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 March 31, 2018



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)



150 Peabody Place, Memphis, Tennessee 38103

(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, a smaller reporting company, or an emerging growth company. See definitions of “large accelerated filer,” “accelerated filer,” “smaller reporting company,” and “emerging growth company” in Rule 12b-2 of the Exchange Act.



If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) 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 April 25, 2018: 135,407,537 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 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 service plans, disaster restoration, janitorial, residential cleaning, 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, 2017, as filed with the SEC (the “2017 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.

American Home Shield Spin-off

On July 26, 2017, the Company announced that it intends to separate its American Home Shield business from its Terminix and Franchise Services Group businesses by means of a spin-off of the American Home Shield business to Company stockholders, resulting in two publicly traded companies. The spin-off would create two independent companies, each with an enhanced strategic focus, simplified operating structure, distinct investment identity and strong financial profile. The transaction is expected to be completed in the third quarter of 2018, subject to satisfaction of customary conditions, including the effectiveness of a Registration Statement on Form 10, receipt of a favorable ruling from the IRS concerning certain tax matters and final approval by the Company’s board of directors, and it is intended to qualify as a tax-free distribution to the Company’s stockholders for U.S. federal income tax purposes.

 



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 2017 Form 10-K. The significant accounting policy for revenue has been updated herein for the adoption of Financial Accounting Standards Board (“FASB”) Accounting Standards Codification (“ASC”) Topic 606, “Revenue from Contracts with Customers” discussed below. There have been no other material changes to the significant accounting policies for the three months ended March 31, 2018.

Adoption of New Accounting Standards

In January 2016, the FASB issued Accounting Standards Update (“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. In March 2018, FASB issued an amendment to this standard (ASU No. 2018-03), which provides further clarification regarding this standard. The Company adopted this ASU on January 1, 2018. As a result of the adoption, approximately $1 million of losses related to the Company’s equity investments were recognized in Net income for the quarter ended March 31, 2018, and approximately $2 million was reclassified from Accumulated other comprehensive income (“AOCI”) to Accumulated deficit related to unrealized gains on available-for-sale equity securities. Additionally, the Company holds minority interests in several strategic investments which do not have readily determinable fair values. The carrying amount of these investments at March 31, 2018 is approximately $4 million. These investments are recorded at cost and will be remeasured upon the occurrence of observable price changes or impairments. No adjustments to the carrying amount were made during the period.

In January 2017, the FASB issued ASU 2017-01, “Business Combinations (Topic 805): Clarifying the Definition of a Business.” The ASU clarifies the definition of a business to assist entities with evaluating whether transactions should be accounted for as acquisitions (or disposals) of assets or businesses by providing a screen to determine when an integrated set of assets or activities is not a business. The Company adopted this ASU on January 1, 2018. The consolidated financial statements may be impacted if an acquisition does not qualify as a business combination under the ASU. Such acquisitions would be accounted for as asset purchases.

In May 2017, the FASB issued ASU 2017-09, “Stock Compensation – Scope of Modification Accounting.” The ASU clarifies the scope of modification accounting for share-based payment arrangements. Specifically, an entity would not apply modification

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accounting if the fair value, vesting conditions and classification of the awards are the same immediately before and after the modification. The Company adopted this ASU on January 1, 2018 and will apply the guidance prospectively to awards modified on or after the adoption date.

In February 2018, the FASB issued ASU 2018-02, “Income Statement – Reporting Comprehensive Income (Topic 220): Reclassification of Certain Tax Effects from Accumulated Other Comprehensive Income” allowing a reclassification from AOCI to Retained Earnings for stranded tax effects resulting from the corporate income tax rate change in the Tax Cuts and Jobs Act (the “Act” or “U.S. Tax Reform”). It is effective for fiscal years, and interim periods within those years, beginning after December 15, 2018. As allowed by the ASU, the Company elected to early adopt the amendments of this ASU and has reclassified approximately $4 million of unrealized losses from AOCI to Accumulated deficit.

Following are the results of the adoption of these standards on the Company’s consolidated statements of stockholders’ equity previously reported:

Accounting Standards Issued But Not Yet Effective

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 the adoption of ASU 2016-02 on the Company’s consolidated financial statements and currently expects that most of the operating lease commitments will be subject to the new standard and recognized as operating lease liabilities and right-of-use assets upon adoption of ASU 2016-02, which will increase the amount of total assets and total liabilities that is reported relative to such amounts prior to adoption.

In August 2017, the FASB issued ASU 2017-12, “Derivatives and Hedging (Topic 815): Targeted Improvements to Accounting for Hedging Activities.” The ASU simplifies certain aspects of hedge accounting and improves disclosures of hedging arrangements through the elimination of the requirement to separately measure and report hedge ineffectiveness. The ASU generally requires the entire change in the fair value of a hedging instrument to be presented in the same income statement line as the hedged item in order to align financial reporting of hedge relationships with economic results. Entities must apply the amendments to cash flow and net investment hedge relationships that exist on the date of adoption using a modified retrospective approach. The presentation and disclosure requirements must be applied prospectively. The Company is currently evaluating the impact of the adoption of ASU 2017-12, including transition elections and required disclosures, on the Company’s consolidated financial statements.

The Company has reviewed all other recently issued, but not yet effective, accounting pronouncements and does not believe the future adoption of any such pronouncements will have a material impact on its financial condition or the results of its operations.

Adoption of ASC Topic 606, “Revenue from Contracts with Customers”

On January 1, 2018, the Company adopted ASC 606 using the modified retrospective method to those contracts which were not completed as of January 1, 2018. Results for reporting periods beginning after January 1, 2018 are presented under ASC 606, while prior period amounts are not adjusted and continue to be reported in accordance with the Company’s historic accounting under ASC 605. The Company implemented internal controls and system functionality where necessary to enable the preparation of financial information on adoption.

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Revenue Recognition

The following table presents the Company’s reportable segment revenues, disaggregated by revenue source. The Company disaggregates revenue from contracts with customers into major product lines. The Company determines that disaggregating revenue into these categories achieves the disclosure objective to depict how the nature, amount, timing, and uncertainty of revenue and cash flows are affected by economic factors. As noted in the business segment reporting information in Note 14, the Company’s reportable segments are Terminix, American Home Shield and Franchise Services Group.

At contract inception, the Company assesses the goods and services promised in its contracts with customers and identifies a performance obligation for each promise to transfer to the customer a good or service (or a bundle of goods and services) that is distinct. To identify the performance obligation, the Company considers all of the goods and services promised in the contract regardless of whether they are explicitly stated or are implied by customary business practices.

Terminix segment

Pest control services

Pest control services can be for one-time or recurring services. Revenues from pest control services are recognized at the agreed-upon contractual amount over time as the services are provided, most of which are started and completed within one day, as the customer simultaneously receives and consumes the benefits of the services as they are performed. Upon completion of service, a receivable is recorded related to this revenue as the Company has an unconditional right to invoice and receive payment. Payments are typically received shortly after services have been rendered.

Termite services

The Company eradicates termites through the use of baiting systems and non-baiting methods (e.g., fumigation or liquid treatments). Termite services using liquid and baiting systems are sold through annual renewable contracts. The Company also performs other termite and related services, which may be one-time or renewable services. Revenue for termite services are recognized at the agreed-upon contractual amount upon the completion of the service. All termite services are generally started and completed within one day. Upon completion of the service, a receivable is recorded related to this revenue as the Company has an unconditional right to invoice and receive payment. Payments are typically received shortly after services have been rendered.

Most termite services can be renewed after the initial year. Revenue on renewal contracts is recognized upon completion of an annual inspection and receipt of payment from the customer which evidences the extension of the contract into a renewal period. Advanced renewal payments generate a contract liability and are deferred until the related renewal period.

Termite inspection and protection contracts are frequently sold through annual contracts. For these contracts, the Company has a stand ready obligation of which the customer receives and consumes the benefits over the annual period. Associated service costs are expensed as incurred. The Company measures progress toward satisfaction of its stand ready obligation over time using costs incurred as the measure of progress under the input method, which results in straight-line recognition of revenue. Payments are received at the commencement of the contract, which generates a contract liability, or in installments over the contract period.

Sales of products and other 

Product revenues are generated from selling product to distributors and franchisees. Revenues from product sales are generally recognized once control of the products transfers to the customer. A receivable is recorded related to these sales as the Company has an unconditional right to invoice and receive payment. Payments are typically received shortly after a customer is invoiced.

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American Home Shield segment

Home service plans

Home service plan contracts are sold through annual renewable contracts and customer payments are received at the commencement of the contract or in installments over the contract period, which generates a contract liability. The Company recognizes revenue related to these contracts at the agreed-upon contractual amount over time using the input method in proportion to the costs expected to be incurred in performing services under the contracts. As the costs to fulfill the obligations of the service plan contracts are incurred on an other than straight-line basis, the Company utilizes historical evidence to estimate the expected claims expense and related timing of such costs. This adjustment to the straight-line revenue creates a contract asset or contract liability. The Company regularly reviews its estimates of claims costs and adjusts the estimates when appropriate.

Franchise Services Group segment

Royalty fees

The Company has franchise agreements in its ServiceMaster Restore, ServiceMaster Clean, Merry Maids, Furniture Medic and AmeriSpec businesses. Royalty fee revenue consists principally of sales-based royalties received as part of the consideration for the franchise right and is calculated as a percentage of customer level revenue. Revenue is recognized by the Company at the agreed-upon contractual rates over time as the customer level revenue is generated by the franchisees. A receivable is recognized for an estimate of the unreported royalty fees, which are reported and remitted to the Company in arrears.

Janitorial national accounts

National account revenues are recognized at the agreed-upon contractual amounts over time as services are completed based on contractual arrangements to provide services at the customers’ locations. The Company engages either a franchisee or non-franchisee business to perform the services. Under these agreements, the Company is directly responsible for providing the services and receives payment directly from the customer. A receivable is recorded related to this revenue as the Company has an unconditional right to invoice and receive payment. Payments are typically received shortly after services have been rendered.

Sales of products and other

Product revenues are generated from selling product to franchisees. Revenues from product sales are generally recognized once control of the products transfers to the customer. A receivable is recorded related to these sales as the Company has an unconditional right to invoice and receive payment. Payments are typically received shortly after a customer is invoiced.

Initial franchise fees result from the sale of a franchise license, which includes the use of the name, trademarks and proprietary methods. The franchise license is considered symbolic intellectual property and revenue related to the sale of this right is recognized at the agreed-upon contractual amount over the term of the initial franchise agreement.

Franchisees contribute a percentage of customer level revenue into a national advertising fund managed by the Company. In cases where the Company has ultimate control of the marketing and advertising, the Company recognizes both revenue and expense for the amount earned.  Prior to the adoption of ASC 606, this revenue was recorded net of the advertising expense incurred.  The impact to revenues as a result of applying ASC 606 was an increase of $3 million for the three months ended March 31, 2018.

In addition, the Company has contractual arrangements with several national insurance companies to maintain a call center which receives and provides non-recurring disaster recovery and restoration referrals from the insurers to qualifying franchisees. The Company receives a referral fee from the franchisee. The Company recognizes the referral fee at the agreed-upon contractual amount as revenue in the month the referral was issued.

Costs to obtain a contract with a customer

Terminix and American Home Shield

The Company capitalizes the incremental costs of obtaining a contract with a customer, primarily commissions, and recognizes the expense on a straight-line basis over the expected customer relationship period. As of January 1, 2018, the date the Company adopted ASC 606, the Company capitalized a total of $61 million at Terminix and $21 million at American Home Shield in deferred customer acquisition costs related to contracts that were not completed. In the three months ended March 31, 2018, the amount of amortization was $16 million at Terminix and $4 million at American Home Shield and there was no impairment loss in relation to costs capitalized.

Franchise Services Group

The Company capitalizes the incremental costs of selling a new franchise license, primarily commissions, and recognizes the expense over the term of the initial franchise agreement. As of January 1, 2018, the date the Company adopted ASC 606, the Company capitalized a total of $1 million in deferred customer acquisition costs related to contracts that were not completed. In the three months ended March 31, 2018, the amount of amortization was less than $1 million and there was no impairment loss in relation to costs capitalized.



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Contract balances

Timing of revenue recognition may differ from the timing of invoicing to customers. Contracts with customers are generally for a period of one year or less, and are generally renewable. The Company records a receivable related to revenue recognized on services once the Company has an unconditional right to invoice and receive payment in the future related to the services provided. All accounts receivables are recorded within Receivables, less allowances, on the condensed consolidated statements of financial position. Notes receivable, which represent amounts financed for customers through the Company’s financing subsidiary, are included within Receivables, less allowances, on the condensed consolidated statement of financial position and totaled $35 million as of March 31, 2018.

Deferred revenue represents a contract liability and is recognized when cash payments are received in advance of the performance of services, including when the amounts are refundable. For Terminix, amounts are recognized as revenue upon completion of services. For American Home Shield, amounts are recognized as revenue in proportion to the costs expected to be incurred in performing services under the Company’s contracts.

Deferred revenue by segment was as follows (in millions):



Changes in deferred revenue for the three months ended March 31, 2018 were as follows (in millions):





There was approximately $104 million of revenue recognized in the three months ended March 31, 2018, that was included in the deferred revenue balance as of January 1, 2018. 

Arrangements with Multiple Performance Obligations

The Company’s contracts with customers may include multiple performance obligations. For such arrangements, we allocate revenue to each performance obligation based on its relative standalone selling price. Any discounts given are allocated to the services to which the discounts relate.

Practical Expedients and Exemptions

The Company offers certain interest-free contracts to customers where payments are received over a period not exceeding one year. Additionally, certain Terminix customers may pay in advance for services and American Home Shield customers have the option to pay for an annual home service plan in advance. The Company does not adjust the promised amount of consideration for the effects of these financing components. At contract inception, the period of time between the performance of services and the customer payment is one year or less.

Revenue is recognized net of any taxes collected from customers, which are subsequently remitted to taxing authorities.

The Company does not disclose the value of unsatisfied performance obligations for contracts with an original expected length of one year or less.

Certain non-commission related incremental costs to obtain a contract with a customer are expensed as incurred because the amortization period would have been one year or less. These costs are recorded within Selling and administrative expenses on the condensed consolidated statements of operations and comprehensive income.

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The Company utilizes the portfolio approach to recognize revenue in situations where a portfolio of contracts have similar characteristics. The revenue recognized under the portfolio approach is not materially different than if every individual contract in the portfolio was accounted for separately.

Impact of ASC 606 on the Condensed Consolidated Financial Statements

The Company recorded a net reduction to opening retained earnings of $16 million, net of tax, as of January 1, 2018 due to the cumulative impact of adopting ASC 606. Changes to the condensed consolidated statements of operations and comprehensive income include: i) costs of obtaining a contract that would have been incurred regardless of whether the contract was obtained, such as direct mail and digital advertising, are now expensed as incurred; ii) initial fees and the related commissions from sales of franchise licenses, previously recognized in the year of the sale, are now recognized over the term of the initial franchise agreement; iii) Franchise Services Group national advertising fund income, previously recorded net of advertising expense incurred for the Company’s advertising programs, will now be reported gross, generally with offsetting increases to both revenue and expense such that there will not be a significant, if any, impact on net income; and iv) commissions costs at Terminix and American Home Shield incremental to a successful sale are deferred and recognized over the expected customer relationship period. Previously, commissions and other sales-related costs were deferred and recognized over the initial contract period.

Changes to the condensed consolidated statements of financial position include: i) the reclassification of Receivables to contract assets which are presented net of contract liabilities within Deferred revenue and ii) the reclassification of Deferred customer acquisition costs to long-term assets as costs are recognized over the expected customer relationship period, which is in excess of one year. Previously, when a customer elected to pay for their home service plan contract on a monthly basis, Receivables and Deferred revenue were recorded based on the total amount due from the customer. Receivables were reduced as amounts were paid, and the Deferred revenue was amortized over the life of the contract. Currently, only the portion of the contract that is due in the current month will be recorded within Receivables.

The following tables compare affected lines of the condensed consolidated financial statements as prepared under the provisions of ASC 606 to a presentation of these financial statements under the prior revenue recognition guidance:





The adoption of ASC 606 had no significant impact on the Company’s cash flows. The aforementioned impacts resulted in offsetting shifts in cash flows from operations between net income and various change in working capital line items.





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Note 3. Restructuring Charges

The Company incurred restructuring charges of $12 million ($9 million, net of tax) and $2 million ($1 million, net of tax) in the three months ended March 31, 2018 and 2017, respectively. Restructuring charges were comprised of the following:





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The pretax charges discussed above are reported in Restructuring charges in the unaudited condensed consolidated statements of operations and comprehensive income. Certain restructuring comparative figures in the condensed consolidated statements of cash flows have been reclassified to conform to the current year presentation.

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





The company expects substantially all of its accrued restructuring charges to be paid within one year.



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Note 4. American Home Shield Spin-Off

The Company’s financial statements include nonrecurring costs incurred to evaluate, plan and execute the spin-off of American Home Shield to company stockholders. These costs are primarily related to third-party consulting and other incremental costs directly associated with the spin-off process. At December 31, 2017, the Company had $1 million of American Home Shield spin-off charges accrued, and $2 million of prepaid spin-off charges which were recognized during the quarter ended March 31, 2018. The Company’s results for the three months ended March 31, 2018 include American Home Shield spin-off charges of $7 million ($6 million, net of tax). Of this amount, $3 million was unpaid and accrued at March 31, 2018 in Accrued liabilities – Other on the condensed consolidated statements of financial position. The Company expects substantially all of the American Home Shield spin-off charges to be paid within one year.

The Company expects to incur aggregate charges related to the spin-off of $35 million to $45 million in 2018. In addition, incremental capital expenditures will be required to effect the spin-off in 2018 and will range from $20 million to $30 million, principally reflecting costs to replicate information technology systems historically shared by the Company’s business units.

Note 5. 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:



Accruals for home service plan 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.

On December 16, 2016, the U.S. Virgin Islands Department of Justice filed a civil complaint in the Superior Court of the Virgin Islands related to a fumigation incident in a matter styled Government of the United States Virgin Islands v. The ServiceMaster Company, LLC, The Terminix International Company Limited Partnership, and Terminix International USVI, LLC. The amount and extent of any 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 fumigation matter, which could be material, is not currently known, and any such further penalties, fines, sanctions, costs or damages would not be covered under the Company’s general liability policies.

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

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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 above, 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 our reputation, business, financial position, results of operations and cash flows. 

Note 6. 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 months ended March 31, 2018 and 2017. There were no accumulated impairment losses recorded as of March 31, 2018. 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 2018 and each of the next five years of $16 million, $16 million, $12 million, $9 million, $6 million and $5 million, respectively. These amounts exclude the intangible assets acquired in connection with the Copesan acquisition on March 30, 2018, as intangible asset values and the related useful lives have not yet been finalized.

 



Note 7. Stock-Based Compensation

For the three months ended March 31, 2018 and 2017, the Company recognized stock-based compensation expense of $4 million ($3 million, net of tax) and $5 million ($3 million, net of tax), respectively. These charges are recorded within Selling and administrative expenses in the condensed consolidated statements of operations and comprehensive income.

As of March 31, 2018 there was $34 million of total unrecognized compensation costs related to non-vested stock options, restricted stock units (“RSUs”) and performance shares granted under the Amended and Restated ServiceMaster Global Holdings, Inc. 2014 Omnibus Incentive Plan (the “Omnibus Incentive Plan”). These remaining costs are expected to be recognized over a weighted-average period of 2.46 years.

Note 8. Comprehensive Income

Comprehensive income, which primarily includes net income (loss), unrealized gain (loss) on derivative instruments and the effect of foreign currency translation gain, is disclosed in the condensed consolidated statements of operations and comprehensive income. Unrealized gains on marketable securities of $3 million ($2 million, net of tax) were included in other comprehensive income prior to the Company’s adoption of ASU 2016-01 on January 1, 2018. Subsequent to the adoption, these unrealized gains have been reclassified to retained earnings. Additionally, stranded tax effects of approximately $4 million resulting from the corporate income tax rate change in U.S. Tax Reform were reclassified upon the Company’s adoption of ASU 2018-02 on January 1, 2018. The income tax effects remaining in AOCI will be released into earnings as the related pre-tax amounts are reclassified to earnings.

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



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Note 9. Supplemental Cash Flow Information

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

As of March 31, 2018 and December 31, 2017, Cash and cash equivalents of $411 million and $475 million, respectively, and Restricted cash of $89 million and $89 million, respectively, as presented on the condensed consolidated statements of financial position represent the amounts comprising Cash and cash equivalents and restricted cash of $500 million and $563 million, respectively, on the condensed consolidated statement of cash flows. 

As of March 31, 2017, Cash and cash equivalents of $334 million and Restricted cash of $89 million as presented on the condensed consolidated statements of financial position represent the amounts comprising Cash and cash equivalents and restricted cash of $423 million on the condensed consolidated statement of cash flows.

The Company acquired $3 million and $12 million of property and equipment through capital leases and other non-cash  financing transactions in the three months ended March 31, 2018 and 2017, respectively, which have been excluded from the condensed consolidated statements of cash flows as non-cash investing and financing activities. 

 



Note 10. 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 March 31, 2018 and December 31, 2017, the Company’s investments consisted primarily of treasury bills (“Debt securities”) and common equity securities (“Equity securities”). The amortized cost, fair value and gross realized and unrealized gains and losses of the Company’s short- and long-term investments in Debt and Equity securities are as follows:





Following the adoption of ASC 2016-01, the Company accounts for equity securities at fair value with adjustments to fair value recognized in Interest and net investment income in the condensed consolidated statements of operations and comprehensive income. For the three months ended March 31, 2018, approximately $1 million of unrealized losses were recorded within Interest and net investment income in the condensed consolidated statements of operations and comprehensive income and approximately $3 million ($2 million, net of tax) of unrealized gains were reclassified from Accumulated other comprehensive income to Accumulated deficit.

The Company periodically reviews its debt securities to determine whether there has been an other than temporary decline in value. There were no impairment charges due to declines in the value of these investments for the three months ended March 31, 2018.

 

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Note 11. Long-Term Debt

Long-term debt is summarized in the following table:



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Interest Rate Swaps

Interest rate swap agreements in effect as of March 31, 2018 are as follows:

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

 



Note 12. Acquisitions

Acquisitions have been accounted for as business combinations 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 March 30, 2018, the Company acquired all of the outstanding stock of Copesan Services, Inc. (“Copesan”) for an aggregate purchase price of $148 million, subject to certain post-closing net working capital adjustments. The acquisition is expected to improve Terminix’s capabilities in commercial pest control as Copesan is expected to provide the Company with significant expertise, system capabilities and processes for delivering pest management solutions to sophisticated commercial customers. The Company funded $104 million at closing using available cash on hand, $11 million of which was funded on the acquisition date, but still outstanding at March 31, 2018 and is included in Accrued liabilities – Other on the condensed consolidated statements of financial position. An additional $35 million of deferred purchase price and up to $10 million earnout contingent on the successful achievement of projected revenue targets are both due to the sellers three years from the acquisition date. Changes in projected revenue would result in a change in the fair value of the recorded earnout obligation. Subsequent changes to the estimated earnout obligation will be recognized in the consolidated statements of operations and comprehensive income when incurred.

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As of March 31, 2018, the purchase price allocation for this acquisition has not been finalized as the Company is still evaluating working capital balances and the fair value and useful lives of the acquired intangible assets. As the Company finalizes its assessment of the fair value of assets acquired and liabilities assumed, additional purchase price adjustments may be recorded during the measurement period.

As a result of this acquisition, the Company recognized a preliminary value of $98 million of goodwill, which is primarily attributable to the expected benefits from synergies of the combination with existing businesses and growth opportunities and Copesan’s workforce and is not deductible for tax purposes.

During the three months ended March 31, 2017, the Company completed a pest control acquisition and purchased a ServiceMaster Clean master distributor within the Franchise Services Group. The total purchase price for these acquisitions was $13 million. The Company recorded goodwill of $6 million and other intangibles, primarily reacquired rights, of $6 million related to these acquisitions. As of March 31, 2017, the purchase price allocation for the master distributor had not been finalized as the Company was still evaluating the fair value of certain intangible assets. As the Company finalizes its assessment of the fair value of assets acquired and liabilities assumed, additional purchase price adjustments may be recorded during the measurement period in 2017.

Supplemental cash flow information regarding the acquisitions is as follows:









Acquisition related costs were less than $1 million for the three months ended March 31, 2018 and 2017.

Note 13. Income Taxes

As required by 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 26.3 percent and 38.3 percent for the three months ended March 31, 2018 and 2017, respectively. The year over year decrease in the effective tax rate on income from continuing operations for the three months ended March 31, 2018 was primarily driven by the reduction in the U.S. federal corporate income tax rate from 35 percent to 21 percent.

As of March 31, 2018 and December 31, 2017, the Company had $15 million and $14 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 $2 million as the result of settlements of ongoing audits, statute of limitation expirations or final settlements of uncertain tax positions in multiple jurisdictions.

On December 22, 2017, U.S. Tax Reform was signed into law. The Act includes numerous changes in existing tax law, including a permanent reduction in the federal corporate income tax rate from 35 percent to 21 percent, effective January 1, 2018. The adjustments to deferred tax assets and liabilities and the liability related to the transition tax recorded in the period ending December 31, 2017 are provisional amounts. As described below, the Company has made reasonable estimates. At March 31, 2018, the Company has considered all available information and no adjustments to our original provisional amounts were identified. These amounts are subject to change as the Company obtains information necessary to complete the calculations. The Company will recognize any changes to the provisional amounts within (Benefit) Provision for Income Taxes on the Consolidated Statements of Operations and Comprehensive Income as estimates of deferred tax assets and liabilities and interpretations of the application of the Act are refined.  The Company expects to complete its analysis of the provisional items described further below during the second half of 2018. The effects of other provisions of the Act are not expected to have a material impact on the Company’s condensed consolidated financial statements.



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Corporate Tax Rate Change

The Company is subject to the provisions of the FASB ASC 740-10, Income Taxes, which requires that the effect on deferred tax assets and liabilities of a change in tax rates be recognized in the period the tax rate change was enacted. The Company remeasured deferred tax assets and liabilities based on the new U.S. tax rates at which they are expected to reverse in the future, which is generally 21 percent. The provisional amount recorded at December 31, 2017 relating to the remeasurement of these deferred tax balances was a net reduction of total deferred tax liabilities of $271 million. We are still analyzing certain aspects of the Act and refining our calculations, which could potentially affect these deferred tax balances or potentially give rise to changes in existing deferred tax amounts.

Deferred Tax Analysis

The Act changes the treatment of certain income and expense items for which the Company records deferred tax assets and liabilities. The Company has assessed its valuation of deferred tax assets and liabilities at March 31, 2018, as well as valuation allowance analyses affected by various aspects of the Act. The Company has recorded no provisional amounts related to valuation allowances and revaluation of deferred tax assets affected by various aspects of the Act. However, the Company is still analyzing certain aspects of the Act and refining its calculations, which could potentially affect the valuation of these balances.

Transition Tax 

The Act imposes a Transition Tax on undistributed and previously untaxed post-1986 foreign earnings and profits, as determined in accordance with U.S. tax principles, of certain foreign owned corporations of U.S. stockholders. The Company recorded a provisional amount at December 31, 2017 for the one-time transition tax liability for the deemed distribution of earnings from our foreign subsidiaries resulting in an increase in income tax expense of less than $1 million. The Company recorded a provisional transition tax amount because certain information related to the computations required to compute the transition tax, including the computation of previously undistributed earnings, is not readily available, and there is limited information from federal and state taxing authorities regarding the application and interpretation of the recently enacted legislation. Accordingly, the Company is still analyzing certain aspects of the transition tax calculations which could potentially affect the amount recorded.

GILTI

Because of the complexity of the new global intangible low-taxed income (“GILTI”) tax rules, we are continuing to evaluate this provision of the Act and the application of ASC 740. Under U.S. GAAP, we are allowed to make an accounting policy choice.  Our selection of an accounting policy with respect to the new GILTI tax rules will depend, in part, on analyzing our global income to determine whether we expect to have future U.S. inclusions in taxable income related to GILTI and, if so, what the impact is expected to be.  The Company is not yet able to reasonably estimate the effect of this provision of the Act. Therefore, the Company has not made any adjustments related to potential GILTI tax in our financial statements and have not made a policy decision regarding whether to record deferred taxes on GILTI.

Note 14. Business Segment Reporting

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

In accordance with accounting standards for segments, the Company’s reportable segments are strategic business units that offer different services. The Terminix segment provides termite and pest control services to residential and commercial customers and distributes pest control products. The American Home Shield segment provides home service plans 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 primarily under the Merry Maids brand name, cabinet and wood furniture repair 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 2017 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: income from discontinued operations, net of income taxes; (benefit) provision for income taxes; interest expense; depreciation and amortization expense; fumigation related matters; non-cash stock-based compensation expense; restructuring charges; American Home Shield spin-off charges; and non-cash impairment of software and

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other related costs. 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:



___________________________________

































 

Note 15. 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 in interest and net investment income in the condensed consolidated statements of operations and comprehensive income. The carrying amount of total debt was $2,740 million and $2,787 million, and the estimated fair value was $2,807 million and $2,888 million as of March 31, 2018 and December 31, 2017, 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 March 31, 2018 and December 31, 2017.

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.

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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 three month periods ended March 31, 2018 and 2017.

We account for these investments at fair value with adjustments to fair value recognized in unrealized gain/(loss) on investments in our income statement under non-operating expense.

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. 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 three months ended March 31, 2018. As of March 31, 2018, the Company had fuel swap contracts to pay fixed prices for fuel with an aggregate notional amount of $31 million, maturing through 2019. 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 March 31, 2018, the Company had posted $2 million in letters of credit as collateral under its fuel hedging program, which were issued under the Revolving Credit Facility.

The effective portion of the gain or loss on derivative instruments designated and qualifying as cash flow hedging instruments is recorded in accumulated other comprehensive income. These amounts are reclassified into earnings in the same period

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or periods during which the hedged forecasted debt interest settlement or the fuel settlement affects earnings. See Note 8 to the condensed consolidated financial statements for the effective portion of the gain or loss on derivative instruments recorded in accumulated other comprehensive income and for the amounts reclassified out of accumulated other comprehensive income 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 expected to be recognized in earnings is a gain of $4 million, net of tax, as of  March 31, 2018. 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 16. 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 earnings 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 service plans, 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.

American Home Shield Spin-off

On July 26, 2017, we announced that we intend to separate our American Home Shield business from our Terminix and Franchise Services Group businesses by means of a spin-off of the American Home Shield business to Company stockholders, resulting in two publicly traded companies. The spin-off would create two independent companies, each with an enhanced strategic focus, simplified operating structure, distinct investment identity and strong financial profile. The transaction is expected to be completed in the third quarter of 2018, subject to satisfaction of customary conditions, including the effectiveness of a Registration Statement on Form 10, receipt of a favorable ruling from the IRS concerning certain tax matters and final approval by our board of directors, and it is intended to qualify as a tax-free distribution to our stockholders for U.S. federal income tax purposes.

Our financial statements include nonrecurring costs incurred to evaluate, plan and execute the spin-off. These costs are primarily related to third-party consulting and other incremental costs directly associated with the spin-off process. Our results for the three months ended March 31, 2018 include charges of $7 million related to the spin-off. We expect to incur charges of $35 million to $45 million in 2018 related to the spin-off. In addition, we expect incremental capital expenditures will be required to effect the spin-off in 2018 and will range from $20 million to $30 million, principally reflecting costs to replicate information technology systems historically shared by our business units.

The separation into two independent public companies is expected to result in increased operating costs which could be material to our results of operations. These increased operating costs are primarily associated with corporate functions such as finance, legal, IT and human resources. We are currently evaluating the optimal structure of corporate functions to support the strategic objectives of these two separate publicly traded companies subsequent to the spin-off and thus are currently unable to estimate the amount of the increased operating costs or the division thereof between the two companies.

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 2017, approximately 98 percent of our revenue was generated by sales in the United States.

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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 basic and diluted 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: income from discontinued operations, net of income taxes; provision for income taxes; 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; American Home Shield spin-off charges; gain on sale of Merry Maids branches; non-cash impairment of software and other related costs; and loss on extinguishment of debt. We believe Adjusted EBITDA is useful for investors, analysts and other interested parties as it facilitates company-to-company operating performance comparisons by excluding potential differences caused by variations in capital structures, taxation, the age and book depreciation of facilities and equipment, restructuring initiatives 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 2017, approximately 22 percent, 28 percent, 27 percent and 23 percent of our revenue and approximately 20 percent, 31 percent, 29 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; 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, and in the third quarter of 2017, our Terminix business was negatively impacted by hurricanes Harvey and Irma, which resulted in 53 branches, primarily in Texas and Florida, being temporarily closed for a period of time during August and September. 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.  For example, in the third and fourth quarters of 2017, our ServiceMaster Restore business saw a significant increase in royalty fees related to hurricanes Harvey and Irma and wildfires.

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 $22 million for both of the three months ended March 31, 2018 and 2017, 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 months ended March 31, 2018. 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 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

Resul



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*     not meaningful

Revenue

We reported revenue of $675 million and $643 million for the three months ended March 31, 2018 and 2017, 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 $361 million and $346 million for the three months ended March 31, 2018 and 2017, 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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At Terminix, the decrease in bad debt expense was driven by enhanced credit policies and collection rates. The decrease in production labor was driven by the realization of benefits from past investments in field operations. The increase in damage claims was driven by increased termite warranty claims. The decrease in chemicals and materials was driven by sourcing savings.

The increase in contract claims cost at American Home Shield was due primarily to higher number of heating work orders driven by colder winter temperatures totaling $5 million and normal inflationary pressure on the underlying cost of repairs totaling $1 million.

Selling and Administrative Expenses

We reported selling and administrative expenses of $197 million and $186 million for the three months ended March 31, 2018 and 2017, respectively, which comprised general and administrative expenses of $77 million and $78 million, respectively, and selling and marketing expenses of $120 million and $109 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 sales and marketing costs at Terminix was driven by targeted marketing investments to drive sales growth and a change in the timing of our recognition of sales costs upon our adoption of ASC 606 on January 1, 2018.

At American Home Shield, the increase in sales and marketing costs was driven by targeted spending to drive sales growth. The increase in customer service costs was an incremental investment in customer care center costs to staff, train and enhance workforce processes to deliver a new level of customer service.

At Franchise Service Group, the increase in sales and marketing costs was driven by the recognition of national advertising fund contributions from franchisees as revenue upon our adoption of ASC 606 on January 1, 2018. Prior to 2018, contributions to the national advertising fund made by our franchisees were treated as an offset to advertising expense.



Amortization Expense

Amortization expense was $5 million and $7 million in the three months ended March 31, 2018 and 2017, respectively.



Fumigation Related Matters

We recorded a charge of $1 million in the three months ended March 31, 2017 for fumigation related matters. There were no charges for fumigation related matters recorded in the three months ended March 31, 2018.

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Impairment of Software and Other Related Costs

We recorded an impairment charge of $2 million in the three months ended March 31, 2017 relating to our decision to replace certain software. There were no impairments of software and other related costs recorded in the three months ended March 31, 2018.

Restructuring Charges

We incurred restructuring charges of $12 million and $2 million in the three months ended March 31, 2018 and 2017, respectively. Restructuring charges were comprised of the following:





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

American Home Shield Spin-Off Charges

Our financial statements include nonrecurring costs incurred to evaluate, plan and execute the spin-off of American Home Shield to company stockholders. These costs are primarily related to third-party consulting and other incremental costs directly associated with the spin-off process. At December 31, 2017, the Company had $1 million of American Home Shield spin-off charges accrued, and $2 million of prepaid spin-off charges which were recognized during the quarter ended March 31, 2018. Our results for the three months ended March 31, 2018 include American Home Shield spin-off charges of $7 million. Of this amount, $3 million was unpaid and accrued at March 31, 2018 in Accrued liabilities – Other on the condensed consolidated statements of financial position.

We expect to incur aggregate charges related to the spin-off of $35 million to $45 million in 2018. In addition, incremental capital expenditures will be required to effect the spin-off in 2018 and will range from $20 million to $30 million, principally reflecting costs to replicate information technology systems historically shared by our business units.

Interest Expense

Interest expense was $37 million in each of the three month periods ended March 31, 2018 and 2017.

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Income from Continuing Operations before Income Taxes

Income from continuing operations before income taxes was $54 million and $62 million for the three months ended March 31, 2018 and 2017, 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 26.3 percent and 38.3 percent for the three months ended March 31, 2018 and 2017, respectively. The effective tax rate on income from continuing operations for the three months ended March 31, 2018 was primarily affected by the implementation of U.S. Tax Reform. 

Net Income

Net income was $40 million and $39 million for the three months ended March 31, 2018 and 2017, respectively.

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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 March 31, 2018 Compared to Three Months Ended March 31, 2017

The Terminix segment, which provides termite and pest control services to residential and commercial customers and distributes pest control products, reported a one percent increase in revenue and a six percent increase in Adjusted EBITDA for the three months ended March 31, 2018 compared to the three months ended March 31, 2017.

Revenue

Revenue by service line is as follows:







Pest control revenue for the three months ended March 31, 2018 was comparable to prior year.

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 one percent. In the three months ended March 31, 2018, termite renewal revenue comprised 55 percent of total termite revenue, while the remainder consisted of termite new unit revenue. Organic termite revenue increased one percent, reflecting an increase in termite renewals and wildlife exclusion, offset by a decline in termite completion and other services revenue, driven primarily by unfavorable weather conditions in the first quarter of 2018. We estimate that the revenue increase would have been approximately $3 million higher, resulting in organic revenue growth of one percent, if not for the unfavorable weather conditions. Termite activity is unpredictable in its nature. Factors that can impact termite activity include conducive weather conditions and consumer awareness of termite swarms.

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Adjusted EBITDA

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



The decrease in bad debt expense was driven by enhanced credit policies and collection rates. The decrease in chemicals and materials was driven by sourcing savings. The decrease in production labor was driven by the realization of benefits from past investments in field operations. The increase in damage claims was driven by increased termite warranty claims. The increase in sales and marketing costs was driven by targeted marketing investments to drive sales growth and a change in the timing of our recognition of sales costs upon our adoption of ASC 606 on January 1, 2018.





American Home Shield Segment

Three Months Ended March 31, 2018 Compared to Three Months Ended March 31, 2017

The American Home Shield segment, which provides home service plans for household systems and appliances, reported a nine percent increase in revenue and a six percent increase in Adjusted EBITDA for the three months ended March 31, 2018 compared to the three months ended March 31, 2017.

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



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Revenue

The revenue results reflect an increase in new unit sales 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 due primarily to a higher number of heating work orders driven by colder winter temperatures totaling $5 million and normal inflationary pressure on the underlying cost of repairs totaling $1 million. The increase in sales and marketing costs was driven by targeted spending to drive sales growth. The increase in customer service costs was an incremental investment in customer care center costs to staff and train appropriately and enhance workforce processes to deliver a new level of customer service. Extreme temperatures in the future could lead to an increase in service requests related to household systems, resulting in higher claim frequency and costs.

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Franchise Services Group Segment

Three Months Ended March 31, 2018 Compared to Three Months Ended March 31, 2017

 The Franchise Services Group segment, which consists of the ServiceMaster Restore (disaster restoration), ServiceMaster Clean (janitorial), Merry Maids (residential cleaning), Furniture Medic (cabinet and wood furniture repair) and AmeriSpec (home inspection) businesses, reported a 21 percent increase in revenue and a five percent increase in Adjusted EBITDA for the three months ended March 31, 2018 compared to the three months ended March 31, 2017.

Revenue

Revenue by service line is as follows:



The increase in royalty fees was driven by higher disaster restoration services. The increase in revenue from janitorial national accounts was driven by increased sales activity. The increase in other was primarily driven by the recognition of approximately $3 million of national advertising fund franchisee contributions as revenue pursuant to our adoption of ASC 606 that took effect on January 1, 2018.  Prior to 2018, contributions to the national advertising fund by our franchisees were treated as an offset to advertising expense. The adoption had no impact on Adjusted EBITDA.

Adjusted EBITDA

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



Corporate

Three Months Ended March 31, 2018 Compared to Three Months Ended March 31, 2017

Adjusted EBITDA for Corporate for the three months ended March 31, 2018 was comparable to the three months ended March 31, 2017.









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 $1,650 million term loan facility maturing November 8, 2023 and the $300 million revolving credit facility maturing November 8, 2021 (together, 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 March 31, 2018, 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 the 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 $457 million as of March 31, 2018, compared with $522 million as of December 31, 2017. As of March 31, 2018, there were $33 million of letters of credit outstanding and $267 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.

In 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 March 31, 2018, we have repurchased $145 million of outstanding shares under this program, which is included in treasury stock on the condensed consolidated statements of financial position.

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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 March 31, 2018, we had posted $31 million in letters of credit, which were issued under the Revolving Credit Facility, and $89 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. 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 in 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 March 31, 2018, the estimated fair value of our fuel swap contracts was a net gain of $3 million, and we had posted $2 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.

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 three months ended March 31, 2018, we acquired $3 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.

Additionally, a portion of our property and equipment is leased through programs outside the scope of the Fleet Agreement. For the three months ended March 31, 2018, no property and equipment was acquired through these incremental leasing programs. We anticipate new lease financings, including the Fleet Agreement and incremental leasing programs, for the full year 2018 will range from $25 million to $35 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 agreements governing the Credit Facilities may 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 service plan 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 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 March 31, 2018, the total net assets subject to these third-party restrictions was $191 million. We expect that such limitations

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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 previously considered the earnings in our non-U.S. subsidiaries to be indefinitely reinvested and, accordingly, recorded no deferred income taxes. The Act imposes a one-time tax (“Transition Tax”) on undistributed and previously untaxed post-1986 foreign earnings and profits, as determined in accordance with U.S. tax principles, of certain foreign owned corporations owned by U.S. stockholders. Prior to the Transition Tax included in the Act discussed herein, we had an excess amount for financial reporting over the tax basis in our foreign subsidiaries, including cumulative undistributed earnings of the Company’s foreign subsidiaries of $60 million as of December 31, 2016. While the Transition Tax resulted in all remaining undistributed foreign earnings being subject to U.S. tax, an actual repatriation from our non-U.S. subsidiaries could still be subject to additional foreign withholding taxes and U.S. state taxes. Included in our December 31, 2017 U.S. income tax provision is less than $1 million in Transition Tax.

Cash Flows

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

Operating Activities

Net cash provided from operating activities from continuing operations increased $15 million to $142 million for the three months ended March 31, 2018 compared to $126 million for the three months ended March 31, 2017.

Net cash provided from operating activities for the three months ended March 31, 2018 comprised $102 million in earnings adjusted for non-cash charges, offset, in part, by $4 million in payments related to restructuring and $3 million in payments related to the American Home Shield spin-off and a $48 million decrease in cash required for working capital (a $32 million decrease excluding the working capital impact of accrued interest and taxes). For the three months ended March 31, 2018, working capital requirements were favorably impacted by seasonal activity.

Net cash provided from operating activities for the three months ended March 31, 2017 comprised $75 million in earnings adjusted for non-cash charges and a $53 million decrease in cash required for working capital, offset, in part, by $1 million in payments related to fumigation matters. For the three months ended March 31, 2017, working capital requirements were favorably impacted by seasonal activity, the timing of income tax payments and the timing of interest payments on the 2024 notes, offset, in part by incentive compensation payments related to 2016 performance.

Investing Activities

Net cash used for investing activities from continuing operations was $112 million for the three months ended March 31, 2018, compared to $31 million for the three months ended March 31, 2017.

This increase was driven by cash paid for business acquisitions, which increased to $92 million and is net of $1 million of cash acquired, for the three months ended March 31, 2018, from $11 million for the three months ended March 31, 2017. Approximately $11 million of additional cash consideration was paid on April 2, 2018. A deferred payment of $35 million and an earnout of up to $10 million is due to the sellers on the third anniversary of the acquisition date. Consideration paid in 2018 for the purchase of Copesan was from cash on hand. Consideration paid in 2017 for the purchase of a master distributor and for a tuck-in acquisition 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.

Capital expenditures increased to $23 million ($23 million net of government grants) for the three months ended March 31, 2018 from $18 million in the three months ended March 31, 2017 and included recurring capital needs, Global Service Center relocation, and information technology projects. We anticipate capital expenditures for the full year 2018 will range from $70 million to $80 million, reflecting additional Global Service Center relocation costs, recurring capital needs and the continuation of investments in information systems and productivity enhancing technology. In addition, we expect incremental capital expenditures will be required to effect the proposed spin-off of American Home Shield in 2018 and will range from $20 million to $30 million, principally reflecting costs to replicate information technology systems historically shared by our business units. We expect to fulfill our ongoing vehicle fleet needs through vehicle capital leases. We have no additional material capital commitments at this time.

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Cash flows used for purchases of securities for the three months ended March 31, 2018 and 2017 totaled $9 million and $3 million, respectively, and were driven by the purchase of marketable securities at American Home Shield. Cash flows from sales and maturities of securities for three months ended March 31, 2018 totaled $10 million and was driven by normal maturities of debt securities.

Cash flows used for notes receivable, net, for both of the three months ended March 31, 2018 and 2017 totaled $1 million 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 $93 million for the three months ended March 31, 2018 compared to $60 million for the three months ended March 31, 2017.



During the three months ended March 31, 2018, we made scheduled principal payments on long-term debt of $95 million, which included a $79 million payment upon maturity of the 2018 Notes using cash on hand from operations. During the three months ended March 31, 2017, we made scheduled principal payments on long-term debt of $14 million, repurchased $51 million of common stock and received $5 million from the issuance of common stock upon the exercise of stock options.

Contractual Obligations

Our 2017 Form 10-K includes disclosures of our contractual obligations and commitments as of December 31, 2017. We continue to make the contractually required payments, and, therefore, the 2018 obligations and commitments as listed in our 2017 Form 10-K have been reduced by the required payments.

Off-Balance Sheet Arrangements

As of March 31, 2018 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

On December 16, 2016, the U.S. Virgin Islands Department of Justice filed a civil complaint in the Superior Court of the Virgin Islands related to a fumigation incident in a matter styled Government of the United States Virgin Islands v. The ServiceMaster Company, LLC, The Terminix International Company Limited Partnership, and Terminix International USVI, LLC. The amount and extent of any 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 fumigation matter, which could be material, is not currently known, and any such further penalties, fines, sanctions, costs or damages would not be covered under the Company’s general liability policies.

In addition to the above matter, the EPA has advised the Company that it has investigated potential pesticide misapplications in Hawaii. In March 2018, the Company and the EPA reached an agreement to resolve the investigation and signed a consent agreement and the Company paid a penalty of less than $175,000.

Information Regarding Forward-Looking Statements

This report contains forward-looking statements and cautionary statements, including statements with respect to the potential separation of American Home Shield from ServiceMaster and the distribution of American Home Shield shares to ServiceMaster stockholders. 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 are subject to known and unknown risks and uncertainties including, but not limited to: uncertainties as to the timing of the spin-off or whether it will be completed at all, the results and impact of the announcement of the proposed spin-off, the failure to satisfy any conditions to complete the spin-off, the expected tax treatment of the spin-off, the increased demands on management to prepare for and accomplish the spin-off, the incurrence of significant transaction costs, the impact of the spin-off on the businesses of ServiceMaster and American Home Shield, and the failure to achieve anticipated benefits of the spin-off.  These forward-looking statements also include, but are not limited to statements regarding our intentions, beliefs, assumptions or current expectations concerning, among other things, financial position; results of operations; cash flows; prospects; growth strategies or expectations; customer retention; the continuation of acquisitions, including the integration of any acquired company and risks relating to any such acquired company; fuel prices; attraction and retention of key personnel; the impact of fuel swaps; the valuation of marketable securities; estimates of accruals for self-insured claims related to workers’ compensation, auto and general liability risks; estimates of accruals for home service plan 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

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administrative proceedings, including, without limitation, collective, representative or class action litigation; and the impact of prevailing economic conditions.

Forward-looking statements are subject to known and unknown risks and uncertainties, many of which may be beyond our control. We caution you that forward-looking statements are not guarantees of future performance or outcomes and that actual performance and outcomes, including, without limitation, our actual results of operations, financial condition and liquidity, and the development of the market segments in which we operate, may differ materially from those made in or suggested by the forward-looking statements contained in this report. In addition, even if our results of operations, financial condition and cash flows, and the development of the market segments in which we operate, are consistent with the forward-looking statements contained in this report, those results or developments may not be indicative of results or developments in subsequent periods. A number of important factors, including, without limitation, the risks and uncertainties discussed in “Risk Factors” in our Annual Report on Form 10-K for the year ended December 31, 2017 and in “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:

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. 

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ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

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

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

Interest Rate Risk

We are exposed to the impact of interest rate changes and manage this exposure through the use of variable-rate and fixed-rate debt and by utilizing interest rate swaps. In our opinion, the market risk associated with debt obligations and other significant instruments as of March 31, 2018 has not materially changed from December 31, 2017 (see Item 7A of the 2017 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 11 million gallons of fuel in 2018.  As of March 31, 2018, 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 March 31, 2018, we had fuel swap contracts to pay fixed prices for fuel with an aggregate notional amount of $31 million, maturing through 2019. The estimated fair value of these contracts as of March 31, 2018 was a net asset of $3 million. These fuel swap contracts provide a fixed price for approximately 87 percent and 46 percent of our estimated fuel usage for the remainder of 2018 and 2019, respectively. 

 

ITEM 4. CONTROLS AND PROCEDURES 

Evaluation of disclosure controls and procedures

Our Chief Executive Officer, Nikhil M. Varty, and Senior Vice President and Chief Financial Officer, Anthony D. DiLucente, 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.  Varty and DiLucente have concluded that both the design and operation of our disclosure controls and procedures were effective as of March 31, 2018.

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 March 31, 2018 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

On December 16, 2016, the U.S. Virgin Islands Department of Justice filed a civil complaint in the Superior Court of the Virgin Islands related to a fumigation incident in a matter styled Government of the United States Virgin Islands v. The ServiceMaster Company, LLC, The Terminix International Company Limited Partnership, and Terminix International USVI, LLC. The amount and extent of any 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 fumigation matter, which could be material, is not currently known, and any such further penalties, fines, sanctions, costs or damages would not be covered under the Company’s general liability policies.

In addition to the above matter, the EPA has advised the Company that it has investigated potential pesticide misapplications in Hawaii. In March 2018, the Company and the EPA reached an agreement to resolve the investigation and signed a consent agreement and the Company paid a penalty of less than $175,000.

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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 5 to the condensed consolidated financial statement for more details.

ITEM 1A. RISK FACTORS

We discuss in our 2017 Form 10-K and our other filings with the SEC various risks that may materially affect our business.  There have been no material changes to the risk factors disclosed in the 2017 Form 10-K.  The materialization of any risks and uncertainties identified in Forward-Looking Statements contained in this report, together with those previously disclosed in the 2017 Form 10-K 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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ITEM 2.  UNREGISTERED SALES OF REGISTERED SECURITIES AND USE OF PROCEEDS

Issuer Purchases of Equity Securities



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Share Repurchase Program

In 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 the 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 stockholder value. No shares were repurchased during the three months ended March 31, 2018. As of March 31, 2018 we have repurchased 3.9 million outstanding shares at an aggregate cost of $145 million under this program.

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ITEM 6. EXHIBITS



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# Filed herewith. 



 



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SIGNATURE

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

Date: May 2, 2018





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