Table ofContents

 

 

 

**UNITED STATES**

**SECURITIES AND EXCHANGE COMMISSION**

**WASHINGTON, D.C. 20549**

 

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**FORM 10-Q**

 

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**x****      QUARTERLY REPORT PURSUANT TOSECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934**

 

**For the quarterly period ended June 30, 2010**

 

**o****         TRANSITION REPORTPURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF1934**

 

**For the transition period from                   to**

 

**Commission file number 1-14762**

 

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**THE SERVICEMASTER COMPANY**

(Exact name of registrant as specified in its charter)

 

| **Delaware**                                                                                  | ** ** | **36-3858106**                                   |
|-----------------------------------------------------------------------------------------------|------------|--------------------------------------------------|
| (State or other jurisdiction of  incorporation or organization) |       | (IRS Employer Identification No.) |

 

**860 Ridge Lake Boulevard, Memphis, Tennessee 38120**

(Address of principal executive offices) (Zip Code)

 

**901-597-1400**

(Registrant’s telephone number, including area code)

 

Indicateby check mark whether the registrant (1) has filed all reports required tobe filed by Section 13 or 15(d) of the Securities Exchange Act of1934 during the preceding 12 months (or for such shorter period that theregistrant was required to file such reports), and (2) has been subject tosuch filing requirements for the past 90 days.  Yes o No x

 

Indicateby check mark whether the registrant has submitted electronically and posted onits corporate Web site, if any, every Interactive Data File required to besubmitted and posted pursuant to Rule 405 of Regulation S-T during thepreceding 12 months (or for such shorter period that the registrant wasrequired to submit and post such files).   Yes o No o

 

Indicateby check mark whether the registrant is a large accelerated filer, anaccelerated filer, a non-accelerated filer, or a smaller reporting company. Seedefinitions of “large accelerated filer,” “accelerated filer,” and “smallerreporting company” in Rule 12b-2 of the Exchange Act. (Check one):

 

| Large accelerated filer o                     |   | Accelerated filer o         |
|-----------------------------------------------|--------|----------------------------------|
|                                          |   |                             |
| Non-accelerated filer x                       |   | Smaller reporting company o |
| (Do not check if a smaller reporting company) |   |                             |

 

Indicateby check mark whether the registrant is a shell company (as defined inRule 12b-2 of the Act).   Yes o No x

 

Theregistrant is a privately held corporation and its equity shares are notpublicly traded. At August 16, 2010, 1,000 shares of the registrant’scommon stock were outstanding, all of which were owned by CDRSVMHolding, Inc.

 

TheServiceMaster Company is not required to file this Quarterly Report onForm 10-Q with the Securities and Exchange Commission and is doing so on avoluntary basis.

 

 

 

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Table ofContents

 

**TABLE OF CONTENTS**

 
| ** **                                                                                                                          | **Page  No.** |
|-------------------------------------------------------------------------------------------------------------------------------------|---------------|
| Part I.  Financial Information                                                                                                 | 3             |
|                                                                                                                                |          |
| Item 1.  Financial Statements                                                                                                       | 3             |
|                                                                                                                                |          |
| Condensed  Consolidated Statements of Operations for the three months ended  June 30, 2010 and June 30, 2009 (Unaudited)  | 3             |
| *** ***                                                                                                                        | *** ***  |
| Condensed  Consolidated Statements of Operations for the six months ended June 30,  2010 and June 30, 2009 (Unaudited)    | 4             |
| *** ***                                                                                                                        | *** ***  |
| Condensed  Consolidated Statements of Financial Position as of June 30, 2010  (Unaudited) and December 31, 2009 (Audited) | 5             |
| *** ***                                                                                                                        | *** ***  |
| Condensed  Consolidated Statements of Cash Flows for the six months ended June 30,  2010 and June 30, 2009 (Unaudited)    | 6             |
|                                                                                                                                |          |
| Notes to Condensed Consolidated Financial Statements  (Unaudited)                                                                   | 7             |
| *** ***                                                                                                                        | *** ***  |
| Item 2. Management’s Discussion and Analysis of  Financial Condition and Results of Operations                                 | 29            |
| *** ***                                                                                                                        | *** ***  |
| Item 3. Quantitative and Qualitative Disclosures  About Market Risk                                                            | 51            |
| *** ***                                                                                                                        | *** ***  |
| Item 4. Controls and Procedures                                                                                                     | 51            |
| *** ***                                                                                                                        | *** ***  |
| Part II.  Other Information                                                                                                    | 52            |
| ** **                                                                                                                          | ** **    |
| Item  1. Legal Proceedings                                                                                                          | 52            |
| ** **                                                                                                                          |          |
| Item  5. Other Information                                                                                                          | 52            |
| ** **                                                                                                                          |          |
| Item 6.  Exhibits                                                                                                                   | 52            |
|                                                                                                                                |          |
| Signature                                                                                                                           | 53            |

 

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** **

**PART I. FINANCIALINFORMATION**

**ITEM 1. FINANCIAL STATEMENTS**

**THE SERVICEMASTER COMPANY**

**Condensed Consolidated Statementsof Operations (Unaudited)**

*(In thousands)*

 
| ** **                                                                  | ** ** | **Three months ended****June 30,** | ** ** |
|-----------------------------------------------------------------------------|------------|-----------------------------------------|------------|
| ** **                                                                  | ** ** | **2010**                                | ** ** | **2009** | ** ** |
| Operating Revenue                                                      |       | $                                       | 1,003,062  |   | $ | 957,292 |   |
|                                                                        |       |                                    |       |   |   |
| Operating Costs and Expenses:                                |       |                                    |       |   |   |
| Cost of services rendered and products sold   |       | 573,581                                 |       | 553,373 |   |
| Selling and administrative expenses                          |       | 263,463                                 |       | 239,929 |   |
| Amortization expense                                                        |       | 40,451                                  |       | 40,401 |   |
| Goodwill and trade name  impairment                                         |       | 46,884                                  |       | — |   |
| Restructuring and Merger  related charges                                   |       | 4,167                                   |       | 5,584 |   |
| Total operating costs and expenses                      |       | 928,546                                 |       | 839,287 |   |
|                                                                        |       |                                    |       |   |   |
| Operating Income                                                       |       | 74,516                                  |       | 118,005 |   |
|                                                                        |       |                                    |       |   |   |
| Non-operating Expense (Income):                                   |       |                                    |       |   |   |
| Interest expense                                                       |       | 73,169                                  |       | 74,656 |   |
| Interest and net  investment income                               |       | (996                                    | )          | (3,395 | ) |
| Other expense                                                          |       | 176                                     |       | 179 |   |
|                                                                        |       |                                    |       |   |   |
| Income  from Continuing Operations  before Income Taxes |       | 2,167                                   |       | 46,565 |   |
| (Benefit) Provision for income taxes                              |       | (10,482                                 | )          | 24,173 |   |
|                                                                        |       |                                    |       |   |   |
| Income  from Continuing Operations                                |       | 12,649                                  |       | 22,392 |   |
|                                                                        |       |                                    |       |   |   |
| Loss from discontinued  operations, net of income taxes                     |       | (205                                    | )          | (107 | ) |
| Net Income                                                             |       | $                                       | 12,444     |   | $ | 22,285 |   |

 

*See accompanying Notes to the Condensed Consolidated FinancialStatements*

 

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**THE SERVICEMASTER COMPANY**

**Condensed Consolidated Statementsof Operations (Unaudited)**

*(In thousands)*

 
| ** **                                                                         | ** ** | **Six months ended****June 30,** | ** ** |
|------------------------------------------------------------------------------------|------------|---------------------------------------|------------|
| ** **                                                                         | ** ** | **2010**                              | ** ** | **2009** | ** ** |
| Operating Revenue                                                             |       | $                                     | 1,642,470  |   | $ | 1,603,219 |   |
|                                                                               |       |                                  |       |   |   |
| Operating Costs and Expenses:                                       |       |                                  |       |   |   |
| Cost of services rendered and products sold          |       | 976,101                               |       | 947,773 |   |
| Selling and administrative expenses                                 |       | 447,338                               |       | 413,692 |   |
| Amortization expense                                                               |       | 80,893                                |       | 80,710 |   |
| Goodwill and trade name  impairment                                                |       | 46,884                                |       | — |   |
| Restructuring and Merger  related charges                                          |       | 8,091                                 |       | 14,361 |   |
| Total operating costs and expenses                             |       | 1,559,307                             |       | 1,456,536 |   |
|                                                                               |       |                                  |       |   |   |
| Operating Income                                                              |       | 83,163                                |       | 146,683 |   |
|                                                                               |       |                                  |       |   |   |
| Non-operating Expense (Income):                                          |       |                                  |       |   |   |
| Interest expense                                                              |       | 145,850                               |       | 151,322 |   |
| Interest and net  investment (income) loss                               |       | (3,498                                | )          | 1,366 |   |
| Gain on extinguishment of  debt                                                    |       | —                                |       | (46,106 | ) |
| Other expense                                                                 |       | 347                                   |       | 379 |   |
|                                                                               |       |                                  |       |   |   |
| (Loss) Income  from Continuing Operations  before Income Taxes |       | (59,536                               | )          | 39,722 |   |
| (Benefit) Provision  for income taxes                                    |       | (39,902                               | )          | 16,618 |   |
|                                                                               |       |                                  |       |   |   |
| (Loss) Income  from Continuing Operations                                |       | (19,634                               | )          | 23,104 |   |
|                                                                               |       |                                  |       |   |   |
| Loss from discontinued  operations, net of income taxes                            |       | (582                                  | )          | (270 | ) |
| Net (Loss) Income                                                             |       | $                                     | (20,216    | ) | $ | 22,834 |   |

 

*See accompanying Notes to the Condensed Consolidated FinancialStatements*

 

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** **

**THE SERVICEMASTER COMPANY**

**Condensed Consolidated Statementsof Financial Position**

*(In thousands, except share data)*

 
| ** **                                                                   | ** ** | **As of****June 30, 2010** | ** ** | **As of****December 31,  2009** | ** ** |
|------------------------------------------------------------------------------|------------|---------------------------------|------------|--------------------------------------|------------|
| ** **                                                                   | ** ** | **(Unaudited)**                 | ** ** | **(Audited)**                        | ** ** |
| Assets                                                                       |       |                            | ** ** | ** **                           | ** ** |
| Current Assets:                                                              |       |                            |       |                                 |       |
| Cash and cash equivalents                                                    |       | $                               | 289,135    |                                 | $          | 253,463 |   |
| Marketable securities                                                        |       | 21,197                          |       | 21,120                               |       |
| Receivables, less allowance  of $22,534 and $20,314, respectively            |       | 435,093                         |       | 348,655                              |       |
| Inventories                                                                  |       | 83,412                          |       | 76,592                               |       |
| Prepaid expenses and other  assets                                           |       | 106,184                         |       | 36,564                               |       |
| Deferred customer  acquisition costs                                         |       | 61,739                          |       | 36,070                               |       |
| Deferred taxes                                                               |       | 24,370                          |       | 21,595                               |       |
| Assets of discontinued  operations                                           |       | 16                              |       | 42                                   |       |
| Total Current Assets                                                         |       | 1,021,146                       |       | 794,101                              |       |
| Property and Equipment:                                                      |       |                            |       |                                 |       |
| At cost                                                                      |       | 388,424                         |       | 345,100                              |       |
| Less: accumulated  depreciation                                              |       | (164,665                        | )          | (132,965                             | )          |
| Net property and equipment                                                   |       | 223,759                         |       | 212,135                              |       |
|                                                                         |       |                            |       |                                 |       |
| Other Assets:                                                                |       |                            |       |                                 |       |
| Goodwill                                                                     |       | 3,088,340                       |       | 3,119,754                            |       |
| Intangible assets, primarily  trade names, service marks and trademarks, net |       | 2,707,761                       |       | 2,787,237                            |       |
| Notes receivable                                                             |       | 24,839                          |       | 23,490                               |       |
| Long-term marketable  securities                                             |       | 112,017                         |       | 111,066                              |       |
| Other assets                                                                 |       | 29,136                          |       | 31,799                               |       |
| Debt issuance costs                                                          |       | 59,504                          |       | 66,807                               |       |
| Total Assets                                                                 |       | $                               | 7,266,502  |                                 | $          | 7,146,389 |   |
|                                                                         |       |                            |       |                                 |       |
| Liabilities and Shareholder’s Equity                                    |       |                            |       |                                 |       |
| Current Liabilities:                                                         |       |                            |       |                                 |       |
| Accounts payable                                                             |       | $                               | 126,541    |                                 | $          | 73,471 |   |
| Accrued liabilities:                                                         |       |                            |       |                                 |       |
| Payroll and related expenses                                                 |       | 89,843                          |       | 74,385                               |       |
| Self-insured claims and  related expenses                                    |       | 93,922                          |       | 87,332                               |       |
| Other                                                                        |       | 186,077                         |       | 156,649                              |       |
| Deferred revenue                                                             |       | 520,547                         |       | 449,746                              |       |
| Liabilities of discontinued  operations                                      |       | 2,736                           |       | 2,806                                |       |
| Current portion of long-term  debt                                           |       | 62,137                          |       | 64,395                               |       |
| Total Current Liabilities                                                    |       | 1,081,803                       |       | 908,784                              |       |
|                                                                         |       |                            |       |                                 |       |
| Long-Term Debt                                                               |       | 3,907,466                       |       | 3,910,549                            |       |
|                                                                         |       |                            |       |                                 |       |
| Other Long-Term Liabilities:                                                 |       |                            |       |                                 |       |
| Deferred taxes                                                               |       | 933,226                         |       | 957,077                              |       |
| Liabilities of discontinued  operations                                      |       | 4,080                           |       | 4,145                                |       |
| Other long-term obligations                                                  |       | 175,620                         |       | 179,503                              |       |
| Total Other Long-Term  Liabilities                                           |       | 1,112,926                       |       | 1,140,725                            |       |
|                                                                         |       |                            |       |                                 |       |
| Commitments and Contingencies (See Note 4)                                   |       |                            |       |                                 |       |
|                                                                         |       |                            |       |                                 |       |
| Shareholder’s Equity:                                                   |       |                            |       |                                 |       |
| Common stock $0.01 par  value, authorized 1,000 shares; issued 1,000 shares  |       | —                          |       | —                               |       |
| Additional paid-in capital                                                   |       | 1,450,868                       |       | 1,446,529                            |       |
| Retained deficit                                                             |       | (256,640                        | )          | (236,424                             | )          |
| Accumulated other  comprehensive loss                                        |       | (29,921                         | )          | (23,774                              | )          |
| Total Shareholder’s Equity                                              |       | 1,164,307                       |       | 1,186,331                            |       |
| Total Liabilities and  Shareholder’s Equity                             |       | $                               | 7,266,502  |                                 | $          | 7,146,389 |   |

 

*See accompanying Notes to the Condensed Consolidated FinancialStatements*

 

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** **

**THE SERVICEMASTER COMPANY**

**Condensed Consolidated Statementsof Cash Flows (Unaudited)**

*(In thousands)*

 
| ** **                                                                           | ** ** | **Six months ended****June 30,** | ** ** |
|--------------------------------------------------------------------------------------|------------|---------------------------------------|------------|
| ** **                                                                           | ** ** | **2010**                              | ** ** | **2009** | ** ** |
| Cash and Cash Equivalents at  Beginning of Period                                    |       | $                                     | 253,463    |   | $ | 405,587 |   |
|                                                                                 |       |                                  |       |   |   |
| Cash Flows from Operating  Activities from Continuing Operations:                    |       |                                  |       |   |   |
| Net (Loss) Income                                                                    |       | (20,216                               | )          | 22,834 |   |
| Adjustments to reconcile net  income to net cash provided from operating activities: |       |                                  |       |   |   |
| Loss from discontinued  operations                                                   |       | 582                                   |       | 270 |   |
| Depreciation expense                                                                 |       | 33,300                                |       | 32,550 |   |
| Amortization expense                                                                 |       | 80,893                                |       | 80,710 |   |
| Amortization of debt issuance  costs                                                 |       | 7,333                                 |       | 9,263 |   |
| Gain on extinguishment of  debt                                                      |       | —                                |       | (46,106 | ) |
| Deferred income tax  provision                                                       |       | (21,193                               | )          | 11,480 |   |
| Stock-based compensation  expense                                                    |       | 4,339                                 |       | 3,901 |   |
| Goodwill and trade name  impairment                                                  |       | 46,884                                |       | — |   |
| Restructuring and Merger  related charges                                            |       | 8,091                                 |       | 14,361 |   |
| Cash payments related to  restructuring charges                                      |       | (7,939                                | )          | (9,955 | ) |
| Change in working capital,  net of acquisitions:                                     |       |                                  |       |   |   |
| Current income taxes                                                                 |       | (30,064                               | )          | 5,202 |   |
| Receivables                                                                          |       | (88,673                               | )          | (52,050 | ) |
| Inventories and other  current assets                                                |       | (76,831                               | )          | (59,565 | ) |
| Accounts payable                                                                     |       | 50,115                                |       | 22,425 |   |
| Deferred revenue                                                                     |       | 69,462                                |       | 46,003 |   |
| Accrued liabilities                                                                  |       | 44,882                                |       | (17,757 | ) |
| Other, net                                                                           |       | 4,959                                 |       | 7,663 |   |
| Net Cash Provided from  Operating Activities from Continuing Operations              |       | 105,924                               |       | 71,229 |   |
|                                                                                 |       |                                  |       |   |   |
| Cash Flows from Investing  Activities from Continuing Operations:                    |       |                                  |       |   |   |
| Property additions                                                                   |       | (40,385                               | )          | (38,893 | ) |
| Sale of equipment and other  assets                                                  |       | 1,088                                 |       | 1,955 |   |
| Acquisition of The  ServiceMaster Company                                            |       | (2,164                                | )          | (1,119 | ) |
| Other business acquisitions,  net of cash acquired                                   |       | (14,753                               | )          | (7,268 | ) |
| Notes receivable, financial  investments and securities, net                         |       | (898                                  | )          | 3,968 |   |
| Net Cash Used for Investing  Activities from Continuing Operations                   |       | (57,112                               | )          | (41,357 | ) |
|                                                                                 |       |                                  |       |   |   |
| Cash Flows from Financing  Activities from Continuing Operations:                    |       |                                  |       |   |   |
| Borrowings of debt                                                                   |       | 10,000                                |       | — |   |
| Payments of debt                                                                     |       | (22,062                               | )          | (64,807 | ) |
| Debt issuance costs paid                                                             |       | (30                                   | )          | (369 | ) |
| Net Cash Used for Financing Activities from  Continuing Operations                   |       | (12,092                               | )          | (65,176 | ) |
|                                                                                 |       |                                  |       |   |   |
| Cash Flows from Discontinued  Operations:                                            |       |                                  |       |   |   |
| Cash used for operating  activities                                                  |       | (1,048                                | )          | (1,209 | ) |
| Cash used for investing  activities                                                  |       | —                                |       | (914 | ) |
| Net Cash Used for  Discontinued Operations                                           |       | (1,048                                | )          | (2,123 | ) |
|                                                                                 |       |                                  |       |   |   |
| Cash Increase (Decrease)  During the Period                                          |       | 35,672                                |       | (37,427 | ) |
|                                                                                 |       |                                  |       |   |   |
| Cash and Cash Equivalents at  End of Period                                          |       | $                                     | 289,135    |   | $ | 368,160 |   |

 

*See accompanying Notes to the Condensed Consolidated FinancialStatements*

 

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**THE SERVICEMASTER COMPANY**

**NOTESTO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS**

**(UNAUDITED)**

 

**Note 1. Basis of Presentation**

 

The ServiceMaster Company is a national company serving bothresidential and commercial customers. Its products and services include lawncare, landscape maintenance, termite and pest control, home service contracts,cleaning and disaster restoration, house cleaning, furniture repair and home inspection.ServiceMaster provides these services through a network of company-ownedlocations and franchise licenses operating under the following leading brands:TruGreen, TruGreen LandCare, Terminix, American Home Shield, ServiceMasterClean, Merry Maids, Furniture Medic and AmeriSpec. ServiceMaster is organizedinto six principal reportable segments: TruGreen LawnCare, TruGreen LandCare,Terminix, American Home Shield, ServiceMaster Clean and Other Operations andHeadquarters.

 

The condensed consolidated financial statements include the accounts ofThe ServiceMaster Company and its majority owned subsidiary partnerships,limited liability companies and corporations, collectively referred to as “ServiceMaster”,the “Company”, “we”, “us” or “our”.

 

The condensed consolidated financial statements have been prepared bythe Company in accordance with generally accepted accounting principles in theUnited States (“GAAP”) and pursuant to the rules and regulations of theSecurities and Exchange Commission (“SEC”). The Company recommends that thequarterly condensed consolidated financial statements be read in conjunctionwith the consolidated financial statements and the notes thereto included inthe Company’s Annual Report on Form 10-K filed with the SEC for the yearended December 31, 2009. The condensed consolidated financial statementsreflect all adjustments which are, in the opinion of management, necessary forthe fair presentation of the financial position, results of operations and cashflows for the interim periods presented. All intercompany transactions andbalances have been eliminated in consolidation. The results of operations forany interim period are not necessarily indicative of the results which might beachieved for a full year.

 

On March 18, 2007, ServiceMaster entered into an Agreement andPlan of Merger (the “Merger Agreement”) with ServiceMaster GlobalHoldings, Inc. (formerly CDRSVM Topco, Inc.) (“Holdings”) and CDRSVMAcquisition Co., Inc., an indirect wholly owned subsidiary ofHoldings (“Acquisition Co.”). The Merger Agreement provided that, upon theterms and subject to the conditions set forth in the Merger Agreement,Acquisition Co. would merge with and into ServiceMaster, withServiceMaster as the surviving corporation (the “Merger”).

 

On July 24, 2007 (the “Closing Date”), the Merger was completed,and, immediately following the completion of the Merger, all of the outstandingcapital stock of Holdings, the ultimate parent company of ServiceMaster, wasowned by investment funds sponsored by, or affiliated with, Clayton,Dubilier & Rice, Inc. (now operated as Clayton,Dublier & Rice, LLC, “CD&R”), Citigroup Private Equity LP(together with its affiliate, Citigroup Alternative Investments LLC, “Citigroup”),BAS Capital Funding Corporation (“BAS”) and J.P. Morgan Ventures Corporation (“JPMorgan”) (collectively, the “Equity Sponsors”).

 

Equity contributions totaling $1,431.1 million from the EquitySponsors, together with (i) borrowings under a new $1,150.0 million seniorunsecured interim loan facility (“Interim Loan Facility”), (ii) borrowingsunder a new $2,650.0 million senior secured term loan facility and(iii) cash on hand at ServiceMaster, were used, among other things, tofinance the aggregate merger consideration, to make payments in satisfaction ofother equity-based interests in ServiceMaster under the Merger Agreement, tosettle existing interest rate swaps, to redeem or provide for the repayment ofcertain of the Company’s existing indebtedness and to pay related transactionfees and expenses. In addition, letters of credit issued under a new$150.0 million pre-funded letter of credit facility (together with thesenior secured term loan facility, the “Term Facilities”) were used to replaceand/or secure letters of credit previously issued under a ServiceMaster creditfacility that was terminated as of the Closing Date. On the Closing Date, theCompany also entered into, but did not then draw under, a new$500.0 million senior secured revolving credit facility (the “RevolvingCredit Facility”).

 

The Interim Loan Facility matured on July 24, 2008. On thematurity date, outstanding amounts under the Interim Loan Facility wereconverted on a one to one basis into 10.75%/11.50% senior toggle notes maturingin 2015 (the “Permanent Notes”). The Permanent Notes were issued pursuant to arefinancing indenture. In connection with the issuance of the Permanent Notes,ServiceMaster entered into a registration rights agreement (the “RegistrationRights Agreement”), pursuant to which ServiceMaster filed with the Securitiesand Exchange Commission (“SEC”) a registration statement with respect to theresale of the Permanent Notes, which was declared effective on January 16,2009. ServiceMaster deregistered the Permanent Notes in accordance with the termsof the Registration Rights Agreement, and the effectiveness of the registrationstatement was terminated, on November 19, 2009.

 

**Note 2. Significant Accounting Policies**

 

TheCompany’s significant accounting policies are included in the Company’s AnnualReport on Form 10-K for the year ended December 31, 2009. Thefollowing selected accounting policies should be read in conjunction with thatAnnual Report on 

 

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Form 10-K.

 

Revenuesfrom lawn care and pest control services, as well as liquid and fumigationtermite applications, are recognized as the services are provided. Revenuesfrom landscaping services are recognized as they are earned based uponcontractual arrangements or when services are performed for non-contractualarrangements. The Company eradicates termites through the use of baitingsystems, as well as through non-baiting methods (e.g., fumigation or liquidtreatments). Termite services using baiting systems, termite inspection andprotection contracts, as well as home service contracts, are frequently soldthrough annual contracts for a one-time, upfront payment. Direct costs of thesecontracts (service costs for termite contracts and claim costs for home servicecontracts) are expensed as incurred. The Company recognizes revenue over thelife of these contracts in proportion to the expected direct costs. Those costsbear a direct relationship to the fulfillment of the Company’s obligationsunder the contracts and are representative of the relative value provided tothe customer (proportional performance method). The Company regularly reviewsits estimates of direct costs for its termite bait and home service contractsand adjusts the estimates when appropriate. Revenue from trade name licensingarrangements is recognized when earned.

 

TheCompany has franchise agreements in its TruGreen LawnCare, Terminix,ServiceMaster Clean, AmeriSpec, Furniture Medic and Merry Maids businesses.Franchise revenue (which in the aggregate represents approximately four percentof consolidated revenue from continuing operations) consists principally ofcontinuing monthly fees based upon the franchisee’s customer level revenue.Monthly fee revenue is recognized when the related customer level revenue isreported by the franchisee and collectability is reasonably assured. Franchiserevenue also includes initial fees resulting from the sale of a franchise.These fees are fixed and are recognized as revenue when collectability isreasonably assured and all material services or conditions relating to the salehave been substantially performed. Total profits from the franchised operations(excluding trade name licensing) were $16.3 million**and$31.6 million for the three and six months ended June 30, 2010,respectively, and $13.8 million and $29.6 million for the three and six monthsended June 30, 2009, respectively. Consolidated operating income fromcontinuing operations was $74.5 million and $83.2 million for the three and sixmonths ended June 30, 2010, respectively, and $118.0 million and $146.7million for the three and six months ended June 30, 2009, respectively.The Company evaluates the performance of its franchise businesses basedprimarily on operating profit before corporate general and administrativeexpenses, interest expense and amortization of intangible assets. The portionof total franchise fee income related to initial fees received from the sale offranchises was immaterial to the Company’s condensed consolidated financialstatements for all periods.

 

TheCompany had $520.5 million and $449.7 million of deferred revenue at June 30,2010 and December 31, 2009, respectively. Deferred revenue consistsprimarily of payments received for annual contracts relating to home servicecontracts, termite baiting, termite inspection, pest control and lawn careservices.

 

Customeracquisition costs, which are incremental and direct costs of obtaining acustomer, are deferred and amortized over the life of the related contract inproportion to revenue recognized. These costs include sales commissions anddirect selling costs which can be shown to have resulted in a successful sale.

 

TruGreenLawnCare has significant seasonality in its business. In the winter and spring,this business sells a series of lawn applications to customers which arerendered primarily in March through October (the production season).This business incurs incremental selling expenses at the beginning of the yearthat directly relate to successful sales for which the revenues are recognizedin later quarters. On an interim basis, TruGreen LawnCare defers theseincremental selling expenses, pre-season advertising costs and annual repairsand maintenance procedures that are performed primarily in the first quarter.These costs are deferred and recognized in proportion to the contract revenueover the production season and are not deferred beyond the calendar year-end.Other business segments of the Company also defer, on an interim basis,advertising costs incurred early in the year. These pre-season costs aredeferred and recognized approximately in proportion to revenue over the balanceof the year and are not deferred beyond the fiscal year-end.

 

Thecost of direct-response advertising at Terminix and TruGreen LawnCare,consisting primarily of direct-mail promotions, is capitalized and amortizedover its expected period of future benefits.

 

Thepreparation of the condensed consolidated financial statements requiresmanagement to make certain estimates and assumptions required under GAAP whichmay differ from actual results. Disclosures in the Company’s Annual Report onForm 10-K for the year ended December 31, 2009 presented thesignificant areas that require the use of management’s estimates and discussedhow management formed its judgments. The areas discussed included revenuerecognition; the allowance for uncollectible receivables; accruals forself-insured retention limits related to medical, workers’ compensation, autoand general liability insurance claims; accruals for home service contracts andtermite damage claims; the possible outcome of outstanding litigation; accrualsfor income tax liabilities, as well as deferred tax accounts; the deferral andamortization of customer acquisition costs; useful lives for depreciation andamortization expense; the valuation of marketable securities; and the valuationof tangible and intangible assets.

 

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**Note 3.Restructuring and Merger Related Charges**

 

TheCompany incurred restructuring and Merger related charges of $4.2 million ($2.6million, net of tax) and $8.1 million ($5.0 million, net of tax) for the threeand six months ended June 30, 2010, respectively, and $5.6 million ($3.4million, net of tax) and $14.4 million ($8.8 million, net of tax) for the threeand six months ended June 30, 2009, respectively. Restructuring and Mergerrelated charges were comprised of the following:

 
| ** **                                             | ** ** | **Three months ended****June 30,** | ** ** | **Six months ended****June 30,** | ** ** |
|--------------------------------------------------------|------------|----------------------------------------------|------------|---------------------------------------|------------|
| **(In thousands)**                                | ** ** | **2010**                                     | ** ** | **2009**                              | ** ** | **2010** | ** ** | **2009** | ** ** |
| TruGreen LawnCare  reorganization and restructuring(1) |       | $                                            | 2,939      |                                  | $          | — |   | $ | 5,962 |   | $ | — |   |
| Information technology  outsourcing(2)                 |       | —                                       |       | 4,187                                 |       | — |   | 9,461 |   |
| Terminix branch  optimization(3)                       |       | —                                       |       | —                                |       | — |   | 3,219 |   |
| Merger related charges(4)                              |       | 1,005                                        |       | 1,154                                 |       | 1,136 |   | 1,448 |   |
| Other                                                  |       | 223                                          |       | 243                                   |       | 993 |   | 233 |   |
| Total restructuring and  Merger related charges        |       | $                                            | 4,167      |                                  | $          | 5,584 |   | $ | 8,091 |   | $ | 14,361 |   |

 

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(1)                                  Representsrestructuring charges related to a reorganization of field leadership and arestructuring of branch operations. For the three months ended June 30,2010, these costs included consulting fees of $1.9 million and severance, leasetermination and other costs of $1.0 million. For the six months ended June 30,2010, these costs included consulting fees of $3.8 million and severance, leasetermination and other costs of $2.2 million.

 

(2)                                  OnDecember 11, 2008, the Company entered into an agreement withInternational Business Machines Corporation (“IBM”) pursuant to which IBMprovides information technology operations and applications developmentservices to the Company. These services were phased in during the first half of2009. For the three months ended June 30, 2009, these costs includedtransition fees paid to IBM of $3.4 million, employee retention and severancecosts of $0.4 million and consulting and other costs of $0.4 million. For thesix months ended June 30, 2009, these costs included transition fees paidto IBM of $7.2 million, employee retention and severance costs of $1.3 millionand consulting and other costs of $1.0 million.

 

(3)                                  Representsrestructuring charges (credits) related to a branch optimization project. Forthe six months ended June 30, 2009, these costs included lease terminationcosts of $2.8 million and severance costs of $0.4 million.

 

(4)                                  Includesseverance, retention, legal fees and other costs associated with the Merger.

 

Thepretax charges discussed above are reported in the “Restructuring and Mergerrelated charges” line in the condensed consolidated statement of operations.

 

A reconciliation of the beginning and ending balances of accruedrestructuring and Merger related charges is presented as follows:

 
| **(In thousands)**           | ** ** | **Accrued Restructuring********and Merger Related********Charges** | ** ** |
|-----------------------------------|------------|-----------------------------------------------------------------------------------|------------|
| Balance at December 31, 2009 |       | $                                                                                 | 12,083     |   |
| Costs incurred                    |       | 8,091                                                                             |       |
| Costs paid or otherwise settled   |       | (14,700                                                                           | )          |
| Balance at June 30, 2010     |       | $                                                                                 | 5,474      |   |

 

**Note 4. Commitments and Contingencies**

 

Aportion of the Company’s vehicle fleet and some equipment are leased throughoperating leases. The lease terms are non-cancelable for the first twelve-monthterm, and then are month-to-month, cancelable at the Company’s option. Thereare residual value guarantees by the Company (ranging from 70 percent to84 percent of the estimated terminal value at the inception of the leasedepending on the agreement) relative to these vehicles and equipment, whichhistorically have not resulted in significant net payments to the lessors. Thefair value of the assets under all of the fleet and equipment leases isexpected to substantially mitigate the Company’s guarantee obligations underthe agreements. At June 30, 2010, the Company’s residual value guaranteesrelated to the leased assets totaled $65.1 million for which the Company hasrecorded a liability for the estimated fair value of these guarantees ofapproximately $1.4 million in the condensed consolidated statement of financialposition.

 

TheCompany maintained lease facilities with banks totaling $65.2 million,which provided for the financing of branch properties to be leased by theCompany. At June 30, 2010, approximately $65.2 million was fundedunder these facilities, including $12.5 million of leases that were accountedfor as capital leases and were included on the condensed consolidated statementof financial position as assets with related debt. The balance of the fundedamount was accounted for as operating leases. In connection 

 

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withthe closing of the Merger, the Company amended these leases effectiveJuly 24, 2007. Among the modifications, the Company extended the leaseterms through July 24, 2010 and made a $22.0 million investment in thelease facilities. This $22.0 million investment was included in other assets inthe condensed consolidated statement of financial position. The operating leaseand capital lease classifications of these leases did not change as a result ofthe modifications. In July 2010, the Company purchased the properties for$65.2 million. The Company’s $22.0 million investment in the lease facilitieswas returned to the Company upon purchase, resulting in a net cash payment of$43.2 million.

 

Inthe third quarter of 2009, the Company determined that it was probable that thefair value of the real properties under operating leases would be below thetotal amount funded under the lease facilities at the end of the lease term.The Company’s estimate of this shortfall was $15.9 million, which was expensedover the remainder of the lease term. The Company recorded charges of $5.5million in 2009 and $3.9 million and $9.1 million in the three and six months endedJune 30, 2010, respectively, related to this shortfall. The remaining $1.3million was recorded in July 2010.

 

TheCompany carries insurance policies on insurable risks at levels that itbelieves to be appropriate, including workers’ compensation, auto and generalliability risks. The Company purchases insurance policies from third partyinsurance carriers, which typically incorporate significant deductibles orself-insured retentions. The Company is responsible for all claims that fall belowthe retention limits. As of June 30, 2010 and December 31, 2009, theCompany had accrued self-insured claims of $129.3 million and $131.3 million,respectively, which are included in Accrued Liabilities — self-insured claimsand related expenses and other long-term obligations on the condensedconsolidated statements of financial position. During the six months ended June 30,2010 and 2009, the Company recorded provisions for uninsured claims totaling$18.7 million and $18.3 million, respectively, and the Company paid claimstotaling $20.7 million and $21.7 million, respectively. In determining theCompany’s accrual for self-insured claims, the Company uses historical claimsexperience to establish both the current year accrual and the underlyingprovision for future losses. This actuarially determined provision and relatedaccrual includes known claims, as well as incurred but not reported claims. TheCompany adjusts its estimate of accrued self-insured claims when required toreflect changes based on factors such as changes in health care costs, accidentfrequency and claim severity.

 

Accrualsfor home service contract claims in the American Home Shield business are madebased on the Company’s claims experience and actuarial projections. Termitedamage claim accruals are recorded based on both the historical rates of claimsincurred within a contract year and the cost per claim. Current activity coulddiffer causing a change in estimates. The Company has certain liabilities withrespect to existing or potential claims, lawsuits and other proceedings. TheCompany accrues for these liabilities when it is probable that future costswill be incurred and such costs can be reasonably estimated. Any resultingadjustments, which could be material, are recorded in the period theadjustments are identified.

 

Aspart of the American Residential Services and American Mechanical Services saleagreements in 2006, the Company continues to be obligated to third parties withrespect to operating leases for which the Company has been released as beingthe primary obligor, as well as certain real estate leased and operated by thebuyers. The Company’s obligations under these agreements may be limited interms of time and or amount, and in some cases, the Company may have recourseagainst the buyers for potential future payments made by the Company. At thepresent time, the Company does not believe it is probable that the buyers willdefault on their obligations subject to guarantee. The fair value of theCompany’s obligations related to these guarantees is not significant and noliability has been recorded.

 

Inthe ordinary course of conducting business activities, the Company and itssubsidiaries become involved in judicial, administrative and regulatoryproceedings involving both private parties and governmental authorities. Theseproceedings include, on an individual, collective and class action basis,regulatory, insured and uninsured employment, general, and commercial liabilityactions and environmental proceedings. Additionally, the Company has enteredinto settlement agreements in certain cases, including putative class actions,which are subject to court approval. If one or more of these settlements arenot finally approved, the Company could have additional or different exposure.The enactment of new federal or state legislation or the promulgation of newregulation or interpretation at any level of government may also expose theCompany to potential new liabilities or costs, or may require the Company tomodify its business model or business practices. At this time, the Company doesnot expect any of these proceedings or changes in law to have a material effecton its financial position, results of operations or cash flows; however, theCompany can give no assurance that the results of any such proceedings may notbe material to its financial position, results of operations and cash flows forany period in which costs, if any, are recognized.

 

**Note 5.Goodwill and Intangible Assets**

 

In accordance with applicable accounting standards,goodwill and intangible assets that are not amortized are subject to assessmentfor impairment by applying a fair-value based test on an annual basis or morefrequently if circumstances indicate a potential impairment. The Company’sannual assessment date is October 1. The results for the three and sixmonths ended June 30, 2010 include a non-cash impairment charge of $46.9million to reduce the carrying value of goodwill and trade names as a result ofthe Company’s interim impairment testing of goodwill and indefinite-livedintangible assets.

 

Based on the results of operations at TruGreen LandCare in the firstsix months of 2010 and the revised outlook for the

 

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remainderof 2010, the Company has concluded there was an impairment indicator requiringthe performance of an interim goodwill impairment test for the TruGreenLandCare reporting unit as of June 30, 2010. The first step of thegoodwill impairment test involves a comparison of the estimated fair value ofthe reporting unit to its carrying amount, including goodwill. In performingthe first step, the Company determined the fair value of the TruGreen LandCarereporting unit using a combination of a discounted cash flow analysis, amarket-based comparable approach and a market-based transaction approach. Basedon the results of the step one analysis, the Company determined that thecarrying value of the TruGreen LandCare reporting unit exceeded its fair value,indicating that goodwill was potentially impaired. As a result, the Companycompleted the second step of the goodwill impairment test which involvescalculating the implied fair value of the reporting unit’s goodwill byallocating the fair value of the reporting unit to all assets and liabilitiesother than goodwill and comparing it to the carrying amount of goodwill. TheCompany determined that the implied fair value of goodwill was less that the carryingvalue for TruGreen LandCare by $43.0 million, which was recorded as a goodwillimpairment charge in the second quarter of 2010. As of June 30, 2010,there was no remaining goodwill at TruGreen LandCare.

 

As a result of the aforementioned goodwill impairment indicators and inaccordance with applicable accounting standards, the Company performed animpairment analysis on its indefinite lived intangible asset related toTruGreen LandCare’s trade name to determine the fair value as of June 30,2010. Based on the lower projected cash flows for TruGreen LandCare asdiscussed above, the Company determined the fair value attributable to theindefinite lived intangible asset was less than the carrying value for TruGreenLandCare by $3.9 million, which was recorded as a trade name impairment in thesecond quarter of 2010.

 

The Company determined that there were no impairment indicators for thegoodwill or other indefinite lived intangible assets of any reporting unitsother than TruGreen LandCare as of June 30, 2010.

 

The table below summarizes the goodwill balances by segment forcontinuing operations:

 
| **(In thousands)**       | ** ** | **TruGreen  LawnCare** | ** ** | **TruGreen  LandCare** | ** ** | **Terminix** | ** ** | **American  Home  Shield** | ** ** | **ServiceMaster  Clean** | ** ** | **Other  Operations &  Headquarters** | ** ** | **Total** | ** ** |
|-------------------------------|------------|------------------------|------------|------------------------|------------|--------------|------------|----------------------------|------------|--------------------------|------------|------------------------------------------------|------------|-----------|------------|
| Balance at Dec. 31, 2009 |       | $                      | 1,178,436  |                   | $          | 43,901       |       | $                          | 1,361,698  |                     | $          | 348,010                                        |       | $         | 135,713    |   | $ | 51,996 |   | $ | 3,119,754 |   |
| Impairment charge             |       | —                 |       | (42,984                | )          | —       |       | —                     |       | —                   |       | —                                         |       | (42,984   | )          |
| Acquisitions                  |       | 4,430                  |       | —                 |       | 8,419        |       | —                     |       | —                   |       | 504                                            |       | 13,353    |       |
| Other(1)                      |       | (298                   | )          | (917                   | )          | (324         | )          | (123                       | )          | (74                      | )          | (47                                            | )          | (1,783    | )          |
| Balance at Jun. 30, 2010 |       | $                      | 1,182,568  |                   | $          | —       |       | $                          | 1,369,793  |                     | $          | 347,887                                        |       | $         | 135,639    |   | $ | 52,453 |   | $ | 3,088,340 |   |

 

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(1)                                 Reflects theimpact of the amortization of tax deductible goodwill and foreign exchange ratechanges.

 

The accumulated impairment losses as of June 30, 2010 were $43.0million associated with our TruGreen LandCare segment. There were noaccumulated impairment losses as of December 31, 2009.

 

The table below summarizes the other intangible asset balances forcontinuing operations:

 
| ** **             | ** ** | **As of********June 30, 2010** | ** ** | **As of********December 31, 2009** | ** ** |
|------------------------|------------|-------------------------------------|------------|-----------------------------------------|------------|
| **(In thousands)**     | ** ** | **Gross**                           | ** ** | **Accumulated  Amortization**           | ** ** | **Net** | ** ** | **Gross** | ** ** | **Accumulated  Amortization** | ** ** | **Net** | ** ** |
| Trade names(1)         |       | $                                   | 2,376,200  |                                    | $          | — |   | $ | 2,376,200 |   | $ | 2,380,100 |   | $ | — |   | $ | 2,380,100 |   |
| Customer relationships |       | 674,898                             |       | (425,086                                | )          | 249,812 |   | 669,581 |   | (352,605 | ) | 316,976 |   |
| Franchise agreements   |       | 88,000                              |       | (30,845                                 | )          | 57,155 |   | 88,000 |   | (26,418 | ) | 61,582 |   |
| Other                  |       | 49,630                              |       | (25,036                                 | )          | 24,594 |   | 49,630 |   | (21,051 | ) | 28,579 |   |
| Total                  |       | $                                   | 3,188,728  |                                    | $          | (480,967 | ) | $ | 2,707,761 |   | $ | 3,187,311 |   | $ | (400,074 | ) | $ | 2,787,237 |   |

 

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(1)                                 Not subject toamortization.

 

**Note 6.Stock-Based Compensation**

 

Forthe three and six months ended June 30, 2010, the Company recognizedstock-based compensation expense of $2.2 million ($1.3 million, net of tax) and$4.3 million ($2.6 million, net of tax), respectively. For the three and sixmonths ended June 30, 2009, the Company recognized stock-basedcompensation expense of $2.0 million ($1.2 million, net of tax) and $3.9million ($2.3 million, net of tax), respectively. As of June 30, 2010, therewas $15.5 million of total unrecognized compensation cost related to non-vestedstock options granted by Holdings under the ServiceMaster GlobalHoldings, Inc. Stock Incentive Plan. These remaining costs are expected tobe recognized over a weighted-average period of 2.0 years.

 

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**Note 7. Supplemental Cash Flow Information**

 

Supplemental information relating to the condensed consolidatedstatement of cash flows for the six months ended June 30, 2010 and 2009 ispresented in the following table:

 
| ** **                                                 | ** ** | **Six months ended****June 30,** | ** ** |
|------------------------------------------------------------|------------|--------------------------------------------|------------|
| **(In thousands)**                                    | ** ** | **2010**                                   | ** ** | **2009** | ** ** |
| Cash paid for or (received from): |       |                                       |       |   |   |
| Interest expense                                           |       | $                                          | 136,540    |   | $ | 162,652 |   |
| Interest and dividend income                               |       | (2,790                                     | )          | (3,626 | ) |
| Income taxes, net of refunds                               |       | 10,127                                     |       | 195 |   |
|                                                            |            |                                            |            |  |  |  |  |

 

**Note 8. Comprehensive Income**

 

Total comprehensive income (loss) was $5.5 million and ($26.4) millionfor the three and six months ended June 30, 2010 and $41.7 million and$41.7 million for the three and six months ended June 30, 2009,respectively. Total comprehensive income primarily includes net income (loss),unrealized gain (loss) on marketable securities, unrealized gain (loss) onderivative instruments and the effect of foreign currency translation.

 

**Note 9.Receivable Sales**

 

The Company has entered into an accounts receivable securitizationarrangement under which TruGreen LawnCare and Terminix may sell certaineligible trade accounts receivable to ServiceMaster Funding Company LLC (“Funding”),the Company’s wholly owned, bankruptcy-remote subsidiary, which is consolidatedfor financial reporting purposes. Funding, in turn, may transfer, on arevolving basis, an undivided percentage ownership interest of up to$50.0 million in the pool of accounts receivable to one or both of theunrelated purchasers who are parties to the accounts receivable securitizationarrangement (“Purchasers”). The amount of the eligible receivables variesduring the year based on seasonality of the businesses and could, at times,limit the amount available to the Company from the sale of these interests.

 

During the six months ended June 30, 2010, there were no transfersof interests in the pool of trade accounts receivables to Purchasers under thisarrangement. As of June 30, 2010 and December 31, 2009, the Companyhad $10.0 million outstanding under the arrangement and, as of June 30,2010, had $40.0 million of remaining capacity available under the tradeaccounts receivable securitization arrangement.

 

Theaccounts receivable securitization arrangement is a 364-day facility that isrenewable annually at the option of Funding, with a final termination date ofJuly 17, 2012. Only one of the Purchasers is required to purchaseinterests under the arrangement. If this Purchaser were to exercise its rightto terminate its participation in the arrangement, which it may do in the thirdquarter of each year, the amount of cash available to the Company under thisagreement may be reduced or eliminated. As part of the annual renewal of thefacility, which last occurred on July 20, 2010, this Purchaser agreed tocontinue its participation in the arrangement at least throughJuly 19, 2011.

 

TheCompany has recorded its obligation to repay the third party for its interestin the pool of receivables as long-term debt in the condensed consolidatedfinancial statements. The interest rates applicable to the Company’s obligationare based on a fluctuating rate of interest based on the third party Purchaser’spooled commercial paper rate (0.42% at June 30, 2010). In addition, theCompany pays usage fees on its obligations and commitment fees on undrawnamounts committed by the Purchasers. All obligations under the accountsreceivable securitization arrangement must be repaid by July 17, 2012, thefinal termination date of the arrangement.

 

**Note10. Cash and Marketable Securities**

 

Cash,money market funds and certificates of deposits, with maturities of threemonths or less when purchased, are included in the condensed consolidatedstatement of financial position caption “Cash and cash equivalents”. As of June 30,2010 and December 31, 2009, the Company’s investments consist primarily ofdomestic publicly traded debt and certificates of deposit totaling$98.3 million and $93.9 million, respectively, and common equity securitiesof $34.9 million and $38.3 million, respectively.

 

Theaggregate market value of the Company’s short-term and long-term investments indebt and equity securities was $133.2 million and $132.2 million, andthe aggregate cost basis was $128.2 million and $126.7 million at June 30,2010 and December 31, 2009, respectively.

 

Gainsand losses on sales of investments, as determined on a specific identificationbasis, are included in investment income 

 

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inthe period they are realized. The Company periodically reviews its portfolio ofinvestments to determine whether there has been an other than temporary declinein the value of the investments from factors such as deterioration in thefinancial condition of the issuer or the market(s) in which the issuercompetes. The Company recorded gross realized gains resulting from sales ofavailable-for-sale securities of $0.6 million ($0.4 million, net of tax) and$1.1 million ($0.7 million, net of tax) for the three and six months ended June 30,2010, respectively, and $1.0 million ($0.6 million, net of tax) and $1.6million ($1.0 million, net of tax) for the three and six months ended June 30,2009, respectively. The Company recorded gross realized losses resulting fromsales of available-for-sale securities of $0.1 million ($0.1 million, net oftax) and $0.1 million ($0.1 million, net of tax) for the three and six monthsended June 30, 2010, respectively, and $0.2 million ($0.1 million, net oftax) and $1.4 million ($0.9 million, net of tax) for the three and six monthsended June 30, 2009, respectively. The Company recorded impairment chargesof $0.5 million ($0.3 million, net of tax) and $5.9 million ($3.7 million, netof tax) for the three and six months ended June 30, 2009, respectively,due to other than temporary declines in the value of certain investments. TheCompany had no such impairments for the three and six months ended June 30,2010. Unrealized gains in the investment portfolio were $7.8 million and$7.7 million as of June 30, 2010 and December 31, 2009,respectively. Unrealized losses were $2.8 million and $2.2 million asof June 30, 2010 and December 31, 2009, respectively. The portion ofunrealized losses which had been in a loss position for more than one year at June 30,2010 and December 31, 2009 was approximately $0.5 million and $0.7million, respectively. The aggregate fair value of the investments withunrealized losses totaled $13.4 million and $26.8 million at June 30,2010 and December 31, 2009, respectively.

 

**Note11. Long-Term Debt**

 

Long-termdebt at June 30, 2010 and December 31, 2009 is summarized in thefollowing table:

 
| **(In thousands)**                              | ** ** | **As of  June 30,  2010** | ** ** | **As of  December 31,  2009** | ** ** |
|------------------------------------------------------|------------|--------------------------------|------------|------------------------------------|------------|
| Senior secured term loan facility maturing in 2014   |       | $                              | 2,570,500  |                               | $          | 2,583,750 |   |
| 10.75% /11.50% senior toggle notes maturing in  2015 |       | 1,061,000                      |       | 1,061,000                          |       |
| Revolving credit facility maturing in 2013           |       | —                         |       | —                             |       |
| 7.10% notes maturing in 2018(1)                      |       | 64,587                         |       | 63,624                             |       |
| 7.45% notes maturing in 2027(1)                      |       | 149,220                        |       | 147,885                            |       |
| 7.25% notes maturing in 2038(1)                      |       | 60,228                         |       | 59,824                             |       |
| Other                                                |       | 64,068                         |       | 58,861                             |       |
| Less current portion                                 |       | (62,137                        | )          | (64,395                            | )          |
| Total long-term debt                                 |       | $                              | 3,907,466  |                               | $          | 3,910,549 |   |

 

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(1)          The increase in the balancefrom December 31, 2009 to June 30, 2010 reflects the amortization offair value adjustments related to purchase accounting, which effectivelyincreases the stated coupon interest rates.

 

TheCompany had $70.1 million and $70.2 million of accrued interest at June 30,2010 and December 31, 2009, respectively. Accrued interest is included inAccrued Liabilities — Other on the condensed consolidated statements offinancial position.

 

In June 2010, the Companyentered into two, two-year interest rate swap agreements effective March 3,2011. The total notional amount of the agreements was $250.0 million. Under theterms of the agreements, the Company will pay a weighted average fixed rate ofinterest of 1.70% on the $250.0 million notional amount and the Company willreceive a floating rate of interest (based on the one month LIBOR) on thenotional amount. Therefore, during the term of the swap agreements, theeffective interest rate for $250.0 million of the term loans will be fixed at arate of 1.70% plus the incremental borrowing margin described in Note 14 in theCompany’s Annual Report on Form 10-K for the year ended December 31, 2009. 

 

In June 2010, the Companyentered into two, two-year interest rate swap agreements effective September 1,2011. The total notional amount of the agreements was $200.0 million. Under theterms of the agreements, the Company will pay a weighted average fixed rate ofinterest of 2.22% on the $200.0 million notional amount and the Company will receivea floating rate of interest (based on the one month LIBOR) on the notionalamount. Therefore, during the term of the swap agreements, the effectiveinterest rate for $200.0 million of the term loans will be fixed at a rate of2.22% plus the incremental borrowing margin described in Note 14 in theCompany’s Annual Report on Form 10-K for the year ended December 31, 2009. 

 

In accordance withaccounting standards for derivative instruments and hedging activities, theseinterest rate swap agreements are classified as cash flow hedges and, as such,the hedging instruments are recorded on the balance sheet as either an asset orliability at fair value, with the effective portion of the changes in fairvalue attributable to the hedged risks recorded in other comprehensive income.

 

**Note12. Discontinued Operations**

 

Reported“loss from discontinued operations, net of income taxes” for all periodspresented includes the operating results of the sold businesses noted in theCompany’s Annual Report on Form 10-K for the year ended December 31,2009. The operating results and financial position of discontinued operationsare as follows:

 
| ** **                                              | ** ** | **Three months ended  June 30,** | ** ** | **Six months ended  June 30,** | ** ** |
|---------------------------------------------------------|------------|---------------------------------------|------------|-------------------------------------|------------|
| **(In thousands)**                                 | ** ** | **2010**                              | ** ** | **2009**                            | ** ** | **2010** | ** ** | **2009** | ** ** |
| Operating Results:                                      |       |                                  |       |                                |       |   |   |   |   |
| Operating revenue                                       |       | $                                     | —     |                                | $          | 56 |   | $ | — |   | $ | 56 |   |
| Operating loss                                          |       | (326                                  | )          | (177                                | )          | (944 | ) | (441 | ) |
| Loss from discontinued operations, before income  taxes |       | (326                                  | )          | (177                                | )          | (944 | ) | (441 | ) |
| Benefit from income taxes                               |       | (121                                  | )          | (70                                 | )          | (362 | ) | (171 | ) |
| Loss from discontinued operations, net of income  taxes |       | $                                     | (205       | )                                   | $          | (107 | ) | $ | (582 | ) | $ | (270 | ) |

 

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| **(In  thousands)**   | ** ** | **As of  June 30, 2010** | ** ** | **As of  December 31,  2009** | ** ** |
|-----------------------|------------|-------------------------------|------------|------------------------------------|------------|
| Financial Position:   |       |                          |       |                               |       |
| Current assets        |       | $                             | 16         |                               | $          | 42 |   |
| Total assets          |       | $                             | 16         |                               | $          | 42 |   |
| Current liabilities   |       | $                             | 2,736      |                               | $          | 2,806 |   |
| Long-term liabilities |       | 4,080                         |       | 4,145                              |       |
| Total liabilities     |       | $                             | 6,816      |                               | $          | 6,951 |   |

 

Thetable below summarizes the activity for the six months ended June 30, 2010for the remaining liabilities from operations that were disposed of in yearsprior to 2010. The remaining obligations primarily relate to long-termself-insurance claims. The Company believes that the remaining reservescontinue to be adequate and reasonable.

 
| **(In  thousands)**                               | ** ** | **As of  December 31,  2009** | ** ** | **Cash Payments  or Other** | ** ** | **Expense** | ** ** | **As of  June 30, 2010** | ** ** |
|---------------------------------------------------|------------|------------------------------------|------------|---------------------------------------|------------|-------------|------------|-------------------------------|------------|
| Remaining liabilities of discontinued operations: |       |                               |       |                                  |       |        |       |                          |       |
| ARS/AMS                                           |       | $                                  | 2,921      |                                  | $          | (485        | )          | $                             | 658        |   | $ | 3,094 |   |
| LandCare Construction                             |       | 722                                |       | (65                                   | )          | 8           |       | 665                           |       |
| LandCare utility line clearing business           |       | 911                                |       | (75                                   | )          | —      |       | 836                           |       |
| Certified Systems, Inc. and other            |       | 2,149                              |       | (167                                  | )          | —      |       | 1,982                         |       |
| InStar                                            |       | 248                                |       | (38                                   | )          | 29          |       | 239                           |       |
| Total liabilities of discontinued operations      |       | $                                  | 6,951      |                                  | $          | (830        | )          | $                             | 695        |   | $ | 6,816 |   |

 

**Note13. Income Taxes**

 

AtJune 30, 2010 and December 31, 2009, the Company had $15.6 million oftax benefits primarily reflected in state tax returns that had not beenrecognized for financial reporting purposes (“unrecognized tax benefits”). TheCompany currently estimates that, as a result of pending tax settlements andexpiration of statutes of limitations, the amount of unrecognized tax benefitscould be reduced by approximately $9.8 million during the next 12 months.

 

**Note14. Business Segment Reporting**

 

Thebusiness of the Company is conducted through six reportablesegments: TruGreen LawnCare, TruGreen LandCare, Terminix, American HomeShield, ServiceMaster Clean and Other Operations and Headquarters.

 

Inaccordance with accounting standards for segments, the Company’s reportablesegments are strategic business units that offer different services. TheTruGreen LawnCare segment provides residential and commercial lawn careservices. The TruGreen LandCare segment provides landscaping services primarilyto commercial customers. The Terminix segment provides termite and pest controlservices to residential and commercial customers. The American Home Shieldsegment provides home service contracts to consumers that cover heating,ventilation, air conditioning, plumbing and other home systems and appliances.The ServiceMaster Clean segment provides residential and commercial disasterrestoration and cleaning services primarily under the ServiceMaster andServiceMaster Clean brand names, on-site furniture repair and restorationservices primarily under the Furniture Medic brand name and home inspectionservices primarily under the AmeriSpec brand name. The Other Operations andHeadquarters segment includes the franchised and Company-owned operations of MerryMaids, which provides house cleaning services. The Other Operations andHeadquarters segment also includes The ServiceMaster Acceptance Company LimitedPartnership (“SMAC”), our financing subsidiary exclusively dedicated toproviding financing to our franchisees and retail customers of our operatingunits, and the Company’s headquarters operations, which provide varioustechnology, marketing, finance, legal and other support services to thebusiness units.

 

Inthe second quarter of 2010, the Company revised its methodology for theallocation of general corporate overhead expenses to each reportable segment. Theportion of general corporate support services previously allocated to eachreportable segment are now reflected in the Other Operations and Headquarterssegment. Under the revised method, allocations are limited to corporate supportservices incurred directly on behalf of each reportable segment. The operatingincome presented below for each reportable segment has been revised to reflectthe new allocation methodology for all periods presented. The revision to theallocation methodology had no impact on reported operating revenue for eachreportable segment or total operating income.

 

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Segmentinformation for continuing operations is presented below.

 
| ** **                          | ** ** | **Three months ended** | ** ** | **Six months ended** | ** ** |
|-------------------------------------|------------|------------------------|------------|----------------------|------------|
| ** **                          | ** ** | **June 30,**      | ** ** | **June 30,**    | ** ** |
| **(In thousands)**             | ** ** | **2010**               | ** ** | **2009**             | ** ** | **2010** | ** ** | **2009** | ** ** |
| Operating Revenue:                  |       |                   |       |                 |       |   |   |   |   |
| TruGreen LawnCare                   |       | $                      | 378,642    |                 | $          | 348,403 |   | $ | 502,724 |   | $ | 483,069 |   |
| TruGreen LandCare                   |       | 63,463                 |       | 69,433               |       | 122,263 |   | 136,318 |   |
| Terminix                            |       | 323,393                |       | 307,375              |       | 594,310 |   | 570,536 |   |
| American Home Shield                |       | 183,792                |       | 179,823              |       | 316,997 |   | 310,691 |   |
| ServiceMaster Clean                 |       | 32,034                 |       | 30,581               |       | 64,296 |   | 60,737 |   |
| Other Operations and Headquarters   |       | 21,738                 |       | 21,677               |       | 41,880 |   | 41,868 |   |
| Total Operating Revenue             |       | $                      | 1,003,062  |                 | $          | 957,292 |   | $ | 1,642,470 |   | $ | 1,603,219 |   |
| Operating Income (Loss):(1),(2),(3) |       |                   |       |                 |       |   |   |   |   |
| TruGreen LawnCare                   |       | $                      | 52,606     |                 | $          | 41,055 |   | $ | 13,518 |   | $ | 24,009 |   |
| TruGreen LandCare                   |       | (50,572                | )          | 591                  |       | (47,229 | ) | 8,631 |   |
| Terminix                            |       | 68,755                 |       | 65,381               |       | 121,735 |   | 115,288 |   |
| American Home Shield                |       | 21,360                 |       | 28,750               |       | 28,468 |   | 36,144 |   |
| ServiceMaster Clean                 |       | 12,572                 |       | 12,139               |       | 25,244 |   | 24,124 |   |
| Other Operations and Headquarters   |       | (30,205                | )          | (29,911              | )          | (58,573 | ) | (61,513 | ) |
| Total Operating Income              |       | $                      | 74,516     |                 | $          | 118,005 |   | $ | 83,163 |   | $ | 146,683 |   |

 

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(1)          Presented below is areconciliation of segment operating income to income (loss) from continuingoperations before income taxes.

 
| ** **                                                         | ** ** | **Three months ended** | ** ** | **Six months ended** | ** ** |
|--------------------------------------------------------------------|------------|------------------------|------------|----------------------|------------|
| ** **                                                         | ** ** | **June 30,**      | ** ** | **June 30,**    | ** ** |
| **(In thousands)**                                            | ** ** | **2010**               | ** ** | **2009**             | ** ** | **2010** | ** ** | **2009** | ** ** |
| Total Segment Operating Income                                     |       | $                      | 74,516     |                 | $          | 118,005 |   | $ | 83,163 |   | $ | 146,683 |   |
| Non-operating expense (income):                                    |       |                   |       |                 |       |   |   |   |   |
| Interest expense                                                   |       | 73,169                 |       | 74,656               |       | 145,850 |   | 151,322 |   |
| Interest and net investment (income) loss                          |       | (996                   | )          | (3,395               | )          | (3,498 | ) | 1,366 |   |
| Gain on extinguishment of debt                                     |       | —                 |       | —               |       | — |   | (46,106 | ) |
| Other expense                                                      |       | 176                    |       | 179                  |       | 347 |   | 379 |   |
| Income (Loss) from Continuing Operations  before Income Taxes |       | $                      | 2,167      |                 | $          | 46,565 |   | $ | (59,536 | ) | $ | 39,722 |   |

 

(2)            As described in Note 5, includes a non-cashimpairment charge of $46.9 million recorded in the second quarter of 2010 toreduce the carrying value of goodwill and trade names at TruGreen LandCare as aresult of the Company’s interim impairment test of goodwill andindefinite-lived intangible assets.

 

(3)            Includes (i) restructuring charges related to areorganization of field leadership and a restructuring of branch operations atTruGreen LawnCare, a branch optimization project at Terminix and informationtechnology outsourcing at Other Operations and Headquarters and(ii) Merger related charges. Presented below is a summary of restructuringand Merger related charges (credits) by segment.

 
| ** **                                     | ** ** | **Three months ended** | ** ** | **Six months ended** | ** ** |
|------------------------------------------------|------------|------------------------|------------|----------------------|------------|
| ** **                                     | ** ** | **June 30,**      | ** ** | **June 30,**    | ** ** |
| **(In thousands)**                        | ** ** | **2010**               | ** ** | **2009**             | ** ** | **2010** | ** ** | **2009** | ** ** |
| Restructuring and Merger related charges:      |       |                   |       |                 |       |   |   |   |   |
| TruGreen LawnCare                              |       | $                      | 2,939      |                 | $          | — |   | $ | 5,962 |   | $ | — |   |
| TruGreen LandCare                              |       | 87                     |       | (21                  | )          | 658 |   | (51 | ) |
| Terminix                                       |       | 32                     |       | (69                  | )          | 78 |   | 3,151 |   |
| American Home Shield                           |       | —                 |       | 36                   |       | (127 | ) | 75 |   |
| ServiceMaster Clean                            |       | —                 |       | —               |       | — |   | — |   |
| Other Operations and Headquarters              |       | 1,109                  |       | 5,638                |       | 1,520 |   | 11,186 |   |
| Total restructuring and Merger related charges |       | $                      | 4,167      |                 | $          | 5,584 |   | $ | 8,091 |   | $ | 14,361 |   |

 

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**Note15. Related Party Transactions**

 

Inconnection with the Merger and the related transactions, the Company enteredinto a consulting agreement with CD&R, which was subsequently amended,under which CD&R provides the Company with on-going consulting andmanagement advisory services in exchange for an annual management fee of $2.0million, which is payable quarterly. On July 30, 2009, the annualmanagement fee payable under the consulting agreement with CD&R wasincreased from $2.0 million to $6.25 million in order to align our feestructure with current market rates. Under this agreement, the Company recordeda management fee of $1.6 million and $3.2 million for the three and six monthsended June 30, 2010, respectively, and $0.5 million and $1.0 million forthe three and six months ended June 30, 2009, respectively. The full yearmanagement fee was applied in 2009, and the incremental fees relating to thefirst three quarters of 2009 were recorded and paid to CD&R in the thirdquarter of 2009. The amended consultingagreement also provides that CD&R may receive additional fees in connectionwith certain subsequent financing and acquisition or disposition transactions.

 

Inaddition, in August 2009, the Company entered into consulting agreementswith Citigroup, BAS and JPMorgan, each of which is an Equity Sponsor or anaffiliate of an Equity Sponsor. Under the consulting agreements, Citigroup, BASand JPMorgan each provide the Company with on-going consulting and managementadvisory services through June 30, 2016 or the earlier termination of theexisting consulting agreement between the Company and CD&R. The Companypays annual management fees of $0.5 million, $0.5 million and $0.25 million toCitigroup, BAS and JPMorgan, respectively. The Company recorded consulting feesrelated to these agreements of $0.3 million and $0.6 million for the three and six months ended June 30,2010, respectively. The full year management fee was applied in 2009,and the incremental fees relating to the first three quarters of 2009 wererecorded and paid to Citigroup, BAS and JPMorgan in the third quarter of 2009.

 

Between the Merger and June 30, 2010, Holdings has completed openmarket purchases totaling $65.0 million in face value of the PermanentNotes for a cost of $21.4 million. The debt acquired by Holdings has notbeen retired, and the Company has continued to pay interest in accordance withthe terms of the debt. The Company recorded interest expense of $3.5 millionand $3.4 million for the six months ended June 30, 2010 and 2009,respectively, related to the Permanent Notes held by Holdings. The Company madecash payments to Holdings of $3.5 million and $3.0 million during the sixmonths ended June 30, 2010 and 2009, respectively. Interest accrued by theCompany and payable to Holdings as of June 30, 2010 and December 31,2009 amounted to $3.2 million.

 

**Note 16. Newly Issued Accounting Statements and Positions**

 

In September 2009, the Financial Accounting Standards Board (“FASB”)issued Accounting Standards Update (“ASU”) 2009-13, “Multiple-DeliverableRevenue Arrangements”, which amends the multiple-element arrangement guidanceunder ASC 605, “Revenue Recognition”. This standard amends the criteria forseparating consideration received for products or services inmultiple-deliverable arrangements. This standard establishes a selling pricehierarchy for determining the selling price of a deliverable, eliminates theresidual method of allocation, and requires that total arrangementconsideration be allocated at the inception of the arrangement to alldeliverables using the relative selling price method. In addition, thisstandard significantly expands required disclosures related to a vendor’smultiple-deliverable revenue arrangements. This standard is effectiveprospectively for revenue arrangements entered into or materially modified infiscal years beginning on or after June 15, 2010 (calendar year 2011). TheCompany is currently evaluating the effect of this standard on its condensedconsolidated financial statements.

 

InDecember 2009, the FASB issued ASU 2009-17, “Accounting byEnterprises Involved with Variable Interest Entities” (“ASU 2009-17”). ASU2009-17 formally incorporates into the FASB Codification amendments to FASBInterpretation No. 46(R) made by Statement of Financial AccountingStandards (“SFAS “) 167 to require that a comprehensive qualitative analysis beperformed to determine whether a holder of variable interests in a variableinterest entity also has a controlling financial interest in that entity. Inaddition, the amendments require that the same type of analysis be applied toentities that were previously designated as qualifying special-purposeentities. This standard applies prospectively for fiscal years beginning on orafter November 15, 2009. The Company adopted the required provisions ofthis standard during the first quarter of 2010. The adoption of this standarddid not have a material impact on the Company’s condensed consolidatedfinancial statements.

 

In January 2010, the FASB issued ASU 2010-06, “ImprovingDisclosures about Fair Value Measurements”, which amends ASC 820 to add newrequirements for disclosures about transfers into and out of Level 1 and 2measurements and separate disclosures about purchases, sales, issuances andsettlements relating to Level 3 measurements. The ASU also clarifies existingfair value disclosure requirements about the level of disaggregation and about inputsand valuation techniques used to measure fair value. Further, the ASU amendsguidance on employers’ disclosures about postretirement benefit plan assetsunder ASC 715 to require that disclosures be provided by classes of assetsinstead of by major categories of assets. This standard is effective for thefirst reporting period (including interim periods) beginning afterDecember 15, 2009, except for the requirement to provide the Level 3activity of purchases, sales, issuances, and settlements on a gross basis,which will be effective for fiscal years beginning after December 15,2010, and for interim periods within those fiscal years. The Company appliedthe required provisions of this standard on the Company’s condensedconsolidated financial statements during the first quarter of 2010 (see Note17).

 

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**Note17. Fair Value of Financial Instruments**

 

The period end carrying amounts of receivables, accounts payable andaccrued liabilities approximate fair value because of the short maturity ofthese instruments. The period end carrying amounts of long-term notesreceivable approximate fair value as the effective interest rates for theseinstruments are comparable to market rates at period end. The period end carryingamounts of current and long-term marketable securities also approximate fairvalue, with unrealized gains and losses reported net-of-tax as a component ofaccumulated comprehensive income (loss), or, for certain unrealized losses,reported in interest and net investment income in the condensed consolidatedstatement of operations if the decline in value is other than temporary. Thecarrying amount of total debt was $3,969.6 million and $3,974.9 millionand the estimated fair value was $3,900.6 million and $3,716.5 million at June 30,2010 and December 31, 2009, respectively. The fair values of the Company’sfinancial instruments reflect the amounts that would be received to sell anasset or paid to transfer a liability in an orderly transaction between marketparticipants at the measurement date (exit price). The fair value estimatespresented in this report are based on information available to the Company asof June 30, 2010 and December 31, 2009.

 

 The Company has estimated thefair value of its financial instruments measured at fair value on a recurringbasis using the market and income approaches. For investments in marketablesecurities, deferred compensation trust assets and derivative contracts, whichare carried at their fair values, the Company’s fair value estimatesincorporate quoted market prices, other observable inputs (for example, forwardinterest rates) and unobservable inputs (for example, forward commodity prices)at the balance sheet date.

 

Interestrate swap contracts are valued using forward interest rate curves obtained fromthird party market data providers. The fair value of each contract is the sumof the expected future settlements between the contract counterparties,discounted to present value. The expected future settlements are determined bycomparing the contract interest rate to the expected forward interest rate asof each settlement date and applying the difference between the two rates tothe notional amount of debt in the interest rate swap contracts.

 

Fuelswap contracts are valued using forward fuel price curves obtained from thirdparty market data providers. The fair value of each contract is the sum of theexpected future settlements between the contract counterparties, discounted topresent value. The expected future settlements are determined by comparing thecontract fuel price to the expected forward fuel price as of each settlementdate and applying the difference between the contract and expected prices tothe notional gallons in the fuel swap contracts.

 

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The carrying amount and estimated fair value of the Company’s financialinstruments that are recorded at fair value for the periods presented are asfollows:

 

 
| ** **                              | ** ** | ** **                                                 | ** ** | **As of  June 30, 2010** | ** ** | **As of  December 31, 2009**                           | ** ** |
|-----------------------------------------|------------|------------------------------------------------------------|------------|-------------------------------|------------|-------------------------------------------------------------|------------|
| ** **                              | ** ** | ** **                                                 | ** ** | ** **                    | ** ** | **Estimated Fair Value Measurements**        | ** ** | ** ** | ** ** | ** ** | ** ** |
| **(In thousands)**                 | ** ** | **Balance Sheet Locations**                                | ** ** | **Carrying  Value**           | ** ** | **Quoted  Prices In  Active  Markets  (Level 1)** | ** ** | **Significant  Other  Observable  Inputs  (Level 2)** | ** ** | **Significant  Unobservable  Inputs  (Level 3)** | ** ** | **Carrying  Value** | ** ** | **Estimated  Fair Value** | ** ** |
| Financial Assets:                       |       |                                                       |       |                          |       |                                                        |       |   |   |   |   |   |   |   |   |
| Deferred compensation trust assets |       | Long-term  marketable securities                           |       | $                             | 9,017      |                                                        | $          | 9,017 |   | $ | — |   | $ | — |   | $ | 9,985 |   | $ | 9,985 |   |
| Investments in marketable securities    |       | Marketable  securities and Long-term marketable securities |       | 124,198                       |       | 43,956                                                      |       | 80,242 |   | — |   | 122,201 |   | 122,201 |   |
| Fuel swap contracts:                    |       |                                                       |       |                          |       |                                                        |       |   |   |   |   |   |   |   |   |
| Current                                 |       | Prepaid  expenses and other assets                         |       | 4,087                         |       | —                                                      |       | — |   | 4,087 |   | 7,840 |   | 7,840 |   |
| Noncurrent                              |       | Other assets                                               |       | 152                           |       | —                                                      |       | — |   | 152 |   | — |   | — |   |
| Total financial assets                  |       |                                                       |       | $                             | 137,454    |                                                        | $          | 52,973 |   | $ | 80,242 |   | $ | 4,239 |   | $ | 140,026 |   | $ | 140,026 |   |
|                                    |       |                                                       |       |                          |       |                                                        |       |   |   |   |   |   |   |   |   |
| Financial Liabilities:                  |       |                                                       |       |                          |       |                                                        |       |   |   |   |   |   |   |   |   |
| Fuel swap contracts:                    |       |                                                       |       |                          |       |                                                        |       |   |   |   |   |   |   |   |   |
| Current                                 |       | Other accrued liabilities                                  |       | $                             | 1,438      |                                                        | $          | — |   | $ | — |   | $ | 1,438 |   | $ | 924 |   | $ | 924 |   |
| Noncurrent                              |       | Other  long-term obligations                               |       | 829                           |       | —                                                      |       | — |   | 829 |   | — |   | — |   |
| Interest rate swap contracts            |       | Other  long-term obligations                               |       | 58,390                        |       | —                                                      |       | 58,390 |   | — |   | 54,120 |   | 54,120 |   |
| Total financial liabilities             |       |                                                       |       | $                             | 60,657     |                                                        | $          | — |   | $ | 58,390 |   | $ | 2,267 |   | $ | 55,044 |   | $ | 55,044 |   |

 

Areconciliation of the beginning and ending fair values of financial instrumentsvalued using significant unobservable inputs (Level 3) is presented as follows:

 
| **(In thousands)**                        | ** ** | **Fuel Swap Contract  Assets (Liabilities)** | ** ** |
|------------------------------------------------|------------|----------------------------------------------|------------|
| Balance at December 31, 2009              |       | $                                            | 6,916      |   |
| Total gains (losses) (realized and unrealized) |       |                                         |       |
| Included in earnings(1)                        |       | 2,784                                        |       |
| Included in other comprehensive income         |       | (4,944                                       | )          |
| Settlements, net                               |       | (2,784                                       | )          |
| Balance at June 30, 2010                  |       | $                                            | 1,972      |   |

 
| **(In thousands)**                        | ** ** | **Fuel Swap Contract  Assets (Liabilities)** | ** ** |
|------------------------------------------------|------------|----------------------------------------------|------------|
| Balance at December 31, 2008              |       | $                                            | (24,924    | ) |
| Total gains (losses) (realized and unrealized) |       |                                         |       |
| Included in earnings(1)                        |       | (14,781                                      | )          |
| Included in other comprehensive income         |       | 20,157                                       |       |
| Settlements, net                               |       | 14,781                                       |       |
| Balance at June 30, 2009                  |       | $                                            | (4,767     | ) |

 

----

(1)                                Gains (losses)included in earnings are reported in cost of services rendered and productssold.

 

TheCompany uses derivative financial instruments to manage risks associated withchanges in fuel prices and interest rates. The Company does not hold or issuederivative financial instruments for trading or speculative purposes. Indesignating its derivative financial instruments as hedging instruments underaccounting standards for derivative instruments, the Company formally documents

 

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therelationship between the hedging instrument and the hedged item, as well as therisk 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 atleast quarterly thereafter, whether the derivative item is effective inoffsetting the projected changes in cash flows of the associated forecastedtransactions. All of the Company’s designated hedging instruments areclassified as cash flow hedges.

 

TheCompany has historically hedged a significant portion of its annual fuelconsumption of approximately 25 million gallons. The Company has also hedgedthe interest payments on a portion of its variable rate debt through the use ofinterest rate swap agreements. Substantially all of the Company’s fuel swapcontracts and interest rate swap contracts are classified as cash flow hedges,and, as such, the hedging instruments are recorded on the condensedconsolidated statement of financial position as either an asset or liability atfair value, with the effective portion of changes in the fair valueattributable to the hedged risks recorded in other comprehensive income. Anychange in the fair value of the hedging instrument resulting fromineffectiveness, as defined by accounting standards, is recognized in currentperiod earnings. Cash flows related to fuel and interest rate derivatives areclassified as operating activities in the condensed consolidated statement ofcash flows.

 

Theeffect of derivative instruments on the condensed consolidated statement ofoperations and other comprehensive income for the six months ended June 30,2010 and 2009, respectively, is presented as follows:

 
| **(In  thousands)**                                                | ** ** | **Effective Portion of  Gain (Loss) Recognized in  Accumulated Other** | ** ** | **Effective Portion of Gain (Loss)  Reclassified from  Accumulated Other** | ** ** | ** **                                 | ** ** |
|--------------------------------------------------------------------|------------|------------------------------------------------------------------------------------------------------|------------|----------------------------------------------------------------------------------------------------------|------------|--------------------------------------------|------------|
| **Derivatives designated as  Cash Flow Hedge** | ** ** | **Comprehensive Income  (Loss)**                                                                     | ** ** | **Comprehensive Income  (Loss) into Income**                                              | ** ** | **Location of Gain (Loss)** | ** ** |
| **Relationships**                                                  | ** ** | **Six months ended June 30, 2010**                                               | ** ** | **included in Income**                                                                         | ** ** |
|                                                               |       |                                                                                                 |       |                                                                                                     |       |                                       |       |
| Fuel swap contracts                                                |       | $                                                                                                    | (4,944     | )                                                                                                        | $          | 2,784                                      |       | Cost  of services rendered and products sold |   |
| Interest rate swap contracts                                       |       | $                                                                                                    | (4,270     | )                                                                                                        | $          | (27,216                                    | )          | Interest expense |   |

 
| **Derivatives designated as  Cash Flow Hedge** | ** ** | **Effective Portion of  Gain (Loss) Recognized in  Accumulated Other  Comprehensive Income  (Loss)** | ** ** | **Effective Portion of Gain (Loss)  Reclassified from  Accumulated Other  Comprehensive Income  (Loss) into Income** | ** ** | **Location of Gain (Loss)** | ** ** |
|--------------------------------------------------------------------|------------|------------------------------------------------------------------------------------------------------------------------------------|------------|----------------------------------------------------------------------------------------------------------------------------------------------------|------------|--------------------------------------------|------------|
| **Relationships**                                                  | ** ** | **Six months ended June 30, 2009**                                                                             | ** ** | **included in Income**                                                                                                                   | ** ** |
|                                                               |       |                                                                                                                               |       |                                                                                                                                               |       |                                       |       |
| Fuel swap contracts                                                |       | $                                                                                                                                  | 20,157     |                                                                                                                                               | $          | (14,781                                    | )          | Cost  of services rendered and products sold |   |
| Interest rate swap contracts                                       |       | $                                                                                                                                  | 2,553      |                                                                                                                                               | $          | (23,389                                    | )          | Interest expense |   |

 

Ineffectiveportions of derivative instruments designated in accordance with accountingstandards as cash flow hedge relationships were insignificant during the sixmonths ended June 30, 2010. As of June 30, 2010, the Company had fuelswap contracts to pay fixed prices for fuel with an aggregate notional amountof $75.1 million, maturing through 2011. Under the terms of its fuel swapcontracts, the Company is required to post collateral in certain circumstances,including in the event that the fair value of the contracts exceeds a certainagreed upon liability level. As of June 30, 2010, the Company had posted$5.0 million in letters of credit as collateral for these contracts, none ofwhich were issued under the Company’s Revolving Credit Facility. As of June 30,2010, the Company had interest rate swap contracts to pay fixed rates forinterest on long-term debt with an aggregate notional amount of $1.43 billion,maturing through 2012.

 

Theeffective portion of the gain or loss on derivative instruments designated andqualifying as cash flow hedging instruments is recorded in other comprehensiveincome. These amounts are reclassified into earnings in the same period orperiods during which the hedged forecasted debt interest settlement or the fuelsettlement affects earnings. The amount expected to be reclassified into earningsduring the next 12 months includes unrealized gains and losses related to openfuel hedges and interest rate swaps. Specifically, as the underlying forecastedtransactions occur during the next 12 months, the hedging gains and losses inaccumulated other comprehensive income expected to be recognized in earnings isa loss of $21.3 million, net of tax, at June 30, 2010. The amounts thatare ultimately reclassified into earnings will be based on actual interestrates and fuel prices at the time the positions are settled and may differmaterially from the amount noted above.

 

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**Note18. Condensed Consolidating Financial Statements of The ServiceMaster Companyand Subsidiaries**

 

Thefollowing condensed consolidating financial statements of the Company and itssubsidiaries have been prepared pursuant to Rule 3-10 of Regulation S-X.These condensed consolidating financial statements have been prepared from theCompany’s financial information on the same basis of accounting as thecondensed consolidated financial statements. Goodwill and other intangibleassets have been allocated to all of the subsidiaries of the Company based onmanagement’s estimates.

 

Thepayment obligations of the Company under the Permanent Notes are jointly andseverally guaranteed on a senior unsecured basis by certain of the Company’sdomestic subsidiaries excluding certain subsidiaries subject to regulatoryrequirements in various states (“Guarantors”). Each of the Guarantors is whollyowned, directly or indirectly, by the Company, and all guarantees are full andunconditional. All other subsidiaries of the Company, either directly orindirectly owned, do not guarantee the Permanent Notes (“Non-Guarantors”).

 

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** **

**THE SERVICEMASTER COMPANY AND SUBSIDIARIES**

**Condensed Consolidating Statement of Operations**

**For the Three Months Ended June 30, 2010(Unaudited)**

**(In thousands)**

 
| ** **                                                        | ** ** | **The**           | ** ** | ** **     | ** ** | ** **     | ** ** | ** **       | ** ** | ** **       | ** ** |
|-------------------------------------------------------------------|------------|-------------------|------------|----------------|------------|----------------|------------|------------------|------------|------------------|------------|
| ** **                                                        | ** ** | **ServiceMaster** | ** ** | ** **     | ** ** | **Non-**       | ** ** | ** **       | ** ** | ** **       | ** ** |
| ** **                                                        | ** ** | **Company**       | ** ** | **Guarantors** | ** ** | **Guarantors** | ** ** | **Eliminations** | ** ** | **Consolidated** | ** ** |
| **Operating Revenue**                                             |       | $                 | —     |           | $          | 798,804        |       | $                | 223,052    |             | $          | (18,794 | ) | $ | 1,003,062 |   |
|                                                              |       |              |       |           |       |           |       |             |       |             |       |
| **Operating Costs and Expenses:**                                 |       |              |       |           |       |           |       |             |       |             |       |
| Cost of services rendered and products sold                       |       | —            |       | 487,251        |       | 105,124        |       | (18,794          | )          | 573,581          |       |
| Selling and administrative expenses                               |       | 2,277             |       | 164,280        |       | 96,906         |       | —           |       | 263,463          |       |
| Amortization expense                                              |       | 56                |       | 31,429         |       | 8,966          |       | —           |       | 40,451           |       |
| Goodwill and trade name impairment                                |       | —            |       | 46,884         |       | —         |       | —           |       | 46,884           |       |
| Restructuring and Merger related charges                          |       | 1,005             |       | 3,058          |       | 104            |       | —           |       | 4,167            |       |
| Total operating costs and expenses                                |       | 3,338             |       | 732,902        |       | 211,100        |       | (18,794          | )          | 928,546          |       |
|                                                              |       |              |       |           |       |           |       |             |       |             |       |
| **Operating (Loss) Income**                                       |       | (3,338            | )          | 65,902         |       | 11,952         |       | —           |       | 74,516           |       |
|                                                              |       |              |       |           |       |           |       |             |       |             |       |
| **Non-operating Expense (Income):**                               |       |              |       |           |       |           |       |             |       |             |       |
| Interest expense (income)                                         |       | 50,486            |       | 25,970         |       | (3,287         | )          | —           |       | 73,169           |       |
| Interest and net investment loss (income)                         |       | 1,518             |       | 1,545          |       | (4,059         | )          | —           |       | (996             | )          |
| Other expense                                                     |       | —            |       | —         |       | 176            |       | —           |       | 176              |       |
|                                                              |       |              |       |           |       |           |       |             |       |             |       |
| **(Loss) Income from Continuing  Operations before Income Taxes** |       | (55,342           | )          | 38,387         |       | 19,122         |       | —           |       | 2,167            |       |
| (Benefit) provision for income taxes                              |       | (30,825           | )          | 3,931          |       | 16,412         |       | —           |       | (10,482          | )          |
|                                                              |       |              |       |           |       |           |       |             |       |             |       |
| **(Loss) Income from Continuing  Operations**                     |       | (24,517           | )          | 34,456         |       | 2,710          |       | —           |       | 12,649           |       |
| Income (loss) from discontinued operations, net of  income taxes  |       | —            |       | 114            |       | (319           | )          | —           |       | (205             | )          |
| Equity in losses of subsidiaries (net of tax)                     |       | 36,961            |       | (9,092         | )          | —         |       | (27,869          | )          | —           |       |
| **Net Loss**                                                      |       | $                 | 12,444     |           | $          | 25,478         |       | $                | 2,391      |             | $          | (27,869 | ) | $ | 12,444 |   |

 

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** **

**THE SERVICEMASTER COMPANY AND SUBSIDIARIES**

**Condensed Consolidating Statement of Operations**

**For the Three Months Ended June 30, 2009(Unaudited)**

**(In thousands)**

** **
| ** **                                                        | ** ** | **The**           | ** ** | ** **     | ** ** | ** **     | ** ** | ** **       | ** ** | ** **       | ** ** |
|-------------------------------------------------------------------|------------|-------------------|------------|----------------|------------|----------------|------------|------------------|------------|------------------|------------|
| ** **                                                        | ** ** | **ServiceMaster** | ** ** | ** **     | ** ** | **Non-**       | ** ** | ** **       | ** ** | ** **       | ** ** |
| ** **                                                        | ** ** | **Company**       | ** ** | **Guarantors** | ** ** | **Guarantors** | ** ** | **Eliminations** | ** ** | **Consolidated** | ** ** |
| **Operating Revenue**                                             |       | $                 | —     |           | $          | 758,031        |       | $                | 218,407    |             | $          | (19,146 | ) | $ | 957,292 |   |
|                                                              |       |              |       |           |       |           |       |             |       |             |       |
| **Operating Costs and Expenses:**                                 |       |              |       |           |       |           |       |             |       |             |       |
| Cost of services rendered and products sold                       |       | —            |       | 472,335        |       | 100,184        |       | (19,146          | )          | 553,373          |       |
| Selling and administrative expenses                               |       | 1,009             |       | 161,166        |       | 77,754         |       | —           |       | 239,929          |       |
| Amortization expense                                              |       | 55                |       | 31,353         |       | 8,993          |       | —           |       | 40,401           |       |
| Restructuring and Merger related charges                          |       | 1,154             |       | (90            | )          | 4,520          |       | —           |       | 5,584            |       |
| Total operating costs and expenses                                |       | 2,218             |       | 664,764        |       | 191,451        |       | (19,146          | )          | 839,287          |       |
|                                                              |       |              |       |           |       |           |       |             |       |             |       |
| **Operating (Loss) Income**                                       |       | (2,218            | )          | 93,267         |       | 26,956         |       | —           |       | 118,005          |       |
|                                                              |       |              |       |           |       |           |       |             |       |             |       |
| **Non-operating Expense (Income):**                               |       |              |       |           |       |           |       |             |       |             |       |
| Interest expense (income)                                         |       | 84,241            |       | (6,682         | )          | (2,903         | )          | —           |       | 74,656           |       |
| Interest and net investment (income) loss                         |       | (321              | )          | 2,357          |       | (5,431         | )          | —           |       | (3,395           | )          |
| Other expense                                                     |       | —            |       | —         |       | 179            |       | —           |       | 179              |       |
|                                                              |       |              |       |           |       |           |       |             |       |             |       |
| **(Loss) Income from Continuing  Operations before Income Taxes** |       | (86,138           | )          | 97,592         |       | 35,111         |       | —           |       | 46,565           |       |
| (Benefit) provision for income taxes                              |       | (33,862           | )          | 9,638          |       | 48,397         |       | —           |       | 24,173           |       |
|                                                              |       |              |       |           |       |           |       |             |       |             |       |
| **(Loss) Income from Continuing  Operations**                     |       | (52,276           | )          | 87,954         |       | (13,286        | )          | —           |       | 22,392           |       |
| Loss from discontinued operations, net of income  taxes           |       | —            |       | —         |       | (107           | )          | —           |       | (107             | )          |
| Equity in earnings of subsidiaries (net of tax)                   |       | 74,561            |       | (17,283        | )          | —         |       | (57,278          | )          | —           |       |
| **Net Income (Loss)**                                             |       | $                 | 22,285     |           | $          | 70,671         |       | $                | (13,393    | )                | $          | (57,278 | ) | $ | 22,285 |   |

 

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**THE SERVICEMASTER COMPANY AND SUBSIDIARIES**

**Condensed Consolidating Statement of Operations**

**For the Six Months Ended June 30, 2010(Unaudited)**

**(In thousands)**

 
| ** **                                                        | ** ** | **The**           | ** ** | ** **     | ** ** | ** **     | ** ** | ** **       | ** ** | ** **       | ** ** |
|-------------------------------------------------------------------|------------|-------------------|------------|----------------|------------|----------------|------------|------------------|------------|------------------|------------|
| ** **                                                        | ** ** | **ServiceMaster** | ** ** | ** **     | ** ** | **Non-**       | ** ** | ** **       | ** ** | ** **       | ** ** |
| ** **                                                        | ** ** | **Company**       | ** ** | **Guarantors** | ** ** | **Guarantors** | ** ** | **Eliminations** | ** ** | **Consolidated** | ** ** |
| **Operating Revenue**                                             |       | $                 | —     |           | $          | 1,295,749      |       | $                | 382,140    |             | $          | (35,419 | ) | $ | 1,642,470 |   |
|                                                              |       |              |       |           |       |           |       |             |       |             |       |
| **Operating Costs and Expenses:**                                 |       |              |       |           |       |           |       |             |       |             |       |
| Cost of services rendered and products sold                       |       | —            |       | 834,069        |       | 177,451        |       | (35,419          | )          | 976,101          |       |
| Selling and administrative expenses                               |       | 4,540             |       | 261,647        |       | 181,151        |       | —           |       | 447,338          |       |
| Amortization expense                                              |       | 111               |       | 62,852         |       | 17,930         |       | —           |       | 80,893           |       |
| Goodwill and trade name impairment                                |       | —            |       | 46,884         |       | —         |       | —           |       | 46,884           |       |
| Restructuring and Merger related charges                          |       | 1,136             |       | 6,698          |       | 257            |       | —           |       | 8,091            |       |
| Total operating costs and expenses                                |       | 5,787             |       | 1,212,150      |       | 376,789        |       | (35,419          | )          | 1,559,307        |       |
|                                                              |       |              |       |           |       |           |       |             |       |             |       |
| **Operating (Loss) Income**                                       |       | (5,787            | )          | 83,599         |       | 5,351          |       | —           |       | 83,163           |       |
|                                                              |       |              |       |           |       |           |       |             |       |             |       |
| **Non-operating Expense (Income):**                               |       |              |       |           |       |           |       |             |       |             |       |
| Interest expense (income)                                         |       | 100,066           |       | 52,185         |       | (6,401         | )          | —           |       | 145,850          |       |
| Interest and net investment loss (income)                         |       | 2,169             |       | 2,742          |       | (8,409         | )          | —           |       | (3,498           | )          |
| Other expense                                                     |       | —            |       | —         |       | 347            |       | —           |       | 347              |       |
|                                                              |       |              |       |           |       |           |       |             |       |             |       |
| **(Loss) Income from Continuing  Operations before Income Taxes** |       | (108,022          | )          | 28,672         |       | 19,814         |       | —           |       | (59,536          | )          |
| (Benefit) provision for income taxes                              |       | (52,442           | )          | (16,008        | )          | 28,548         |       | —           |       | (39,902          | )          |
|                                                              |       |              |       |           |       |           |       |             |       |             |       |
| **(Loss) Income from Continuing  Operations**                     |       | (55,580           | )          | 44,680         |       | (8,734         | )          | —           |       | (19,634          | )          |
| Income (loss) from discontinued operations, net of  income taxes  |       | —            |       | 335            |       | (917           | )          | —           |       | (582             | )          |
| Equity in losses of subsidiaries (net of tax)                     |       | 35,364            |       | (13,585        | )          | —         |       | (21,779          | )          | —           |       |
| **Net Loss**                                                      |       | $                 | (20,216    | )              | $          | 31,430         |       | $                | (9,651     | )                | $          | (21,779 | ) | $ | (20,216 | ) |

 

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** **

**THE SERVICEMASTER COMPANY AND SUBSIDIARIES**

**Condensed Consolidating Statement of Operations**

**For the Six Months Ended June 30, 2009(Unaudited)**

**(In thousands)**

** **
| ** **                                                        | ** ** | **The**           | ** ** | ** **     | ** ** | ** **     | ** ** | ** **       | ** ** | ** **       | ** ** |
|-------------------------------------------------------------------|------------|-------------------|------------|----------------|------------|----------------|------------|------------------|------------|------------------|------------|
| ** **                                                        | ** ** | **ServiceMaster** | ** ** | ** **     | ** ** | **Non-**       | ** ** | ** **       | ** ** | ** **       | ** ** |
| ** **                                                        | ** ** | **Company**       | ** ** | **Guarantors** | ** ** | **Guarantors** | ** ** | **Eliminations** | ** ** | **Consolidated** | ** ** |
| **Operating Revenue**                                             |       | $                 | —     |           | $          | 1,264,967      |       | $                | 374,691    |             | $          | (36,439 | ) | $ | 1,603,219 |   |
|                                                              |       |              |       |           |       |           |       |             |       |             |       |
| **Operating Costs and Expenses:**                                 |       |              |       |           |       |           |       |             |       |             |       |
| Cost of services rendered and products sold                       |       | —            |       | 815,109        |       | 169,103        |       | (36,439          | )          | 947,773          |       |
| Selling and administrative expenses                               |       | 2,007             |       | 260,323        |       | 151,362        |       | —           |       | 413,692          |       |
| Amortization expense                                              |       | 110               |       | 62,601         |       | 17,999         |       | —           |       | 80,710           |       |
| Restructuring and Merger related charges                          |       | 1,448             |       | 3,100          |       | 9,813          |       | —           |       | 14,361           |       |
| Total operating costs and expenses                                |       | 3,565             |       | 1,141,133      |       | 348,277        |       | (36,439          | )          | 1,456,536        |       |
|                                                              |       |              |       |           |       |           |       |             |       |             |       |
| **Operating (Loss) Income**                                       |       | (3,565            | )          | 123,834        |       | 26,414         |       | —           |       | 146,683          |       |
|                                                              |       |              |       |           |       |           |       |             |       |             |       |
| **Non-operating Expense (Income):**                               |       |              |       |           |       |           |       |             |       |             |       |
| Interest expense (income)                                         |       | 161,100           |       | (3,481         | )          | (6,297         | )          | —           |       | 151,322          |       |
| Interest and net investment loss (income)                         |       | 1,163             |       | 4,432          |       | (4,229         | )          | —           |       | 1,366            |       |
| Gain on extinguishment of debt                                    |       | (46,106           | )          | —         |       | —         |       | —           |       | (46,106          | )          |
| Other expense                                                     |       | —            |       | —         |       | 379            |       | —           |       | 379              |       |
|                                                              |       |              |       |           |       |           |       |             |       |             |       |
| **(Loss) Income from Continuing  Operations before Income Taxes** |       | (119,722          | )          | 122,883        |       | 36,561         |       | —           |       | 39,722           |       |
| (Benefit) provision for income taxes                              |       | (57,068           | )          | 24,647         |       | 49,039         |       | —           |       | 16,618           |       |
|                                                              |       |              |       |           |       |           |       |             |       |             |       |
| **(Loss) Income from Continuing  Operations**                     |       | (62,654           | )          | 98,236         |       | (12,478        | )          | —           |       | 23,104           |       |
| Loss from discontinued operations, net of income  taxes           |       | —            |       | —         |       | (270           | )          | —           |       | (270             | )          |
| Equity in earnings of subsidiaries (net of tax)                   |       | 85,488            |       | (15,884        | )          | —         |       | (69,604          | )          | —           |       |
| **Net Income (Loss)**                                             |       | $                 | 22,834     |           | $          | 82,352         |       | $                | (12,748    | )                | $          | (69,604 | ) | $ | 22,834 |   |

 

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**THE SERVICEMASTER COMPANY AND SUBSIDIARIES**

**Condensed Consolidating Statement of FinancialPosition (Unaudited)**

**As of June 30, 2010**

**(In thousands)**

** **
| ** **                                                                   | ** ** | **The**           | ** ** | ** **     | ** ** | ** **     | ** ** | ** **       | ** ** | ** **       | ** ** |
|------------------------------------------------------------------------------|------------|-------------------|------------|----------------|------------|----------------|------------|------------------|------------|------------------|------------|
| ** **                                                                   | ** ** | **ServiceMaster** | ** ** | ** **     | ** ** | **Non-**       | ** ** | ** **       | ** ** | ** **       | ** ** |
| ** **                                                                   | ** ** | **Company**       | ** ** | **Guarantors** | ** ** | **Guarantors** | ** ** | **Eliminations** | ** ** | **Consolidated** | ** ** |
| **Assets**                                                                   |       |              |       |           |       |           |       |             |       |             |       |
| **Current Assets:**                                                          |       |              |       |           |       |           |       |             |       |             |       |
| Cash and cash equivalents                                                    |       | $                 | 142,223    |           | $          | 19,660         |       | $                | 127,252    |             | $          | — |   | $ | 289,135 |   |
| Marketable securities                                                        |       | —            |       | —         |       | 21,197         |       | —           |       | 21,197           |       |
| Receivables                                                                  |       | 1,174             |       | 199,387        |       | 479,374        |       | (244,842         | )          | 435,093          |       |
| Inventories                                                                  |       | —            |       | 80,768         |       | 2,644          |       | —           |       | 83,412           |       |
| Prepaid expenses and other assets                                            |       | 32,146            |       | 53,639         |       | 20,399         |       | —           |       | 106,184          |       |
| Deferred customer acquisition costs                                          |       | —            |       | 38,053         |       | 23,686         |       | —           |       | 61,739           |       |
| Deferred taxes                                                               |       | —            |       | 23,222         |       | 1,450          |       | (302             | )          | 24,370           |       |
| Assets of discontinued operations                                            |       | —            |       | —         |       | 16             |       | —           |       | 16               |       |
| Total Current Assets                                                         |       | 175,543           |       | 414,729        |       | 676,018        |       | (245,144         | )          | 1,021,146        |       |
| **Property and Equipment:**                                                  |       |              |       |           |       |           |       |             |       |             |       |
| At cost                                                                      |       | —            |       | 303,209        |       | 85,215         |       | —           |       | 388,424          |       |
| Less: accumulated depreciation                                               |       | —            |       | (117,855       | )          | (46,810        | )          | —           |       | (164,665         | )          |
| Net property and equipment                                                   |       | —            |       | 185,354        |       | 38,405         |       | —           |       | 223,759          |       |
|                                                                         |       |              |       |           |       |           |       |             |       |             |       |
| **Other Assets:**                                                            |       |              |       |           |       |           |       |             |       |             |       |
| Goodwill                                                                     |       | —            |       | 2,724,210      |       | 364,130        |       | —           |       | 3,088,340        |       |
| Intangible assets, primarily trade names, service  marks and trademarks, net |       | —            |       | 1,931,591      |       | 776,170        |       | —           |       | 2,707,761        |       |
| Notes receivable                                                             |       | 2,024,394         |       | 352            |       | 24,487         |       | (2,024,394       | )          | 24,839           |       |
| Long-term marketable securities                                              |       | 9,017             |       | —         |       | 103,000        |       | —           |       | 112,017          |       |
| Investments in and advances to subsidiaries                                  |       | 3,614,151         |       | 1,459,763      |       | 23,576         |       | (5,097,490       | )          | —           |       |
| Other assets                                                                 |       | 108,775           |       | 4,002          |       | 1,538          |       | (85,179          | )          | 29,136           |       |
| Debt issuance costs                                                          |       | 59,504            |       | —         |       | —         |       | —           |       | 59,504           |       |
| Total Assets                                                                 |       | $                 | 5,991,384  |           | $          | 6,720,001      |       | $                | 2,007,324  |             | $          | (7,452,207 | ) | $ | 7,266,502 |   |
|                                                                         |       |              |       |           |       |           |       |             |       |             |       |
| **Liabilities and Shareholder’s  Equity**                               |       |              |       |           |       |           |       |             |       |             |       |
| **Current Liabilities:**                                                     |       |              |       |           |       |           |       |             |       |             |       |
| Accounts payable                                                             |       | $                 | 13         |           | $          | 87,319         |       | $                | 39,209     |             | $          | — |   | $ | 126,541 |   |
| Accrued liabilities:                                                         |       |              |       |           |       |           |       |             |       |             |       |
| Payroll and related expenses                                                 |       | 2,275             |       | 47,042         |       | 40,526         |       | —           |       | 89,843           |       |
| Self-insured claims and related expenses                                     |       | —            |       | 23,040         |       | 70,882         |       | —           |       | 93,922           |       |
| Other                                                                        |       | 77,417            |       | 60,446         |       | 48,516         |       | (302             | )          | 186,077          |       |
| Deferred revenue                                                             |       | —            |       | 194,716        |       | 325,831        |       | —           |       | 520,547          |       |
| Liabilities of discontinued operations                                       |       | —            |       | 239            |       | 2,497          |       | —           |       | 2,736            |       |
| Current portion of long-term debt                                            |       | 141,427           |       | 25,332         |       | 140,220        |       | (244,842         | )          | 62,137           |       |
| Total Current Liabilities                                                    |       | 221,132           |       | 438,134        |       | 667,681        |       | (245,144         | )          | 1,081,803        |       |
|                                                                         |       |              |       |           |       |           |       |             |       |             |       |
| **Long-Term Debt**                                                           |       | 3,879,022         |       | 1,997,318      |       | 55,520         |       | (2,024,394       | )          | 3,907,466        |       |
|                                                                         |       |              |       |           |       |           |       |             |       |             |       |
| **Other Long-Term Liabilities:**                                             |       |              |       |           |       |           |       |             |       |             |       |
| Deferred taxes                                                               |       | —            |       | 730,052        |       | 288,353        |       | (85,179          | )          | 933,226          |       |
| Intercompany payable                                                         |       | 650,515           |       | —         |       | —         |       | (650,515         | )          | —           |       |
| Liabilities of discontinued operations                                       |       | —            |       | —         |       | 4,080          |       | —           |       | 4,080            |       |
| Other long-term obligations                                                  |       | 76,408            |       | 1,838          |       | 97,374         |       | —           |       | 175,620          |       |
| Total Other Long-Term Liabilities                                            |       | 726,923           |       | 731,890        |       | 389,807        |       | (735,694         | )          | 1,112,926        |       |
|                                                                         |       |              |       |           |       |           |       |             |       |             |       |
| **Shareholder’s Equity**                                                |       | 1,164,307         |       | 3,552,659      |       | 894,316        |       | (4,446,975       | )          | 1,164,307        |       |
|                                                                         |       |              |       |           |       |           |       |             |       |             |       |
| **Total Liabilities and  Shareholder’s Equity**                         |       | $                 | 5,991,384  |           | $          | 6,720,001      |       | $                | 2,007,324  |             | $          | (7,452,207 | ) | $ | 7,266,502 |   |

 

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**THE SERVICEMASTER COMPANY AND SUBSIDIARIES**

**Condensed Consolidating Statement of Financial Position(Audited)**

**As of December 31, 2009**

**(In thousands)**

 
| ** **                                                                   | ** ** | **The**           | ** ** | ** **     | ** ** | ** **     | ** ** | ** **       | ** ** | ** **       | ** ** |
|------------------------------------------------------------------------------|------------|-------------------|------------|----------------|------------|----------------|------------|------------------|------------|------------------|------------|
| ** **                                                                   | ** ** | **ServiceMaster** | ** ** | ** **     | ** ** | **Non-**       | ** ** | ** **       | ** ** | ** **       | ** ** |
| ** **                                                                   | ** ** | **Company**       | ** ** | **Guarantors** | ** ** | **Guarantors** | ** ** | **Eliminations** | ** ** | **Consolidated** | ** ** |
| **Assets**                                                                   |       |              |       |           |       |           |       |             |       |             |       |
| **Current Assets:**                                                          |       |              |       |           |       |           |       |             |       |             |       |
| Cash and cash equivalents                                                    |       | $                 | 124,674    |           | $          | 15,796         |       | $                | 112,993    |             | $          | — |   | $ | 253,463 |   |
| Marketable securities                                                        |       | —            |       | —         |       | 21,120         |       | —           |       | 21,120           |       |
| Receivables                                                                  |       | 1,162             |       | 133,866        |       | 424,395        |       | (210,768         | )          | 348,655          |       |
| Inventories                                                                  |       | —            |       | 74,041         |       | 2,551          |       | —           |       | 76,592           |       |
| Prepaid expenses and other assets                                            |       | 7,840             |       | 15,239         |       | 13,485         |       | —           |       | 36,564           |       |
| Deferred customer acquisition costs                                          |       | —            |       | 13,759         |       | 22,311         |       | —           |       | 36,070           |       |
| Deferred taxes                                                               |       | —            |       | 22,481         |       | 996            |       | (1,882           | )          | 21,595           |       |
| Assets of discontinued operations                                            |       | —            |       | 15             |       | 27             |       | —           |       | 42               |       |
| Total Current Assets                                                         |       | 133,676           |       | 275,197        |       | 597,878        |       | (212,650         | )          | 794,101          |       |
| **Property and Equipment:**                                                  |       |              |       |           |       |           |       |             |       |             |       |
| At cost                                                                      |       | —            |       | 262,223        |       | 82,877         |       | —           |       | 345,100          |       |
| Less: accumulated depreciation                                               |       | —            |       | (94,423        | )          | (38,542        | )          | —           |       | (132,965         | )          |
| Net property and equipment                                                   |       | —            |       | 167,800        |       | 44,335         |       | —           |       | 212,135          |       |
|                                                                         |       |              |       |           |       |           |       |             |       |             |       |
| **Other Assets:**                                                            |       |              |       |           |       |           |       |             |       |             |       |
| Goodwill                                                                     |       | —            |       | 2,755,813      |       | 363,941        |       | —           |       | 3,119,754        |       |
| Intangible assets, primarily trade names, service  marks and trademarks, net |       | —            |       | 1,992,843      |       | 794,394        |       | —           |       | 2,787,237        |       |
| Notes receivable                                                             |       | 1,992,857         |       | 707            |       | 22,783         |       | (1,992,857       | )          | 23,490           |       |
| Long-term marketable securities                                              |       | 9,985             |       | —         |       | 101,081        |       | —           |       | 111,066          |       |
| Investments in and advances to subsidiaries                                  |       | 3,586,670         |       | 1,392,095      |       | 7,934          |       | (4,986,699       | )          | —           |       |
| Other assets                                                                 |       | 105,761           |       | 3,889          |       | 4,292          |       | (82,143          | )          | 31,799           |       |
| Debt issuance costs                                                          |       | 66,807            |       | —         |       | —         |       | —           |       | 66,807           |       |
| Total Assets                                                                 |       | $                 | 5,895,756  |           | $          | 6,588,344      |       | $                | 1,936,638  |             | $          | (7,274,349 | ) | $ | 7,146,389 |   |
|                                                                         |       |              |       |           |       |           |       |             |       |             |       |
| **Liabilities and Shareholder’s  Equity**                               |       |              |       |           |       |           |       |             |       |             |       |
| **Current Liabilities:**                                                     |       |              |       |           |       |           |       |             |       |             |       |
| Accounts payable                                                             |       | $                 | 1,046      |           | $          | 42,325         |       | $                | 30,100     |             | $          | — |   | $ | 73,471 |   |
| Accrued liabilities:                                                         |       |              |       |           |       |           |       |             |       |             |       |
| Payroll and related expenses                                                 |       | 2,185             |       | 33,687         |       | 38,513         |       | —           |       | 74,385           |       |
| Self-insured claims and related expenses                                     |       | —            |       | 21,727         |       | 65,605         |       | —           |       | 87,332           |       |
| Other                                                                        |       | 51,391            |       | 41,716         |       | 65,424         |       | (1,882           | )          | 156,649          |       |
| Deferred revenue                                                             |       | —            |       | 138,691        |       | 311,055        |       | —           |       | 449,746          |       |
| Liabilities of discontinued operations                                       |       | —            |       | 248            |       | 2,558          |       | —           |       | 2,806            |       |
| Current portion of long-term debt                                            |       | 141,230           |       | 27,226         |       | 106,707        |       | (210,768         | )          | 64,395           |       |
| Total Current Liabilities                                                    |       | 195,852           |       | 305,620        |       | 619,962        |       | (212,650         | )          | 908,784          |       |
|                                                                         |       |              |       |           |       |           |       |             |       |             |       |
| **Long-Term Debt**                                                           |       | 3,889,574         |       | 1,999,226      |       | 14,606         |       | (1,992,857       | )          | 3,910,549        |       |
|                                                                         |       |              |       |           |       |           |       |             |       |             |       |
| **Other Long-Term Liabilities:**                                             |       |              |       |           |       |           |       |             |       |             |       |
| Deferred taxes                                                               |       | —            |       | 754,531        |       | 284,689        |       | (82,143          | )          | 957,077          |       |
| Intercompany payable                                                         |       | 545,995           |       | —         |       | —         |       | (545,995         | )          | —           |       |
| Liabilities of discontinued operations                                       |       | —            |       | —         |       | 4,145          |       | —           |       | 4,145            |       |
| Other long-term obligations                                                  |       | 78,004            |       | 2,284          |       | 99,215         |       | —           |       | 179,503          |       |
| Total Other Long-Term Liabilities                                            |       | 623,999           |       | 756,815        |       | 388,049        |       | (628,138         | )          | 1,140,725        |       |
|                                                                         |       |              |       |           |       |           |       |             |       |             |       |
| **Shareholder’s Equity**                                                |       | 1,186,331         |       | 3,526,683      |       | 914,021        |       | (4,440,704       | )          | 1,186,331        |       |
|                                                                         |       |              |       |           |       |           |       |             |       |             |       |
| **Total Liabilities and Shareholder’s  Equity**                         |       | $                 | 5,895,756  |           | $          | 6,588,344      |       | $                | 1,936,638  |             | $          | (7,274,349 | ) | $ | 7,146,389 |   |

 

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**THE SERVICEMASTER COMPANY AND SUBSIDIARIES**

**Condensed Consolidating Statement of Cash Flows(Unaudited)**

**For the Six Months Ended June 30, 2010**

**(In thousands)**

 
| ** **                                                                             | ** ** | **The**           | ** ** | ** **     | ** ** | ** **     | ** ** | ** **       | ** ** | ** **       | ** ** |
|----------------------------------------------------------------------------------------|------------|-------------------|------------|----------------|------------|----------------|------------|------------------|------------|------------------|------------|
| ** **                                                                             | ** ** | **ServiceMaster** | ** ** | ** **     | ** ** | **Non-**       | ** ** | ** **       | ** ** | ** **       | ** ** |
| ** **                                                                             | ** ** | **Company**       | ** ** | **Guarantors** | ** ** | **Guarantors** | ** ** | **Eliminations** | ** ** | **Consolidated** | ** ** |
| **Cash and Cash Equivalents at  Beginning of Period**                                  |       | $                 | 124,674    |           | $          | 15,796         |       | $                | 112,993    |             | $          | — |   | $ | 253,463 |   |
| **Net Cash (Used for) Provided from  Operating Activities from Continuing Operations** |       | (51,391           | )          | 170,576        |       | 28,561         |       | (41,822          | )          | 105,924          |       |
|                                                                                   |       |              |       |           |       |           |       |             |       |             |       |
| **Cash Flows from Investing Activities  from Continuing Operations:**                  |       |              |       |           |       |           |       |             |       |             |       |
| Property additions                                                                     |       | —            |       | (37,030        | )          | (3,355         | )          | —           |       | (40,385          | )          |
| Sale of equipment and other assets                                                     |       | —            |       | 983            |       | 105            |       | —           |       | 1,088            |       |
| Acquisition of The ServiceMaster Company                                               |       | (2,164            | )          | —         |       | —         |       | —           |       | (2,164           | )          |
| Other business acquisitions, net of cash acquired                                      |       | —            |       | (14,644        | )          | (109           | )          | —           |       | (14,753          | )          |
| Notes receivable, financial investments and  securities, net                           |       | —            |       | —         |       | (898           | )          | —           |       | (898             | )          |
| **Net Cash Used for Investing  Activities from Continuing Operations**                 |       | (2,164            | )          | (50,691        | )          | (4,257         | )          | —           |       | (57,112          | )          |
|                                                                                   |       |              |       |           |       |           |       |             |       |             |       |
| **Cash Flows from Financing  Activities from Continuing Operations:**                  |       |              |       |           |       |           |       |             |       |             |       |
| Borrowings of debt                                                                     |       | —            |       | —         |       | 10,000         |       | —           |       | 10,000           |       |
| Payments of debt                                                                       |       | (13,625           | )          | (7,827         | )          | (610           | )          | —           |       | (22,062          | )          |
| Debt issuance costs paid                                                               |       | —            |       | —         |       | (30            | )          | —           |       | (30              | )          |
| Shareholders’ dividends                                                           |       | —            |       | (20,911        | )          | (20,911        | )          | 41,822           |       | —           |       |
| Net intercompany advances                                                              |       | 84,729            |       | (87,283        | )          | 2,554          |       | —           |       | —           |       |
| **Net Cash Provided from (Used for)  Financing Activities from Continuing Operations** |       | 71,104            |       | (116,021       | )          | (8,997         | )          | 41,822           |       | (12,092          | )          |
|                                                                                   |       |              |       |           |       |           |       |             |       |             |       |
| **Cash Flows from Discontinued  Operations:**                                          |       |              |       |           |       |           |       |             |       |             |       |
| Cash used for operating activities                                                     |       | —            |       | —         |       | (1,048         | )          | —           |       | (1,048           | )          |
| **Net Cash Used for Discontinued  Operations**                                         |       | —            |       | —         |       | (1,048         | )          | —           |       | (1,048           | )          |
| **Cash (Decrease) Increase During  the Period**                                        |       | 17,549            |       | 3,864          |       | 14,259         |       | —           |       | 35,672           |       |
|                                                                                   |       |              |       |           |       |           |       |             |       |             |       |
| **Cash and Cash Equivalents at End  of Period**                                        |       | $                 | 142,223    |           | $          | 19,660         |       | $                | 127,252    |             | $          | — |   | $ | 289,135 |   |

 

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**THESERVICEMASTER COMPANY AND SUBSIDIARIES**

**Condensed Consolidating Statement of Cash Flows(Unaudited)**

**For the Six Months Ended June 30, 2009**

**(In thousands)**

 
| ** **                                                                             | ** ** | **The**           | ** ** | ** **     | ** ** | ** **     | ** ** | ** **       | ** ** | ** **       | ** ** |
|----------------------------------------------------------------------------------------|------------|-------------------|------------|----------------|------------|----------------|------------|------------------|------------|------------------|------------|
| ** **                                                                             | ** ** | **ServiceMaster** | ** ** | ** **     | ** ** | **Non-**       | ** ** | ** **       | ** ** | ** **       | ** ** |
| ** **                                                                             | ** ** | **Company**       | ** ** | **Guarantors** | ** ** | **Guarantors** | ** ** | **Eliminations** | ** ** | **Consolidated** | ** ** |
| **Cash and Cash Equivalents at  Beginning of Period**                                  |       | $                 | 300,362    |           | $          | 12,105         |       | $                | 93,120     |             | $          | — |   | $ | 405,587 |   |
| **Net Cash (Used for) Provided from  Operating Activities from Continuing Operations** |       | (82,702           | )          | 208,214        |       | (10,649        | )          | (43,634          | )          | 71,229           |       |
|                                                                                   |       |              |       |           |       |           |       |             |       |             |       |
| **Cash Flows from Investing  Activities from Continuing Operations:**                  |       |              |       |           |       |           |       |             |       |             |       |
| Property additions                                                                     |       | —            |       | (33,520        | )          | (5,373         | )          | —           |       | (38,893          | )          |
| Sale of equipment and other assets                                                     |       | —            |       | 1,905          |       | 50             |       | —           |       | 1,955            |       |
| Acquisition of The ServiceMaster Company                                               |       | (1,119            | )          | —         |       | —         |       | —           |       | (1,119           | )          |
| Other business acquisitions, net of cash acquired                                      |       | —            |       | (7,268         | )          | —         |       | —           |       | (7,268           | )          |
| Notes receivable, financial investments and  securities, net                           |       | —            |       | —         |       | 3,968          |       | —           |       | 3,968            |       |
| **Net Cash (Used for) Provided from  Investing Activities from Continuing Operations** |       | (1,119            | )          | (38,883        | )          | (1,355         | )          | —           |       | (41,357          | )          |
|                                                                                   |       |              |       |           |       |           |       |             |       |             |       |
| **Cash Flows from Financing  Activities from Continuing Operations:**                  |       |              |       |           |       |           |       |             |       |             |       |
| Payments of debt                                                                       |       | (54,635           | )          | (8,249         | )          | (1,923         | )          | —           |       | (64,807          | )          |
| Debt issuance costs paid                                                               |       | (369              | )          | —         |       | —         |       | —           |       | (369             | )          |
| Shareholders’ dividends                                                           |       | —            |       | (21,817        | )          | (21,817        | )          | 43,634           |       | —           |       |
| Net intercompany advances                                                              |       | 55,670            |       | (132,980       | )          | 77,310         |       | —           |       | —           |       |
| **Net Cash (Used for) Provided from  Financing Activities from Continuing Operations** |       | 666               |       | (163,046       | )          | 53,570         |       | 43,634           |       | (65,176          | )          |
|                                                                                   |       |              |       |           |       |           |       |             |       |             |       |
| **Cash Flows from Discontinued  Operations:**                                          |       |              |       |           |       |           |       |             |       |             |       |
| Cash used for operating activities                                                     |       | —            |       | —         |       | (1,209         | )          | —           |       | (1,209           | )          |
| Cash used for investing activities                                                     |       | —            |       | —         |       | (914           | )          | —           |       | (914             | )          |
| **Net Cash Used for Discontinued  Operations**                                         |       | —            |       | —         |       | (2,123         | )          | —           |       | (2,123           | )          |
| **Cash (Decrease) Increase During  the Period**                                        |       | (83,155           | )          | 6,285          |       | 39,443         |       | —           |       | (37,427          | )          |
|                                                                                   |       |              |       |           |       |           |       |             |       |             |       |
| **Cash and Cash Equivalents at End  of Period**                                        |       | $                 | 217,207    |           | $          | 18,390         |       | $                | 132,563    |             | $          | — |   | $ | 368,160 |   |

 

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

 

**Merger Agreement**

 

On March 18, 2007, ServiceMaster entered into the Merger Agreementwith Holdings and Acquisition Co., and the Merger was completed onJuly 24, 2007. Immediately following the completion of the Merger, all ofthe outstanding capital stock of Holdings, the ultimate parent company ofServiceMaster, was owned by investment funds sponsored by, or affiliated with,the Equity Sponsors.

 

Equity contributions totaling $1,431.1 million from the EquitySponsors, together with (i) borrowings under the Interim Loan Facility,(ii) borrowings under a new $2,650.0 million senior secured term loanfacility and (iii) cash on hand at ServiceMaster, were used, among otherthings, to finance the aggregate merger consideration, to make payments insatisfaction of other equity-based interests in ServiceMaster under the MergerAgreement, to settle existing interest rate swaps, to redeem or provide for therepayment of certain of the Company’s existing indebtedness and to pay relatedtransaction fees and expenses. In addition, letters of credit issued under anew $150.0 million pre-funded letter of credit facility were used toreplace and/or secure letters of credit previously issued under a ServiceMastercredit facility that was terminated as of the Closing Date. On the ClosingDate, the Company also entered into, but did not then draw under, the RevolvingCredit Facility.

 

On July 24, 2008, outstanding amounts under the Interim LoanFacility were converted on a one to one basis into the Permanent Notes. ThePermanent Notes were issued pursuant to a refinancing indenture. In connectionwith the issuance of Permanent Notes, ServiceMaster entered into theRegistration Rights Agreement, pursuant to which ServiceMaster filed with theSEC a registration statement with respect to the resale of the Permanent Notes,which was declared effective on January 16, 2009. ServiceMasterderegistered the Permanent Notes in accordance with the terms of theRegistration Rights Agreement, and the effectiveness of the registrationstatement was terminated, on November 19, 2009.

 

**Results of Operations**

 

**Second Quarter 2010 Compared to 2009**

 

The Company reported second quarter 2010 revenue of $1,003.1 million, a$45.8 million, or 4.8 percent, increase compared to 2009. The revenue increasewas driven by the results of our business units as described in “SegmentReviews for the Second Quarter 2010 Compared to 2009”.

 

Operating income was $74.5 million for the second quarter of 2010compared to $118.0 million for the second quarter of 2009. Income fromcontinuing operations before income taxes was $2.2 million for the secondquarter of 2010 compared to $46.6 million for the second quarter of 2009.The decrease in income from continuing operations before income taxes of $44.4million reflects the net effect of:

 
| **(In  millions)**                             | ** ** | ** ** | ** ** |
|------------------------------------------------|------------|------------|------------|
| Interest expense(1)                            |       | $          | 1.5        |   |
| Interest and net investment income(2)          |       | (2.4       | )          |
| Restructuring and Merger related charges(3)    |       | 1.4        |       |
| Non-cash goodwill and trade name impairment(4) |       | (46.9      | )          |
| Management fee(5)                              |       | (1.4       | )          |
| Residual value guarantee charge(6)             |       | (3.9       | )          |
| Segment results(7)                             |       | 7.3        |       |
|                                           |       | $          | (44.4      | ) |

 

----

(1)                                 Represents adecrease in interest expense as a result of a decrease in our weighted averagelong-term debt balance as compared to the second quarter of 2009.

 

(2)                                 As furtherdescribed in “Operating and Non-Operating Expenses”, represents a decrease ininterest and net investment income.

 

(3)                                 Represents thenet positive effect of (i) an increase in restructuring charges related toa reorganization of field leadership and a restructuring of branch operationsat TruGreen LawnCare, (ii) a decrease in restructuring charges related toan information technology outsourcing at Other Operations and Headquartersand (iii) a decrease in Merger related charges.

 

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(4)                                  Represents anon-cash impairment charge of $46.9 million recorded in the second quarter of2010 to reduce the carrying value of goodwill and trade names at TruGreenLandCare as a result of the Company’s interim impairment test of goodwill andindefinite-lived intangible assets. SeeNote 5 to the condensed consolidated financial statements for furtherinformation.

 

(5)                                  Represents anincrease in management and consulting fees payable to certain related parties.A management fee is payable to CD&R pursuant to a consulting agreementunder which CD&R provides the Company with on-going consulting andmanagement advisory services in exchange for an annual management fee of$6.25 million, which is payable quarterly. On July 30, 2009, theannual management fee payable under the consulting agreement with CD&R wasincreased from $2.0 million to $6.25 million in order to align thefee structure with current market rates. Under this agreement, the Companyrecorded a management fee of $1.6 million and $0.5 million for the secondquarter of 2010 and 2009, respectively. The full year management fee wasapplied in 2009, and the incremental fees relating to the first three quartersof 2009 were recorded and paid to CD&R in the third quarter of 2009.

 

In addition, in August 2009, the Companyentered into consulting agreements with Citigroup, BAS and JPMorgan, each ofwhich is an Equity Sponsor or an affiliate of an Equity Sponsor. Under theconsulting agreements, Citigroup, BAS and JPMorgan each provide the Companywith on-going consulting and management advisory services through June 30,2016 or the earlier termination of the existing consulting agreement betweenthe Company and CD&R. The Company pays annual management fees of$0.5 million, $0.5 million and $0.25 million to Citigroup, BASand JPMorgan, respectively. The Company recorded consulting fees related tothese agreements of $0.3 million for the second quarter of 2010. The fullyear management fee was applied in 2009, and the incremental fees relating tothe first three quarters of 2009 were recorded and paid to Citigroup, BAS andJPMorgan in the third quarter of 2009.

 

(6)                                  Represents residual valueguarantee charges related to a synthetic lease for operating properties that donot result in additional cash payments to exit the facility at the end of thelease term. In the third quarter of 2009, the Company determined that it wasprobable that the fair value of the real properties under operating leaseswould be below the total amount funded under the lease facilities at the end ofthe lease term. The Company’s estimate of this shortfall was $15.9 million,which was expensed over the remainder of the lease term. The Company recordedcharges of $5.5 million in 2009 and $9.1 million in the first six months of2010 (of which $3.9 million was recorded in the second quarter) related to thisshortfall. The remaining $1.3 million was recorded in July 2010.

 

(7)                                 Represents anet increase in income from continuing operations before income taxes, interestexpense, interest and net investment income, restructuring and Merger relatedcharges, non-cash goodwill and trade name impairment, residual value guaranteecharge and management fee, reflecting the improvement in results at TruGreenLawnCare, Terminix and ServiceMaster Clean, offset, in part, by the decline inresults at American Home Shield, TruGreen LandCare and Other Operations andHeadquarters as described in “Segment Reviews for the Second Quarter 2010Compared to 2009”.

 

***Operating and Non-Operating Expenses***

 

The Company reported cost of services rendered and products sold of$573.6 million for the second quarter of 2010 compared to $553.4 millionfor the second quarter of 2009. As a percentage of revenue, these costsdecreased to 57.2 percent for the second quarter of 2010 from57.8 percent for the second quarter of 2009. This primarily reflectsreduced fuel costs, as well as reduced fertilizer costs at TruGreen LawnCare,offset, in part, by the impact of residual value guarantee charges at TruGreenLawnCare, decreased labor efficiencies at TruGreen LandCare and increasedfrequency of contract claims costs at American Home Shield.

 

TheCompany reported selling and administrative expenses of $263.5 million for thesecond quarter of 2010 compared to $239.9 million for the second quarter of2009. As a percentage of revenue, these costs increased to 26.3 percentfor the second quarter of 2010 from 25.1 percent for the second quarter of2009. This primarily reflects investments in sales and marketing, increasedprovisions for incentive compensation, increased project costs related to ourongoing initiatives to restructure our branch operations and to improvecustomer service at TruGreen LawnCare, increased provisions for certain legal mattersat American Home Shield and increased management fees related to the consultingagreements with the Equity Sponsors amended and executed in 2009.

 

Amortization expense was $40.5 million for the second quarter of 2010compared to $40.4 million for the second quarter of 2009.

 

Non-operating expense totaled $72.3 million for the second quarter of2010 compared to $71.4 million for the second quarter of 2009. This changeincludes a $2.4 million decrease in interest and net investment income, offset,in part, by a $1.5 million decrease in interest expense resulting from adecrease in our weighted average long-term debt balance. Interest and netinvestment income was comprised of the following for the second quarter of 2010and 2009:

 

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| ** **                         | ** ** | **Three months ended  June 30,** | ** ** |
|------------------------------------|------------|---------------------------------------|------------|
| **(In  thousands)**                | ** ** | **2010**                              | ** ** | **2009** | ** ** |
| Realized gains(1)                  |       | $                                     | 1,604      |   | $ | 2,141 |   |
| Impairments of securities(2)       |       | —                                |       | (469 | ) |
| Deferred compensation trust(3)     |       | (810                                  | )          | 1,203 |   |
| Other(4)                           |       | 202                                   |       | 520 |   |
| Interest and net investment income |       | $                                     | 996        |   | $ | 3,395 |   |

 

----

(1)                                 Represents thenet investment gains and the interest and dividend income realized on theAmerican Home Shield investment portfolio.

 

(2)                                 Representsother than temporary declines in the value of certain investments in theAmerican Home Shield investment portfolio.

 

(3)                                 Representsinvestment (loss) income resulting from a change in the market value ofinvestments within an employee deferred compensation trust (for which there isa corresponding and offsetting change in compensation expense within incomefrom continuing operations before income taxes).

 

(4)                                 Represents aportion of the earnings generated by SMAC, our financing subsidiary exclusivelydedicated to providing financing to our franchisees and retail customers of ouroperating units, and interest income on other cash balances.

 

The effective tax rate on income from continuing operations was abenefit of 483.7 percent for the second quarter of 2010 compared to a provisionof 51.9 percent for the second quarter of 2009. The benefit in the secondquarter of 2010 is primarily the result of a change in the full year projectedrate (due to the impairment of goodwill and trade names at TruGreen LandCare)applied to the loss from continuing operations before income taxes for the sixmonths ended June 30, 2010.

 

***Restructuring and Merger RelatedCharges***

 

TheCompany incurred restructuring and Merger related charges of $4.2 million and$5.6 million for the second quarter of 2010 and 2009, respectively.Restructuring and Merger related charges were comprised of the following:

 
| ** **                                             | ** ** | **Three months ended****June 30,** | ** ** |
|--------------------------------------------------------|------------|----------------------------------------------|------------|
| **(In thousands)**                                | ** ** | **2010**                                     | ** ** | **2009** | ** ** |
| TruGreen LawnCare  reorganization and restructuring(1) |       | $                                            | 2,939      |   | $ | — |   |
| Information technology  outsourcing(2)                 |       | —                                       |       | 4,187 |   |
| Merger related charges(3)                              |       | 1,005                                        |       | 1,154 |   |
| Other                                                  |       | 223                                          |       | 243 |   |
| Total restructuring and  Merger related charges        |       | $                                            | 4,167      |   | $ | 5,584 |   |

 

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(1)                                  Representsrestructuring charges related to a reorganization of field leadership and arestructuring of branch operations. For the second quarter of 2010, these costsincluded consulting fees of $1.9 million and severance, lease termination andother costs of $1.0 million. In connection with the restructuring of branchoperations, we expect to incur cash charges through the fourth quarter of 2010related to, among other things, employee retention, severance costs andconsulting fees. Such charges are expected to amount to an additional $2.9million, pre-tax, and will be recorded as restructuring charges in thecondensed consolidated statement of operations as incurred.

 

(2)                                  OnDecember 11, 2008, the Company entered into an agreement with IBM pursuantto which IBM provides information technology operations and applicationsdevelopment services to the Company. These services were phased in during thefirst half of 2009. For the second quarter of 2009, these costs includedtransition fees paid to IBM of $3.4 million, employee retention and severancecosts of $0.4 million and consulting and other costs of $0.4 million.

 

(3)                                  Includesseverance, retention, legal fees and other costs associated with the Merger.

 

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***Impairment ofGoodwill and Trade Names***

 

During the second quarter of 2010, theCompany recorded a non-cash impairment charge of $46.9 million to reduce thecarrying value of goodwill and trade names at TruGreen LandCare as a result ofan interim impairment test of goodwill and indefinite-lived intangible assets.See Note 5 to the condensed consolidated financial statements for furtherdetails.

 

**KeyPerformance Indicators**

 

The table below presents selected operating metrics related to customercounts and customer retention for the three largest revenue generatingbusinesses in the Company. These measures are presented on a rolling,twelve-month basis in order to avoid seasonal anomalies.

 
| ** **                                   | ** ** | **Key Performance Indicators  as of June 30,** | ** ** |
|----------------------------------------------|------------|---------------------------------------------------------------|------------|
| ** **                                   | ** ** | **2010**                                                      | ** ** | **2009** | ** ** |
| **TruGreen LawnCare—**                  |       |                                                          |       |   |   |
| Growth (Reduction) in Full Program Accounts  |       | 3                                                             | %          | (3 | )% |
| Customer Retention Rate                      |       | 70.9                                                          | %          | 68.3 | % |
| **Terminix—**                           |       |                                                          |       |   |   |
| Growth in Pest Control Customers             |       | 2                                                             | %          | 1 | % |
| Pest Control Customer Retention Rate         |       | 79.7                                                          | %          | 77.9 | % |
| Growth (Reduction) in Termite Customers      |       | 0                                                             | %          | (1 | )% |
| Termite Customer Retention Rate              |       | 86.2                                                          | %          | 86.2 | % |
| **American Home Shield—**               |       |                                                          |       |   |   |
| Growth (Reduction) in Home Service Contracts |       | 5                                                             | %          | (3 | )% |
| Customer Retention Rate                      |       | 65.6                                                          | %          | 62.6 | % |

 

**Segment Reviews for the Second Quarter 2010 Comparedto 2009**

 

The following business segment reviews should be read in conjunctionwith the required footnote disclosures presented in the Notes to the condensedconsolidated financial statements. This disclosure provides a reconciliation ofsegment operating income to income from continuing operations before incometaxes, with net non-operating expenses as the only reconciling item. Theoperating income, EBITDA, Adjusted EBITDA, and Comparable Operating Performancefor each reportable segment have been revised to reflect the Company’s revisedallocation methodology for all periods presented. See Note 14 to the condensedconsolidated financial statements for further information.

 

The Company uses Adjusted EBITDA and Comparable Operating Performanceto facilitate operating performance comparisons from period to period. AdjustedEBITDA and Comparable Operating Performance are supplemental measures of theCompany’s performance that are not required by, or presented in accordancewith, GAAP. Adjusted EBITDA and Comparable Operating Performance are notmeasurements of the Company’s financial performance under GAAP and should notbe considered as alternatives to net income or any other performance measuresderived in accordance with GAAP or as alternatives to net cash provided byoperating activities or any other measures of the Company’s cash flow orliquidity. “Adjusted EBITDA” means net income (loss) before net income (loss)from discontinued operations; provision (benefit) for income taxes; otherexpense; gain on extinguishment of debt; interest expense and interest and netinvestment loss (income); and depreciation and amortization expense; as well asadding back interest and net investment loss (income), residual value guaranteecharge and non-cash goodwill and trade name impairment. “Comparable OperatingPerformance” is calculated by adding back to Adjusted EBITDA an amount equal tothe non-cash stock-based compensation expense and non-cash effects on AdjustedEBITDA attributable to the application of purchase accounting in connectionwith the Merger.

 

The Company believes Adjusted EBITDA facilitates company-to-companyoperating performance comparisons by backing out potential differences causedby variations in capital structures (affecting net interest income andexpense), taxation and the age and book depreciation of facilities andequipment (affecting relative depreciation expense), which may vary fordifferent companies for reasons unrelated to operating performance. Inaddition, the Company excludes residual value guarantee charges that do notresult in additional cash payments to exit the facility at the end of the leaseterm. The Company uses Comparable Operating Performance as a supplementalmeasure to assess the Company’s performance because it excludes non-cashstock-based compensation expense and non-cash effects on Adjusted EBITDAattributable to the application of purchase accounting in connection with theMerger. The Company presents Comparable Operating Performance because itbelieves that it is useful for investors, analysts and other interested partiesin their analysis of the Company’s operating results.

 

TheCompany believes Comparable Operating Performance, which excludes the impact ofpurchase accounting and non-cash stock-based compensation expense adjustments,is useful to investors. The exclusion of the impact of these items facilitatesa comparison of operating results from periods pre-dating the Mergertransaction with the Equity Sponsors with periods subsequent to the Merger. Thepurchase accounting charges were not present prior to the Merger. In addition,charges relating to non-cash stock-

 

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basedcompensation expense prior to the Merger were computed under different plansand formulas than charges subsequent to the Merger. Moreover, such charges arenon-cash and the exclusion of the impact of these items from Comparable OperatingPerformance allows investors to understand the current period results ofoperations of the business on a comparable basis with previous periods and,secondarily, gives the investors added insight into cash earnings available toservice the Company’s debt. We believe this to be of particular importance tothe Company’s public investors, which are debt holders. The Company alsobelieves that the exclusion of the impact of purchase accounting and non-cashstock-based compensation expense may provide an additional means for comparingthe Company’s performance to the performance of other companies by eliminatingthe impact of differently structured equity-based long-term incentive plans(although care must be taken in making any such comparison, as there may beinconsistencies among companies in the manner of computing similarly titledfinancial measures).

 

Adjusted EBITDA and Comparable Operating Performance are notnecessarily comparable to other similarly titled financial measures of othercompanies due to the potential inconsistencies in the method of calculation.

 

Adjusted EBITDA and Comparable Operating Performance have limitationsas analytical tools, and should not be considered in isolation or assubstitutes for analyzing the Company’s results as reported under GAAP. Some ofthese limitations are:

 

·                  Adjusted EBITDA andComparable Operating Performance do not reflect changes in, or cashrequirements for, the Company’s working capital needs;

 

·                  Adjusted EBITDA andComparable Operating Performance do not reflect the Company’s interest expenseor the cash requirements necessary to service interest or principal payments onthe Company’s debt;

 

·                  Adjusted EBITDA andComparable Operating Performance do not reflect the Company’s tax expense orthe cash requirements to pay the Company’s taxes;

 

·                  Adjusted EBITDA andComparable Operating Performance do not reflect historical cash expenditures orfuture requirements for capital expenditures or contractual commitments;

 

·                  Although depreciation andamortization are non-cash charges, the assets being depreciated and amortizedwill often have to be replaced in the future, and Adjusted EBITDA andComparable Operating Performance do not reflect any cash requirements for suchreplacements;

 

·                  Other companies in the Company’sindustries may calculate Adjusted EBITDA and Comparable Operating Performancedifferently, limiting their usefulness as comparative measures; and

 

·                  Comparable OperatingPerformance does not include the impact of purchase accounting and non-cash stock-basedcompensation expense, the latter exclusion may cause the overall compensationcost of the business to be understated.

 

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Operating revenues and Comparable Operating Performance by operatingsegment are as follows:

 
| ** **                                                   | ** ** | **Three months ended  June 30,** | ** ** |
|--------------------------------------------------------------|------------|---------------------------------------|------------|
| **(In thousands)**                                      | ** ** | **2010**                              | ** ** | **2009** | ** ** |
| Operating Revenue:                                           |       |                                  |       |   |   |
| TruGreen LawnCare                                            |       | $                                     | 378,642    |   | $ | 348,403 |   |
| TruGreen LandCare                                            |       | 63,463                                |       | 69,433 |   |
| Terminix                                                     |       | 323,393                               |       | 307,375 |   |
| American Home Shield                                         |       | 183,792                               |       | 179,823 |   |
| ServiceMaster Clean                                          |       | 32,034                                |       | 30,581 |   |
| Other Operations and Headquarters                            |       | 21,738                                |       | 21,677 |   |
| Total Operating Revenue                                      |       | $                                     | 1,003,062  |   | $ | 957,292 |   |
| Comparable Operating Performance:                            |       |                                  |       |   |   |
| TruGreen LawnCare                                            |       | $                                     | 78,577     |   | $ | 63,192 |   |
| TruGreen LandCare                                            |       | (855                                  | )          | 3,472 |   |
| Terminix                                                     |       | 85,091                                |       | 81,210 |   |
| American Home Shield                                         |       | 33,775                                |       | 41,118 |   |
| ServiceMaster Clean                                          |       | 14,745                                |       | 14,222 |   |
| Other Operations and Headquarters                            |       | (25,140                               | )          | (22,748 | ) |
| Total Comparable Operating Performance                       |       | $                                     | 186,193    |   | $ | 180,466 |   |
|                                                         |       |                                  |       |   |   |
| Memo: Items included in Comparable Operating  Performance:   |       |                                  |       |   |   |
| Restructuring and Merger related charges(1)                  |       | $                                     | 4,167      |   | $ | 5,584 |   |
| Management fee(2)                                            |       | $                                     | 1,875      |   | $ | 500 |   |
|                                                         |       |                                  |       |   |   |
| Memo: Items excluded from Comparable Operating  Performance: |       |                                  |       |   |   |
| Comparable Operating Performance of Discontinued  Operations |       | $                                     | (326       | ) | $ | (177 | ) |

 

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(1)                                 Represents(i) restructuring charges related to a reorganization of field leadershipand a restructuring of branch operations at TruGreen LawnCare and informationtechnology outsourcing at Other Operations and Headquarters and(ii) Merger related charges.

 

(2)                                 Represents management andconsulting fees payable to certain related parties. See Note 15 to thecondensed consolidated financial statements for further information onmanagement and consulting fees.

 

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Thefollowing table presents reconciliations of operating income, the most directlycomparable financial measure under GAAP, to Adjusted EBITDA and ComparableOperating Performance for the periods presented.

 

 
| **(in thousands)**                                            | ** ** | **TruGreen  LawnCare** | ** ** | **TruGreen  LandCare** | ** ** | **Terminix** | ** ** | **American  Home  Shield** | ** ** | **Service********Master  Clean** | ** ** | **Other  Operations  and  Headquarters** | ** ** | **Total** | ** ** |
|--------------------------------------------------------------------|------------|------------------------|------------|------------------------|------------|--------------|------------|----------------------------|------------|----------------------------------|------------|------------------------------------------|------------|-----------|------------|
| **Three Months Ended June 30,  2010**                         |       |                   |       |                   |       |         |       |                       |       |                             |       |                                     |       |      |       |
| Operating income (loss)(1)                                         |       | $                      | 52,606     |                   | $          | (50,572      | )          | $                          | 68,755     |                             | $          | 21,360                                   |       | $         | 12,572     |   | $ | (30,205 | ) | $ | 74,516 |   |
| Depreciation and amortization expense                              |       | 22,536                 |       | 2,987                  |       | 16,386       |       | 10,850                     |       | 1,789                            |       | 3,395                                    |       | 57,943    |       |
| EBITDA                                                             |       | 75,142                 |       | (47,585                | )          | 85,141       |       | 32,210                     |       | 14,361                           |       | (26,810                                  | )          | 132,459   |       |
| Interest and net investment income (2)                             |       | —                 |       | —                 |       | —       |       | 1,603                      |       | —                           |       | (607                                     | )          | 996       |       |
| Residual value guarantee charge(3)                                 |       | 3,448                  |       | —                 |       | —       |       | —                     |       | 384                              |       | 96                                       |       | 3,928     |       |
| Non-cash goodwill and trade name impairment(4)                     |       | —                 |       | 46,884                 |       | —       |       | —                     |       | —                           |       | —                                   |       | 46,884    |       |
| Adjusted EBITDA                                                    |       | 78,590                 |       | (701                   | )          | 85,141       |       | 33,813                     |       | 14,745                           |       | (27,321                                  | )          | 184,267   |       |
| Non-cash stock-based compensation expense                          |       | —                 |       | —                 |       | —       |       | —                     |       | —                           |       | 2,181                                    |       | 2,181     |       |
| Non-cash credits attributable to purchase  accounting(5)           |       | (13                    | )          | (154                   | )          | (50          | )          | (38                        | )          | —                           |       | —                                   |       | (255      | )          |
| Comparable Operating Performance                                   |       | $                      | 78,577     |                   | $          | (855         | )          | $                          | 85,091     |                             | $          | 33,775                                   |       | $         | 14,745     |   | $ | (25,140 | ) | $ | 186,193 |   |
| Memo: Items included in Comparable Operating  Performance          |       |                   |       |                   |       |         |       |                       |       |                             |       |                                     |       |      |       |
| Restructuring and Merger related charges(6)                        |       | $                      | 2,939      |                   | $          | 87           |       | $                          | 32         |                             | $          | —                                   |       | $         | —     |   | $ | 1,109 |   | $ | 4,167 |   |
| Management fee(7)                                                  |       | $                      | —     |                   | $          | —       |       | $                          | —     |                             | $          | —                                   |       | $         | —     |   | $ | 1,875 |   | $ | 1,875 |   |
| Memo: Items excluded from Comparable Operating  Performance        |       |                   |       |                   |       |         |       |                       |       |                             |       |                                     |       |      |       |
| Comparable Operating Performance of Discontinued  Operations(8)    |       | $                      | —     |                   | $          | —       |       | $                          | —     |                             | $          | —                                   |       | $         | —     |   | $ | (326 | ) | $ | (326 | ) |
|                                                               |       |                   |       |                   |       |         |       |                       |       |                             |       |                                     |       |      |       |
| **Three Months Ended June 30,  2009**                         |       |                   |       |                   |       |         |       |                       |       |                             |       |                                     |       |      |       |
| Operating income (loss)(1)                                         |       | $                      | 41,055     |                   | $          | 591          |       | $                          | 65,381     |                             | $          | 28,750                                   |       | $         | 12,139     |   | $ | (29,911 | ) | $ | 118,005 |   |
| Depreciation and amortization expense                              |       | 22,166                 |       | 3,044                  |       | 15,929       |       | 10,645                     |       | 2,083                            |       | 3,473                                    |       | 57,340    |       |
| EBITDA                                                             |       | 63,221                 |       | 3,635                  |       | 81,310       |       | 39,395                     |       | 14,222                           |       | (26,438                                  | )          | 175,345   |       |
| Interest and net investment income(2)                              |       | —                 |       | —                 |       | —       |       | 1,672                      |       | —                           |       | 1,723                                    |       | 3,395     |       |
| Adjusted EBITDA                                                    |       | 63,221                 |       | 3,635                  |       | 81,310       |       | 41,067                     |       | 14,222                           |       | (24,715                                  | )          | 178,740   |       |
| Non-cash stock-based compensation expense                          |       | —                 |       | —                 |       | —       |       | —                     |       | —                           |       | 1,967                                    |       | 1,967     |       |
| Non-cash (credits) charges attributable to  purchase accounting(5) |       | (29                    | )          | (163                   | )          | (100         | )          | 51                         |       | —                           |       | —                                   |       | (241      | )          |
| Comparable Operating Performance                                   |       | $                      | 63,192     |                   | $          | 3,472        |       | $                          | 81,210     |                             | $          | 41,118                                   |       | $         | 14,222     |   | $ | (22,748 | ) | $ | 180,466 |   |
| Memo: Items included in Comparable Operating  Performance          |       |                   |       |                   |       |         |       |                       |       |                             |       |                                     |       |      |       |
| Restructuring and Merger related (credits)  charges(6)             |       | $                      | —     |                   | $          | (21          | )          | $                          | (69        | )                                | $          | 36                                       |       | $         | —     |   | $ | 5,638 |   | $ | 5,584 |   |
| Management fee(7)                                                  |       | $                      | —     |                   | $          | —       |       | $                          | —     |                             | $          | —                                   |       | $         | —     |   | $ | 500 |   | $ | 500 |   |
| Memo: Items excluded from Comparable Operating  Performance        |       |                   |       |                   |       |         |       |                       |       |                             |       |                                     |       |      |       |
| Comparable Operating Performance of Discontinued  Operations(8)    |       | $                      | —     |                   | $          | —       |       | $                          | —     |                             | $          | —                                   |       | $         | —     |   | $ | (177 | ) | $ | (177 | ) |

 

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(1)                                  Presented belowis a reconciliation of total segment operating income to net income.

 
| ** **                                              | ** ** | **Three months ended  June 30,** | ** ** |
|---------------------------------------------------------|------------|---------------------------------------|------------|
| **(In thousands)**                                 | ** ** | **2010**                              | ** ** | **2009** | ** ** |
| Total Segment Operating Income                          |       | $                                     | 74,516     |   | $ | 118,005 |   |
| Non-operating Expense (Income):                         |       |                                  |       |   |   |
| Interest expense                                        |       | 73,169                                |       | 74,656 |   |
| Interest and net investment income                      |       | (996                                  | )          | (3,395 | ) |
| Other expense                                           |       | 176                                   |       | 179 |   |
| Income from Continuing Operations before Income  Taxes  |       | 2,167                                 |       | 46,565 |   |
| (Benefit) Provision for income taxes                    |       | (10,482                               | )          | 24,173 |   |
| Income from Continuing Operations                       |       | 12,649                                |       | 22,392 |   |
| Loss from discontinued operations, net of income  taxes |       | (205                                  | )          | (107 | ) |
| Net Income                                              |       | $                                     | 12,444     |   | $ | 22,285 |   |

 

(2)                                 Interest and net investmentincome is primarily comprised of investment income and realized gain (loss) onour American Home Shield segment investment portfolio. Cash, short-term andlong-term marketable securities associated with regulatory requirements inconnection with American Home Shield and for other purposes totaled $278.7million as of June 30, 2010. American Home Shield interest and netinvestment income was $1.6 million and $1.7 million for the second quarter of2010 and 2009, respectively. The balance of interest and net investment incomeprimarily relates to (i) a portion of the earnings generated by SMAC,(ii) investment income (loss) from our employee deferred compensationtrust (for which there is a corresponding and offsetting change in compensationexpense within income from continuing operations before income taxes) and(iii) interest income on other cash balances.

 

(3)                                  Represents residual valueguarantee charges related to a synthetic lease for operating properties that donot result in additional cash payments to exit the facility at the end of thelease term. In the third quarter of 2009, the Company determined that it wasprobable that the fair value of the real properties under operating leaseswould be below the total amount funded under the lease facilities at the end ofthe lease term. The Company’s estimate of this shortfall was $15.9 million,which was expensed over the remainder of the lease term. The Company recordedcharges of $5.5 million in 2009 and $9.1 million in the first six months of2010 (of which $3.9 million was recorded in the second quarter) related to thisshortfall. The remaining $1.3 million was recorded in July 2010.

 

(4)                                Represents anon-cash impairment charge of $46.9 million recorded in the second quarter of2010 to reduce the carrying value of goodwill and trade names at TruGreenLandCare as a result of the Company’s interim impairment test of goodwill andindefinite-lived intangible assets. SeeNote 5 to the condensed consolidated financial statements for furtherinformation.

 

(5)                                The Merger wasaccounted for using purchase accounting. This adjustment represents theaggregate, non-cash adjustments (other than amortization and depreciation)attributable to the application of purchase accounting.

 

(6)                                 Represents(i) restructuring charges related to a reorganization of field leadershipand a restructuring of branch operations at TruGreen LawnCare and informationtechnology outsourcing at Other Operations and Headquarters and(ii) Merger related charges.

 

(7)                                 Represents management andconsulting fees payable to certain related parties. See Note 15 to thecondensed consolidated financial statements for further information onmanagement and consulting fees.

 

(8)                                 There are no adjustmentsnecessary to reconcile operating loss from discontinued operations, the mostdirectly comparable financial measure under GAAP, to Adjusted EBITDA orComparable Operating Performance from discontinued operations for the secondquarter of 2010 and 2009.

 

***TruGreen LawnCareSegment***

 

TheTruGreen LawnCare segment, which includes lawn, tree and shrub care services,reported an 8.7 percent increase in revenue, a 28.1 percent increase inoperating income and a 24.3 percent improvement in Comparable OperatingPerformance for the second quarter of 2010 compared to 2009. The revenue andComparable Operating Performance results were favorably impacted by a delay inthe timing of service delivery from the first quarter into the second quarterof 2010 as a result of the unfavorable weather conditions experienced in thefirst quarter in almost all areas of the country. The revenue results alsoreflect a 2.5 percent increase in customer counts, higher sales of expandedservices to existing customers, lower discounts and improved price realization.The increase in customer counts was driven by a 260 basis point improvement inthe customer retention rate and an increase in new unit sales generated in ourneighborhood selling channel. Customer service remains the key focus forTruGreen LawnCare to drive 

 

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continuedimprovement in customer retention in 2010.

 

TruGreenLawnCare’s Comparable Operating Performance improved $15.4 million for thesecond quarter of 2010 compared to 2009, which includes the impact of a $2.9million increase in restructuring charges related to a reorganization of fieldleadership and a restructuring of branch operations. TruGreen LawnCare’simproved Comparable Operating Performance also reflects reduced fuel andfertilizer costs, offset, in part, by investments in sales and marketing andincreased project costs related to our ongoing initiatives to restructure ourbranch operations and to improve customer service.

 

***TruGreen LandCare Segment***

 

The TruGreen LandCare segment, which includes landscape maintenanceservices, reported an 8.6 percent decrease in revenue, a $51.2 million decreasein operating income and a 124.6 percent decline in Comparable OperatingPerformance for the second quarter of 2010 compared to 2009. The decrease inrevenue included a 10.1 percent decrease in base contract maintenance revenueand an 8.0 percent decrease in enhancement revenue. Revenue trends wereprimarily impacted by contract cancellations and pricing concessions granted in2009 and 2010 to offset the impacts of a difficult economic environment.However, the ratio of enhancement revenue to base contract maintenance revenuefor the second quarter of 2010 increased 120 basis points as compared to 2009.

 

TruGreen LandCare’s $51.2 million decline in operating income includesa non-cash impairment charge of $46.9 million to reduce the carrying value ofgoodwill and trade names to their estimated fair value as further described inNote 5 to the condensed consolidated financial statements. TruGreen LandCare’sComparable Operating Performance declined $4.3 million for the second quarterof 2010 compared to 2009, which also reflects decreased labor efficienciesresulting from increased technician overtime, offset, in part, by reduced fuelcosts.

 

***Terminix Segment***

 

The Terminix segment, which includes termite and pest control servicesand sales of pest control products, reported a 5.2 percent increase in revenue,a 5.2 percent increase in operating income and a 4.8 percent improvement inComparable Operating Performance for the second quarter of 2010 compared to2009. The segment’s overall revenue results reflected growth in termite andpest control revenues, as well as increased sales of products of $7.6 million.Termite revenues increased 1.3 percent for the second quarter of 2010 comparedto 2009, due to an increase in new unit sales, while customer retentionremained flat year over year. Pest control revenues increased 4.3 percent forthe second quarter of 2010 compared to 2009, reflecting a 2.4 percent increasein customer counts due to a 180 basis point improvement in the customerretention rate and an increase in new unit sales.

 

Terminix’s Comparable Operating Performance improved $3.9 million forthe second quarter of 2010 compared to 2009, which also reflects reduced fuelcosts and the favorable impact of acquiring assets in connection with exitingcertain fleet leases, offset, in part, by investments in sales and marketingand increased provisions for incentive compensation.

 

***American Home Shield Segment***

 

The American Home Shield segment, which provides home service contractsto consumers that cover heating, ventilation, air conditioning, plumbing and othersystems and appliances, reported a 2.2 percent increase in revenue, a 25.7percent decrease in operating income and a 17.9 percent decline in ComparableOperating Performance for the second quarter of 2010 compared to 2009. Theincrease in revenue reflects a 5.0 percent increase in customer counts andimproved price realization. The increase in customer counts was driven by anincrease in new unit sales and a 300 basis point improvement in customerretention. The second quarter revenue results were adversely impacted by adifference between years in the timing of revenue recognition. American HomeShield recognizes revenue over the contract period in proportion to theexpected direct costs. However, in the second quarter of 2010, seasonalcontract claims significantly exceeded historical averages, and the Company hasconcluded these claims will result in a full year reduction in American HomeShield’s planned operating income and Comparable Operating Performance. As aresult, in the second quarter of 2010, the Company did not adjust the timing ofrevenue recognition related to the unusual volume of seasonal contract claims.In the second quarter of 2009, revenue was recognized in proportion with thedirect costs incurred.

 

American Home Shield’s Comparable Operating Performance declined $7.3million for the second quarter of 2010 compared to 2009, which includes a 5.9percent increase in contract claims costs driven by an increase in seasonalcontract claims. American Home Shield’s Comparable Operating Performance alsoreflects increased provisions for certain legal matters and investments inconsumer sales programs.

 

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***ServiceMaster Clean Segment***

 

The ServiceMaster Clean segment, which provides residential andcommercial disaster restoration and cleaning services through franchiseesprimarily under the ServiceMaster and ServiceMaster Clean brand names, on-sitefurniture repair and restoration services primarily under the Furniture Medicbrand name and home inspection services primarily under the AmeriSpec brandname, reported a 4.8 percent increase in revenue, a 3.6 percentincrease in operating income and a 3.7 percent improvement in ComparableOperating Performance for the second quarter of 2010 compared to 2009. Trendsin revenue reflect an increase in national janitorial accounts and otherrevenues.

 

ServiceMaster Clean’s Comparable Operating Performance improved$0.5 million for the second quarter of 2010 compared to 2009, primarilyreflecting the impact of increased revenues.

 

***Other Operations and HeadquartersSegment***

 

This segment includes the operations of Merry Maids, SMAC and theCompany’s headquarters functions. The segment reported comparable revenue, a1.0 percent increase in operating loss and a 10.5 percent decline in ComparableOperating Performance for the second quarter of 2010 compared to 2009. TheMerry Maids operations reported comparable revenue, a 20.5 percentincrease in operating income and a 15.1 percent improvement in ComparableOperating Performance for the second quarter of 2010 compared to 2009.

 

The segment’s Comparable Operating Performance declined $2.4 millionfor the second quarter of 2010 compared to 2009, which includes the impact of a$1.4 million increase in management and consulting fees payable to the EquitySponsors and increased provisions for incentive compensation in 2010, dueprimarily to the reversal of a $4.4 million reserve for cash awards in 2009related to a long-term incentive plan as certain performance measures under theplan were not achieved. These factors were offset, in part, by a $4.5 milliondecrease in restructuring and Merger related charges. Comparable OperatingPerformance for Merry Maids improved $0.7 million for the second quarter of2010 compared to 2009, which reflects reduced overhead spending.

 

***Discontinued Operations***

 

The components of loss from discontinued operations, net of incometaxes for the second quarter of 2010 and 2009 are as follows:

 
| ** **                                              | ** ** | **Three months ended  June 30,** | ** ** |
|---------------------------------------------------------|------------|---------------------------------------|------------|
| **(In thousands)**                                 | ** ** | **2010**                              | ** ** | **2009** | ** ** |
| Operating loss                                          |       | $                                     | (326       | ) | $ | (177 | ) |
| Interest expense                                        |       | —                                |       | — |   |
| Loss from discontinued operations, before income  taxes |       | (326                                  | )          | (177 | ) |
| Benefit for income taxes                                |       | (121                                  | )          | (70 | ) |
| Loss from discontinued operations, net of income  taxes |       | $                                     | (205       | ) | $ | (107 | ) |

 

Thereare no adjustments necessary to reconcile operating loss from discontinuedoperations to Adjusted EBITDA or Comparable Operating Performance fromdiscontinued operations for the second quarter of 2010 and 2009.

 

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**Six Months Ended June 30, 2010 Compared to 2009**

 

The Company reported revenue of $1,642.5 million for the six monthsended June 30, 2010, a $39.3 million, or 2.4 percent, increase compared to2009. The revenue increase was driven by the results of our business units asdescribed in “Segment Reviews for the Six Months Ended June 30, 2010Compared to 2009”.

 

Operating income was $83.2 million for the six months ended June 30,2010 compared to $146.7 million for the six months ended June 30, 2009.Loss from continuing operations before income taxes was $59.5 million for thesix months ended June 30, 2010 compared to income from continuingoperations before income taxes of $39.7 million for the six months ended June 30,2009. The decrease in income from continuing operations before income taxes of$99.3 million reflects the net effect of:

 
| **(In  millions)**                             | ** ** | ** ** | ** ** |
|------------------------------------------------|------------|------------|------------|
| Interest expense(1)                            |       | $          | 5.5        |   |
| Interest and net investment income(2)          |       | 4.9        |       |
| Restructuring and Merger related charges(3)    |       | 6.3        |       |
| Non-cash goodwill and trade name impairment(4) |       | (46.9      | )          |
| Gain on extinguishment of debt(5)              |       | (46.1      | )          |
| Management fee(6)                              |       | (2.8       | )          |
| Residual value guarantee charge(7)             |       | (9.1       | )          |
| Segment results(8)                             |       | (11.1      | )          |
|                                           |       | $          | (99.3      | ) |

 

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(1)                                 Represents adecrease in interest expense as a result of a decrease in our weighted averagelong-term debt balance as compared to the six months ended June 30, 2009.

 

(2)                                 As furtherdescribed in “Operating and Non-Operating Expenses”, represents an increase ininterest and net investment income.

 

(3)                                 Represents thenet positive effect of (i) an increase in restructuring charges related toa reorganization of field leadership and a restructuring of branch operationsat TruGreen LawnCare, (ii) a decrease in restructuring charges related toa branch optimization project at Terminix, (iii) a decrease inrestructuring charges related to an information technology outsourcing at OtherOperations and Headquarters and (iv) a decrease in Merger relatedcharges.

 

(4)                                 Represents anon-cash impairment charge of $46.9 million recorded in the second quarter of2010 to reduce the carrying value of goodwill and trade names at TruGreenLandCare as a result of the Company’s interim impairment testing of goodwilland indefinite-lived intangible assets.See Note 5 to the condensed consolidated financial statements for furtherinformation.

 

(5)                                 Represents thegain on extinguishment of debt recorded in the six months ended June 30,2009 related to the completion of open market purchases of $89.0 million inface value of the Company’s Permanent Notes. There were no open market or otherpurchases of Permanent Notes by the Company in the six months ended June 30,2010.

 

(6)                                  Represents anincrease in management and consulting fees payable to certain related parties.A management fee is payable to CD&R pursuant to a consulting agreementunder which CD&R provides the Company with on-going consulting andmanagement advisory services in exchange for an annual management fee of$6.25 million, which is payable quarterly. On July 30, 2009, theannual management fee payable under the consulting agreement with CD&R wasincreased from $2.0 million to $6.25 million in order to align thefee structure with current market rates. Under this agreement, the Companyrecorded a management fee of $3.2 million and $1.0 million for the six monthsended June 30, 2010 and 2009, respectively. The full year management feewas applied in 2009, and the incremental fees relating to the first threequarters of 2009 were recorded and paid to CD&R in the third quarter of2009.

 

In addition, in August 2009, the Companyentered into consulting agreements with Citigroup, BAS and JPMorgan, each ofwhich is an Equity Sponsor or an affiliate of an Equity Sponsor. Under theconsulting agreements, Citigroup, BAS and JPMorgan each provide the Companywith on-going consulting and management advisory services through June 30,2016 or the earlier termination of the existing consulting agreement betweenthe Company and CD&R. The Company pays annual management fees of$0.5 million, $0.5 million and $0.25 million to Citigroup, BASand JPMorgan, respectively. The Company recorded consulting fees related tothese agreements of $0.6 million for the six months ended June 30,2010. The full year management fee was applied in 2009, and the incrementalfees relating to the first three quarters of 2009 were recorded and paid toCitigroup, BAS and JPMorgan in the third quarter of 2009.

 

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(7)                                  Represents residual valueguarantee charges related to a synthetic lease for operating properties that donot result in additional cash payments to exit the facility at the end of thelease term. In the third quarter of 2009, the Company determined that it wasprobable that the fair value of the real properties under operating leaseswould be below the total amount funded under the lease facilities at the end ofthe lease term. The Company’s estimate of this shortfall was $15.9 million,which was expensed over the remainder of the lease term. The Company recordedcharges of $5.5 million in 2009 and $9.1 million in the first six months of2010 related to this shortfall. The remaining $1.3 million was recorded inJuly 2010.

 

(8)                                 Represents anet decrease in income from continuing operations before income taxes, interestexpense, interest and net investment income, gain on extinguishment of debt,restructuring and Merger related charges, non-cash goodwill and trade nameimpairment, residual value guarantee charge and management fee, reflecting thedecline in results at TruGreen LandCare, American Home Shield and OtherOperations and Headquarters, offset, in part, by the improvement in results atTerminix, TruGreen LawnCare and ServiceMaster Clean as described in “SegmentReviews for the Six Months Ended June 30, 2010 Compared to 2009”.

 

***Operating and Non-Operating Expenses***

 

The Company reported cost of services rendered and products sold of$976.1 million for the six months ended June 30, 2010 compared to$947.8 million for the six months ended June 30, 2009. As apercentage of revenue, these costs increased to 59.4 percent for the sixmonths ended June 30, 2010 from 59.1 percent for the six months endedJune 30, 2009. This primarily reflects the impact of residual valueguarantee charges at TruGreen LawnCare, decreased labor efficiencies atTruGreen LandCare, increased provisions for certain legal matters at Terminixand increased frequency of contract claims costs at American Home Shield,offset, in part, by reduced fuel costs, as well as reduced fertilizer costs atTruGreen LawnCare and favorable termite damage claim trends at Terminix.

 

TheCompany reported selling and administrative expenses of $447.3 million for thesix months ended June 30, 2010 compared to $413.7 million for the sixmonths ended June 30, 2009. As a percentage of revenue, these costsincreased to 27.2 percent for the six months ended June 30, 2010 from25.8 percent for the six months ended June 30, 2009. This primarilyreflects investments in sales and marketing, increased provisions for incentivecompensation, increased project costs related to our ongoing initiatives torestructure our branch operations and to improve customer service at TruGreenLawnCare, increased provisions for certain legal matters at American HomeShield and increased management fees related to the consulting agreements withthe Equity Sponsors amended and executed in 2009.

 

Amortization expense was $80.9 million for the six months ended June 30,2010 compared to $80.7 million for the six months ended June 30, 2009.

 

Non-operating expense totaled $142.7 million for the six months ended June 30,2010 compared to $107.0 million for the six months ended June 30,2009. This change includes a $46.1 million gain on extinguishment of debtrecorded in the six months ended June 30, 2009, offset, in part, by a$5.5 million decrease in interest expense resulting from a decrease in ourweighted average long-term debt balance and a $4.9 million increase in interestand net investment income. Interest and net investment income was comprised ofthe following for the six months ended June 30, 2010 and 2009:

 
| ** **                                | ** ** | **Six months ended  June 30,** | ** ** |
|-------------------------------------------|------------|-------------------------------------|------------|
| **(In  thousands)**                       | ** ** | **2010**                            | ** ** | **2009** | ** ** |
| Realized gains(1)                         |       | $                                   | 3,229      |   | $ | 2,761 |   |
| Impairments of securities(2)              |       | —                              |       | (5,854 | ) |
| Deferred compensation trust(3)            |       | (373                                | )          | 502 |   |
| Other(4)                                  |       | 642                                 |       | 1,225 |   |
| Interest and net investment income (loss) |       | $                                   | 3,498      |   | $ | (1,366 | ) |

 

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(1)                                 Represents thenet investment gains and the interest and dividend income realized on theAmerican Home Shield investment portfolio.

 

(2)                                 Representsother than temporary declines in the value of certain investments in theAmerican Home Shield investment portfolio.

 

(3)                                 Representsinvestment (loss) income resulting from a change in the market value ofinvestments within an employee deferred compensation trust (for which there isa corresponding and offsetting change in compensation expense within incomefrom continuing operations before income taxes).

 

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(4)                                 Represents aportion of the earnings generated by SMAC and interest income on other cashbalances.

 

The effective tax rate on income from continuing operations was abenefit of 67.0 percent for the six months ended June 30, 2010 compared toa provision of 41.8 percent for the six months ended June 30, 2009. Thebenefit for the six months ended June 30, 2010 is primarily the result ofa change in the full year projected rate (due to the impairment of goodwill andtrade names at TruGreen LandCare) applied to the loss from continuingoperations before income taxes for the six months ended June 30, 2010.

 

***Restructuring and Merger RelatedCharges***

 

TheCompany incurred restructuring and Merger related charges of $8.1 million and$14.4 million for the six months ended June 30, 2010 and 2009,respectively. Restructuring and Merger related charges were comprised of thefollowing:

 
| ** **                                             | ** ** | **Six months ended****June 30,** | ** ** |
|--------------------------------------------------------|------------|---------------------------------------|------------|
| **(In thousands)**                                | ** ** | **2010**                              | ** ** | **2009** | ** ** |
| TruGreen LawnCare  reorganization and restructuring(1) |       | $                                     | 5,962      |   | $ | — |   |
| Information technology  outsourcing(2)                 |       | —                                |       | 9,461 |   |
| Terminix branch  optimization(3)                       |       | —                                |       | 3,219 |   |
| Merger related charges(4)                              |       | 1,136                                 |       | 1,448 |   |
| Other                                                  |       | 993                                   |       | 233 |   |
| Total restructuring and  Merger related charges        |       | $                                     | 8,091      |   | $ | 14,361 |   |

 

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(1)                                  Representsrestructuring charges related to a reorganization of field leadership and arestructuring of branch operations. For the six months ended June 30,2010, these costs included consulting fees of $3.8 million and severance, leasetermination and other costs of $2.2 million. In connection with therestructuring of branch operations, we expect to incur cash charges through thefourth quarter of 2010 related to, among other things, employee retention,severance costs and consulting fees. Such charges are expected to amount to anadditional $2.9 million, pre-tax, and will be recorded as restructuring chargesin the condensed consolidated statement of operations as incurred.

 

(2)                                  OnDecember 11, 2008, the Company entered into an agreement with IBM pursuantto which IBM provides information technology operations and applicationsdevelopment services to the Company. These services were phased in during the firsthalf of 2009. For the six months ended June 30, 2009, these costs includedtransition fees paid to IBM of $7.2 million, employee retention and severancecosts of $1.3 million and consulting and other costs of $1.0 million.

 

(3)                                  Representsrestructuring charges related to a branch optimization project. For the sixmonths ended June 30, 2009, these costs included lease termination costsof $2.8 million and severance costs of $0.4 million.

 

(4)                                  Includesseverance, retention, legal fees and other costs associated with the Merger.

 

***Impairment ofGoodwill and Trade Names***

 

During the second quarter of 2010, theCompany recorded a non-cash impairment charge of $46.9 million to reduce thecarrying value of goodwill and trade names at TruGreen LandCare as a result ofan interim impairment test of goodwill and indefinite-lived intangible assets.See Note 5 to the condensed consolidated financial statements for furtherinformation.

 

**Segment Reviews for the Six Months Ended June 30,2010 Compared to 2009**

 

The following business segment reviews should be read in conjunctionwith the required footnote disclosures presented in the Notes to the condensedconsolidated financial statements. This disclosure provides a reconciliation ofsegment operating income to income from continuing operations before incometaxes, with net non-operating expenses as the only reconciling item. As notedin segment reviews for the second quarter 2010 compared to 2009, the Companyuses Adjusted EBITDA and Comparable Operating Performance to facilitateoperating performance comparisons from period to period. The operating income,EBITDA, Adjusted EBITDA, and Comparable Operating Performance for eachreportable segment have been revised to reflect the Company’s revisedallocation methodology for all periods presented. See Note 14 to the condensedconsolidated financial statements for further information.

 

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Operating revenues and Comparable Operating Performance by operatingsegment are as follows:

 
| ** **                                                   | ** ** | **Six months ended  June 30,** | ** ** |
|--------------------------------------------------------------|------------|-------------------------------------|------------|
| **(In thousands)**                                      | ** ** | **2010**                            | ** ** | **2009** | ** ** |
| Operating Revenue:                                           |       |                                |       |   |   |
| TruGreen LawnCare                                            |       | $                                   | 502,724    |   | $ | 483,069 |   |
| TruGreen LandCare                                            |       | 122,263                             |       | 136,318 |   |
| Terminix                                                     |       | 594,310                             |       | 570,536 |   |
| American Home Shield                                         |       | 316,997                             |       | 310,691 |   |
| ServiceMaster Clean                                          |       | 64,296                              |       | 60,737 |   |
| Other Operations and Headquarters                            |       | 41,880                              |       | 41,868 |   |
| Total Operating Revenue                                      |       | $                                   | 1,642,470  |   | $ | 1,603,219 |   |
| Comparable Operating Performance:                            |       |                                |       |   |   |
| TruGreen LawnCare                                            |       | $                                   | 65,983     |   | $ | 67,762 |   |
| TruGreen LandCare                                            |       | 5,118                               |       | 14,246 |   |
| Terminix                                                     |       | 154,072                             |       | 146,764 |   |
| American Home Shield                                         |       | 52,795                              |       | 54,043 |   |
| ServiceMaster Clean                                          |       | 29,684                              |       | 28,238 |   |
| Other Operations and Headquarters                            |       | (47,015                             | )          | (49,069 | ) |
| Total Comparable Operating Performance                       |       | $                                   | 260,637    |   | $ | 261,984 |   |
|                                                         |       |                                |       |   |   |
| Memo: Items included in Comparable Operating  Performance:   |       |                                |       |   |   |
| Restructuring and Merger related charges(1)                  |       | $                                   | 8,091      |   | $ | 14,361 |   |
| Management fee(2)                                            |       | $                                   | 3,750      |   | $ | 1,000 |   |
|                                                         |       |                                |       |   |   |
| Memo: Items excluded from Comparable Operating  Performance: |       |                                |       |   |   |
| Comparable Operating Performance of Discontinued  Operations |       | $                                   | (944       | ) | $ | (441 | ) |

 

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(1)                                 Represents(i) restructuring charges related to a reorganization of field leadershipand a restructuring of branch operations at TruGreen LawnCare, a branchoptimization project at Terminix and information technology outsourcing atOther Operations and Headquarters and (ii) Merger related charges.

 

(2)                                 Represents management andconsulting fees payable to certain related parties. See Note 15 to thecondensed consolidated financial statements for further information onmanagement and consulting fees.

 

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Thefollowing table presents reconciliations of operating income, the most directlycomparable financial measure under GAAP, to Adjusted EBITDA and ComparableOperating Performance for the periods presented.

 
| **(in thousands)**                                              | ** ** | **TruGreen  LawnCare** | ** ** | **TruGreen  LandCare** | ** ** | **Terminix** | ** ** | **American  Home  Shield** | ** ** | **Service********Master  Clean** | ** ** | **Other  Operations  and  Headquarters** | ** ** | **Total** | ** ** |
|-----------------------------------------------------------------|------------|------------------------|------------|------------------------|------------|--------------|------------|----------------------------|------------|----------------------------------|------------|------------------------------------------|------------|-----------|------------|
| **Six months ended June 30, 2010**                         |       |                   |       |                   |       |         |       |                       |       |                             |       |                                     |       |      |       |
| Operating  income (loss)(1)                                     |       | $                      | 13,518     |                   | $          | (47,229      | )          | $                          | 121,735    |                             | $          | 28,468                                   |       | $         | 25,244     |   | $ | (58,573 | ) | $ | 83,163 |   |
| Depreciation  and amortization expense                          |       | 44,511                 |       | 5,775                  |       | 32,450       |       | 21,137                     |       | 3,584                            |       | 6,736                                    |       | 114,193   |       |
| EBITDA                                                          |       | 58,029                 |       | (41,454                | )          | 154,185      |       | 49,605                     |       | 28,828                           |       | (51,837                                  | )          | 197,356   |       |
| Interest  and net investment income (2)                         |       | —                 |       | —                 |       | —       |       | 3,228                      |       | —                           |       | 270                                      |       | 3,498     |       |
| Residual  value guarantee charge(3)                             |       | 7,982                  |       | —                 |       | —       |       | —                     |       | 856                              |       | 213                                      |       | 9,051     |       |
| Non-cash  goodwill and trade name impairment(4)                 |       | —                 |       | 46,884                 |       | —       |       | —                     |       | —                           |       | —                                   |       | 46,884    |       |
| Adjusted  EBITDA                                                |       | 66,011                 |       | 5,430                  |       | 154,185      |       | 52,833                     |       | 29,684                           |       | (51,354                                  | )          | 256,789   |       |
| Non-cash  stock-based compensation expense                      |       | —                 |       | —                 |       | —       |       | —                     |       | —                           |       | 4,339                                    |       | 4,339     |       |
| Non-cash  credits attributable to purchase accounting(5)        |       | (28                    | )          | (312                   | )          | (113         | )          | (38                        | )          | —                           |       | —                                   |       | (491      | )          |
| Comparable  Operating Performance                               |       | $                      | 65,983     |                   | $          | 5,118        |       | $                          | 154,072    |                             | $          | 52,795                                   |       | $         | 29,684     |   | $ | (47,015 | ) | $ | 260,637 |   |
| Memo:  Items included in Comparable Operating Performance       |       |                   |       |                   |       |         |       |                       |       |                             |       |                                     |       |      |       |
| Restructuring  and Merger related charges (credits)(6)          |       | $                      | 5,962      |                   | $          | 658          |       | $                          | 78         |                             | $          | (127                                     | )          | $         | —     |   | $ | 1,520 |   | $ | 8,091 |   |
| Management  fee(7)                                              |       | $                      | —     |                   | $          | —       |       | $                          | —     |                             | $          | —                                   |       | $         | —     |   | $ | 3,750 |   | $ | 3,750 |   |
| Memo:  Items excluded from Comparable Operating Performance     |       |                   |       |                   |       |         |       |                       |       |                             |       |                                     |       |      |       |
| Comparable  Operating Performance of Discontinued Operations(8) |       | $                      | —     |                   | $          | —       |       | $                          | —     |                             | $          | —                                   |       | $         | —     |   | $ | (944 | ) | $ | (944 | ) |
|                                                            |       |                   |       |                   |       |         |       |                       |       |                             |       |                                     |       |      |       |
| **Six months ended June 30, 2009**                         |       |                   |       |                   |       |         |       |                       |       |                             |       |                                     |       |      |       |
| Operating  income (loss)(1)                                     |       | $                      | 24,009     |                   | $          | 8,631        |       | $                          | 115,288    |                             | $          | 36,144                                   |       | $         | 24,124     |   | $ | (61,513 | ) | $ | 146,683 |   |
| Depreciation  and amortization expense                          |       | 43,811                 |       | 5,941                  |       | 31,518       |       | 21,060                     |       | 4,114                            |       | 6,816                                    |       | 113,260   |       |
| EBITDA                                                          |       | 67,820                 |       | 14,572                 |       | 146,806      |       | 57,204                     |       | 28,238                           |       | (54,697                                  | )          | 259,943   |       |
| Interest  and net investment (loss) income(2)                   |       | —                 |       | —                 |       | —       |       | (3,093                     | )          | —                           |       | 1,727                                    |       | (1,366    | )          |
| Adjusted  EBITDA                                                |       | 67,820                 |       | 14,572                 |       | 146,806      |       | 54,111                     |       | 28,238                           |       | (52,970                                  | )          | 258,577   |       |
| Non-cash  stock-based compensation expense                      |       | —                 |       | —                 |       | —       |       | —                     |       | —                           |       | 3,901                                    |       | 3,901     |       |
| Non-cash  credits attributable to purchase accounting(5)        |       | (58                    | )          | (326                   | )          | (42          | )          | (68                        | )          | —                           |       | —                                   |       | (494      | )          |
| Comparable  Operating Performance                               |       | $                      | 67,762     |                   | $          | 14,246       |       | $                          | 146,764    |                             | $          | 54,043                                   |       | $         | 28,238     |   | $ | (49,069 | ) | $ | 261,984 |   |
| Memo:  Items included in Comparable Operating Performance       |       |                   |       |                   |       |         |       |                       |       |                             |       |                                     |       |      |       |
| Restructuring  and Merger related (credits) charges(6)          |       | $                      | —     |                   | $          | (51          | )          | $                          | 3,151      |                             | $          | 75                                       |       | $         | —     |   | $ | 11,186 |   | $ | 14,361 |   |
| Management  fee(7)                                              |       | $                      | —     |                   | $          | —       |       | $                          | —     |                             | $          | —                                   |       | $         | —     |   | $ | 1,000 |   | $ | 1,000 |   |
| Memo:  Items excluded from Comparable Operating Performance     |       |                   |       |                   |       |         |       |                       |       |                             |       |                                     |       |      |       |
| Comparable  Operating Performance of Discontinued Operations(8) |       | $                      | —     |                   | $          | —       |       | $                          | —     |                             | $          | —                                   |       | $         | —     |   | $ | (441 | ) | $ | (441 | ) |

 

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(1)                                  Presented belowis a reconciliation of total segment operating income to net income.

 
| ** **                                                    | ** ** | **Six months ended  June 30,** | ** ** |
|---------------------------------------------------------------|------------|-------------------------------------|------------|
| **(In thousands)**                                       | ** ** | **2010**                            | ** ** | **2009** | ** ** |
| Total Segment Operating Income                                |       | $                                   | 83,163     |   | $ | 146,683 |   |
| Non-operating Expense (Income):                               |       |                                |       |   |   |
| Interest expense                                              |       | 145,850                             |       | 151,322 |   |
| Interest and net investment (income) loss                     |       | (3,498                              | )          | 1,366 |   |
| Gain on extinguishment of debt                                |       | —                              |       | (46,106 | ) |
| Other expense                                                 |       | 347                                 |       | 379 |   |
| (Loss) Income from Continuing Operations before  Income Taxes |       | (59,536                             | )          | 39,722 |   |
| (Benefit) Provision for income taxes                          |       | (39,902                             | )          | 16,618 |   |
| (Loss) Income from Continuing Operations                      |       | (19,634                             | )          | 23,104 |   |
| Loss from discontinued operations, net of income  taxes       |       | (582                                | )          | (270 | ) |
| Net (Loss) Income                                             |       | $                                   | (20,216    | ) | $ | 22,834 |   |

 

(2)                                 Interest and net investmentincome (loss) is primarily comprised of investment income and realized gain(loss) on our American Home Shield segment investment portfolio. Cash,short-term and long-term marketable securities associated with regulatoryrequirements in connection with American Home Shield and for other purposestotaled $278.7 million as of June 30, 2010. American Home Shield interestand net investment income (loss) was $3.2 million and ($3.1) million for thesix months ended June 30, 2010 and 2009, respectively. The balance ofinterest and net investment income (loss) primarily relates to (i) aportion of the earnings generated by SMAC, (ii) investment income (loss)from our employee deferred compensation trust (for which there is acorresponding and offsetting change in compensation expense within income fromcontinuing operations before income taxes) and (iii) interest income onother cash balances.

 

(3)                                  Represents residual valueguarantee charges related to a synthetic lease for operating properties that donot result in additional cash payments to exit the facility at the end of thelease term. In the third quarter of 2009, the Company determined that it wasprobable that the fair value of the real properties under operating leaseswould be below the total amount funded under the lease facilities at the end ofthe lease term. The Company’s estimate of this shortfall was $15.9 million,which was expensed over the remainder of the lease term. The Company recordedcharges of $5.5 million in 2009 and $9.1 million in the first six months of2010 related to this shortfall. The remaining $1.3 million was recorded inJuly 2010.

 

(4)                                Represents anon-cash impairment charge of $46.9 million recorded in the second quarter of2010 to reduce the carrying value of goodwill and trade names at TruGreenLandCare as a result of the Company’s interim impairment test of goodwill andindefinite-lived intangible assets. SeeNote 5 to the condensed consolidated financial statements for furtherinformation.

 

(5)                                The Merger wasaccounted for using purchase accounting. This adjustment represents the aggregate,non-cash adjustments (other than amortization and depreciation) attributable tothe application of purchase accounting.

 

(6)                                 Represents(i) restructuring charges related to a reorganization of field leadershipand a restructuring of branch operations at TruGreen LawnCare, a branchoptimization project at Terminix and information technology outsourcing atOther Operations and Headquarters and (ii) Merger related charges.

 

(7)                                 Represents management andconsulting fees payable to certain related parties. See Note 15 to thecondensed consolidated financial statements for further information onmanagement and consulting fees.

 

(8)                                 There are no adjustmentsnecessary to reconcile operating loss from discontinued operations, the mostdirectly comparable financial measure under GAAP, to Adjusted EBITDA orComparable Operating Performance from discontinued operations for the sixmonths ended June 30, 2010 and 2009.

 

***TruGreen LawnCareSegment***

 

TheTruGreen LawnCare segment reported a 4.1 percent increase in revenue, a 43.7percent decrease in operating income and a 2.6 percent decline in ComparableOperating Performance for the six months ended June 30, 2010 compared to2009. The revenue results reflect a 2.5 percent increase in customer counts,higher sales of expanded services to existing customers, lower discounts andimproved price realization. The increase in customer counts was driven by a 260basis point improvement in the customer retention rate and an increase in newunit sales generated in our neighborhood selling channel.

 

TruGreenLawnCare’s Comparable Operating Performance declined $1.8 million for the sixmonths ended June 30, 2010

 

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comparedto 2009, which includes the impact of a $6.0 million increase in restructuringcharges related to a reorganization of field leadership and a restructuring ofbranch operations. TruGreen LawnCare’s Comparable Operating Performance alsoreflects reduced fuel and fertilizer costs, offset, in part, by investments insales and marketing and increased project costs related to our ongoinginitiatives to restructure our branch operations and to improve customerservice.

 

***TruGreen LandCare Segment***

 

TheTruGreen LandCare segment reported a 10.3 percent decrease in revenue, a $55.9million decrease in operating income and a 64.1 percent decline in ComparableOperating Performance for the six months ended June 30, 2010 compared to2009. The decline in revenue included an 11.6 percent decrease in base contractmaintenance revenue and a 12.0 percent decrease in enhancement revenue. Revenuetrends were primarily impacted by contract cancellations and pricingconcessions granted in 2009 and 2010 to offset the impacts of a difficulteconomic environment. The ratio of enhancement revenue to base contractmaintenance revenue for the six months ended June 30, 2010 was comparableto 2009.

 

TruGreenLandCare’s $55.9 million decline in operating income includes a non-cashimpairment charge of $46.9 million to reduce the carrying value of goodwill andtrade names to their estimated fair value as further described in Note 5 to thecondensed consolidated financial statements. TruGreen LandCare’s ComparableOperating Performance declined $9.1 million for the six months ended June 30,2010 compared to 2009, which also reflects decreased labor efficienciesresulting from increased technician overtime, offset, in part, by reduced fuelcosts.

 

***Terminix Segment***

 

The Terminix segment reported a 4.2 percent increase in revenue, a 5.6percent increase in operating income and a 5.0 percent improvement inComparable Operating Performance for the six months ended June 30, 2010compared to 2009. The segment’s overall revenue results reflected growth intermite and pest control revenues, as well as increased sales of products of$12.6 million. Termite revenues increased 0.8 percent for the six months ended June 30,2010 compared to 2009, due to an increase in new unit sales, while customerretention remained flat year over year. Pest control revenues increased 3.1percent for the six months ended June 30, 2010 compared to 2009,reflecting a 2.4 percent increase in customer counts due to a 180 basis pointimprovement in the customer retention rate and an increase in new unit sales.

 

Terminix’s Comparable Operating Performance improved $7.3 million forthe six months ended June 30, 2010 compared to 2009, which includes theimpact of a $3.1 million decrease in restructuring charges related to a branchoptimization program completed in 2009. Terminix’s Comparable OperatingPerformance also reflects reduced fuel costs, favorable termite damage claimstrends and the favorable impact of acquiring assets in connection with exitingcertain fleet leases, offset, in part, by increased provisions for certainlegal matters, investments in sales and marketing and increased provisions forincentive compensation.

 

***American Home Shield Segment***

 

The American Home Shield segment reported a 2.0 percent increase inrevenue, a 21.2 percent decrease in operating income and a 2.3 percent declinein Comparable Operating Performance for the six months ended June 30, 2010compared to 2009. The increase in revenue reflects a 5.0 percent increase incustomer counts and improved price realization. The increase in customer countswas driven by an increase in new unit sales and a 300 basis point improvementin customer retention. The second quarter revenue results were adverselyimpacted by a difference between years in the timing of revenue recognition.American Home Shield recognizes revenue over the contract period in proportionto the expected direct costs. However, in the first six months of 2010, seasonalcontract claims significantly exceeded historical averages, and the Company hasconcluded these claims will result in a full year reduction in American HomeShield’s planned operating income and Comparable Operating Performance. As a result,in the second quarter of 2010, the Company did not adjust the timing of revenuerecognition related to the unusual volume of seasonal contract claims. In thefirst six months of 2009, revenue was recognized in proportion with the directcosts incurred.

 

American Home Shield’s Comparable Operating Performance declined $1.2million for the six months ended June 30, 2010 compared to 2009, whichincludes a $6.3 million increase in interest and net investment income from theAmerican Home Shield investment portfolio (primarily reflecting reductions inimpairments of securities) and a 4.9 percent increase in contract claims costsdriven by an increase in seasonal contract claims. American Home Shield’sComparable Operating Performance also reflects increased provisions for certainlegal matters and investments in consumer sales programs.

 

***ServiceMaster Clean Segment***

 

The ServiceMaster Clean segment reported a 5.9 percent increase inrevenue, a 4.6 percent increase in operating income and 

 

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a5.1 percent improvement in Comparable Operating Performance for the sixmonths ended June 30, 2010 compared to 2009. Trends in revenue reflect anincrease in national janitorial accounts, product sales to franchisees andother revenues.

 

ServiceMaster Clean’s Comparable Operating Performance improved$1.4 million for the six months ended June 30, 2010 compared to 2009,primarily reflecting the impact of increased revenues.

 

***Other Operations and HeadquartersSegment***

 

This segment includes the operations of Merry Maids, SMAC and theCompany’s headquarters functions. The segment reported comparable revenue, a4.8 percent improvement in operating loss and a 4.2 percent improvement inComparable Operating Performance for the six months ended June 30, 2010compared to 2009. The Merry Maids operations reported comparable revenue, a26.8 percent increase in operating income and a 19.6 percentimprovement in Comparable Operating Performance for the six months ended June 30,2010 compared to 2009.

 

The segment’s Comparable Operating Performance improved $2.1 millionfor the six months ended June 30, 2010 compared to 2009, which includes theimpact of a $9.7 million decrease in restructuring and Merger related charges,offset, in part, by a $2.8 million increase in management and consulting feespayable to Equity Sponsors and increased provisions for incentive compensationin 2010, due primarily to the reversal of a $4.4 million reserve for cashawards in 2009 related to a long-term incentive plan as certain performance measuresunder the plan were not achieved. Comparable Operating Performance for MerryMaids improved $1.7 million for the six months ended June 30, 2010compared to 2009, which reflects reduced overhead spending.

 

***Discontinued Operations***

 

The components of loss from discontinued operations, net of incometaxes for the six months ended June 30, 2010 and 2009 are as follows:

 
| ** **                                              | ** ** | **Six months ended  June 30,** | ** ** |
|---------------------------------------------------------|------------|-------------------------------------|------------|
| **(In thousands)**                                 | ** ** | **2010**                            | ** ** | **2009** | ** ** |
| Operating Loss                                          |       | $                                   | (944       | ) | $ | (441 | ) |
| Interest expense                                        |       | —                              |       | — |   |
| Loss from discontinued operations, before income  taxes |       | (944                                | )          | (441 | ) |
| Benefit for income taxes                                |       | (362                                | )          | (171 | ) |
| Loss from discontinued operations, net of income  taxes |       | $                                   | (582       | ) | $ | (270 | ) |

 

Thereare no adjustments necessary to reconcile operating loss from discontinuedoperations to Adjusted EBITDA or Comparable Operating Performance fromdiscontinued operations for the six months ended June 30, 2010 and 2009.

 

**FINANCIAL POSITION AND LIQUIDITY**

 

***Cash Flows from Operating Activities fromContinuing Operations***

 

Netcash provided from operating activities from continuing operations increased$34.7 million to $105.9 million for the six months ended June 30, 2010compared to $71.2 million for the six months ended June 30, 2009.

 

Netcash provided from operating activities for the six months ended June 30,2010 was comprised of $140.0 million in earnings as adjusted for non-cashcharges, offset, in part, by a $26.2 million increase in cash required forworking capital and $7.9 million in cash payments related to restructuringcharges. Working capital requirements were impacted by normal seasonal workingcapital needs. Working capital requirements were adversely impacted by growthin accounts receivable balances due to the timing of services in the secondquarter, as well as increases in revenue in service lines with longer thanaverage collection terms. Working capital requirements were also adversely impactedby growth in current income taxes receivable due to the application of the fullyear projected income tax rate to the loss from continuing operations beforeincome taxes for the six months ended June 30, 2010. Working capitalrequirements were favorably impacted by increased accruals for residual valueguarantee charges related to the synthetic lease, certain legal matters andincentive compensation related to 2010 performance.

 

Netcash provided from operating activities for the six months ended June 30,2009 was comprised of $129.3 million in earnings as adjusted for non-cashcharges, offset in part, by a $48.1 million increase in cash required forworking capital and $10.0 million in cash payments related to restructuringcharges. The increase in working capital requirements for the six months ended June 30,2009 was driven primarily by seasonal activity and the timing of interestpayments on the Term Facilities.

 

***Cash Flows from Investing Activities fromContinuing Operations***

 

Netcash used for investing activities from continuing operations was $57.1 millionfor the six months ended June 30, 2010 compared to $41.4 million forthe six months ended June 30, 2009.

 

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Capitalexpenditures increased to $40.4 million for the six months ended June 30,2010 from $38.9 million for the six months ended June 30, 2009 andincluded vehicle purchases of $15.6 million, recurring capital needs andinformation technology projects. The Company anticipates that capitalexpenditures, excluding vehicle fleet purchases, for 2010 will range from $55.0million to $65.0 million, reflecting recurring needs and the continuation ofinvestments in information systems and productivity enhancing operatingsystems. The Company’s capital requirement for fleet vehicles for 2010 isexpected to range from $50.0 million to $60.0 million. As further discussed in “Liquidity”,the Company made a net cash payment of $43.2 million in July 2010 inconnection with exiting certain real estate leases. The Company has noadditional material capital commitments at this time.

 

Cashpayments for acquisitions, excluding the Merger, for the six months ended June 30,2010 totaled $14.8 million, compared with $7.3 million for the six months endedJune 30, 2009. Consideration paid for acquisitions consisted of cashpayments and debt payable to sellers. The Company expects to continue itsacquisition program at Terminix, TruGreen LawnCare and Merry Maids.

 

Thechange in notes receivable, financial investments and securities for the sixmonths ended June 30, 2010 compared to December 31, 2009 reflects adecrease in net sales of certain marketable securities.

 

***Cash Flows from Financing Activities fromContinuing Operations***

 

Netcash used for financing activities from continuing operations was$12.1 million for the six months ended June 30, 2010 compared to$65.2 million for the six months ended June 30, 2009. During the sixmonths ended June 30, 2010, the Company borrowed $10.0 million and madescheduled principal payments of long-term debt of $22.1 million. During the sixmonths ended June 30, 2009, the Company completed open market purchases of$89.0 million in face value of the Permanent Notes for a cost of $41.0 million.The Company also made scheduled principal payments of long-term debt of $23.8million during the six months ended June 30, 2009.

 

***Liquidity***

 

TheCompany is highly leveraged, and a very substantial portion of the Company’sliquidity needs arise from debt service on indebtedness incurred in connectionwith the Merger and from funding the Company’s operations, working capital andcapital expenditures.

 

Theagreements governing the Term Facilities, the Permanent Notes and the RevolvingCredit Facility contain certain covenants that limit or restrict the incurrenceof additional indebtedness, debt repurchases, liens, sales of assets, certainpayments (including dividends) and transactions with affiliates, subject tocertain exceptions. The Company was in compliance with the covenants underthese agreements at June 30, 2010.

 

ThroughJuly 15, 2011, the Company may, at its option prior to the start of anyinterest period, elect to pay interest on outstanding amounts under thePermanent Notes entirely in cash (“Cash Interest”), entirely by increasing theprincipal amount of the outstanding loans (“PIK Interest”), or 50 percent asCash Interest and 50 percent as PIK Interest. Interest payable afterJuly 15, 2011 is payable entirely as Cash Interest. All interest paymentsdue through July 2010 were paid entirely as Cash Interest. The Companyelected to pay all interest payable through January 2011 entirely as CashInterest.

 

Cashand short- and long-term marketable securities totaled $422.3 million at June 30,2010, compared with $385.6 million at December 31, 2009. As of June 30,2010 and December 31, 2009, $278.7 million and $256.5 million,respectively, of the cash and short- and long-term marketable securities balanceare associated with regulatory requirements at American Home Shield and forother purposes. American Home Shield’s investment portfolio has been investedin a combination of high quality, short duration fixed income securities andequities. The Company closely monitors the performance of the investments. Fromtime to time, the Company reviews the statutory reserve requirements to whichits regulated entities are subject and any changes to such requirements. Thesereviews may result in identifying current reserve levels above or below minimumstatutory reserve requirements, in which case the Company may adjust itsreserves. The reviews may also identify opportunities to satisfy certainregulatory reserve requirements through alternate financial vehicles, whichcould enhance our liquidity.

 

Aportion of the Company’s vehicle fleet and some equipment are leased throughoperating leases. The lease terms are non-cancelable for the first twelve-monthterm, and then are month-to-month, cancelable at the Company’s option. Thereare residual value guarantees by the Company (ranging from 70 percent to84 percent of the estimated terminal value at the inception of the leasedepending on the agreement) relative to these vehicles and equipment, whichhistorically have not resulted in significant net payments to the lessors. Thefair value of the assets under all of the fleet and equipment leases isexpected to substantially mitigate the Company’s guarantee obligations underthe agreements. At June 30, 2010, the Company’s residual value guaranteesrelated to the leased assets totaled $65.1 million for which the Company hasrecorded a liability for the estimated fair value of these guarantees ofapproximately $1.4 million in the condensed consolidated statement of financialposition.

 

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TheCompany maintained lease facilities with banks totaling $65.2 million,which provided for the financing of branch properties to be leased by theCompany. At June 30, 2010, approximately $65.2 million was fundedunder these facilities, including $12.5 million of leases that were accountedfor as capital leases and were included on the condensed consolidated statementof financial position as assets with related debt. The balance of the fundedamount was accounted for as operating leases. In connection with the closing ofthe Merger, the Company amended these leases effective July 24, 2007. Amongthe modifications, the Company extended the lease terms through July 24,2010 and made a $22.0 million investment in the lease facilities. This $22.0million investment was included in other assets in the condensed consolidatedstatement of financial position. The operating lease and capital leaseclassifications of these leases did not change as a result of themodifications. In July 2010, the Company purchased the properties for$65.2 million. The Company’s $22.0 million investment in the lease facilitieswas returned to the Company upon purchase, resulting in a net cash payment of$43.2 million.

 

Inthe third quarter of 2009, the Company determined that it was probable that thefair value of the real properties under operating leases would be below thetotal amount funded under the lease facilities at the end of the lease term.The Company’s estimate of this shortfall was $15.9 million, which was expensedover the remainder of the lease term. The Company recorded charges of $5.5million in 2009 and $9.1 million in the first six months of 2010 related tothis shortfall. The remaining $1.3 million was recorded in July 2010.

 

TheCompany holds certain financial instruments that are measured at fair value ona recurring basis. The fair values of these instruments are measured using boththe market and income approaches. For investments in marketable securities,deferred compensation trust assets and derivative contracts, which are carriedat their fair values, the Company’s fair value estimates incorporate quoted marketprices, other observable inputs (for example, forward interest rates) andunobservable inputs (for example, forward commodity prices) at the balancesheet date.

 

Underthe terms of its fuel swap contracts, the Company is required to postcollateral in certain circumstances, including in the event that the fair valueof the contracts exceeds a certain agreed upon liability level. As of June 30,2010, the fair value of the Company’s fuel swap contracts was an asset of $2.0million, and the Company posted approximately $5.0 million in letters of creditas collateral for these contracts, none of which were issued under the Company’sRevolving Credit Facility. The continued use of letters of credit for thispurpose could limit the Company’s ability to post letters of credit for otherpurposes and could limit the Company’s borrowing availability under theRevolving Credit Facility. However, the Company does not expect the fair valueof its outstanding fuel swap contacts to materially impact its financial positionor liquidity.

 

TheCompany’s ongoing liquidity needs are expected to be funded by cash on hand,net cash provided by operating activities and, as required, borrowings underthe Revolving Credit Facility and accounts receivable securitization arrangement(discussed below). We expect that cash provided from operations and availablecapacity under the Revolving Credit Facility and accounts receivablesecuritization arrangement will provide sufficient funds to operate ourbusiness, make expected capital expenditures and meet our liquidityrequirements for the following 12 months, including payment of interest andprincipal on our debt. As of June 30, 2010, the Company had $500.0 millionof remaining capacity available under the Revolving Credit Facility and $40.0million of remaining capacity under the accounts receivable securitizationarrangement.

 

The Company may from time to time repurchase or otherwise retire theCompany’s debt and take other steps to reduce the Company’s debt or otherwiseimprove the Company’s financial position. These actions may include open marketdebt repurchases, negotiated repurchases, other retirements of outstanding debtand opportunistic refinancing of debt. The amount of debt that may berepurchased or otherwise retired, if any, will depend on market conditions,trading levels of the Company’s debt, the Company’s cash position, compliancewith debt covenants and other considerations. Affiliates of the Company mayalso purchase the Company’s debt from time to time, through open marketpurchases or other transactions. In such cases, the Company’s debt may not beretired, in which case the Company would continue to pay interest in accordancewith the terms of the debt, and the Company would continue to reflect the debtas outstanding in its condensed consolidated statement of financial position.

 

Between the Merger and June 30, 2010, Holdings has completed openmarket purchases totaling $65.0 million in face value of the PermanentNotes for a cost of $21.4 million. The debt acquired by Holdings has notbeen retired, and the Company has continued to pay interest in accordance withthe terms of the debt. The Company recorded interest expense of $3.5 millionand $3.4 million for the six months ended June 30, 2010 and 2009,respectively, related to the Permanent Notes held by Holdings. The Company madecash payments to Holdings of $3.5 million and $3.0 million during the sixmonths ended June 30, 2010 and 2009, respectively. Interest accrued by theCompany and payable to Holdings as of June 30, 2010 and December 31,2009 amounted to $3.2 million.

 

The Company has entered into an accounts receivable securitizationarrangement under which TruGreen LawnCare and Terminix may sell certaineligible trade accounts receivable to Funding, the Company’s wholly owned,bankruptcy-remote subsidiary, which is consolidated for financial reportingpurposes. Funding, in turn, may transfer, on a revolving basis, an undividedpercentage ownership interest of up to $50.0 million in the pool ofaccounts receivable to one or both of the Purchasers. The amount of theeligible receivables varies during the year based on seasonality of thebusinesses and could, at times, limit the amount available to the Company fromthe sale of these interests.

 

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During the six months ended June 30, 2010, there were no transfersof interests in the pool of trade accounts receivables to Purchasers under thisarrangement. As of June 30, 2010 and December 31, 2009, the Companyhad $10.0 million outstanding under the arrangement and, as of June 30,2010, had $40.0 million of remaining capacity available under the tradeaccounts receivable securitization arrangement.

 

The accounts receivable securitization arrangement is a 364-dayfacility that is renewable annually at the option of Funding, with a finaltermination date of July 17, 2012. Only one of the Purchasers is requiredto purchase interests under the arrangement. If this Purchaser were to exerciseits right to terminate its participation in the arrangement, which it may do inthe third quarter of each year, the amount of cash available to the Companyunder this arrangement may be reduced or eliminated. As part of the annualrenewal of the facility, which last occurred on July 20, 2010, thisPurchaser agreed to continue its participation in the arrangement at leastthrough July 19, 2011.

 

Asa holding company, we depend on our subsidiaries to distribute funds to us sothat we may pay our obligations and expenses, including our debt serviceobligations. The ability of our subsidiaries to make distributions anddividends to us depends on their operating results, cash requirements andfinancial condition and general business conditions. Our insurance subsidiariesand home services and similar subsidiaries (through which we conduct ourAmerican Home Shield business) are subject to significant regulatoryrestrictions under the laws and regulations of the states in which theyoperate. Among other things, such laws and regulations require certain suchsubsidiaries to maintain minimum capital and net worth requirements and maylimit the amount of ordinary and extraordinary dividends and other payments thatthese subsidiaries can pay to us. For example, certain states prohibit paymentby these subsidiaries to the Company of dividends in excess of 10 percent oftheir capital as of the most recent year end, as determined in accordance withprescribed insurance accounting practices in those states. Of the $278.7million as of June 30, 2010, which we identify as being potentiallyunavailable to be paid to the Company by its subsidiaries, approximately $220.2million is held by our home services and insurance subsidiaries and is subjectto these regulatory limitations on the payment of funds to us. Such limitationswill be in effect throughout 2010, and similar limitations will be re-computedas of December 31, 2010 and will be in effect in 2011. The remainder of the$278.7 million, or $58.5 million, is related to amounts that the Company’smanagement does not consider readily available to be used to service theCompany’s indebtedness due, among other reasons, to the Company’s cashmanagement practices and working capital needs at various subsidiaries.

 

TheCompany’s Annual Report on Form 10-K for the year ended December 31,2009 included disclosure of the Company’s contractual obligations andcommitments as of December 31, 2009. The Company continues to make the contractuallyrequired payments and, therefore, the 2010 obligations and commitments aslisted in the Company’s Annual Report on Form 10-K for the year endedDecember 31, 2009 have been reduced by the required payments. There wereno material changes outside of the ordinary course of business in the Company’spreviously disclosed contractual obligations and commitments during the sixmonths ended June 30, 2010.

 

***Off-Balance Sheet Arrangements***

 

TheCompany has off-balance sheet arrangements in the form of guarantees asdiscussed in Note 4 of the condensed consolidated financial statements.

 

**Information Regarding Forward-Looking Statements**

 

This report includes forward-looking statements and cautionarystatements. Some of the forward-looking statements can be identified by the useof forward-looking terms such as “believes”, “expects”, “may”, “will”, “shall”,“should”, “would”, “could”, “seek”, “aims”, “projects”, “is optimistic”, “intends”,“plans”, “estimates”, “anticipates” or other comparable terms. These forward-lookingstatements include all matters that are not historical facts. They appear in anumber of places throughout this report and include, without limitation,statements regarding our intentions, beliefs, assumptions or currentexpectations concerning, among other things, the degree and timing of economicrecovery; governmental regulation or interpretation thereof; our liquidity;cash flows; results of operations; financial condition; prospects; growthstrategies; future impairments; capital expenditures and requirements; customerretention; the continuation of acquisitions; the impact of interest rate hedgesand fuel swaps; the cost savings from restructurings and reorganizations andexpected charges related to such restructurings and reorganizations; and theimpact of prevailing economic conditions.

 

Forward-looking statements are subject to known and unknown risks anduncertainties, many of which may be beyond our control. We caution you thatforward-looking statements are not guarantees of future performance oroutcomes, and that actual outcomes and performances, including, withoutlimitation, our actual results of operations, financial condition andliquidity, and the development of the industries in which we operate may differmaterially from those made in or suggested by the forward-looking statementscontained in this report. In addition, even if our results of operations,financial condition and liquidity, and the development of the industries inwhich we operate are consistent with the forward-looking statements containedin this report, those results or developments may not be indicative of resultsor developments in subsequent periods. A number of important factors, includingthe 

 

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risksand uncertainties discussed in Item 1A—Risk Factors in Part I in theCompany’s Annual Report on Form 10-K for the year ended December 31,2009, could cause actual results and outcomes to differ materially from thosein the forward-looking statements. Additional factors that could cause actualresults and outcomes to differ from those reflected in forward-lookingstatements include, without limitation:

 

·                  the effects of oursubstantial indebtedness and the limitations contained in the agreementsgoverning such indebtedness;

 

·                  our ability to generate thesignificant amount of cash needed to fund our operations and service our debtobligations and debt repurchases;

 

·                  changes in interest ratesbecause a significant portion of our indebtedness bears interest at variablerates;

 

·                  our ability to securesources of financing or other funding to allow for direct purchases ofcommercial vehicles, primarily for TruGreen LawnCare, Terminix and TruGreenLandCare;

 

·                  changes in the source andintensity of competition in our market segments;

 

·                  weather conditions andseasonality factors that affect the demand for our services, including anyimpact from climate change factors, known and unknown;

 

·                  higher commodity prices andlack of availability, including fuel and fertilizers (primarily at TruGreenLawnCare, Terminix and TruGreen LandCare) could impact our ability to provideand the profitability of our brands;

 

·                  increases in operatingcosts, such as higher insurance premiums, self-insurance costs and health carecosts;

 

·                  employee retention, laborshortages, including shortages due to immigration legislation, or increases incompensation and benefits costs, including costs related to the comprehensivehealth care reform law enacted in the first quarter of 2010;

 

·                  epidemics, pandemics orother public health concerns or crises could affect the demand for, or ourability to provide, our services resulting in a reduction in revenues;

 

·                  a continuation or change ingeneral economic, financial and credit conditions in the United States andelsewhere (including further deterioration or disruption in the credit andfinancial markets), especially as such may affect home sales, consumer orbusiness liquidity, bank failures, consumer or commercial confidence orspending levels including as a result of inflation or deflation, unemployment,interest rate fluctuations, mortgage foreclosures and subprime creditdislocations;

 

·                  a failure of any insurancecompany that provides insurance to us;

 

·                  changes in the type or mixof our service offerings or products;

 

·                  existing and futuregovernmental regulation and the enforcement thereof, including regulationrelating to restricting or banning of telemarketing; door-to-door solicitation;direct mail or other marketing activities; the Termite Inspection ProtectionPlan; pesticides and/or fertilizers; or other legislation, regulation orinterpretations impacting our business models;

 

·                  laws and regulationsrelating to financial reform and the use of derivative instruments, includingby companies such as ServiceMaster;

 

·                  the success of and costsassociated with restructuring initiatives;

 

·                  the number, type, outcomesand costs of legal or administrative proceedings;

 

·                  possible labor organizingactivities at the Company or its franchisees;

 

·                  risks associated withacquisitions and dispositions, including retaining customers from thebusinesses acquired, difficulties in integrating acquired businesses andachieving expected synergies therefrom;

 

·                  risks associated with budgetdeficits at federal, state and local levels resulting from deterioratingeconomic conditions, which could result in federal, state and local governmentsdecreasing their purchasing of our products or services and/or increasing taxeson businesses to generate more tax revenues, which could adversely impact ourrevenue, earnings, tax payments and cash flows, as applicable;

 

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·                  the timing and structuringof our business process outsourcing, including any current or futureoutsourcing of all or portions of our information technology, call center andother corporate functions, and risks associated with such outsourcing; and

 

·                  other factors described fromtime to time in documents that we file with the SEC.

 

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

 

Comparisons of results for current and any prior periods are notintended to express any future trends, or indications of future performance,unless expressed as such, and should only be viewed as historical data.

 

**ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURESABOUT MARKET RISK**

 

*InterestRate Risk*

 

TheCompany is exposed to the impact of interest rate changes and manages thisexposure through the use of variable-rate and fixed-rate debt and by utilizinginterest rate swaps. The Company does not enter into these contracts fortrading or speculative purposes. The market risk associated with debt obligationsand other significant instruments as of June 30, 2010 has not materiallychanged from December 31, 2009 (see Item 7A of the Company’s AnnualReport on Form 10-K for the year ended December 31, 2009).

 

*Fuel Price Risk*

 

TheCompany is exposed to market risk for changes in fuel prices through theconsumption of fuel by its vehicle fleet in the delivery of services to itscustomers. The Company uses approximately 25 million gallons of fuel on anannual basis. A 10 percent change in fuel prices would result in a change ofapproximately $6.5 million in the Company’s annual fuel cost before consideringthe impact of fuel swap contracts.

 

TheCompany uses fuel swap contracts to mitigate the financial impact offluctuations in fuel prices. As of June 30, 2010, the Company had fuelswap contracts to pay fixed prices for fuel with an aggregate notional amountof $75.1 million, maturing through 2011. The estimated fair value of thesecontracts at June 30, 2010 was an asset of $2.0 million. These fuel swapcontracts provide a fixed price for approximately 80.2 percent and 61.5 percentof the Company’s estimated fuel usage for the remainder of 2010 and 2011,respectively.

 

**ITEM 4. CONTROLS AND PROCEDURES**

 

**Effectiveness of Disclosure Controls and Procedures.**ServiceMaster’sChief Executive Officer, J. Patrick Spainhour, and ServiceMaster’s Senior VicePresident and Chief Financial Officer, Steven J. Martin, have evaluatedServiceMaster’s disclosure controls and procedures (as defined inRule 15d-15(e)) as of the end of the period covered by this QuarterlyReport on Form 10-Q. ServiceMaster’s disclosure controls and proceduresinclude a roll-up of financial and non-financial reporting that is consolidatedin the principal executive office of ServiceMaster in Memphis, Tennessee.Messrs. Spainhour and Martin have concluded that both the design andoperation of ServiceMaster’s disclosure controls and procedures are effective.

 

**Changes in Internal Control over Financial Reporting.**No change inServiceMaster’s internal control over financial reporting occurred during thesecond quarter of 2010 that has materially affected, or is reasonably likely tomaterially affect, ServiceMaster’s internal control over financial reporting.

 

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**PART II. OTHER INFORMATION**

 

**ITEM 1. LEGAL PROCEEDINGS**

** **

In the ordinary course ofconducting business activities, the Company and its subsidiaries become involvedin judicial, administrative and regulatory proceedings involving both privateparties and governmental authorities. These proceedings include, on anindividual, collective and class action basis, regulatory, insured anduninsured employment, general, and commercial liability actions andenvironmental proceedings.  For instance,American Home Shield Corporation was sued in a putative class action on May 26,2009 in the U.S. District Court for the Northern District of Alabama by AbigailRudd, *et al.*, and is alleged to have violatedSection 8 of the Real Estate Settlement Procedures Act in connection withcertain payments made to real estate agencies. The plaintiffs seek damages equal to three times the amount of theallegedly improper payments occurring after May 26, 2008.  The Company intends to defend its interestsvigorously.

 

Additionally, the Companyhas entered into settlement agreements in certain cases, including putativeclass actions, which are subject to court approval. If one or more of these settlementsare not finally approved, the Company could have additional or differentexposure. The enactment of new federal or state legislation or the promulgationof new regulation or interpretation at any level of government may also exposethe Company to potential new liabilities or costs, or may require the Companyto modify its business model or business practices. At this time, the Companydoes not expect any of these proceedings or changes in law to have a materialeffect on its financial position, results of operations or cash flows; however,the Company can give no assurance that the results of any such proceedings maynot be material to its financial position, results of operations and cash flowsfor any period in which costs, if any, are recognized.

 

**ITEM 5. OTHER INFORMATION**

 

In August 2010, ServiceMaster received a letterfrom the SEC Staff informing ServiceMaster that the SEC Staff does not intendto recommend any enforcement action by the SEC against ServiceMaster related toan investigation described in the Company’s annual report on Form 10-K forthe year ended December 31, 2009.

 

**ITEM 6. EXHIBITS**

** **
| **Exhibit No.** | ** ** | **Description of Exhibit**                                                                                                                                                                      |
|----------------------|------------|-----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|                 |       |                                                                                                                                                                                                      |
| 31.1                 |       | Certification  of Chief Executive Officer Pursuant to Rule 15d — 14(a), as adopted  pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.                                             |
|                 |       |                                                                                                                                                                                                      |
| 31.2                 |       | Certification  of Chief Financial Officer Pursuant to Rule 15d — 14(a), as adopted  pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.                                             |
|                 |       |                                                                                                                                                                                                      |
| 32.1                 |       | Certification  of Chief Executive Officer Pursuant to Section 1350 of Chapter 63 of  Title 18 of the United States Code, as adopted pursuant to Section 906  of the Sarbanes-Oxley Act of 2002. |
|                 |       |                                                                                                                                                                                                      |
| 32.2                 |       | Certification  of Chief Financial Officer Pursuant to Section 1350 of Chapter 63 of  Title 18 of the United States Code, as adopted pursuant to Section 906  of the Sarbanes-Oxley Act of 2002. |

 

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**SIGNATURE**

 

Pursuantto the requirements of the Securities Exchange Act of 1934, the Registrant hasduly caused this report to be signed on its behalf by the undersigned thereuntoduly authorized.

 

Date: August 16,2010

 
|   | THE  SERVICEMASTER COMPANY

(Registrant) |
|--------|------------------------------------------|
|   |                                     |   |
|   | By:                                      | /s/  Steven J. Martin |
|   |                                     | Steven  J. Martin |
|   |                                     | Senior  Vice President and Chief Financial Officer |

 

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