. For example, in the third quarter of 2016, we experienced an increase in contract claims cost at American Home Shield driven by a higher number of HVAC work orders driven by high temperatures. These or other weather conditions could adversely impact our business, financial position, results of operations and cash flows.

Compliance with IRS rules for our 401(k) Plan could result in significant costs that adversely impact our financial position, results of operations and cash flows.

In 2008, we amended the 401(k) Plan to implement a QACA under the safe harbor provisions of the Code. QACA plans, in general, require automatic enrollment of employees into the retirement plan absent an affirmative election that such employees do not wish to participate.

Although we implemented processes to auto-enroll new hires after adopting the QACA plan in 2008, we have discovered that we did not auto-enroll then existing employees who were not participating in the 401(k) Plan. In response, we implemented an auto-enrollment process for affected active employees, and we submitted to the IRS a voluntary correction proposal to remedy the issue for prior years. Our current estimate of the cost of the correction ranges from $24 million to approximately $89 million. We recorded in the condensed consolidated statement of operations and comprehensive income charges of $24 million. However, there can be no assurances as to the ultimate costs of the correction.

Increases in raw material prices, fuel prices and other operating costs could adversely impact our business, financial position, results of operations and cash flows.

Our financial performance may be adversely affected by increases in the level of our operating expenses, such as fuel, chemicals, refrigerants, appliances and equipment, parts, raw materials, wages and salaries, employee benefits, health care, vehicle maintenance, contractor costs, self‑insurance costs and other insurance premiums, as well as various regulatory compliance costs, all of which may be subject to inflationary pressures.

In recent years, fuel prices have fluctuated widely, and previous increases in fuel prices increased our costs of operating vehicles and equipment. Although in the first nine months of 2016 fuel prices remained relatively low, there can be no assurances that rates will not return to historical levels. We cannot predict what effect global events or any future Middle East, Russia or other crisis could have on fuel prices, but it is possible that such events could lead to higher fuel prices. With respect to fuel, our fleet has been negatively impacted by significant increases in fuel prices in the past and could be negatively impacted in the future. Although we hedge a significant portion of our fuel costs, we do not hedge all of those costs. We expect to use approximately 12 million gallons of fuel in 2016. As of September 30, 2016, a ten percent change in fuel prices would result in a change of approximately $3 million in our annual fuel cost before considering the impact of fuel swap contracts. Fuel price increases can also result in increases in the cost of chemicals and other materials used in our business. We cannot predict the extent to which we may experience future increases in costs of fuel, chemicals, refrigerants, appliances and equipment, parts, raw materials, wages and salaries, employee benefits, health care, vehicle, self‑insurance costs and other insurance premiums as well as various regulatory compliance costs and other operating costs. To the extent such costs increase, we may be prevented, in whole or in part, from passing these cost increases through to our existing and prospective customers, and the rates we pay to our subcontractors and suppliers may increase, any of which could have a material adverse impact on our business, financial position, results of operations and cash flows.

We may not be able to attract and retain qualified key executives or transition smoothly to new leadership, which could adversely impact us and our businesses and inhibit our ability to operate and grow successfully.

The execution of our business strategy and our financial performance will continue to depend in significant part on our executive management team and other key management personnel. Any inability to attract in a timely manner other qualified key executives, retain our leadership team and recruit other important personnel could have a material adverse impact on our business, financial position, results of operations and cash flows.

Compliance with, or violation of, environmental, health and safety laws and regulations, including laws pertaining to the use of pesticides, could result in significant costs that adversely impact our reputation, business, financial position, results of operations and cash flows.

International, federal, state, provincial and local laws and regulations relating to environmental, health and safety matters affect us in several ways. In the United States, products containing pesticides generally must be registered with the EPA, and similar state agencies before they can be sold or applied. The failure to obtain or the cancellation of any such registration, or the withdrawal from the marketplace of such pesticides, could have an adverse effect on our business, the severity of which would depend on the products involved, whether other products could be substituted and whether our competitors were similarly affected. The pesticides we use are manufactured by independent third parties and are evaluated by the EPA as part of its ongoing exposure risk assessment. The EPA may decide that a pesticide we use will be limited or will not be re‑registered for use in the United States. We cannot predict the outcome or the severity of the effect of the EPA’s continuing evaluations.

In addition, the use of certain pesticide products is regulated by various international, federal, state, provincial and local environmental and public health agencies. Although we strive to comply with such laws and regulations and have processes in place designed to achieve compliance, given our dispersed locations, distributed operations and numerous associates, we may be unable to

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prevent violations of these or other laws and regulations from occurring. Even if we are able to comply with all such laws and regulations and obtain all necessary registrations and licenses, the pesticides or other products we apply or use, or the manner in which we apply or use them, could be alleged to cause injury to the environment, to people or to animals, or such products could be banned in certain circumstances. The laws and regulations may also apply to third‑party vendors who are hired to repair or remediate property and who may fail to comply with environmental laws, health and safety laws and regulations and subject us to risk of legal exposure. The costs of compliance, non‑compliance, investigation, remediation, combating reputational harm or defending civil or criminal proceedings, products liability, personal injury or other lawsuits could have a material adverse impact on our reputation, business, financial position, results of operations and cash flows.

International, federal, state, provincial and local agencies regulate the disposal, handling and storage of waste, discharges from our facilities and the investigation and clean‑up of contaminated sites. We could incur significant costs, including investigation and clean‑up costs, fines, penalties and civil or criminal sanctions and claims by third parties for property damage and personal injury, as a result of violations of, or liabilities under, these laws and regulations. In addition, potentially significant expenditures could be required to comply with environmental, health and safety laws and regulations, including requirements that may be adopted or imposed in the future.

As previously disclosed, on July 21, 2016, TMX USVI and TMX LP, each an indirect, wholly-owned subsidiary of the Company, entered into the Superseding Plea Agreement in connection with the investigation initiated by DOJ into allegations that a local Terminix branch used methyl bromide as a fumigant at a resort in St. John, U.S. Virgin Islands. The Superseding Plea Agreement was intended to resolve four misdemeanor charges of violations of the Federal Insecticide, Fungicide, and Rodenticide Act related to improper applications of methyl bromide. Those charges were set forth in an Information, dated March 29, 2016, in the matter styled United States of America v. The Terminix International Company Limited Partnership and Terminix International USVI, LLC.  At a hearing held on August 25, 2016, the United States District Court of the U.S. Virgin Islands rejected the Superseding Plea Agreement.  On August 31, 2016, the DOJ requested that the charges be dismissed, reserving its right to re-file the charges, in light of ongoing discussions to resolve the matter, and the court has granted that request. We continue to cooperate with the DOJ in an effort to resolve the matter in a manner consistent with the terms and conditions of the Superseding Plea Agreement.  While the Superseding Plea Agreement, and any modifications thereto, would not bind any other federal, state or local authority, the EPA has stated that it does not intend to initiate any administrative enforcement action or refer the matter to the DOJ for any civil enforcement once an appropriate plea agreement is approved by the court. We have previously recorded in the condensed consolidated statement of operations and comprehensive income total charges of $10 million in connection with the terms of the Superseding Plea Agreement. 

The amount and extent of any further potential penalties, fines, sanctions, costs and damages that the federal or other governmental authorities may yet impose, investigation or other costs and reputational harm, as well as the impact of any additional civil, criminal or other claims or judicial, administrative or regulatory proceedings resulting from or related to the U.S. Virgin Islands matter, which could be material, is not currently known or reasonably estimable, and any such further penalties, fines, sanctions, costs or damages would not be covered under our general liability insurance policies. 

Public perceptions that the products we use and the services we deliver are not environmentally friendly or safe may adversely impact the demand for our services.

In providing our services, we use, among other things, pesticides and other chemicals. Public perception that the products we use and the services we deliver are not environmentally friendly or safe or are harmful to humans or animals, whether justified or not, or our improper application of these chemicals, could reduce demand for our services, increase regulation or government restrictions or actions, result in fines or penalties, impair our reputation, involve us in litigation, damage our brand names and otherwise have a material adverse impact on our business, financial position, results of operations and cash flows.

Laws and government regulations applicable to our businesses and lawsuits, enforcement actions and other claims by third parties or governmental authorities could increase our legal and regulatory expenses, and impact our business, financial position, results of operations and cash flows.

Our businesses are subject to significant international, federal, state, provincial and local laws and regulations. These laws and regulations include laws relating to consumer protection, wage and hour requirements, franchising, the employment of immigrants, labor relations, permitting and licensing, building code requirements, workers’ safety, the environment, insurance and home warranties, employee benefits, marketing (including, without limitation, telemarketing) and advertising, the application and use of pesticides and other chemicals. In particular, we anticipate that various international, federal, state, provincial and local governing bodies may propose additional legislation and regulation that may be detrimental to our business or may substantially increase our operating costs, including increases in the minimum wage, environmental regulations related to chemical use, climate change, equipment efficiency standards, refrigerant production and use and other environmental matters; other consumer protection laws or regulations; health care coverage; or “do‑not‑knock,” “do‑not‑mail,” “do‑not‑leave” or other marketing regulations. It is difficult to predict the future impact of the broad and expanding legislative and regulatory requirements affecting our businesses and changes to such requirements may adversely affect our business, financial position, results of operations and cash flows. In addition, if we were to fail to comply with any applicable law or regulation, we could be subject to substantial fines or damages, be involved in lawsuits, enforcement actions and other claims by third parties or governmental authorities, suffer losses to our reputation, suffer the loss of licenses or incur penalties that may affect how our business is operated, which, in turn, could have a material adverse impact on our business, financial position, results of operations and cash flows.

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Our franchisees, subcontractors, third‑party distributors and vendors could take actions that could harm our business.

For the nine months ended September 30, 2016 and the year ended December 31, 2015, $101 million and $132 million, respectively, of our consolidated revenue was received in the form of franchise revenues. Accordingly, our financial results are dependent in part upon the operational and financial success of our franchisees. Our franchisees, subcontractors, third‑party distributors and vendors are contractually obligated to operate their businesses in accordance with the standards set forth in our agreements with them. Each franchising brand also provides training and support to franchisees. However, franchisees, subcontractors, third‑party distributors and vendors are independent third parties that we do not control, and who own, operate and oversee the daily operations of their businesses. As a result, the ultimate success of any franchise operation rests with the franchisee. If franchisees do not successfully operate their businesses in a manner consistent with required standards, royalty payments to us will be adversely affected and our brands’ image and reputation could be harmed, which in turn could adversely impact our business, financial position, results of operations and cash flows. Similarly, if third‑party distributors, subcontractors, vendors and franchisees do not successfully operate their businesses in a manner consistent with required laws, standards and regulations, we could be subject to claims from regulators or legal claims for the actions or omissions of such third‑party distributors, subcontractors, vendors and franchisees. In addition, our relationship with our franchisees, third‑party distributors, subcontractors and vendors could become strained (including resulting in litigation) as we impose new standards or assert more rigorous enforcement practices of the existing required standards. These strains in our relationships or claims could have a material adverse impact on our reputation, business, financial position, results of operations and cash flows.

From time to time, we receive communications from our franchisees regarding complaints, disputes or questions about our practices and standards in relation to our franchised operations and certain economic terms of our franchise arrangements. If franchisees or groups representing franchisees were to bring legal proceedings against us, we would vigorously defend against the claims in any such proceeding, but our reputation, business, financial position, results of operations and cash flows could be materially adversely impacted and the price of our common stock could decline.

Disruptions or failures in our information technology systems could create liability for us or limit our ability to effectively monitor, operate and control our operations and adversely impact our reputation, business, financial position, results of operations and cash flows.

Our information technology systems facilitate our ability to monitor, operate and control our operations. Changes or modifications to our information technology systems could cause disruption to our operations or cause challenges with respect to our compliance with laws, regulations or other applicable standards. As the development and implementation of our information technology systems (including our operating systems) evolve, we may elect to modify, replace or abandon certain technology initiatives, which could result in write‑downs. For example, in February 2014, American Home Shield ceased efforts to deploy a new operating system that had been intended to improve customer relationship management capabilities and enhance its operations. We recorded an impairment charge of $47 million in the year ended December 31, 2014 relating to this decision.

Any disruption in our information technology systems, including capacity limitations, instabilities, or failure to operate as expected, could, depending on the magnitude of the problem, adversely impact our business, financial position, results of operations and cash flows, including by limiting our capacity to monitor, operate and control our operations effectively. Failures of our information technology systems could also lead to violations of privacy laws, regulations, trade guidelines or practices related to our customers and associates. If our disaster recovery plans do not work as anticipated, or if the third‑party vendors to which we have outsourced certain information technology, contact center or other services fail to fulfill their obligations to us, our operations may be adversely impacted, and any of these circumstances could adversely impact our reputation, business, financial position, results of operations and cash flows.

Changes in the services we deliver or the products we use could impact our reputation, business, financial position, results of operations and cash flows and our future plans.

Our financial performance is affected by changes in the services and products we offer our customers. For example, in 2014, Terminix introduced new products relating to mosquito control, crawlspace encapsulation and wildlife exclusion. There can be no assurance that our new strategies or product offerings will succeed in increasing revenue and growing profitability. An unsuccessful execution of new strategies, including the rollout or adjustment of our new services or products or sales and marketing plans, could cause us to re‑evaluate or change our business strategies and could have a material adverse impact on our reputation, business, financial position, results of operations and cash flows and our future plans.

If we fail to protect the security of personal information about our customers, associates and third parties, we could be subject to interruption of our business operations, private litigation, reputational damage and costly penalties.

We rely on, among other things, commercially available systems, software, tools and monitoring to provide security for processing, transmission and storage of confidential information of customers, associates and third parties, such as payment card and personal information. The systems currently used for transmission and approval of payment card transactions, and the technology utilized in payment cards themselves, all of which can put payment card data at risk, are central to meeting standards set by the payment card industry (“PCI”). We continue to evaluate and modify our systems and protocols for PCI compliance purposes, and such PCI standards may change from time to time. Activities by third parties, advances in computer and software capabilities and encryption technology, new tools and discoveries and other events or developments may facilitate or result in a compromise or breach

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of our systems. Any compromises, breaches or errors in applications related to our systems or failures to comply with standards set by the PCI could cause damage to our reputation and interruptions in our operations, including our customers’ ability to pay for our services and products by credit card or their willingness to purchase our services and products and could result in a violation of applicable laws, regulations, orders, industry standards or agreements and subject us to costs, penalties and liabilities which could have a material adverse impact on our reputation, business, financial position, results of operations and cash flows.

We may not be able to adequately protect our intellectual property and other proprietary rights that are material to our business.

Our ability to compete effectively depends in part on our rights to service marks, trademarks, trade names and other intellectual property rights we own or license, particularly our registered brand names, ServiceMaster, Terminix, American Home Shield, ServiceMaster Restore, ServiceMaster Clean, Merry Maids, Furniture Medic and AmeriSpec. We have not sought to register or protect every one of our marks either in the United States or in every country in which they are or may be used. Furthermore, because of the differences in foreign trademark, patent and other intellectual property or proprietary rights laws, we may not receive the same protection in other countries as we would in the United States. If we are unable to protect our proprietary information and brand names, we could suffer a material adverse impact on our reputation, business, financial position, results of operations and cash flows. Litigation may be necessary to enforce our intellectual property rights and protect our proprietary information, or to defend against claims by third parties that our products, services or activities infringe their intellectual property rights.

Future acquisitions or other strategic transactions could negatively impact our reputation, business, financial position, results of operations and cash flows.

We may pursue strategic transactions in the future, which could involve acquisitions or dispositions of businesses or assets. Any future strategic transaction could involve integration or implementation challenges, business disruption or other risks, or change our business profile significantly. Any inability on our part to consolidate and manage growth from acquired businesses or successfully implement other strategic transactions could have an adverse impact on our reputation, business, financial position, results of operations and cash flows. Any acquisition that we make may not provide us with the benefits that were anticipated when entering into such acquisition. The process of integrating an acquired business may create unforeseen difficulties and expenses, including the diversion of resources needed to integrate new businesses, technologies, products, personnel or systems; the inability to retain associates, customers and suppliers; the assumption of actual or contingent liabilities (including those relating to the environment); failure to effectively and timely adopt and adhere to our internal control processes and other policies; write‑offs or impairment charges relating to goodwill and other intangible assets; unanticipated liabilities relating to acquired businesses; and potential expense associated with litigation with sellers of such businesses. Any future disposition transactions could also impact our business and may subject us to various risks, including failure to obtain appropriate value for the disposed businesses, post‑closing claims being levied against us and disruption to our other businesses during the sale process or thereafter.

We may be required to recognize additional impairment charges.

In the first quarter of 2014, we incurred impairment charges with respect to fixed assets, and we have also incurred impairment charges in the past in connection with our disposition activities. We have significant amounts of goodwill and intangible assets, such as trade names. In accordance with applicable accounting standards, goodwill and indefinite-lived intangible assets are not amortized and are subject to assessment for impairment by applying a fair‑value based test annually, or more frequently if there are indicators of impairment, including:

In February 2014, American Home Shield ceased efforts to deploy a new operating system that had been intended to improve customer relationship management capabilities and enhance its operations. We recorded an impairment charge of $47 million in the year ended December 31, 2014 relating to this decision.

Based upon future economic and financial market conditions, the operating performance of our reporting units and other factors, including those listed above, we may incur impairment charges in the future. It is possible that such impairment, if required, could be material. Any future impairment charges that we are required to record could have a material adverse impact on our results of operations.

We are subject to various restrictive covenants that could adversely impact our business, financial position, results of operations and cash flows.

From time to time, we enter into noncompetition agreements or other restrictive covenants (e.g., exclusivity, take or pay and non‑solicitation), including in connection with business dispositions or strategic contracts, that restrict us from entering into lines of business or operating in certain geographic areas into which we may desire to expand our business. We also are subject to various

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non‑solicitation and no‑hire covenants that may restrict our ability to solicit potential customers or associates. If we do not comply with such restrictive covenants, or if a dispute arises regarding the scope and interpretation thereof, litigation could ensue, which could have an adverse impact on our business, financial position, results of operations and cash flows. Further, to the extent that such restrictive covenants prevent us from taking advantage of business opportunities, our business, financial position, results of operations and cash flows may be adversely impacted.

Our business process outsourcing initiatives have increased our reliance on third‑party contractors and may expose our business to harm upon the termination or disruption of our third‑party contractor relationships.

Our strategy to increase profitability, in part, by reducing our costs of operations includes the implementation of certain business process outsourcing initiatives. Any disruption, termination or substandard performance of these outsourced services, including possible breaches by third‑party vendors of their agreements with us, could adversely affect our brands, reputation, customer relationships, financial position, results of operations and cash flows. Also, to the extent a third‑party outsourcing provider relationship is terminated, there is a risk that we may not be able to enter into a similar agreement with an alternate provider in a timely manner or on terms that we consider favorable, and even if we find an alternate provider, or choose to insource such services, there are significant risks associated with any transitioning activities. In addition, to the extent we decide to terminate outsourcing services and insource such services, there is a risk that we may not have the capabilities to perform these services internally, resulting in a disruption to our business, which could adversely impact our reputation, business, financial position, results of operations and cash flows. We could incur costs, including personnel and equipment costs, to insource previously outsourced services like these, and these costs could adversely affect our results of operations and cash flows.

In addition, when a third‑party provider relationship is terminated, there is a risk of disputes or litigation and that we may not be able to enter into a similar agreement with an alternate provider in a timely manner or on terms that we consider favorable, and even if we find an alternate provider, there are significant risks associated with any transitioning activities.

Our future success depends on our ability to attract, retain and maintain positive relations with trained workers and third‑party contractors.

Our future success and financial performance depend substantially on our ability to attract, train and retain workers, attract and retain third‑party contractors and ensure third‑party contractor compliance with our policies and standards. Our ability to conduct our operations is in part impacted by our reliance on a network of third-party contractors. When a contractor relationship is terminated, there is a risk that we may not be able to enter into a similar agreement with an alternate contractor in a timely manner or on terms that we consider favorable. We could incur costs to transition to other contractors, and these costs could adversely affect our results of operations and cash flows.

Our ability to conduct our operations is in part impacted by our ability to increase our labor force, including on a seasonal basis, which may be adversely impacted by a number of factors. In the event of a labor shortage, we could experience difficulty in delivering our services in a high‑quality or timely manner and could be forced to increase wages in order to attract and retain associates, which would result in higher operating costs and reduced profitability. New decisions and rules by the National Labor Relations Board, including “expedited elections” and restrictions on appeals, could lead to increased organizing activities at our subsidiaries or franchisees. If these labor organizing activities were successful, it could further increase labor costs, decrease operating efficiency and productivity in the future, or otherwise disrupt or negatively impact our operations. In addition, potential competition from key associates who leave ServiceMaster could impact our ability to maintain our market segment share in certain geographic areas.

Risks Related to Our Substantial Indebtedness

We have substantial indebtedness and may incur substantial additional indebtedness, which could adversely affect our financial health and our ability to obtain financing in the future, react to changes in our business and satisfy our obligations.

As of September 30, 2016, we had approximately $2.9 billion of total long‑term consolidated indebtedness outstanding.

As of September 30, 2016, there were $35 million of letters of credit outstanding and $265 million of available borrowing capacity under the Revolving Credit Facility. In addition, we are able to incur additional indebtedness in the future, subject to the limitations contained in the agreements governing our indebtedness. Our substantial indebtedness could have important consequences to you. Because of our substantial indebtedness:

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Increases in interest rates would increase the cost of servicing our indebtedness and could reduce our profitability.

A significant portion of our outstanding indebtedness, including indebtedness incurred under the Credit Facilities, bears interest at variable rates. As a result, increases in interest rates would increase the cost of servicing our indebtedness and could materially reduce our profitability and cash flows. As of September 30, 2016, each one percentage point change in interest rates would result in an approximately $17 million change in the annual interest expense on the Term Loan Facility after considering the impact of the effective interest rate swaps. Assuming all revolving loans were fully drawn as of September 30, 2016, each one percentage point change in interest rates would result in an approximately $3 million change in annual interest expense on the Revolving Credit Facility. The impact of increases in interest rates could be more significant for us than it would be for some other companies because of our substantial indebtedness.

A lowering or withdrawal of the ratings, outlook or watch assigned to our debt securities by rating agencies may increase our future borrowing costs and reduce our access to capital.

Our indebtedness currently has a non‑investment grade rating, and any rating, outlook or watch assigned could be lowered or withdrawn entirely by a rating agency if, in that rating agency’s judgment, current or future circumstances relating to the basis of the rating, outlook, or watch such as adverse changes to our business, so warrant. Any future lowering of our ratings, outlook or watch likely would make it more difficult or more expensive for us to obtain additional debt financing.

The agreements and instruments governing our indebtedness contain restrictions and limitations that could significantly impact our ability to operate our business.

The Credit Facilities contain covenants that, among other things, restrict our ability to:

The restrictions in the agreements governing the Credit Facilities and the instruments governing our other indebtedness may prevent us from taking actions that we believe would be in the best interest of our business and may make it difficult for us to execute our business strategy successfully or effectively compete with companies that are not similarly restricted. We may also incur future debt obligations that might subject us to additional restrictive covenants that could affect our financial and operational flexibility. We may be unable to refinance our indebtedness, at maturity or otherwise, on terms acceptable to us, or at all.

Our ability to comply with the covenants and restrictions contained in the agreements governing the Credit Facilities and the instruments governing our other indebtedness may be affected by economic, financial and industry conditions beyond our control including credit or capital market disruptions. The breach of any of these covenants or restrictions could result in a default that would permit the applicable lenders to declare all amounts outstanding thereunder to be due and payable, together with accrued and unpaid interest. If we are unable to repay indebtedness, lenders having secured obligations, such as the lenders under the Credit Facilities, could proceed against the collateral securing the indebtedness. In any such case, we may be unable to borrow under the Credit Facilities and may not be able to repay the amounts due under such facilities or our other outstanding indebtedness. This could have serious consequences to our financial position and results of operations and could cause us to become bankrupt or insolvent.



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Our ability to generate the significant amount of cash needed to pay interest and principal on our indebtedness and our ability to refinance all or a portion of our indebtedness or obtain additional financing depends on many factors beyond our control.

We are a holding company, and as such we have no independent operations or material assets other than ownership of equity interests in our subsidiaries. We depend on our subsidiaries to distribute funds to us so that we may pay obligations and expenses, including satisfying obligations with respect to indebtedness. Our ability to make scheduled payments on, or to refinance our obligations under, our indebtedness depends on the financial and operating performance of our subsidiaries, and their ability to make distributions and dividends to us, which, in turn, depends on their results of operations, cash flows, cash requirements, financial position and general business conditions and any legal and regulatory restrictions on the payment of dividends to which they may be subject, many of which may be beyond our control.

There are third party restrictions on the ability of certain of our subsidiaries to transfer funds to us. If we cannot receive sufficient distributions from our subsidiaries, we may not be able to meet our obligations to fund general corporate expenses or service our debt obligations. 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, 2016, the total net assets subject to these third party restrictions was $152 million. Such limitations are expected to be in effect for the foreseeable future.

We may be unable to maintain a level of cash flows from operating activities sufficient to permit us to pay the principal and interest on our indebtedness. If our cash flow and capital resources are insufficient to fund our debt service obligations, we may be forced to reduce or delay capital expenditures, sell assets, seek to obtain additional equity capital or restructure our indebtedness. In the future, our cash flow and capital resources may not be sufficient for payments of interest on and principal of our indebtedness, and such alternative measures may not be successful and may not permit us to meet our scheduled debt service obligations.

The $2,323 million of outstanding borrowings under the Term Loan Facility, as of September 30, 2016, after including the unamortized portion of the original issue discount paid and the unamortized debt issuance costs, have a maturity date of July 1, 2021. The Revolving Credit Facility is scheduled to mature on July 1, 2019. We have announced our intent to refinance the Credit Facilities; however, we may be unable to refinance any of our indebtedness or obtain additional financing, particularly because of our high levels of indebtedness. Market disruptions, such as those experienced in 2008 and 2009, as well as our significant indebtedness levels, may increase our cost of borrowing or adversely affect our ability to refinance our obligations as they become due. If we are unable to refinance our indebtedness or access additional credit, or if short-term or long-term borrowing costs dramatically increase, our ability to finance current operations and meet our short term and long term obligations could be adversely affected.

If we cannot make scheduled payments on our indebtedness, we will be in default, the lenders under the Credit Facilities could terminate their commitments to loan money, the secured lenders could foreclose against the assets securing their borrowings and we could be forced into bankruptcy or liquidation.

Despite our indebtedness levels, we and our subsidiaries may be able to incur substantially more indebtedness. This could further exacerbate the risks associated with our substantial indebtedness.

We and our subsidiaries may be able to incur substantial additional indebtedness in the future. The terms of the instruments governing our indebtedness do not prohibit us or fully prohibit our subsidiaries from doing so. The Credit Facilities permit additional borrowings beyond the committed amounts under certain circumstances. If new indebtedness is added to our current indebtedness levels, the related risks we face would increase, and we may not be able to meet all of our debt obligations.

Risks Related to Our Common Stock

ServiceMaster is a holding company with no operations of its own, and it depends on its subsidiaries for cash to fund all of its operations and expenses, including to make future dividend payments, if any.

ServiceMaster’s operations are conducted entirely through our subsidiaries, and our ability to generate cash to fund our operations and expenses, to pay dividends or to meet debt service obligations is highly dependent on the earnings and the receipt of funds from our subsidiaries through dividends or intercompany loans. Deterioration in the financial condition, earnings or cash flow of our subsidiaries for any reason could limit or impair their ability to pay such distributions. Additionally, to the extent that ServiceMaster needs funds, and its subsidiaries are restricted from making such distributions under applicable law or regulation or under the terms of our financing arrangements, or are otherwise unable to provide such funds, it could materially adversely affect our business, financial condition, results of operations or prospects.

For example, there are third-party restrictions on the ability of certain of our subsidiaries to transfer funds to us. If we cannot receive sufficient distributions from our subsidiaries, we may not be able to meet our obligations to fund general corporate expenses or service our debt obligations. 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

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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, 2016, the total net assets subject to these third-party restrictions was $152 million. Such limitations are expected to be in effect for the foreseeable future.

Further, the terms of the agreements governing the Credit Facilities significantly restrict the ability of our subsidiaries to pay dividends, make loans or otherwise transfer assets to ServiceMaster. Furthermore, our subsidiaries are permitted under the terms of the 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 us. In addition, Delaware law may impose requirements that may restrict our ability to pay dividends to holders of our common stock.

We do not currently expect to declare or pay dividends on our common stock for the foreseeable future. Payments of dividends, if any, will be at the sole discretion of our board of directors after taking into account various factors, including general and economic conditions, our financial condition and operating results, our available cash and current and anticipated cash needs, capital requirements, contractual, legal, tax and regulatory restrictions and implications of the payment of dividends by us to our stockholders or by our subsidiaries to us, and such other factors as our board of directors may deem relevant. In addition, Delaware law may impose requirements that may restrict our ability to pay dividends to holders of our common stock. To the extent that we determine in the future to pay dividends on our common stock, none of our subsidiaries will be obligated to make funds available to us for the payment of dividends.

The market price of our common stock may be volatile and could decline.

The market price of our common stock may fluctuate significantly. Among the factors that could affect our stock price are:

The stock markets have experienced extreme volatility in recent years that has been unrelated to the operating performance of particular companies. These broad market fluctuations may adversely affect the market price of our common stock. In the past, following periods of volatility in the market price of a company’s securities, class action litigation has often been instituted against the affected company. Any litigation of this type brought against us could result in substantial costs and a diversion of our management’s attention and resources, which would harm our business, operating results and financial condition.

Future sales of shares by existing stockholders could cause our stock price to decline.

Sales of substantial amounts of our common stock in the public market, or the perception that these sales could occur, could cause the market price of our common stock to decline. These sales, or the possibility that these sales may occur, also might make it more difficult for us to sell equity securities in the future at a time and at a price that we deem appropriate. As of October 21, 2016, we had 134,757,904 outstanding shares of common stock.

In July 2014, we filed a registration statement on Form S-8 under the Securities Act to register the shares of common stock to be issued under our equity compensation plans and, as a result, all shares of common stock acquired upon exercise of (i) stock options granted under these plans and (ii) other equity based awards granted under the Omnibus Incentive Plan, including approximately 2 million shares of our common stock that have been sold in the public market through the exercise of stock options as of October 21, 2016, are freely tradable under the Securities Act, unless purchased by our affiliates. As of October 21, 2016, there were stock options outstanding to purchase a total of 3,588,236 shares of our common stock, there were 453,316 shares of our common stock subject to restricted stock units and there were 109,881 shares of our common stock subject to performance share units. In addition, 6,827,153 shares of our common stock are reserved for future issuances under our Omnibus Incentive Plan.

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On February 24, 2015, our board of directors approved and recommended for approval by our stockholders the Employee Stock Purchase Plan, which became effective for offering periods commencing July 1, 2015. The Employee Stock Purchase Plan is intended to qualify for the favorable tax treatment under Section 423 of the Code. Under the plan, eligible employees of the Company may purchase common stock, subject to IRS limits, during pre-specified offering periods at a discount established by the Company not to exceed 10 percent of the then current fair market value. On April 27, 2015, our stockholders approved the Employee Stock Purchase Plan with a maximum of one million shares of common stock authorized for sale under the plan. On November 3, 2015, we filed a registration statement on Form S-8 under the Securities Act to register the 1,000,000 shares of common stock that may be issued under the Employee Stock Purchase Plan and, as a result, all shares of common stock acquired under the Employee Stock Purchase Plan will be freely tradable under the Securities Act, unless purchased by our affiliates. As of October 21, 2016, 929,896 shares of our common stock are reserved for future issuances under the Employee Stock Purchase Plan.

The remaining shares of our common stock outstanding as of February 19, 2016 are restricted securities within the meaning of Rule 144 under the Securities Act, but are eligible for resale subject to applicable volume, means of sale, holding period and other limitations of Rule 144 under the Securities Act or pursuant to an exception from registration under Rule 701 under the Securities Act.

In the future, we may issue additional shares of common stock or other equity or debt securities convertible into or exercisable or exchangeable for shares of our common stock in connection with a financing, acquisition, litigation settlement or employee arrangement or otherwise. Any of these issuances could result in substantial dilution to our existing stockholders and could cause the trading price of our common stock to decline.

If securities or industry analysts do not publish research or publish misleading or unfavorable research about our business, our stock price and trading volume could decline.

The trading market for our common stock depends in part on the research and reports that securities or industry analysts publish about us or our business. If one or more of the analysts that covers our common stock downgrades our stock or publishes misleading or unfavorable research about our business, our stock price would likely decline. If one or more of the analysts ceases coverage of our common stock or fails to publish reports on us regularly, demand for our common stock could decrease, which could cause our common stock price or trading volume to decline.

Future offerings of debt or equity securities which would rank senior to our common stock may adversely affect the market price of our common stock.

If, in the future, we decide to issue debt or equity securities that rank senior to our common stock, it is likely that such securities will be governed by an indenture or other instrument containing covenants restricting our operating flexibility. Additionally, any convertible or exchangeable securities that we issue in the future may have rights, preferences and privileges more favorable than those of our common stock and may result in dilution to owners of our common stock. We and, indirectly, our stockholders, will bear the cost of issuing and servicing such securities. Because our decision to issue debt or equity securities in any future offering will depend on market conditions and other factors beyond our control, we cannot predict or estimate the amount, timing or nature of our future offerings. Thus, holders of our common stock will bear the risk of our future offerings reducing the market price of our common stock and diluting the value of their stock holdings in us.

Fulfilling our obligations incident to being a public company, including with respect to the requirements of and related rules under the Sarbanes-Oxley Act of 2002, is expensive and time-consuming, and any delays or difficulties in satisfying these obligations could have a material adverse effect on our future results of operations and our stock price.

Our initial public offering was completed on July 1, 2014. As a public company, we are subject to the reporting and corporate governance requirements, under the listing standards of the NYSE and the Sarbanes-Oxley Act of 2002, that apply to issuers of listed equity, which impose certain significant compliance costs and obligations upon us. The changes necessitated by being a publicly listed company require a significant commitment of additional resources and management oversight which increase our operating costs. Other expenses associated with being a public company include increases in auditing, accounting and legal fees and expenses, investor relations expenses, increased directors’ fees and director and officer liability insurance costs, registrar and transfer agent fees and listing fees, as well as other expenses. As a public company, we are required, among other things, to define and expand the roles and the duties of our board of directors and its committees and institute more comprehensive compliance and investor relations functions. Failure to comply with the Sarbanes-Oxley Act of 2002 could potentially subject us to sanctions or investigations by the SEC, the NYSE or other regulatory authorities.

Anti-takeover provisions in our amended and restated certificate of incorporation and amended and restated by-laws could discourage, delay or prevent a change of control of our company and may affect the trading price of our common stock.

Our amended and restated certificate of incorporation and amended and restated by laws include a number of provisions that may discourage, delay or prevent a change in our management or control over us that stockholders may consider favorable. For example, our amended and restated certificate of incorporation and amended and restated by laws collectively:

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These provisions may prevent our stockholders from receiving the benefit from any premium to the market price of our common stock offered by a bidder in a takeover context. Even in the absence of a takeover attempt, the existence of these provisions may adversely affect the prevailing market price of our common stock if the provisions are viewed as discouraging takeover attempts in the future.

Our amended and restated certificate of incorporation and amended and restated by laws may also make it difficult for stockholders to replace or remove our management. These provisions may facilitate management entrenchment that may delay, deter, render more difficult or prevent a change in our control, which may not be in the best interests of our stockholders.

We do not intend to pay dividends on our common stock and, consequently, your ability to achieve a return on your investment will depend on appreciation in the price of our common stock.

We do not intend to declare and pay dividends on our common stock for the foreseeable future. We currently intend to use our future earnings, if any, to repay debt, to repurchase shares of our common stock, to fund our growth, to develop our business, for working capital needs and general corporate purposes. Therefore, you are not likely to receive any dividends on your common stock for the foreseeable future and the success of an investment in shares of our common stock will depend upon any future appreciation in their value. There is no guarantee that shares of our common stock will appreciate in value or even maintain the price at which our stockholders have purchased their shares. In addition, ServiceMaster’s operations are conducted almost entirely through our subsidiaries. As such, to the extent that we determine in the future to pay dividends on our common stock, none of our subsidiaries will be obligated to make funds available to ServiceMaster for the payment of dividends. Further, the agreements governing our Credit Facilities significantly restrict the ability of our subsidiaries to pay dividends or otherwise transfer assets to us. In addition, the payment of ordinary and extraordinary dividends by our subsidiaries that are regulated as insurance, home service, or similar companies is subject to applicable state law limitations, and Delaware law may impose additional requirements that may restrict our ability to pay dividends to holders of our common stock.

Our amended and restated certificate of incorporation designates the Court of Chancery of the State of Delaware as the exclusive forum for certain litigation that may be initiated by our stockholders, which could limit our stockholders’ ability to obtain a favorable judicial forum for disputes with us.

Our amended and restated certificate of incorporation provides that the Court of Chancery of the State of Delaware is the sole and exclusive forum for (i) any derivative action or proceeding brought on our behalf, (ii) any action asserting a claim of breach of a fiduciary duty owed to us or our stockholders by any of our directors, officers, employees or agents, (iii) any action asserting a claim against us arising under the General Corporation Law of the State of Delaware or (iv) any action asserting a claim against us that is governed by the internal affairs doctrine. By becoming a stockholder in our company, you will be deemed to have notice of and have consented to the provisions of our amended and restated certificate of incorporation related to choice of forum. The choice of forum provision in our amended and restated certificate of incorporation may limit our stockholders’ ability to obtain a favorable judicial forum for disputes with us.

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

Share Repurchase Program

On February 23, 2016, our board of directors authorized a three-year share repurchase program, under which we may repurchase up to $300 million of outstanding shares of our common stock. We expect to fund all share repurchases from net cash provided from operating activities. The share repurchase program is part of our capital allocation strategy that focuses on sustainable growth and maximizing shareholder value.

Issuer Purchases of Equity Securities



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(1) All shares were acquired as part of our share repurchase program.



ITEM 5.  OTHER INFORMATION  

Director Resignation

On October 28, 2016, John Krenicki, Jr. resigned as a member of our board of directors. Mr. Krenicki was appointed to the board as a designee of investment funds managed by, or affiliated with, Clayton, Dubilier & Rice, LLC, a former controlling stockholder of the Company.  Mr. Krenicki’s resignation from the board is the final step in the Company transitioning from a board of directors appointed by its former controlling stockholders.

Amendment to By-Laws

On October 28, 2016, the board of directors amended and restated the Company’s By-Laws to provide for the election of directors by a majority vote of stockholders, except in the case of contested elections.





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ITEM 6. EXHIBITS [Open]



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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: October 28, 2016





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