Tableof Contents

 

 

 

**UNITEDSTATESSECURITIES AND EXCHANGE COMMISSION**

**WASHINGTON,D.C. 20549**

** **

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** **

**FORM 10-Q**

** **

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| **x**                                                  | ** ** | **QUARTERLY  REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES**        |
|--------------------------------------------------------|------------|------------------------------------------------------------------------------------|
|                                                   |       | **EXCHANGE  ACT OF 1934**                                                          |
| ** **                                             |
| **For the quarterly period ended June 30,  2008** |
|                                                   |       |                                                                               |
| **o**                                                  | ** ** | **TRANSITION  REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES** |
|                                                   |       | **EXCHANGE  ACT OF 1934**                                                          |

** **

**Forthe transition periodfrom             to          **

** **

**Commissionfile number 1-14762**

 

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**THE SERVICEMASTER COMPANY**

(Exact name of registrantas specified in its charter)

** **

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

** **

**860 RidgeLake Boulevard, Memphis, Tennessee**·**38120**

(Address ofprincipal executive offices)    (Zip Code)

 

**901-597-1400**

(Registrant’stelephone number, including area code)

 

Indicate by check mark whether the registrant(1) has filed all reports required to be filed by Section 13 or 15(d) ofthe Securities Exchange Act of 1934 during the preceding 12 months (or forsuch shorter period that the registrant was required to file such reports), and(2) has been subject to such filing requirements for the past90 days. Yes o  No x

 

Indicate by check mark whether the registrantis a large accelerated filer, an accelerated filer, a non-accelerated filer, ora smaller reporting company. See definitions of “large accelerated filer,” “acceleratedfiler,” and “smaller reporting 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) |   |                             |

 

Indicate by check mark whether the registrantis a shell company (as defined in Rule 12b-2 of the Act). Yes  o  No x

 

On July 24, 2007, the registrantcompleted a transaction pursuant to an Agreement and Plan of Merger, dated asof March 18, 2007, among the registrant and two corporations formed toeffect the merger transactions. As a result of the merger transaction, theregistrant became a privately held corporation and its equity shares are nolonger publicly traded. At August 8, 2008, 1,000 shares of the registrant’scommon stock were outstanding, all of which were owned by CDRSVM Holding, Inc.

 

 

 

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**TABLE OFCONTENTS**

 
| ** **                                                                                                                                        | **Page  No.** |
|---------------------------------------------------------------------------------------------------------------------------------------------------|---------------|
| THE SERVICEMASTER COMPANY (Registrant) -                                                                                                          |          |
|                                                                                                                                              |          |
| Part I -  Financial Information                                                                                                              | 3             |
|                                                                                                                                              |          |
| Item 1.  Financial Statements (Unaudited)                                                                                                         | 3             |
|                                                                                                                                              |          |
| Condensed Consolidated Statements of Operations for  the three months ended June 30, 2008 (Successor) and June 30, 2007  (Predecessor). | 3             |
|                                                                                                                                              |          |
| Condensed Consolidated Statements of Operations for  the six months ended June 30, 2008 (Successor) and June 30, 2007  (Predecessor).   | 4             |
|                                                                                                                                              |          |
| Condensed Consolidated Statements of Financial  Position as of June 30, 2008 and December 31, 2007                                      | 5             |
|                                                                                                                                              |          |
| Condensed  Consolidated Statements of Cash Flows for the six months ended June 30,  2008 (Successor) and June 30, 2007 (Predecessor).   | 6             |
|                                                                                                                                              |          |
| Notes to Condensed Consolidated Financial Statements                                                                                              | 7             |
|                                                                                                                                              |          |
| Item 2. Management’s Discussion and Analysis of  Financial Condition and Results of Operations                                               | 20            |
|                                                                                                                                              |          |
| Item 3. Quantitative and Qualitative Disclosures  About Market Risk                                                                          | 42            |
|                                                                                                                                              |          |
| Item 4T. Controls and Procedures                                                                                                                  | 43            |
|                                                                                                                                              |          |
| Part II  - Other Information                                                                                                                 | 43            |
|                                                                                                                                              |          |
| Item  1A. Risk Factors                                                                                                                            | 43            |
|                                                                                                                                              |          |
| Item 6.  Exhibits                                                                                                                                 | 43            |
|                                                                                                                                              |          |
| Signature                                                                                                                                         | 44            |

 

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### **PART I - FINANCIAL INFORMATION**

**ITEM 1.FINANCIAL STATEMENTS**

### **THE SERVICEMASTER COMPANY**

### **Condensed Consolidated Statements of Operations (Unaudited)**

*(In thousands)*

* *
| ** **                                                                               | ** ** | **Successor**               | ** ** | ** ** | **Predecessor**             | ** ** |
|------------------------------------------------------------------------------------------|------------|-----------------------------|------------|------------|-----------------------------|------------|
| ** **                                                                               | ** ** | **Three**                   | ** ** | ** ** | **Three**                   | ** ** |
| ** **                                                                               | ** ** | **months ended**       | ** ** | ** ** | **months ended**       | ** ** |
| ** **                                                                               | ** ** | **June 30, 2008** | ** ** | ** ** | **June 30, 2007** | ** ** |
| **Operating Revenue**                                                               |       | $                           | 997,305    |       |                        | $          | 1,008,737 |   |
|                                                                                     |       |                        |       |       |                        |       |
| **Operating Costs and Expenses:**                                         |       |                        |       |       |                        |       |
| Cost of services rendered and products sold                |       | 589,734                     |       |       | 590,509                     |       |
| Selling and administrative expenses                                       |       | 247,114                     |       |       | 270,833                     |       |
| Amortization expense                                                                     |       | 41,968                      |       |       | 2,309                       |       |
| Merger related charges                                                                   |       | 305                         |       |       | 2,794                       |       |
| Restructuring charges                                                                    |       | 4,005                       |       |       | 8,260                       |       |
| Total operating costs and expenses                                   |       | 883,126                     |       |       | 874,705                     |       |
|                                                                                     |       |                        |       |       |                        |       |
| **Operating Income**                                                                     |       | 114,179                     |       |       | 134,032                     |       |
|                                                                                     |       |                        |       |       |                        |       |
| **Non-operating Expense (Income):**                                            |       |                        |       |       |                        |       |
| Interest expense                                                                    |       | 83,425                      |       |       | 13,879                      |       |
| Interest and net  investment income                                       |       | (4,164                      | )          |       | (18,118                     | )          |
| Minority interest and other expense, net                        |       | 145                         |       |       | 1,472                       |       |
|                                                                                     |       |                        |       |       |                        |       |
| **Income from Continuing Operations  before Income Taxes**      |       | 34,773                      |       |       | 136,799                     |       |
| Provision  for income taxes                                                    |       | 13,947                      |       |       | 46,546                      |       |
|                                                                                     |       |                        |       |       |                        |       |
| **Income  from Continuing Operations**                                         |       | 20,826                      |       |       | 90,253                      |       |
|                                                                                     |       |                        |       |       |                        |       |
| Loss from businesses held  pending sale and discontinued operations, net of income taxes |       | (2,736                      | )          |       | (1,622                      | )          |
| **Net Income**                                                                      |       | $                           | 18,090     |       |                        | $          | 88,631 |   |

 

*See accompanying Notes to the CondensedConsolidated Financial Statements*

 

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### **Table of Contents**

 

### **THE SERVICEMASTER COMPANY**

### **Condensed Consolidated Statements of Operations (Unaudited)**

*(In thousands)*

* *
| ** **                                                                                  | ** ** | **Successor**               | ** ** | ** ** | **Predecessor**             | ** ** |
|---------------------------------------------------------------------------------------------|------------|-----------------------------|------------|------------|-----------------------------|------------|
| ** **                                                                                  | ** ** | **Six**                     | ** ** | ** ** | **Six**                     | ** ** |
| ** **                                                                                  | ** ** | **months ended**       | ** ** | ** ** | **months ended**       | ** ** |
| ** **                                                                                  | ** ** | **June 30, 2008** | ** ** | ** ** | **June 30, 2007** | ** ** |
| **Operating Revenue**                                                                  |       | $                           | 1,629,536  |       |                        | $          | 1,682,232 |   |
|                                                                                        |       |                        |       |       |                        |       |
| **Operating Costs and Expenses:**                                            |       |                        |       |       |                        |       |
| Cost of services rendered and products sold                   |       | 1,007,102                   |       |       | 1,033,859                   |       |
| Selling and administrative expenses                                          |       | 418,230                     |       |       | 464,052                     |       |
| Amortization expense                                                                        |       | 92,642                      |       |       | 4,575                       |       |
| Merger related charges                                                                      |       | 355                         |       |       | 5,334                       |       |
| Restructuring charges                                                                       |       | 7,330                       |       |       | 15,318                      |       |
| Total operating costs and expenses                                      |       | 1,525,659                   |       |       | 1,523,138                   |       |
|                                                                                        |       |                        |       |       |                        |       |
| **Operating Income**                                                                   |       | 103,877                     |       |       | 159,094                     |       |
|                                                                                        |       |                        |       |       |                        |       |
| **Non-operating Expense (Income):**                                               |       |                        |       |       |                        |       |
| Interest expense                                                                       |       | 173,011                     |       |       | 28,143                      |       |
| Interest and net  investment loss (income)                                   |       | 1,881                       |       |       | (26,184                     | )          |
| Minority interest and other expense, net                           |       | 277                         |       |       | 3,521                       |       |
|                                                                                        |       |                        |       |       |                        |       |
| **(Loss)  Income from Continuing Operations  before Income Taxes** |       | (71,292                     | )          |       | 153,614                     |       |
| (Benefit) provision  for income taxes                                             |       | (17,024                     | )          |       | 53,313                      |       |
|                                                                                        |       |                        |       |       |                        |       |
| **(Loss) Income  from Continuing Operations**                                     |       | (54,268                     | )          |       | 100,301                     |       |
|                                                                                        |       |                        |       |       |                        |       |
| Loss from businesses held  pending sale and discontinued operations, net of income taxes    |       | (3,484                      | )          |       | (3,121                      | )          |
| **Net (Loss) Income**                                                                  |       | $                           | (57,752    | )          |                        | $          | 97,180 |   |

 

*See accompanying Notes to the CondensedConsolidated Financial Statements*

 

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**THE SERVICEMASTER COMPANY**

## **Condensed Consolidated Statementsof Financial Position (Unaudited)**

*(In thousands, except share data)*

 
| ** **                                                                   | ** ** | **Successor**                     | ** ** |
|------------------------------------------------------------------------------|------------|-----------------------------------|------------|
| ** **                                                                   | ** ** | **As of June 30,** | ** ** | **As of December 31,** | ** ** |
| ** **                                                                   | ** ** | **2008**                          | ** ** | **2007** | ** ** |
| **Assets**                                                                   |       |                              |       |   |   |
| **Current Assets:**                                                          |       |                              |       |   |   |
| Cash and cash equivalents                                                    |       | $                                 | 225,366    |   | $ | 207,219 |   |
| Marketable securities                                                        |       | 30,278                            |       | 108,816 |   |
| Receivables, less allowance of $24,136 and $20,994, respectively             |       | 395,079                           |       | 336,068 |   |
| Inventories                                                                  |       | 83,611                            |       | 72,352 |   |
| Prepaid expenses and other assets                                            |       | 77,407                            |       | 26,843 |   |
| Deferred customer acquisition costs                                          |       | 58,269                            |       | 25,322 |   |
| Deferred taxes                                                               |       | 38,235                            |       | 48,177 |   |
| Assets of businesses held pending sale and discontinued operations           |       | 31,124                            |       | 42,474 |   |
| Total Current Assets                                                         |       | 939,369                           |       | 867,271 |   |
| **Property and Equipment:**                                                  |       |                              |       |   |   |
| At cost                                                                      |       | 220,478                           |       | 210,144 |   |
| Less: accumulated depreciation                                               |       | (46,144                           | )          | (22,147 | ) |
| Net property and equipment                                                   |       | 174,334                           |       | 187,997 |   |
|                                                                         |       |                              |       |   |   |
| **Other Assets:**                                                            |       |                              |       |   |   |
| Goodwill                                                                     |       | 3,058,314                         |       | 3,049,923 |   |
| Intangible assets, primarily  trade names, service marks and trademarks, net |       | 3,095,382                         |       | 3,185,253 |   |
| Notes receivable                                                             |       | 27,418                            |       | 26,401 |   |
| Long-term marketable securities                                              |       | 134,221                           |       | 152,974 |   |
| Other assets                                                                 |       | 35,520                            |       | 36,299 |   |
| Debt issuance costs                                                          |       | 64,894                            |       | 84,942 |   |
| Total Assets                                                                 |       | $                                 | 7,529,452  |   | $ | 7,591,060 |   |
|                                                                         |       |                              |       |   |   |
| **Liabilities  and Shareholder’s Equity**                               |       |                              |       |   |   |
|                                                                         |       |                              |       |   |   |
| **Current Liabilities:**                                                     |       |                              |       |   |   |
| Accounts payable                                                             |       | $                                 | 124,536    |   | $ | 103,400 |   |
| Accrued liabilities:                                                         |       |                              |       |   |   |
| Payroll and related expenses                                                 |       | 90,615                            |       | 132,054 |   |
| Self-insured claims and related expenses                                     |       | 95,590                            |       | 84,781 |   |
| Other                                                                        |       | 142,999                           |       | 138,049 |   |
| Deferred revenue                                                             |       | 499,474                           |       | 408,476 |   |
| Liabilities of businesses held pending sale and discontinued  operations     |       | 14,627                            |       | 12,983 |   |
| Current portion of long-term debt                                            |       | 45,475                            |       | 53,564 |   |
| Total Current Liabilities                                                    |       | 1,013,316                         |       | 933,307 |   |
|                                                                         |       |                              |       |   |   |
| **Long-Term Debt**                                                           |       | 4,055,918                         |       | 4,077,247 |   |
|                                                                         |       |                              |       |   |   |
| **Other Long-Term Liabilities:**                                             |       |                              |       |   |   |
| Deferred taxes                                                               |       | 1,038,608                         |       | 1,079,500 |   |
| Liabilities of businesses held pending sale and discontinued  operations     |       | 5,629                             |       | 7,765 |   |
| Other long-term obligations, primarily self-insured claims                   |       | 160,614                           |       | 189,707 |   |
| Total Other Long-Term Liabilities                                            |       | 1,204,851                         |       | 1,276,972 |   |
|                                                                         |       |                              |       |   |   |
| **Commitments  and Contingencies (See Note 5)**                              |       |                              |       |   |   |
|                                                                         |       |                              |       |   |   |
| **Shareholder’s Equity:**                                               |       |                              |       |   |   |
| Common stock $0.01 par value, authorized 1,000 shares; issued 1,000  shares  |       | —                            |       | — |   |
| Additional paid-in capital                                                   |       | 1,434,800                         |       | 1,431,400 |   |
| Retained deficit                                                             |       | (181,272                          | )          | (123,520 | ) |
| Accumulated other comprehensive income (loss)                                |       | 1,839                             |       | (4,346 | ) |
| Total Shareholder’s Equity                                              |       | 1,255,367                         |       | 1,303,534 |   |
| Total Liabilities and Shareholder’s Equity                              |       | $                                 | 7,529,452  |   | $ | 7,591,060 |   |

 

*Seeaccompanying Notes to the Condensed Consolidated Financial Statements*

 

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**THE SERVICEMASTER COMPANY**

## **CondensedConsolidated Statements of Cash Flows (Unaudited)**

*(Inthousands)*

 
| ** **                                                                                  | ** ** | **Successor**               | ** ** | ** ** | **Predecessor**             | ** ** |
|---------------------------------------------------------------------------------------------|------------|-----------------------------|------------|------------|-----------------------------|------------|
| ** **                                                                                  | ** ** | **Six**                     | ** ** | ** ** | **Six**                     | ** ** |
| ** **                                                                                  | ** ** | **months ended**       | ** ** | ** ** | **months ended**       | ** ** |
| ** **                                                                                  | ** ** | **June 30, 2008** | ** ** | ** ** | **June 30, 2007** | ** ** |
| **Cash and Cash Equivalents at  Beginning of Period**                                       |       | $                           | 207,219    |       |                        | $          | 123,675 |   |
|                                                                                        |       |                        |       |       |                        |       |
| **Cash Flows from Operating  Activities from Continuing Operations:**                       |       |                        |       |       |                        |       |
| **Net (Loss) Income**                                                                       |       | (57,752                     | )          |       | 97,180                      |       |
| Adjustments to reconcile net  (loss) income to net cash provided from operating activities: |       |                        |       |       |                        |       |
| Loss from discontinued  operations                                                          |       | 3,484                       |       |       | 3,121                       |       |
| Depreciation expense                                                                        |       | 25,951                      |       |       | 24,372                      |       |
| Amortization expense                                                                        |       | 92,642                      |       |       | 4,575                       |       |
| Amortization of debt issuance  costs                                                        |       | 18,269                      |       |       | 1,138                       |       |
| Option and restricted stock  expense                                                        |       | 3,401                       |       |       | 3,058                       |       |
| Restructuring charges                                                                       |       | 7,330                       |       |       | 15,318                      |       |
| Cash payments related to restructuring  charges                                             |       | (16,236                     | )          |       | (6,012                      | )          |
| Merger related charges                                                                      |       | 355                         |       |       | 5,334                       |       |
| Change in working capital, net  of acquisitions:                                            |       |                        |       |       |                        |       |
| Current and deferred income  taxes                                                          |       | (22,941                     | )          |       | 34,087                      |       |
| Receivables                                                                                 |       | (59,455                     | )          |       | (68,024                     | )          |
| Inventories and other current assets                                                        |       | (88,273                     | )          |       | (65,180                     | )          |
| Accounts payable                                                                            |       | 22,291                      |       |       | 17,318                      |       |
| Deferred revenue                                                                            |       | 88,910                      |       |       | 64,851                      |       |
| Accrued liabilities                                                                         |       | (4,056                      | )          |       | 3,061                       |       |
| Other, net                                                                                  |       | 4                           |       |       | 2,480                       |       |
| **Net Cash Provided from  Operating Activities from Continuing Operations**                 |       | 13,924                      |       |       | 136,677                     |       |
|                                                                                        |       |                        |       |       |                        |       |
| **Cash Flows from Investing  Activities from Continuing Operations:**                       |       |                        |       |       |                        |       |
| Property additions                                                                          |       | (18,121                     | )          |       | (24,239                     | )          |
| Sale of equipment and other  assets                                                         |       | 4,560                       |       |       | 1,076                       |       |
| Acquisition of The  ServiceMaster Company                                                   |       | (20,957                     | )          |       | (3,546                      | )          |
| Other business acquisitions,  net of cash acquired                                          |       | (9,961                      | )          |       | (25,217                     | )          |
| Notes receivable, financial  investments and securities                                     |       | 76,987                      |       |       | 49,340                      |       |
| **Net Cash Provided from (Used  for) Investing Activities from Continuing Operations**      |       | 32,508                      |       |       | (2,586                      | )          |
|                                                                                        |       |                        |       |       |                        |       |
| **Cash Flows from Financing  Activities from Continuing Operations:**                       |       |                        |       |       |                        |       |
| Borrowings of debt                                                                          |       | 182,000                     |       |       | 415,411                     |       |
| Payments of debt                                                                            |       | (217,288                    | )          |       | (458,245                    | )          |
| Shareholders’ dividends                                                                |       | —                      |       |       | (70,077                     | )          |
| Debt issuance costs paid                                                                    |       | (99                         | )          |       | —                      |       |
| Proceeds from employee share  plans                                                         |       | —                      |       |       | 36,277                      |       |
| **Net Cash Used for Financing Activities from  Continuing Operations**                      |       | (35,387                     | )          |       | (76,634                     | )          |
| ** **                                                                                  |       |                        |       |       |                        |       |
| **Cash Flows from Discontinued  Operations:**                                               |       |                        |       |       |                        |       |
| Cash provided from operating  activities                                                    |       | 7,389                       |       |       | 10,719                      |       |
| Cash (used for) provided from  investing activities                                         |       | (191                        | )          |       | 1,006                       |       |
| Cash used for financing  activities                                                         |       | (96                         | )          |       | (159                        | )          |
| **Net Cash Provided from  Discontinued Operations**                                         |       | 7,102                       |       |       | 11,566                      |       |
|                                                                                        |       |                        |       |       |                        |       |
| **Cash Increase During the  Period**                                                        |       | 18,147                      |       |       | 69,023                      |       |
|                                                                                        |       |                        |       |       |                        |       |
| **Cash and Cash Equivalents at  End of Period**                                             |       | $                           | 225,366    |       |                        | $          | 192,698 |   |

 

*See accompanying Notes to the CondensedConsolidated Financial Statements*

 

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# **THE SERVICEMASTER COMPANY**

**NOTESTO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS**

**(UNAUDITED)**

 

**Note 1. Basis of Presentation**

 

The condensed consolidated financial statementsinclude the accounts of The ServiceMaster Company and its subsidiaries,collectively referred to as the “Company” or “ServiceMaster”.

 

On March 18, 2007, ServiceMaster entered into an Agreement andPlan of Merger (the “Merger Agreement”) with ServiceMaster Global Holdings, Inc.(formerly CDRSVM Topco, Inc.) (“Holdings”) and CDRSVM Acquisition Co., Inc.,an indirect wholly owned subsidiary of Holdings (“Acquisition Co.”). The MergerAgreement provided that, upon the terms and subject to the conditions set forthin the Merger Agreement, Acquisition Co. would merge with and intoServiceMaster, with ServiceMaster as the surviving corporation (the “Merger”).

 

On July 24, 2007 (the “Closing Date”), the Merger was completed,and each issued and outstanding share of ServiceMaster common stock, other thanshares held by ServiceMaster or Holdings or their subsidiaries and shares heldby stockholders who validly perfected their appraisal rights under Delawarelaw, was converted into the right to receive $15.625 in cash (the “MergerConsideration”). Each share of ServiceMaster common stock owned byServiceMaster, Holdings or Acquisition Co. or any of their respectivedirect or indirect wholly-owned subsidiaries was cancelled and retired, and noconsideration was paid in exchange for it.

 

Although ServiceMaster continued as the same legal entity after the Merger, the accompanyingcondensed consolidated financial statements are presented for two periods:Predecessor and Successor, which relate to the period preceding the Merger andthe period succeeding the Merger, respectively. The Company refers to theoperations of ServiceMaster for both the Predecessor and Successor periods. Thecondensed consolidated statements of financial position as of June 30,2008 and December 31, 2007, the condensed consolidated statements ofoperations and of cash flows for the six months ended June 30, 2008 andthe condensed consolidated statement of operations for the three months ended June 30,2008 reflect the financial position, operations and cash flows of theSuccessor. The condensed consolidated statements of operations and of cashflows for the six months ended June 30, 2007 and the condensedconsolidated statement of operations for the three months ended June 30,2007 reflect the operations and cash flows of the Predecessor.

 

As a result of the consummation of the Merger and the application of purchase accounting described inNote 3, the condensed consolidated financial statements for the Predecessor andSuccessor are not comparable.

 

The condensed consolidated financialstatements have been prepared by the Company in accordance with generallyaccepted accounting principles in the United States (“GAAP”) and pursuant tothe rules and regulations of the Securities and Exchange Commission (“SEC”).The Company recommends that the quarterly condensed consolidated financialstatements be read in conjunction with the consolidated financial statementsand the notes thereto included in the Company’s Annual Report on Form 10-Kfiled with the SEC for the year ended December 31, 2007 (“2007 AnnualReport”). The condensed consolidated financial statements reflect alladjustments which are, in the opinion of management, necessary for the fairpresentation of the financial position, results of operations and cash flowsfor the interim periods presented. All intercompany transactions and balanceshave been eliminated in consolidation. The financial results as well as theassets and liabilities related to InStar have been classified in the financial statementcaption “businesses held pending sale and discontinued operations” in allperiods due to the classification of InStar as held for sale in 2007. Theresults of operations for any interim period are not necessarily indicative ofthe results which might be achieved for a full year.

 

**Note 2. Significant Accounting Policies**

 

TheCompany has identified the most important accounting policies with respect toits financial position and results of operations. These relate primarily torevenue recognition and the deferral of customer acquisition costs. Thefollowing revenue recognition policies have not changed from those disclosed inthe 2007 Annual Report.

 

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 upon contractarrangements or when services are performed for non-contractual arrangements.The Company eradicates termites through the use of baiting systems, as well asthrough non-baiting methods (e.g., fumigation or liquid treatments). Termiteservices using baiting systems, termite inspection and protection contracts,and home warranty services are frequently sold 

 

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throughannual contracts for a one-time, upfront payment. Direct costs of thesecontracts (service costs for termite contracts and claim costs for warrantycontracts) 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). Home warranty contract revenueis recognized based on the expected emergence of total claim costs. The Companyregularly reviews its estimates of direct costs for its termite bait and homewarranty contracts and adjusts the estimates when appropriate. Revenuefrom trade name licensing arrangements is recognized when earned. The Companyhas franchise agreements in its TruGreen LawnCare, Terminix, ServiceMasterClean, Merry Maids, AmeriSpec and Furniture Medic businesses. Franchise revenue(which in the aggregate represents approximately four percent of consolidatedrevenue from continuing operations) consists principally of continuing monthlyfees based upon the franchisee’s customer level revenue. Monthly fee revenue isrecognized when the related customer level revenue is reported by thefranchisee and collectibility is assured. Franchise revenue also includesinitial fees resulting from the sale of a franchise. These fees are fixed andare recognized as revenue when collectibility is assured and all materialservices or conditions relating to the sale have been substantially performed.Total profits from the franchised operations (excluding trade name licensing)were approximately $18 million and $15 million for the three months ended June 30,2008 and 2007, respectively, and consolidated operating income from continuingoperations was approximately $114 million and $134 million for the three monthsended June 30, 2008 and 2007, respectively. Total profits from thefranchised operations (excluding trade name licensing) were approximately $32million and $27 million for the six months ended June 30, 2008 and 2007,respectively, and consolidated operating income from continuing operations wasapproximately $104 million and $159 million for the six months ended June 30,2008 and 2007, respectively. The portion of total franchise fee income relatedto initial fees received from the sale of franchises was immaterial to theCompany’s consolidated financial statements for all periods.

 

The Company had $499 million and $408 million of deferred revenue at June 30,2008 and December 31, 2007, respectively. Deferred revenue consistsprimarily of payments received for annual contracts relating to home warranty,termite, pest control and lawn care services.

 

Customer acquisition costs, which are incremental and direct costs ofobtaining a customer, are deferred and amortized over the life of the relatedcontract in proportion to revenue recognized. These costs include salescommissions and direct selling costs which can be shown to have resulted in asuccessful sale.

 

TruGreen LawnCare has significant seasonality in its business. In thewinter and spring, this business sells a series of lawn applications tocustomers which are rendered primarily in March through October (theproduction season). This business incurs incremental selling expenses at thebeginning of the year that directly relate to successful sales for which therevenues are recognized in later quarters. On an interim basis, TruGreenLawnCare defers these incremental selling expenses, pre-season advertisingcosts and annual repairs and maintenance procedures that are performed primarilyin the first quarter. These costs are deferred and recognized in proportion tothe contract revenue over the production season, and are not deferred beyondthe calendar year-end. Other business segments of the Company also defer, on aninterim basis, advertising costs incurred early in the year. These costs aredeferred and recognized approximately in proportion to revenue over the balanceof the year, and are not deferred beyond the calendar year-end.

 

The cost of direct-response advertising at Terminix and TruGreenLawnCare, consisting primarily of direct-mail promotions, is capitalized andamortized over its expected period of future benefits.

 

Thefair values of the Company’s financial instruments reflect the amounts thatwould be received to sell an asset or paid to transfer a liability in anorderly transaction between market participants at the measurement date (exitprice). The fair value estimates presented in this report are based oninformation available to the Company as of June 30, 2008 and December 31, 2007.

 

The preparation of the condensed consolidated financial statementsrequires management to make certain estimates and assumptions required underGAAP which may differ from actual results. Disclosures in the 2007 AnnualReport presented the significant areas that require the use of management’sestimates and discussed how management formed its judgments. The areasdiscussed included revenue recognition; the allowance for uncollectiblereceivables; accruals for self-insured retention limits related to medical,workers’ compensation, auto and general liability insurance claims; accrualsfor home warranty and termite damage claims; the possible outcome ofoutstanding litigation; accruals for income tax liabilities as well as deferredtax accounts; the deferral and amortization of customer acquisition costs;useful lives for depreciation and amortization expense; and the valuation oftangible and intangible assets.

 

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**Note 3. Acquisition of ServiceMaster**

 

As discussed in Note 1, the Merger was completed on July 24,2007.

 

Immediately following the completion of the Merger, all of theoutstanding capital stock of Holdings, the ultimate parent company ofServiceMaster, was owned by investment funds sponsored by, or affiliates of,Clayton, Dubilier & Rice, Inc. (“CD&R”), Citigroup PrivateEquity L.P., BAS Capital Funding Corporation and J.P. Morgan VenturesCorporation (collectively, the “Equity Sponsors”).

 

Equity contributions totaling $1,431 million from the EquitySponsors, together with (i) borrowings under a new $1,150 millionsenior unsecured interim loan facility (“Interim Loan Facility”), (ii) borrowingsunder a new $2,650 million senior secured term loan facility and (iii) cashon hand at ServiceMaster, were used, among other things, to finance theaggregate Merger Consideration, to make payments in satisfaction of otherequity-based interests in ServiceMaster under the Merger Agreement, to settleexisting interest rate swaps, to redeem or provide for the repayment of certainof the Company’s existing indebtedness and to pay related transaction fees andexpenses. In addition, letters of credit issued under a new $150 millionpre-funded letter of credit facility (together with the senior secured termloan facility, the “Term Facilities”) were used to replace and/or secureletters of credit previously issued under a ServiceMaster credit facility thatwas terminated as of the Closing Date. On the Closing Date, the Company alsoentered into, but did not draw under, a new $500 million senior securedrevolving credit facility (the “Revolving Credit Facility”).

 

In connection with the Merger and the related transactions (the “Transactions”),ServiceMaster retired certain of its existing indebtedness, includingServiceMaster’s $179.0 million, 7.875% notes due August 15, 2009 (the“2009 Notes”). On the Closing Date, the 2009 Notes were called for redemptionand they were redeemed on August 29, 2007. Additionally, the Companyutilized a portion of the proceeds from the Term Facilities to repay atmaturity ServiceMaster’s $49.2 million, 6.95% notes due August 15, 2007.

 

TheInterim Loan Facility matured on July 24, 2008. On the maturity date,outstanding amounts under the Interim Loan Facility were converted on a one toone basis into 10.75%/11.50% senior toggle notes due 2015 (“Permanent Notes”).The Permanent Notes were issued pursuant to a refinancing indenture. In connectionwith the issuance of Permanent Notes, ServiceMaster entered into a registrationrights agreement, pursuant to which ServiceMaster will be required to file withthe SEC a registration statement with respect to the resale of the PermanentNotes.

 

See Note 14 to the consolidated financial statements in the 2007Annual Report for a description of the Company’s indebtedness.

 

The Company accounted for the Merger in accordance with SFAS No. 141,“Business Combinations”, which requires the cost of the Merger to be allocatedto the assets and liabilities of the Company based on fair value. The Mergerand the allocation of the purchase price have been recorded as of July 25,2007.

 

The excess of the purchase price over the net tangible and intangibleassets acquired was recorded as goodwill. The Company recorded purchaseaccounting adjustments to increase the carrying value of property, to establishintangible assets for trade names, service marks and trademarks (“trade names”),customer relationships, franchise agreements, backlog and lease commitments,among other things, as well as to reduce to fair value deferred revenue anddeferred customer acquisition costs.

 

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Thepurchase price has been allocated as follows:

 

| **(In millions)**                                        | ** ** | ** ** | ** ** |
|---------------------------------------------------------------|------------|------------|------------|
| Purchase consideration                                        |       | $          | 4,893      |   |
| Net assets acquired (historical basis)                        |       | (1,262     | )          |
| Purchase price in excess of historical  assets                |       | $          | 3,631      |   |
| Identifiable intangible assets:                               |       |       |       |
| Trade names                                                   |       | $          | 2,484      |   |
| Customer relationships                                        |       | 652        |       |
| Franchise agreements                                          |       | 88         |       |
| Backlog                                                       |       | 68         |       |
| Subcontractor and realtor network                             |       | 10         |       |
| Favorable lease commitments                                   |       | 10         |       |
| Software                                                      |       | 17         |       |
| Total identifiable intangible assets                          |       | 3,329      |       |
| Eliminate historical basis of identifiable  intangible assets |       | (249       | )          |
| Net adjustment to identifiable intangible  assets             |       | 3,080      |       |
| Goodwill                                                      |       | 1,377      |       |
| Current assets (deferred customer  acquisition costs)         |       | (68        | )          |
| Current liabilities (primarily deferred  revenue)             |       | 94         |       |
| Fixed assets                                                  |       | 29         |       |
| Fair value adjustment to existing debt                        |       | 88         |       |
| Other non-current liabilities                                 |       | (5         | )          |
| Historical debt issuance fees written off                     |       | (16        | )          |
| Deferred taxes                                                |       | (951       | )          |
| Other                                                         |       | 3          |       |
| Allocation of purchase price in excess of  historical assets  |       | $          | 3,631      |   |

 

Goodwill and most trade names are indefinite-lived intangible assets.As a result, goodwill and indefinite-lived trade names will not be amortizedbut will be evaluated for impairment at least annually.

 

TheCompany incurred certain costs related to the Merger that are presented as “Mergerrelated charges” in the Condensed Consolidated Statements of Operations and arerecorded in the Other Operations and Headquarters business segment.

 

**Note 4.Restructuring Charges**

 

The Company is engaged in a reorganization and restructuring of certainof its businesses and support functions (“Fast Forward”). Among the purposes ofFast Forward is to eliminate layers and bureaucracy and simplify work processesin order to better align the Company’s work processes around its operationaland strategic objectives. It is expected that Fast Forward will be effected inphases. The first phase involved, among other things, a reduction in work forceand various process improvements, including the closing of American Home Shield’scall center located in Santa Rosa, California. The second phase is expected toinclude the organization of certain corporate support functions into Centers ofExcellence which are expected to deliver higher quality services to ourbusiness units at lower costs, the outsourcing to third party vendors ofvarious business activities that currently are handled internally, as well asother employee workforce reductions expected to result in cost-savings. Thefirst phase of Fast Forward was substantially completed in the first quarter of2008, and the second phase is expected to begin implementation in the secondhalf of 2008.

 

In connection with Fast Forward, the Company incurred costs in thethree and six months ended June 30, 2008 of approximately$4.1 million and $6.7 million, respectively. Such costs includedconsulting fees of approximately $2.1 million and severance, leasetermination and other costs of approximately $2.0 million for the threemonths ended June 30, 2008. These charges included consulting fees ofapproximately $3.7 million and severance, lease termination and other costs ofapproximately $3.0 million for the six months ended June 30, 2008. Norestructuring charges related to Fast Forward were incurred in the three andsix months ended June 30, 2007.

 

The results for the three and six monthsended June 30, 2007 include restructuring charges related to the Company’sconsolidation of its corporate headquarters into its operations support centerin Memphis, Tennessee and the closing of its headquarters in Downers Grove,Illinois. Thetransition to Memphis was substantially completed in 2007. Almost all costsrelated to the transition were cash expenditures, and, in accordance with GAAP,these costs were expensed throughout the transition period. In the three andsix months ended June 30, 2007, the Company recognized charges ofapproximately $8.3 million and $15.3 million, respectively. These chargesconsisted of $5.8 million of employee retention and severance and $2.5 millionof recruiting and related costs for the three months ended June 30, 2007.These charges consisted of $11.4 

 

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millionof employee retention and severance and $3.9 million of recruiting and relatedcosts for the six months ended June 30, 2007.

 

During the three and six months ended June 30, 2008, the Companyreversed net expenses of $0.1 million and recorded additional expenses of $0.6million, respectively, relating to this relocation, which includes additionalseverance and other costs.

 

Thepretax charges discussed above are reported in the “Restructuring charges” linein the Condensed Consolidated Statements of Operations.

 

**Note 5. Commitments and Contingencies**

 

The Company carries insurance policies on insurable risks at levelsthat it believes to be appropriate, including workers’ compensation, auto andgeneral liability risks. The Company has both self-insured retention limits andlayers of excess insurance coverage above such self-insured retention limitsthat is insured by third parties. The Company is required to pay all claimsthat fall below the retention limits. As of June 30, 2008 and December 31,2007, the Company had accrued self-insured claims of $150 million and $159million, respectively. During the six months ended June 30, 2008 and 2007,the Company recorded provisions for uninsured claims totaling $19 million and$24 million, respectively, and the Company paid claims totaling $28 million and$32 million, respectively. The Company uses historical claims experience toestablish both the current year accrual and the underlying provision for futurelosses. This actuarially determined provision and related accrual includes bothknown claims, as well as incurred but not reported claims. The Company adjustsits estimate of accrued self-insured claims when required to reflect changesbased on factors such as changes in health care costs, accident frequency andclaim severity.

 

Accruals for warranty claims in the American Home Shield business aremade based on the Company’s claims experience and actuarial projections.Termite damage claim accruals are recorded based on both the historical ratesof claims incurred within a contract year and the cost per claim. Currentactivity could differ causing a change in estimates. The Company has certainliabilities with respect to existing or potential claims, lawsuits and otherproceedings. The Company accrues for these liabilities when it is probable thatfuture costs will be incurred and such costs can be reasonably estimated. Anyresulting adjustments, which could be material, are recorded in the period theadjustments are identified.

 

The Company maintains lease facilities with bankstotaling $65 million, which provide for the financing of branch propertiesto be leased by the Company. At June 30, 2008, approximately$65 million was funded under these facilities. Approximately $12 millionof these leases are treated as capital leases and have been included on thebalance sheet as assets with related debt as of June 30, 2008. The balanceof the funded amount is treated as operating leases. The Company has guaranteedthe residual value of the properties under the leases up to 73 percent ofthe fair market value at the commencement of the lease. At June 30, 2008,the Company’s residual value guarantee related to the leased assets totaled $53million for which the Company has recorded the estimated fair value of thisguarantee (approximately $0.1 million) in the Condensed ConsolidatedStatement of Financial Position. In connection with the closing of the Merger,the Company amended these leases effective July 24, 2007. Among themodifications, the Company extended the lease terms through July 24, 2010.The operating lease and capital lease classifications of these leases did notchange as a result of the modifications.

 

The majority of the Company’s vehicle fleet and someequipment are leased through operating leases. The lease terms arenon-cancelable for the first twelve-month term, and then are month-to-month,cancelable at the Company’s option. There are residual value guarantees by theCompany (ranging from 70 percent to 87 percent of the estimatedterminal value at the inception of the lease depending on the agreement)relative to these vehicles and equipment, which historically have not resultedin significant net payments to the lessors. At June 30, 2008, there wasapproximately $161 million of residual value relating to the Company’sfleet and equipment leases. Approximately $52 million of this residual value iswith a lessor that has exercised its option to terminate the lease effective August 2008.The cost of acquiring the assets subject to these leases is expected to amount toapproximately $50 million. The fair value of the assets under all of thefleet and equipment leases is expected to substantially mitigate the Company’sguarantee obligations under the agreements. At June 30, 2008, the Companyhas recorded the estimated fair value of this guarantee of approximately$2.9 million in the Condensed Consolidated Statement of FinancialPosition.

 

The Company has guarantees on certain bonds issued by divestedcompanies, primarily performance type bonds. The maximum payments the Companycould be required to make if the buyers of the divested companies are unable tofulfill their obligations is approximately $2 million at June 30,2008. Substantially all of the bonds are scheduled to expire in 2008, but maybe extended depending on the completion of the related projects. The Companybelieves that if it were to incur a loss on 

 

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anyindividual bond guarantee, the likelihood of which the Company believes isremote, such loss would not have a material effect on the Company’s business,financial condition, annual results of operations or cash flows.

 

In the ordinary course of conducting its business activities, theCompany becomes involved in judicial, administrative and regulatory proceedingsinvolving both private parties and governmental authorities. These proceedingsinclude general and commercial liability and employment actions as well as environmentalproceedings. The Company does not expect any of these proceedings to have amaterial effect on the Company’s business, financial condition, annual resultsof operations or cash flows.

 

**Note 6. Goodwill and Intangible Assets**

 

In accordance with SFAS No. 142, “Goodwilland Other Intangible Assets”, goodwill and intangible assets that are notamortized are subject to assessment for impairment by applying a fair-valuebased test on an annual basis or more frequently if circumstances indicate apotential impairment. The Company’s annual assessment date is October 1.

 

Thetable below summarizes the goodwill balances by segment for continuingoperations:

 
| **(In  thousands)**           | ** ** | **TruGreen  LawnCare** | ** ** | **TruGreen  LandCare** | ** ** | **Terminix** | ** ** | **American  Home  Shield** | ** ** | **Other  Operations  and  Headquarters** | ** ** | **Total** | ** ** |
|-------------------------------|------------|------------------------|------------|------------------------|------------|--------------|------------|----------------------------|------------|------------------------------------------|------------|-----------|------------|
| Balance at Dec. 31, 2007 |       | $                      | 1,143,670  |                   | $          | 47,872       |       | $                          | 1,323,953  |                                     | $          | 350,079   |       | $ | 184,349 |   | $ | 3,049,923 |   |
| Acquisitions                  |       | 6,912                  |       | —                 |       | 4,361        |       | —                     |       | 52                                       |       | 11,325    |       |
| Other(1)                      |       | (1,031                 | )          | (995                   | )          | (1,118       | )          | (423                       | )          | 633                                      |       | (2,934    | )          |
| Balance at June 30, 2008 |       | $                      | 1,149,551  |                   | $          | 46,877       |       | $                          | 1,327,196  |                                     | $          | 349,656   |       | $ | 185,034 |   | $ | 3,058,314 |   |

 

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(1)                        Primarily reflects the tax effect of theamortization of tax deductible goodwill and the impact of the resolution ofcertain tax items. Also reflects adjustments to the preliminary purchase priceallocation related to the Merger.

 

Thetable below summarizes the other intangible asset balances for continuingoperations:

 
| ** **               | ** ** | **June 30,** | ** ** | **December 31,** | ** ** |
|--------------------------|------------|-------------------|------------|-----------------------|------------|
| **(In thousands)**  | ** ** | **2008**          | ** ** | **2007**              | ** ** |
| Trade names(1)           |       | $                 | 2,468,200  |                  | $          | 2,468,200 |   |
| Other intangible assets  |       | 852,486           |       | 849,715               |       |
| Accumulated amortization |       | (225,304          | )          | (132,662              | )          |
| Net other intangibles    |       | 627,182           |       | 717,053               |       |
| Total                    |       | $                 | 3,095,382  |                  | $          | 3,185,253 |   |

 

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(1)                                 Not subject to amortization.

 

**Note 7. Stock-Based Compensation**

 

On November 20, 2007, the board ofdirectors of Holdings adopted the ServiceMaster Global Holdings, Inc.Stock Incentive Plan (the “Stock Incentive Plan”). The Stock Incentive Planprovides for the sale of shares of Holdings stock to ServiceMaster’s executiveofficers, other key employees and directors as well as the grant of deferredshare units and options to purchase shares of Holdings to those individuals.The board of directors of Holdings, or a committee designated by it, selectsthe officers, employees and directors eligible to participate in the StockIncentive Plan and determines the specific number of shares to be offered oroptions to be granted to an individual employee or director. A maximum of12,445,000 shares of Holdings stock are reserved for issuance under the StockIncentive Plan. Holdings currently intends to satisfy any need for shares ofcommon stock of Holdings associated with the exercise of options issued underthe Stock Incentive Plan through those new shares reserved for issuance.

 

All option grants under the Stock IncentivePlan will be non-qualified options with a per-share exercise price no less thanthe fair market value of one share of Holdings stock on the grant date. Anystock options granted will generally have a term of ten years and vesting will besubject to an employee’s continued employment. The board of directors ofHoldings, or a committee designated by it, may accelerate the vesting of anoption at any time. In addition, vesting of options will be accelerated ifHoldings experiences a change in control (as defined in the Stock IncentivePlan) unless options with substantially equivalent terms and economic value aresubstituted for existing options in place of accelerated vesting. Vesting ofoptions will also be accelerated in the event of an employee’s death ordisability (as defined in the Stock Incentive Plan). 

 

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Upon a termination for cause (as defined in the Stock Incentive Plan),all options held by an employee are immediately cancelled. Following atermination without cause, vested options will generally remain exercisablethrough the earliest of the expiration of their term or three months followingtermination of employment (one year in the case of death, disability orretirement at normal retirement age).

 

Unless sooner terminated by the board ofdirectors of Holdings, the Stock Incentive Plan will remain in effect until November 20,2017.

 

All options granted will vest in four equalannual installments, subject to an employee’s continued employment. Thefour-year vesting period is the requisite service period over whichcompensation cost will be recognized on a straight-line basis for all grants.The options will be accounted for as equity-classified awards. The non-cashstock-based compensation expense associated with the Stock Incentive Plan ispushed down from Holdings and recorded in the financial statements ofServiceMaster.

 

During the Successor three and six months ended June 30, 2008,stock-based compensation expense was approximately $1.7 million ($1.0 millionafter-tax) and $3.4 million ($2.6 million after-tax), respectively. During thePredecessor three and six months ended June 30, 2007, stock-basedcompensation expense was approximately $1.5 million ($1.0 million after-tax)and $3.1 million ($2.0 million after-tax), respectively.

 

As of June 30, 2008, there was approximately $24.1 million oftotal unrecognized compensation cost related to non-vested options to purchaseshares of Holdings stock. These remaining costs are expected to be recognizedover the remaining 3.5 years of the four-year requisite service period.

 

**Note 8. Supplemental Cash Flow Information**

 

In the condensed consolidated statements ofcash flows, the caption Cash and Cash Equivalents includes investments inshort-term, highly-liquid securities having a maturity of three months or lesswhen purchased. Supplemental information relating to the condensed consolidatedstatements of cash flows for the Successor six months ended June 30, 2008and the Predecessor six months ended June 30, 2007 is presented in thefollowing table:

 

| ** **                                                     | ** ** | **Successor**               | ** ** | ** ** | **Predecessor**             | ** ** |
|----------------------------------------------------------------|------------|-----------------------------|------------|------------|-----------------------------|------------|
| ** **                                                     | ** ** | **Six**                     | ** ** | ** ** | **Six**                     | ** ** |
| **(In thousands)**                                        | ** ** | **months ended**       | ** ** | ** ** | **months ended**       | ** ** |
| **Cash paid for or (received from):** | ** ** | **June 30, 2008** | ** ** | ** ** | **June 30, 2007** | ** ** |
| Interest expense                                               |       | $                           | 158,012    |       |                        | $          | 27,136 |   |
| Interest and dividend income                                   |       | (7,342                      | )          |       | (6,445                      | )          |
| Income taxes, net of refunds                                   |       | 5,913                       |       |       | 17,221                      |       |
|                                                                |            |                             |            |            |                             |            |  |  |

 

**Note 9. Comprehensive Income**

 

Total comprehensive income (loss) was $39million and ($51) million for the Successor three and six months ended June 30,2008, respectively, and $89 million and $99 million for the Predecessor threeand six months ended June 30, 2007, respectively. Total comprehensiveincome primarily includes net income, unrealized gains/(losses) on marketablesecurities, unrealized gains/(losses) on derivative instruments and the effectof foreign currency translation.

 

**Note 10. Receivable Sales**

 

The Company has an arrangement to provide for the ongoing revolvingsale of a designated pool of accounts receivable of TruGreen LawnCare andTerminix to a wholly-owned, bankruptcy-remote subsidiary, ServiceMaster FundingCompany LLC. ServiceMaster Funding Company LLC has entered into anarrangement pursuant to which it may transfer, on a revolving basis, anundivided percentage ownership interest in a pool of accounts receivable tounrelated third party purchasers. ServiceMaster Funding Company LLCretains an undivided percentage interest in the pool of accounts receivable andbad debt losses for the entire pool are allocated first to this retainedinterest. During the Successor three and six months ended June 30, 2008and the Predecessor three and six months ended June 30, 2007, there wereno receivables sold to third parties under this arrangement. However, theCompany may sell its receivables in the future which would provide analternative funding source. The arrangement is a 364-day facility that isrenewable at the option of ServiceMaster Funding Company LLC, with a finaltermination date of July 17, 2012. The Company may sell up to$50 million of its receivables to these purchasers and therefore hasimmediate access to cash proceeds from these sales. The amount of the eligiblereceivables varies during the year based on seasonality of the business andcould, at times, limit the amount available to the Company. There is presentlyonly one purchaser that is required to purchase receivables under thearrangement. If this purchaser were to 

 

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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 Company maybe reduced or eliminated.

 

**Note 11. Cash and MarketableSecurities**

 

Cash, money market funds and certificates ofdeposits, with maturities of three months or less, are included in theStatements of Financial Position caption “Cash and Cash Equivalents.” As of June 30,2008 and December 31, 2007, the Company’s investments consist primarily ofdomestic publicly traded debt of $94.3 million and $130.6 million,respectively and common equity securities of $70.2 million and$131.2 million, respectively.

 

The aggregate market value of the Company’sshort-term and long-term investments in debt and equity securities was$164.5 million and $261.8 million and the aggregate cost basis was$163.9 million and $254.7 million at June 30, 2008 and December 31,2007, respectively.

 

Gainsand losses on sales of investments, as determined on a specific identificationbasis, are included in investment income in the period they are realized. TheCompany periodically reviews its portfolio of investments to determine whetherthere has been an other than temporary decline in the value of the investmentsfrom factors such as deterioration in the financial condition of the issuer orthe market(s) in which it competes. The Company recorded an impairmentcharge of approximately $3.0 million ($1.8 million after-tax) and$0.3 million ($0.2 million after-tax) during the three months ended June 30,2008 and 2007, respectively, due to other than temporary declines in the valueof certain investments. The Company recorded an impairment charge ofapproximately $8.2 million ($6.2 million after-tax) and $0.9 million ($0.6million after-tax) during the six months ended June 30, 2008 and 2007,respectively, due to other than temporary declines in the value of certaininvestments. The unrealized gains in the investment portfolio wereapproximately $5.2 million and $8.4 million as of June 30, 2008and December 31, 2007, respectively. Unrealized losses were approximately$5.2 million and $1.4 million as of June 30, 2008 and December 31,2007, respectively. There were no unrealized losses older than one year at June 30,2008 or December 31, 2007. The aggregate fair value of the investmentswith unrealized losses totaled $52.0 million and $20.4 million at June 30,2008 and December 31, 2007, respectively. The Company’s marketablesecurities consist primarily of corporate bonds and common equity securities.

 

**Note 12. Long-Term Debt**

 

Long-term debt at June 30,2008 and December 31, 2007 is summarized in the following table:

 
| **(In thousands)**                                  | ** ** | **June 30,  2008** | ** ** | **December 31,  2007** | ** ** |
|----------------------------------------------------------|------------|-------------------------|------------|-----------------------------|------------|
| Senior secured term loan facility maturing  in 2014      |       | $                       | 2,623,500  |                        | $          | 2,636,750 |   |
| Senior unsecured interim loan facility  maturing in 2008 |       | 1,150,000               |       | 1,150,000                   |       |
| Revolving credit facility maturing in 2013               |       | —                  |       | —                      |       |
| 7.10% notes maturing in 2018 (1)                         |       | 60,736                  |       | 59,772                      |       |
| 7.45% notes maturing in 2027 (1)                         |       | 143,880                 |       | 142,457                     |       |
| 7.25% notes maturing in 2038 (1)                         |       | 58,607                  |       | 58,206                      |       |
| Other                                                    |       | 64,670                  |       | 83,626                      |       |
| Less current portion                                     |       | (45,475                 | )          | (53,564                     | )          |
| Total long-term debt                                     |       | $                       | 4,055,918  |                        | $          | 4,077,247 |   |

 

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(1)                          Theincrease from the balance at December 31, 2007 reflects the amortizationof fair value adjustments related to purchase accounting, which increases theeffective interest rate from the coupon rates shown above.

 

TheInterim Loan Facility matured on July 24, 2008. On the maturity date,outstanding amounts under the Interim Loan Facility were converted on a one toone basis into 10.75%/11.50% senior toggle notes due 2015 (“Permanent Notes”).The Permanent Notes were issued pursuant to a refinancing indenture. Inconnection with the issuance of Permanent Notes, ServiceMaster entered into aregistration rights agreement, pursuant to which ServiceMaster will be requiredto file with the SEC a registration statement with respect to the resale of thePermanent Notes.

 

InFebruary 2008, the Company entered into two 3-year interest rate swapagreements and one 4-year interest rate swap agreement, effective March 3,2008. The total notional amount of the 3-year agreements was $250 millionand the total notional amount of the 4-year swap agreement was$250 million. Under the terms of the agreements, the Company will pay aweighted average fixed rate of interest of approximately 3.15% on the notionalamount of the 3-year swap agreements and 3.48% on the notional amount of the4-year swap agreement. The Company will receive a floating rate of interest(based on three month LIBOR) on the notional amount. Therefore, the effectiveinterest rate for $500 million of the term loans is fixed 

 

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ata rate between 5.90% and 6.23%, including the borrowing margin described inNote 14 to the consolidated financial statements in the 2007 AnnualReport. In accordance with SFAS No. 133, “Accounting for DerivativeInstruments and Hedging Activities”, these interest rate swap agreements areclassified as cash flow hedges and, as such, the hedging instruments are recordedon the balance sheet as either an asset or liability at fair value, with theeffective portion of the changes in fair value attributable to the hedged risksrecorded in other comprehensive income.

 

**Note 13. Businesses Held PendingSale and Discontinued Operations**

 

Reported “loss from businesses held pending sale and discontinuedoperations, net of income taxes” for all periods presented include theoperating results of the sold and discontinued businesses noted in the 2007Annual Report. During the second quarter of 2008, the Company recorded apre-tax impairment charge of $6.3 million as a result of a change in our fairvalue estimate of InStar’s net assets based on changing market conditions andthe ongoing sales process.

 

Theoperating results and financial position of discontinued operations are asfollows:

 
| ** **                                                          | ** ** | **Successor**                | ** ** | ** ** | **Predecessor**              | ** ** |
|---------------------------------------------------------------------|------------|------------------------------|------------|------------|------------------------------|------------|
| ** **                                                          | ** ** | **Three  months ended** | ** ** | ** ** | **Three  months ended** | ** ** |
| **(In thousands)**                                             | ** ** | **June 30, 2008**  | ** ** | ** ** | **June 30, 2007**  | ** ** |
| Operating Results:                                                  |       |                         |       |       |                         |       |
| Operating revenue                                                   |       | $                            | 21,834     |       |                         | $          | 17,839 |   |
|                                                                |       |                         |       |       |                         |       |
| Operating income(loss)                                              |       | 1,766                        |       |       | (2,704                       | )          |
| Interest expense                                                    |       | (29                          | )          |       | (17                          | )          |
| Impairment charge                                                   |       | (6,317                       | )          |       | —                       |       |
| Pretax loss                                                         |       | (4,580                       | )          |       | (2,721                       | )          |
| Benefit from income taxes                                           |       | (1,844                       | )          |       | (1,099                       | )          |
| Loss from businesses held pending sale and  discontinued operations |       | $                            | (2,736     | )          |                         | $          | (1,622 | ) |

 
| ** **                                                          | ** ** | **Successor**               | ** ** | ** ** | **Predecessor**             | ** ** |
|---------------------------------------------------------------------|------------|-----------------------------|------------|------------|-----------------------------|------------|
| ** **                                                          | ** ** | **Six  months ended**  | ** ** | ** ** | **Six  months ended**  | ** ** |
| **(In thousands)**                                             | ** ** | **June 30, 2008** | ** ** | ** ** | **June 30, 2007** | ** ** |
| Operating Results:                                                  |       |                        |       |       |                        |       |
| Operating revenue                                                   |       | $                           | 39,640     |       |                        | $          | 40,239 |   |
|                                                                |       |                        |       |       |                        |       |
| Operating income(loss)                                              |       | 629                         |       |       | (5,177                      | )          |
| Interest expense                                                    |       | (70                         | )          |       | (36                         | )          |
| Impairment charge                                                   |       | (6,317                      | )          |       | —                      |       |
| Pretax loss                                                         |       | (5,758                      | )          |       | (5,213                      | )          |
| Benefit from income taxes                                           |       | (2,274                      | )          |       | (2,092                      | )          |
| Loss from businesses held pending sale and  discontinued operations |       | $                           | (3,484     | )          |                        | $          | (3,121 | ) |

 
| ** **            | ** ** | **June 30,  2008** | ** ** | **December 31,  2007** | ** ** |
|-----------------------|------------|-------------------------|------------|-----------------------------|------------|
| Financial Position:   |       |                    |       |                        |       |
| Current assets        |       | $                       | 31,124     |                        | $          | 42,474 |   |
| Current liabilities   |       | 14,627                  |       | 12,983                      |       |
| Long-term liabilities |       | 5,629                   |       | 7,765                       |       |
| Total liabilities     |       | $                       | 20,256     |                        | $          | 20,748 |   |

 

Thetable below summarizes the activity during the six months ended June 30,2008 for the remaining liabilities from operations that were disposed of inyears prior to 2008. The remaining obligations primarily relate to long-termself-insurance claims. The Company believes that the remaining reservescontinue to be adequate and reasonable.

 
| **(In thousands)**                                 | ** ** | **Balance at  Dec. 31, 2007** | ** ** | **Cash Payments  or Other** | ** ** | **(Income)/  Expense** | ** ** | **Balance at  June 30, 2008** | ** ** |
|----------------------------------------------------|------------|----------------------------------------------|------------|---------------------------------------|------------|------------------------|------------|----------------------------------------------|------------|
| Remaining liabilities of discontinued  operations: |       |                                         |       |                                  |       |                   |       |                                         |       |
| ARS/AMS                                            |       | $                                            | 2,384      |                                  | $          | (311                   | )          | $                                            | 177        |   | $ | 2,250 |   |
| LandCare Construction                              |       | 1,257                                        |       | (360                                  | )          | 169                    |       | 1,066                                        |       |
| LandCare utility line clearing business            |       | 1,350                                        |       | (84                                   | )          | —                 |       | 1,266                                        |       |
| Certified Systems, Inc. and other             |       | 6,721                                        |       | 220                                   |       | (1,920                 | )          | 5,021                                        |       |
|                                                    |            |                                              |            |                                       |            |                        |            |                                              |            |  |  |  |  |

 

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**Note14. Income Taxes**

 

Asof June 30, 2008 and December 31, 2007, the Company had $14.1 millionand $13.3 million, respectively, of tax items primarily reflected in state taxreturns that had not been recognized for financial reporting (“unrecognized taxbenefits”). If recognized prior to December 31, 2008, $12.5 million($9.0 million, net of federal and state tax effects) would be recorded as apurchase accounting adjustment to goodwill and $1.6 million ($1.2 million,net of federal and state tax effects) would affect the Company’s effective taxrate.

 

Upto $5.1 million of the Company’s unrecognized tax benefits could berecognized within the next twelve months. The Company recognized approximately$0.3 million of its unrecognized tax benefits during the Successor six monthsended June 30, 2008 and approximately $6.6 million during the Predecessorsix months ended June 30, 2007.

 

TheCompany files consolidated and separate income tax returns in the United Statesfederal jurisdiction and in many state and foreign jurisdictions. The Companyhas been audited by the United States Internal Revenue Service (“IRS”) through2006 and is no longer subject to state and local or foreign income taxexaminations by tax authorities for years before 2001.

 

Inthe ordinary course, the Company is subject to review by domestic and foreigntaxing authorities, including the IRS. As noted above, the U.S. federal taxreturns filed by the Company through the 2006 return have been reviewed by theIRS. The Company paid $5 million primarily in the first quarter of 2006relating to the resolution of the 2003 and 2004 audits. The IRS completed theaudits of the Company’s tax returns for 2005 and 2006, with no adjustments oradditional payments. The IRS commenced examinations of the Company’s U.S.federal income tax returns for 2007 and 2008 in the first quarter of 2007 andthe second quarter of 2008, respectively. At this time, the outcome of theseaudits is not known and no significant adjustments have been proposed by theIRS pertaining to these audit periods. Five state tax authorities are in theprocess of auditing state income tax returns of various subsidiaries. One stateaudit is at the appeals level. If state authorities were to prevail with theirassessments, the Company does not anticipate that these adjustments would havea material impact on the Company’s financial position, annual results ofoperations or cash flows.

 

TheCompany’s policy is to recognize potential interest and penalties related toits tax positions within the tax provision. During the Successor three and sixmonths ended June 30, 2008, the Company recognized interest expense ofless than $0.1 million and approximately $0.6 million, respectively, throughthe tax provision. During the Predecessor three and six months ended June 30,2007, the Company recognized interest expense of approximately$0.8 million and $0.7 million, respectively, through the taxprovision. As of June 30, 2008 and December 31, 2007, the Company hadaccrued for the payment of interest and penalties of approximately$3.3 million ($2.0 million, net of federal and state tax effects) and $2.4million ($1.4 million, net of federal and state tax effects), respectively.

 

***Note15. Business Segment Reporting***

* *

*Thebusiness of the Company is conducted through five reportablesegments: TruGreen LawnCare, TruGreen LandCare, Terminix, American HomeShield and Other Operations and Headquarters. The TruGreen LawnCare segmentprovides residential and commercial lawn care services. The TruGreen LandCaresegment provides landscaping services primarily to commercial customers. TheTerminix segment provides termite and pest control services to residential andcommercial customers. The American Home Shield segment provides home warrantiesto consumers that cover HVAC, plumbing and other home systems and appliances.The Other Operations and Headquarters segment includes the franchised andCompany-owned operations of ServiceMaster Clean (which includes the operationsof AmeriSpec and Furniture Medic) and Merry Maids, which provide primarilyresidential disaster restoration, commercial cleaning, carpet and upholsterycleaning, home inspection services, furniture repair and maid services. TheOther Operations and Headquarters segment also includes the Company’sheadquarters operations, which provide various technology, marketing, finance,legal and other support services to the business units.*

* *

*16*

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* *

*Segment information forcontinuing operations is presented below.*

* *
| ** **                           | ** ** | **Successor**          | ** ** | ** ** | **Predecessor**        | ** ** | **Successor**          | ** ** | ** ** | **Predecessor**        | ** ** |
|--------------------------------------|------------|------------------------|------------|------------|------------------------|------------|------------------------|------------|------------|------------------------|------------|
| ** **                           | ** ** | **Three**              | ** ** | ** ** | **Three**              | ** ** | **Six**                | ** ** | ** ** | **Six**                | ** ** |
| ** **                           | ** ** | **months ended**       | ** ** | ** ** | **months ended**       | ** ** | **months ended**       | ** ** | ** ** | **months ended**       | ** ** |
| **(In thousands)**              | ** ** | **June 30, 2008** | ** ** | ** ** | **June 30, 2007** | ** ** | **June 30, 2008** | ** ** | ** ** | **June 30, 2007** | ** ** |
| Operating Revenue:                   |       |                   |       |       |                   |       |                   |       |       |                   |       |
| TruGreen LawnCare                    |       | $                      | 377,296    |       |                   | $          | 375,548                |       | $          | 511,738                |       |   | $ | 508,220 |   |
| TruGreen LandCare                    |       | 83,877                 |       |       | 112,298                |       | 162,529                |       |       | 215,240                |       |
| Terminix                             |       | 311,774                |       |       | 311,328                |       | 573,422                |       |       | 573,500                |       |
| American Home Shield                 |       | 167,570                |       |       | 156,040                |       | 272,988                |       |       | 281,227                |       |
| Other Operations and Headquarters    |       | 56,788                 |       |       | 53,523                 |       | 108,859                |       |       | 104,045                |       |
| Total Operating Revenue              |       | $                      | 997,305    |       |                   | $          | 1,008,737              |       | $          | 1,629,536              |       |   | $ | 1,682,232 |   |
| Operating Income (Loss):(1),(2)      |       |                   |       |       |                   |       |                   |       |       |                   |       |
| TruGreen LawnCare                    |       | $                      | 55,913     |       |                   | $          | 72,813                 |       | $          | 21,854                 |       |   | $ | 61, 220 |   |
| TruGreen LandCare                    |       | (2,693                 | )          |       | (2,126                 | )          | (602                   | )          |       | (2,060                 | )          |
| Terminix                             |       | 59,682                 |       |       | 62,589                 |       | 102,895                |       |       | 107,360                |       |
| American Home Shield                 |       | 9,401                  |       |       | 20,278                 |       | (8,291                 | )          |       | 27,299                 |       |
| Other Operations and Headquarters(2) |       | (8,124                 | )          |       | (19,522                | )          | (11,979                | )          |       | (34,725                | )          |
| Total Operating Income               |       | $                      | 114,179    |       |                   | $          | 134,032                |       | $          | 103,877                |       |   | $ | 159,094 |   |

 

----

(1)          Presented below is a reconciliation of segment operating (loss) incometo (loss) income from continuing operations before income taxes.

 
| ** **                                                    | ** ** | **Successor**          | ** ** | ** ** | **Predecessor**        | ** ** | **Successor**          | ** ** | ** ** | **Predecessor**        | ** ** |
|---------------------------------------------------------------|------------|------------------------|------------|------------|------------------------|------------|------------------------|------------|------------|------------------------|------------|
| ** **                                                    | ** ** | **Three**              | ** ** | ** ** | **Three**              | ** ** | **Six**                | ** ** | ** ** | **Six**                | ** ** |
| ** **                                                    | ** ** | **months ended**       | ** ** | ** ** | **months ended**       | ** ** | **months ended**       | ** ** | ** ** | **months ended**       | ** ** |
| **(In thousands)**                                            | ** ** | **June 30, 2008** | ** ** | ** ** | **June 30, 2007** | ** ** | **June 30, 2008** | ** ** | ** ** | **June 30, 2007** | ** ** |
| Segment Operating Income                                      |       | $                      | 114,179    |       |                   | $          | 134,032                |       | $          | 103,877                |       |   | $ | 159,094 |   |
| Non-operating expense (income):                               |       |                   |       |       |                   |       |                   |       |       |                   |       |
| Interest expense                                              |       | 83,425                 |       |       | 13,879                 |       | 173,011                |       |       | 28,143                 |       |
| Interest and net investment (income) loss                     |       | (4,164                 | )          |       | (18,118                | )          | 1,881                  |       |       | (26,184                | )          |
| Minority interest and other expense, net                      |       | 145                    |       |       | 1,472                  |       | 277                    |       |       | 3,521                  |       |
| Income (Loss) from Continuing Operations  before Income Taxes |       | $                      | 34,773     |       |                   | $          | 136,799                |       | $          | (71,292                | )          |   | $ | 153,614 |   |

 

(2)          The results includerestructuring charges for severance, as well as costs associated with FastForward, and payments for employee retention and severance related to theCompany’s decision to consolidate its corporate headquarters into itsoperations support center in Memphis, Tennessee and close its formerheadquarters in Downers Grove, Illinois. The restructuring charges totaled$4.0 million and $8.3 million in the three months ended June 30, 2008and 2007, respectively, and $7.3 million and $15.3 million in the six monthsended June 30, 2008 and 2007, respectively. The results also includeMerger charges related to the purchase of ServiceMaster by a group of investorsled by CD&R. The Merger related charges totaled $0.3 million and $2.8million pretax in the three months ended June 30, 2008 and 2007,respectively, and $0.4 million and $5.3 million pretax in the six monthsended June 30, 2008 and 2007, respectively.

 

**Note16. Related Party Transactions**

 

Inconnection with the Transactions, the Company entered into a consultingagreement with CD&R under which CD&R provides the Company with on-goingconsulting and management advisory services in exchange for an annualmanagement fee of $2 million. This fee is payable quarterly. The Companyrecorded a management fee of $0.5 million and $1.0 million for the three and six months ended June 30,2008, respectively. There was no management fee recorded for the three and sixmonths ended June 30, 2007. The consulting agreement also provides thatCD&R may receive future fees in connection with certain subsequentfinancing and acquisition or disposition transactions.

 

**Note 17. Newly Issued Accounting Statementsand Positions**

 

In September 2006, the Financial Accounting Standards Board (“FASB”)issued SFAS 157, “Fair Value Measurement”. This Statement defines fairvalue, establishes a framework for measuring fair value in accordance withGAAP, and expands disclosures about fair value measurements. SFAS No. 157does not require any new fair value 

 

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measurements.In February 2008, the FASB approved FASB Staff Position FAS 157-2, “EffectiveDate of FASB Statement No. 157” (“FSP 157-2”), that permits companies topartially defer the effective date of SFAS No. 157 for one year fornon-financial assets and non-financial liabilities that are recognized ordisclosed at fair value in the financial statements on a nonrecurring basis.FSP 157-2 does not permit companies to defer recognition and disclosurerequirements for financial assets and financial liabilities or fornon-financial assets and non-financial liabilities that are re-measured atleast annually. SFAS No. 157 therefore is effective for financialassets and financial liabilities and for non-financial assets and non-financialliabilities that are re-measured at least annually for fiscal years beginningafter November 15, 2007. It is effective for non-financial assets andnon-financial liabilities that are recognized or disclosed at fair value in thefinancial statements on a nonrecurring basis for fiscal years beginning after November 15,2008. The Company has assessed the impact of this Statement to the Company’sconsolidated financial position, results of operations and cash flows. TheCompany has adopted this Statement for financial assets and liabilities (SeeNote 18). The Company does not expect the adoption of this Statement fornon-financial assets and liabilities recognized at fair value on a nonrecurringbasis to have a material effect on these consolidated financial statements.

 

InFebruary 2007, the FASB issued SFAS 159, “The Fair Value Option forFinancial Assets and Financial Liabilities”. This Statement permits entities tochoose to measure at fair value many financial instruments and certain otheritems such as investments, debt and derivative instruments. This statement iseffective for financial statements issued for fiscal years beginning after November 15,2007. The Company has elected not to apply the fair value option to any of itsfinancial assets or liabilities.

 

InDecember 2007, the FASB issued SFAS 141(R), “Business Combinations”.This Statement will significantly change the accounting for businesscombinations and is effective for business combinations finalized in fiscalyears beginning after December 15, 2008. SFAS No. 141(R) changesthe method for applying the accounting for business combinations in a number ofsignificant respects including the requirement to expense transaction fees andexpected restructuring costs as incurred, rather than including these amountsin the allocated purchase price; the requirement to recognize the fair value ofcontingent consideration at the acquisition date, rather than the expectedamount when the contingency is resolved; the requirement to recognize the fairvalue of acquired in-process research and development assets at the acquisitiondate, rather than immediately expensing; and the requirement to recognize again in relation to a bargain purchase price, rather than reducing theallocated basis of long-lived assets. Because this standard is generallyapplied prospectively, the effect of adoption on the Company’s financialstatements will depend primarily on specific transactions, if any, completedafter 2008. The Company is currently evaluating the effects that this statementis likely to have on potential post-2008 transactions.

 

InDecember 2007, the FASB issued SFAS 160, “Non-controlling Interestsin Consolidated Financial Statements—An Amendment of ARB No. 51”. ThisStatement establishes new accounting and reporting standards for thenon-controlling interest in a subsidiary and for the deconsolidation of asubsidiary. This Statement is effective for fiscal years beginning after December 15,2008. The Company is currently assessing the impact of this Statement on itsconsolidated financial statements.

 

InMarch 2008, the FASB issued SFAS 161, “Disclosures about Derivative Instruments and Hedging Activities – anamendment of FASB Statement No. 133”. This statement requiresadditional disclosures for derivative instruments and hedging activities thatinclude how and why an entity uses derivatives, how these instruments and therelated hedged items are accounted for under SFAS No. 133 and relatedinterpretations, and how derivative instruments and related hedged items affectthe entity’s financial position, results of operations and cash flows. Thisstatement is effective for financial statements issued for fiscal years andinterim periods beginning after November 15, 2008. The Company iscurrently assessing the impact of this Statement on its consolidated financialstatements.

 

In April 2008, the FASB approved FASB Staff Position FAS 142-3, “Determinationof the Useful Life of Intangible Assets” (“FSP 142-3”). FSP 142-3 amends thefactors that should be considered in developing renewal or extensionassumptions used to determine the useful life of a recognized intangible assetunder SFAS No. 142, “Goodwill and Other Intangible Assets.” FSP 142-3 iseffective for financial statements issued for fiscal years beginning after November 15,2008. The Company is currently assessing the impact of adopting FSP 142-3 onits consolidated financial statements.

 

**Note 18. Fair Value of Financial Instruments**

 

The Company has estimated the fair value of its financial instrumentsmeasured at fair value on a recurring basis using the market and incomeapproaches. For investments in marketable securities, deferred compensationtrust assets and derivative contracts, which are carried at their fair values,the Company’s fair value estimates incorporate quoted market 

 

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prices,other observable inputs (for example, interest rates) and unobservable inputs(for example, forward commodity prices) at the balance sheet date.

 

Thecarrying amount, including accrued interest, and estimated fair value ofcertain of the Company’s financial instruments for the periods presentedare as follows:

 
| ** **                           | ** ** | **June 30, 2008** | ** ** | **December 31, 2007**                             | ** ** |
|--------------------------------------|------------|-----------------------------|------------|-------------------------------------------------------------|------------|
| ** **                           | ** ** | ** **                  | ** ** | **Estimated Fair Value Measurements**        | ** ** | ** ** | ** ** | ** ** | ** ** |
| **(In thousands)**              | ** ** | **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   |       | $                           | 19,400     |                                                        | $          | 19,400 |   | $ | — |   | $ | — |   | $ | 35,100 |   | $ | 35,100 |   |
| Investments in marketable securities |       | 145,099                     |       | 73,436                                                      |       | 71,663 |   | — |   | 226,690 |   | 226,690 |   |
| Fuel swap contracts                  |       | 10,871                      |       | —                                                      |       | — |   | 10,871 |   | — |   | — |   |
| Total financial assets               |       | $                           | 175,370    |                                                        | $          | 92,836 |   | $ | 71,663 |   | $ | 10,871 |   | $ | 261,790 |   | $ | 261,790 |   |
|                                 |       |                        |       |                                                        |       |   |   |   |   |   |   |   |   |
| **Financial Liabilities**            | ** ** | ** **                  | ** ** | ** **                                                  | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| Interest rate swap contracts         |       | $                           | 9,818      |                                                        | $          | — |   | $ | 9,818 |   | $ | — |   | $ | 16,557 |   | $ | 16,557 |   |
| Total financial liabilities          |       | $                           | 9,818      |                                                        | $          | — |   | $ | 9,818 |   | $ | — |   | $ | 16,557 |   | $ | 16,557 |   |

 

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

 

| **(In thousands)**                       | ** ** | **Fuel   Swap Contracts** | ** ** |
|-----------------------------------------------|------------|--------------------------------|------------|
| Balance at December 31, 2007             |       | $                              | —     |   |
| Gains included in other comprehensive  income |       | 3,118                          |       |
| Balance at March 31, 2008                |       | $                              | 3,118      |   |
| Total gains (realized/unrealized)             |       |                           |       |
| Included in earnings(1)                       |       | 3,913                          |       |
| Included in other comprehensive income        |       | 7,753                          |       |
| Settlements, net                              |       | (3,913                         | )          |
| Balance at June 30, 2008                 |       | $                              | 10,871     |   |
|                                               |            |                                |            |  |  |

 

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(1)          Gains included in earnings are reported in cost of services rendered andproducts sold.

 

The Company uses fuel swap contracts to mitigate the impact offluctuations in fuel prices. The Company’s exposure to market risk for changesin fuel prices relates to the forecasted consumption of fuel by the Company’svehicle fleet in the delivery of services to customers. As of June 30, 2008,the Company had fuel swap contracts, designated as cash flow hedges, to payfixed prices for fuel with an aggregate notional amount of $41.4 million,maturing through 2009.

 

**Note 19. Subsequent Events**

 

 In August 2008,the Company entered into two 3-year interest rate swap agreements effective September 2,2008. The total notional amount of the swap agreements was $200 million. Underthe terms of the agreements, the Company will pay a weighted average fixed rateof interest of approximately 3.83% on the $200 million notional amount of theswap agreements. The Company will receive a floating rate of interest (based onone month LIBOR) on the notional amount. Therefore, the effective interest ratefor $200 million of the term loans is fixed at a rate of approximately 6.58%,including the borrowing margin described in Note 14 of the 2007 Annual Report.In accordance with SFAS No. 133, “Accounting for Derivative Instrumentsand Hedging Activities”, these interest rate swap agreements are classified ascash flow hedges and, as such, the hedging instruments will be recorded on thebalance sheet as either an asset or liability at fair value, with the effectiveportion of the changes in fair value attributable to the hedged risks recordedin other comprehensive income.

 

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

 

**Merger Agreement**

 

On March 18, 2007, ServiceMaster entered into the Merger Agreementwith Holdings and Acquisition Co. The Merger Agreement provided that, uponthe terms and subject to the conditions set forth in the Merger Agreement,Acquisition Co. would merge with and into ServiceMaster, withServiceMaster as the surviving corporation.

 

On the Closing Date, the Merger was completed, and each issued andoutstanding share of ServiceMaster common stock, other than shares held byServiceMaster or Holdings or their subsidiaries and shares held by stockholderswho validly perfected their appraisal rights under Delaware law, was convertedinto the right to receive $15.625 in cash. Each share of ServiceMaster commonstock owned by ServiceMaster, Holdings or Acquisition Co. or any of theirrespective direct or indirect wholly-owned subsidiaries was cancelled andretired, and no consideration was paid in exchange for it.

 

Immediately following the completion of the Merger, all of theoutstanding capital stock of Holdings, the ultimate parent company ofServiceMaster, was owned by investment funds sponsored by, or affiliates of theEquity Sponsors.

 

Equity contributions totaling $1,431 million from the EquitySponsors, together with (i) borrowings under a new $1,150 million seniorunsecured interim loan facility (“Interim Loan Facility”), (ii) borrowingsunder a new $2,650 million senior secured term loan facility and (iii) cashon hand at ServiceMaster, were used, among other things, to finance theaggregate Merger Consideration, to make payments in satisfaction of otherequity-based interests in ServiceMaster under the Merger Agreement, to settleexisting interest rate swaps, to redeem or provide for the repayment of certainof the Company’s existing indebtedness and to pay related transaction fees andexpenses. In addition, letters of credit issued under a new $150 millionpre-funded letter of credit facility (together with the senior secured termloan facility, the “Term Facilities”) were used to replace and/or secure lettersof credit previously issued under a ServiceMaster credit facility that wasterminated as of the Closing Date. On the Closing Date, the Company alsoentered into, but did not draw under, a new $500 million senior securedrevolving credit facility (the “Revolving Credit Facility”).

 

In connection with the Merger and the related transactions (the “Transactions”),ServiceMaster retired certain of its existing indebtedness, includingServiceMaster’s $179.0 million, 7.875% notes due August 15, 2009 (the“2009 Notes”). On the Closing Date, the 2009 Notes were called for redemptionand they were redeemed on August 29, 2007. Additionally, the Companyutilized a portion of the proceeds from the Term Facilities to repay atmaturity ServiceMaster’s $49.2 million, 6.95% notes due August 15,2007.

 

TheInterim Loan Facility matured on July 24, 2008. On the maturity date,outstanding amounts under the Interim Loan Facility were converted on a one toone basis into 10.75%/11.50% senior toggle notes due 2015 (“Permanent Notes”).The Permanent Notes were issued pursuant to a refinancing indenture. Inconnection with the issuance of Permanent Notes, ServiceMaster entered into aregistration rights agreement, pursuant to which ServiceMaster will be requiredto file with the SEC a registration statement with respect to the resale of thePermanent Notes.

 

**Results of Operations**

 

Although The ServiceMaster Company continued as the same legal entityafter the Merger, the accompanying consolidated financial statements arepresented for two periods, Predecessor and Successor, which relate to theperiod preceding the Merger and the period succeeding the Merger, respectively.The separate presentation is required under GAAP when there is a change inaccounting basis, which occurred when purchase accounting was applied to theacquisition of the Predecessor. Purchase accounting requires that thehistorical carrying value of the assets acquired and liabilities assumed beadjusted to fair value, which may yield results that are not comparable on aperiod-to-period basis due to the different, and sometimes higher, cost basisassociated with the allocation of the purchase price. The Company refers to theoperations of The ServiceMaster Company for both the Predecessor and Successorperiods. The condensed consolidated statements of financial position as of June 30,2008 and December 31, 2007 and the condensed consolidated statements ofoperations and of cash flows for the six months ended June 30, 2008 andthe condensed consolidated statement of operations for the three months ended June 30,2008 reflect the financial position, operations and cash flows of theSuccessor. The condensed consolidated statements of operations and of cashflows for the six months ended June 30, 2007 and the condensed consolidatedstatement of operations for the three months ended June 30, 2007 reflectthe operations and cash flows of the Predecessor.

 

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**Second Quarter 2008 Compared to 2007**

 

The Company reported second quarter 2008 revenue of $997.3 million, an$11.4 million or 1.1 percent decrease compared to 2007. The revenue for thesecond quarter of 2008 has been reduced by $11.6 million (non-cash) resultingfrom recording deferred revenue at its fair value in connection with purchaseaccounting. Excluding this impact of purchase accounting, revenue for thesecond quarter of 2008 was comparable to 2007 levels, driven by the results ofour business units as described in our “Segment Review for the Second Quarter2008 compared to 2007”.

 

Operating income was $114.2 million in the second quarter of 2008compared to $134.0 million in 2007. Income from continuing operationsbefore income taxes was $34.8 million in the second quarter of 2008 compared to$136.8 million in 2007. The decrease in income from continuing operationsbefore income taxes of $102.0 million primarily reflects the net effect of:

 
| **(In millions)**                            | ** ** | ** ** | ** ** |
|---------------------------------------------------|------------|------------|------------|
| Non-cash purchase accounting adjustments  (1)     |       | $          | (49.4      | ) |
| Increased interest expense (2)                    |       | (69.5      | )          |
| Decreased interest and net investment  income (3) |       | (14.0      | )          |
| Decreased merger related charges (4)              |       | 2.5        |       |
| Decreased restructuring charges (5)               |       | 4.3        |       |
| Improved segment results (6)                      |       | 24.1       |       |
|                                              |       | $          | (102.0     | ) |

 

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(1)           The net unfavorable impact of non-cash purchase accounting adjustmentsin the second quarter of 2008 of $49.4 million consists primarily of increasedamortization of intangible assets of $39.9 million and an $11.6 million reductionin revenue partially offset by reduced deferred customer acquisition expense of$4.3 million.

 

(2)           Represents an increase in interest expense as a result of the new debtstructure entered into upon the completion of the Transactions.

 

(3)           As further described in “Operating and Non-Operating Expenses”,represents a decrease in interest and net investment income primarilyreflecting (1) the unfavorable impact to investment gains and incomerealized on the American Home Shield investment portfolio due to realizedlosses on disposals of securities and other than temporary declines in the value of certain investments and (2) lowerinvestment income resulting from a decrease in the market value of investmentswithin an employee deferred compensation trust (for which there is acorresponding and offsetting decrease in compensation expense within operatingloss (income)).

 

(4)           Represents a decrease in charges related to the Merger which cannot becapitalized as part of the purchase cost for financial reporting purposes.

 

(5)           Represents a decrease in restructuring charges primarily resulting fromFast Forward and the consolidation of the Company’s corporate headquarters intoits operations support center in Memphis, Tennessee.

 

(6)            Represents an increase in income fromcontinuing operations before income taxes, non-cash purchase accountingadjustments, interest expense, interest and net investment income, mergerrelated charges and restructuring charges supported by the improved results atTerminix, TruGreen LandCare, American Home Shield and Other Operations andHeadquarters as described in our “Segment Reviews for the Second Quarter 2008Compared to 2007”.

 

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

 

The Company reported cost of services rendered and products sold of $589.7million for the second quarter of 2008 compared to $590.5 million in 2007.Excluding the unfavorable non-cash reduction of revenue of $11.6 millionresulting from recording deferred revenue at its fair value in conjunction withpurchase accounting, as a percentage of revenue these costs remained unchangedfrom the prior year at 58.5 percent for the second quarter of 2008. Thisreflects the impact of improved labor efficiency at Terminix and LandCareoffset by increases in fuel, fertilizer and other factor costs throughout theenterprise. The Company expects year-over-year increases in fuel and fertilizercosts to continue to negatively impact our results during the second half of2008.

 

The Company reported selling and administrative expenses of $247.1 millionfor the second quarter of 2008 compared to $270.8 million in 2007. Thesecond quarter of 2008 includes a $4.3 million (non-cash) decrease in sellingand 

 

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administrativeexpenses resulting from recording deferred customer acquisition costs at theirfair value in connection with purchase accounting. Excluding the impact ofpurchase accounting, these costs decreased as a percentage of revenue to 24.9percent for the second quarter of 2008 from 26.8 percent for 2007. Thedecrease in selling and administrative expenses as a percentage of revenueprimarily reflects lower functional support costs, improved sales laborefficiency at TruGreen LawnCare and Terminix, and lower compensation chargesfor the Company resulting from a decrease in the market value of investmentswithin an employee deferred compensation trust (for which there is acorresponding and offsetting decrease within interest and net investmentincome).

 

Amortization expense was $42.0 million for the second quarter of 2008compared to $2.3 million for 2007. The increase reflects $39.9 million ofamortization for the second quarter of 2008 related to recording amortizableintangible assets of $844 million in purchase accounting in connectionwith the Merger.

 

Non-operating expense totaled $79.4 million for the second quarterof 2008 compared with non-operating income of $2.8 million for 2007. Thischange includes a $69.5 million increase in interest expense for thesecond quarter of 2008, primarily resulting from the increased debt levelsrelated to the Merger, and a $14.0 million decrease in interest and netinvestment income for the second quarter of 2008. Interest and net investmentincome was comprised of the following for the three months ended June 30,2008 and 2007:

 
| ** **                         | ** ** | **Successor**               | ** ** | ** ** | **Predecessor**             | ** ** |
|------------------------------------|------------|-----------------------------|------------|------------|-----------------------------|------------|
| ** **                         | ** ** | **Three**                   | ** ** | ** ** | **Three**                   | ** ** |
| ** **                         | ** ** | **months ended**       | ** ** | ** ** | **months ended**       | ** ** |
| **(In  millions)**            | ** ** | **June 30, 2008** | ** ** | ** ** | **June 30, 2007** | ** ** |
| Realized gains (losses) (1)        |       | $                           | 6.5        |       |                        | $          | 15.4 |   |
| Impairments (2)                    |       | (3.0                        | )          |       | (0.3                        | )          |
| Deferred compensation trust (3)    |       | (0.1                        | )          |       | 2.2                         |       |
| Other                              |       | 0.7                         |       |       | 0.8                         |       |
| Interest and net investment income |       | $                           | 4.1        |       |                        | $          | 18.1 |   |

 

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(1)            Represents the net investment gains (losses)and the interest and dividend income realized on the American Home Shieldinvestment portfolio.

 

(2)            Represents other than temporary declines inthe value of certain investments in the American Home Shield investmentportfolio.

 

(3)            Represents investment income (loss) resultingfrom a change in the market value of investments within an employee deferredcompensation trust (for which there is an offsetting adjustment in compensationexpense within operating loss (income)).

 

The effective tax rate on income from continuing operations was 40.1percent for the second quarter of 2008 compared to 34.0 percent for 2007. The2007 effective tax rate was impacted by a $4.2 million reduction in tax expenseresulting from the favorable resolution of state tax items related to a prior non-recurringtransaction, as well as a $2.7 million reduction in tax expense resulting fromincremental deferred tax benefits that became recognizable during the secondquarter of 2007 upon the conversion of the minority equity interests inTerminix into eight million shares of ServiceMaster common stock. There were nocomparable favorable items impacting the effective tax rate in 2008.

 

***Restructuring and Merger RelatedCharges***

 

The Company is engaged in a reorganization and restructuring of certainof its businesses and support functions under Fast Forward. Among the purposesof Fast Forward is to eliminate layers and bureaucracy and simplify workprocesses in order to better align the Company’s work processes around itsoperational and strategic objectives. It is expected that Fast Forward will beeffected in phases. The first phase involved, among other things, a reductionin work force and various process improvements, including the closing ofAmerican Home Shield’s call center located in Santa Rosa, California. Thesecond phase is expected to include the organization of certain corporatesupport functions into Centers of Excellence which are expected to deliverhigher quality services to our business units at lower costs, the outsourcingto third party vendors of various business activities that currently arehandled internally, as well as other employee workforce reductions expected toresult in cost-savings. The first phase of Fast Forward was substantiallycompleted in the first quarter of 2008, and the second phase is expected tobegin implementation in the second half of 2008.

 

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Inconnection with Fast Forward, the Company incurred costs in the three monthsended June 30, 2008 of approximately $4.1 million. Such costs includeconsulting fees of approximately $2.1 million and severance, leasetermination and other costs of approximately $2.0 million. No costs relatedto Fast Forward were incurred in the three months ended June 30, 2007.

 

TheCompany expects that it will incur substantial additional costs in order toimplement the second phase of Fast Forward, but is currently unable to estimatethe aggregate amount or timing of such charges or the anticipated related cashoutlays.

 

The Company is on schedule with respect to realizing its previouslyforecasted savings from Fast Forward. The Company believes that it willultimately realize annualized pretax savings of $60 million by the end of 2009.Most of these savings will benefit the selling, general and administrative linein the statement of operations.

 

The 2007 second quarter results include restructuring charges relatedto the Company’s consolidation of its corporate headquarters into itsoperations support center in Memphis, Tennessee and the closing of itsheadquarters in Downers Grove, Illinois. The transition to Memphis was substantiallycompleted in 2007. Almost all costs related to the transition were cashexpenditures, and, in accordance with GAAP, these costs were expensedthroughout the transition period. In the three months ended June 30, 2007,the Company recognized charges of approximately $8.3 million. These chargesconsisted of $5.8 million of employee retention and severance and $2.5 millionof recruiting and related costs.

 

Duringthe three months ended June 30, 2008, the Company recognized a reductionin expense of $0.1 million relating to this relocation, which includes netadjustments for severance and other costs.

 

During the three months ended June 30, 2008 and 2007, the Companyincurred Merger related charges totaling $0.3 million and $2.8 million,respectively. These Merger related charges include investment banking,accounting, legal and other costs associated with the Merger, which cannot becapitalized as part of the purchase cost for financial reporting purposes.

 

**Key Performance Indicators**

 

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

 
| ** **                           | ** ** | **Key  Performance  Indicators  as of June 30,** | ** ** |
|--------------------------------------|------------|-----------------------------------------------------------------|------------|
| ** **                           | ** ** | **2008**                                                        | ** ** | **2007** | ** ** |
| **TruGreen LawnCare—**          | ** ** | ** **                                                      | ** ** | ** ** | ** ** |
| Growth in Full Program Accounts      |       | -2                                                              | %          | 1 | % |
| Customer Retention Rate              |       | 68.4                                                            | %          | 68.5 | % |
| **Terminix—**                   | ** ** | ** **                                                      | ** ** | ** ** | ** ** |
| Growth in Pest Control Customers     |       | 1                                                               | %          | 7 | % |
| Pest Control Customer Retention Rate |       | 78.5                                                            | %          | 78.9 | % |
| Growth in Termite Customers          |       | 2                                                               | %          | 1 | % |
| Termite Customer Retention Rate      |       | 88.1                                                            | %          | 87.6 | % |
| **American Home Shield—**       | ** ** | ** **                                                      | ** ** | ** ** | ** ** |
| Growth in Warranty Contracts         |       | 2                                                               | %          | 5 | % |
| Customer Retention Rate              |       | 61.9                                                            | %          | 59.7 | % |

 

**SegmentReviews for the Second Quarter 2008 Compared to 2007**

 

The following businesssegment reviews should be read in conjunction with the required footnotedisclosures presented in the Notes to the Condensed Consolidated FinancialStatements. This disclosure provides a reconciliation of segment operating(loss) income to income from continuing operations before income taxes, with netnon-operating expenses as the only reconciling item.

 

The Company uses AdjustedEBITDA and Comparable Operating Performance to facilitate operating performancecomparisons from period to period. Adjusted EBITDA and Comparable OperatingPerformance are supplemental measures of the Company’s performance that are notrequired by, or presented in accordance with, GAAP. Adjusted EBITDA andComparable Operating Performance are not measurements of the Company’sfinancial performance under GAAP and should not be considered as alternativesto net income or any other performance measures derived in accordance with GAAPor as 

 

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alternatives to net cash provided by operatingactivities or any other measures of the Company’s cash flow or liquidity. “AdjustedEBITDA” means net income before net income (loss) from businesses held pendingsale and discontinued operations; provision (benefit) for income taxes;minority interest and other expense, net; interest expense and interest and netinvestment income; and depreciation and amortization expense; as well as addingback interest and net investment income. The Company views its total interestand investment income as an integral part of its business model and earningsstream. “Comparable Operating Performance” is calculated by adding back toAdjusted EBITDA non-cash option and restricted stock expense and non-casheffects on Adjusted EBITDA attributable to the application of purchaseaccounting in connection with the Merger.

 

The Company believesAdjusted EBITDA facilitates company-to-company operating performancecomparisons by backing out potential differences caused by variations incapital structures (affecting net interest income and expense), taxation andthe age and book depreciation of facilities and equipment (affecting relativedepreciation expense), which may vary for different companies for reasonsunrelated to operating performance. The Company uses Comparable OperatingPerformance as a supplemental measure to assess the Company’s performancebecause it excludes non-cash option and restricted stock expense and non-casheffects on Adjusted EBITDA attributable to the application of purchaseaccounting in connection with the Merger. The Company presents ComparableOperating Performance because it believes that it is useful for investors andlenders to analyze disclosures of the Company’s operating results on the samebasis as that used by the Company’s management.

 

Adjusted EBITDA andComparable Operating Performance are not necessarily comparable to othersimilarly titled financial measures of other companies due to the potentialinconsistencies in the method of calculation.

 

Adjusted EBITDA andComparable Operating Performance have limitations as analytical tools, andshould not be considered in isolation or as substitutes for analyzing theCompany’s results as reported under GAAP. Some of these limitations are:

 

·                  Adjusted EBITDA and Comparable OperatingPerformance do not reflect changes in, or cash requirements for, the Company’sworking capital needs;

 

·                  Adjusted EBITDA and Comparable OperatingPerformance do not reflect the Company’s interest expense, or the cash requirementsnecessary to service interest or principal payments on the Company’s debt;

 

·                  Adjusted EBITDA and Comparable OperatingPerformance do not reflect the Company’s tax expense or the cash requirementsto pay the Company’s taxes;

 

·                  Adjusted EBITDA and Comparable OperatingPerformance do not reflect historical cash expenditures or future requirementsfor capital expenditures or contractual commitments;

 

·                Although depreciation and amortization arenon-cash charges, the assets being depreciated and amortized will often have tobe replaced in the future, and Adjusted EBITDA and Comparable OperatingPerformance do not reflect any cash requirements for such replacements; and

 

·                Other companies in the Company’s industriesmay calculate Adjusted EBITDA and Comparable Operating Performance differently,limiting their usefulness as comparative measures.

 

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Operatingrevenues and Comparable Operating Performance by operating segment are asfollows:

 
| ** **                                                                                    | ** ** | **Successor**               | ** ** | ** ** | **Predecessor**             | ** ** |
|-----------------------------------------------------------------------------------------------|------------|-----------------------------|------------|------------|-----------------------------|------------|
| ** **                                                                                    | ** ** | **Three**                   | ** ** | ** ** | **Three**                   | ** ** |
| ** **                                                                                    | ** ** | **months ended**       | ** ** | ** ** | **months ended**       | ** ** |
| **(In thousands)**                                                                       | ** ** | **June 30, 2008** | ** ** | ** ** | **June 30, 2007** | ** ** |
| Operating Revenue:                                                                            |       |                        |       |       |                        |       |
| TruGreen LawnCare                                                                             |       | $                           | 377,296    |       |                        | $          | 375,548 |   |
| TruGreen LandCare                                                                             |       | 83,877                      |       |       | 112,298                     |       |
| Terminix                                                                                      |       | 311,774                     |       |       | 311,328                     |       |
| American Home Shield                                                                          |       | 167,570                     |       |       | 156,040                     |       |
| Other Operations and Headquarters                                                             |       | 56,788                      |       |       | 53,523                      |       |
| Total Operating Revenue                                                                       |       | $                           | 997,305    |       |                        | $          | 1,008,737 |   |
| Comparable Operating Performance:                                                             |       |                        |       |       |                        |       |
| TruGreen LawnCare                                                                             |       | $                           | 75,336     |       |                        | $          | 76,630 |   |
| TruGreen LandCare                                                                             |       | (66                         | )          |       | (699                        | )          |
| Terminix                                                                                      |       | 73,513                      |       |       | 67,485                      |       |
| American Home Shield                                                                          |       | 36,419                      |       |       | 37,032                      |       |
| Other Operations and Headquarters                                                             |       | (230                        | )          |       | (12,144                     | )          |
| Total Comparable Operating Performance                                                        |       | $                           | 184,972    |       |                        | $          | 168,304 |   |
|                                                                                          |       |                        |       |       |                        |       |
| Memo: Items included in Comparable  Operating Performance                                     |       |                        |       |       |                        |       |
| Restructuring charges and Merger related  expenses(1)                                         |       | $                           | 4,310      |       |                        | $          | 11,054 |   |
| Management fee(2)                                                                             |       | $                           | 500        |       |                        | $          | — |   |
|                                                                                          |       |                        |       |       |                        |       |
| Memo: Items excluded from Comparable  Operating Performance                                   |       |                        |       |       |                        |       |
| Comparable Operating Performance of InStar                                                    |       | $                           | 133        |       |                        | $          | (2,288 | ) |
| Comparable Operating Performance of all  other discontinued operations                        |       | 1,633                       |       |       | 528                         |       |
| Comparable Operating Performance of  businesses held pending sale and discontinued operations |       | $                           | 1,766      |       |                        | $          | (1,760 | ) |

 

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(1)                                Comparable Operating Performance includes (i) severanceand employee retention costs and costs related to the consolidation of ourcorporate headquarters in Memphis, Tennessee, including the closing of ouroffice in Downers Grove, Illinois, (ii) costs to exit leases and severancepayments related to organizational changes within the TruGreen LandCareoperations, (iii) charges related to Fast Forward and (iv) Merger relatedexpenses. Substantially all of the restructuring charges and Merger relatedexpenses are included in the Comparable Operating Performance of the OtherOperations and Headquarters segment.

 

(2)                                Represents a management fee payable toCD&R pursuant to a consulting agreement under which CD&R will providethe Company with on-going consulting and management advisory services for aminimum annual fee of $2 million.

 

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The following table presentsreconciliations of operating (loss) income to Adjusted EBITDA and ComparableOperating Performance for the periods presented.

 
| **(In thousands)**                                                                       | ** ** | **TruGreen  LawnCare** | ** ** | **TruGreen  LandCare** | ** ** | **Terminix** | ** ** | **American  Home Shield** | ** ** | **Other  Operations  and  Headquarters** | ** ** | **Total**  | ** ** |
|-----------------------------------------------------------------------------------------------|------------|------------------------|------------|------------------------|------------|--------------|------------|--------------------------------|------------|------------------------------------------|------------|------------|------------|
| ** **                                                                                    | ** ** | ** **             | ** ** | ** **             | ** ** | ** **   | ** ** | ** **                     | ** ** | ** **                               | ** ** | ** ** | ** ** |
| **Successor three months ended June 30,  2008**                                          | ** ** | ** **             | ** ** | ** **             | ** ** | ** **   | ** ** | ** **                     | ** ** | ** **                               | ** ** | ** ** | ** ** |
| Operating income (loss)(1)                                                                    |       | $                      | 55,913     |                   | $          | (2,693       | )          | $                              | 59,682     |                                     | $          | 9,401      |       | $ | (8,124 | ) | $ | 114,179 |   |
| Depreciation and amortization expense                                                         |       | 19,402                 |       | 2,789                  |       | 14,879       |       | 12,759                         |       | 5,532                                    |       | 55,361     |       |
| EBITDA before adding back interest and net  investment income                                 |       | 75,315                 |       | 96                     |       | 74,561       |       | 22,160                         |       | (2,592                                   | )          | 169,540    |       |
| Interest and net investment income (2)                                                        |       | —                 |       | —                 |       | —       |       | 3,539                          |       | 625                                      |       | 4,164      |       |
| Adjusted EBITDA                                                                               |       | 75,315                 |       | 96                     |       | 74,561       |       | 25,699                         |       | (1,967                                   | )          | 173,704    |       |
| Non-cash option and restricted stock  expense                                                 |       | —                 |       | —                 |       | —       |       | —                         |       | 1,737                                    |       | 1,737      |       |
| Non-cash charges (credits) attributable to  purchase accounting(3)                            |       | 21                     |       | (162                   | )          | (1,048       | )          | 10,720                         |       | —                                   |       | 9,531      |       |
| Comparable Operating Performance                                                              |       | $                      | 75,336     |                   | $          | (66          | )          | $                              | 73,513     |                                     | $          | 36,419     |       | $ | (230 | ) | $ | 184,972 |   |
|                                                                                          |       |                   |       |                   |       |         |       |                           |       |                                     |       |       |       |
| Memo: Items included in Comparable  Operating Performance                                     |       |                   |       |                   |       |         |       |                           |       |                                     |       |       |       |
| Restructuring charges and merger related  expenses(4)                                         |       | $                      | 35         |                   | $          | 623          |       | $                              | —     |                                     | $          | 448        |       | $ | 3,204 |   | $ | 4,310 |   |
| Management fee(5)                                                                             |       | $                      | —     |                   | $          | —       |       | $                              | —     |                                     | $          | —     |       | $ | 500 |   | $ | 500 |   |
|                                                                                          |       |                   |       |                   |       |         |       |                           |       |                                     |       |       |       |
| Memo: Items excluded from Comparable  Operating Performance                                   |       |                   |       |                   |       |         |       |                           |       |                                     |       |       |       |
| Comparable Operating Performance of InStar                                                    |       | $                      | —     |                   | $          | —       |       | $                              | —     |                                     | $          | —     |       | $ | 133 |   | $ | 133 |   |
| Comparable Operating Performance of all  other discontinued operations                        |       | —                 |       | —                 |       | —       |       | —                         |       | 1,633                                    |       | 1,633      |       |
| Comparable Operating Performance of  businesses held pending sale and discontinued operations |       | $                      | —     |                   | $          | —       |       | $                              | —     |                                     | $          | —     |       | $ | 1,766 |   | $ | 1,766 |   |
|                                                                                          |       |                   |       |                   |       |         |       |                           |       |                                     |       |       |       |
| **Predecessor three months ended  June 30, 2007**                                        | ** ** | ** **             | ** ** | ** **             | ** ** | ** **   | ** ** | ** **                     | ** ** | ** **                               | ** ** | ** ** | ** ** |
| Operating income (loss)(1)                                                                    |       | $                      | 72,813     |                   | $          | (2,126       | )          | $                              | 62,589     |                                     | $          | 20,278     |       | $ | (19,522 | ) | $ | 134,032 |   |
| Depreciation and amortization expense                                                         |       | 3,817                  |       | 1,427                  |       | 4,896        |       | 1,633                          |       | 2,878                                    |       | 14,651     |       |
| EBITDA before adding back interest and net  investment income                                 |       | 76,630                 |       | (699                   | )          | 67,485       |       | 21,911                         |       | (16,644                                  | )          | 148,683    |       |
| Interest and net investment income (2)                                                        |       | —                 |       | —                 |       | —       |       | 15,121                         |       | 2,997                                    |       | 18,118     |       |
| Adjusted EBITDA                                                                               |       | 76,630                 |       | (699                   | )          | 67,485       |       | 37,032                         |       | (13,647                                  | )          | 166,801    |       |
| Non-cash option and restricted stock  expense                                                 |       | —                 |       | —                 |       | —       |       | —                         |       | 1,503                                    |       | 1,503      |       |
| Non-cash charges attributable to purchase  accounting(3)                                      |       | —                 |       | —                 |       | —       |       | —                         |       | —                                   |       | —     |       |
| Comparable Operating Performance                                                              |       | $                      | 76,630     |                   | $          | (699         | )          | $                              | 67,485     |                                     | $          | 37,032     |       | $ | (12,144 | ) | $ | 168,304 |   |
|                                                                                          |       |                   |       |                   |       |         |       |                           |       |                                     |       |       |       |
| Memo: Items included in Comparable  Operating Performance                                     |       |                   |       |                   |       |         |       |                           |       |                                     |       |       |       |
| Restructuring charges and merger related  expenses(4)                                         |       | $                      | —     |                   | $          | —       |       | $                              | —     |                                     | $          | —     |       | $ | 11,054 |   | $ | 11,054 |   |
| Management fee(5)                                                                             |       | $                      | —     |                   | $          | —       |       | $                              | —     |                                     | $          | —     |       | $ | — |   | $ | — |   |
|                                                                                          |       |                   |       |                   |       |         |       |                           |       |                                     |       |       |       |
| Memo: Items excluded from Comparable  Operating Performance                                   |       |                   |       |                   |       |         |       |                           |       |                                     |       |       |       |
| Comparable Operating Performance of InStar                                                    |       | $                      | —     |                   | $          | —       |       | $                              | —     |                                     | $          | —     |       | $ | (2,288 | ) | $ | (2,288 | ) |
| Comparable Operating Performance of all  other discontinued operations                        |       | —                 |       | —                 |       | —       |       | —                         |       | 528                                      |       | 528        |       |
| Comparable Operating Performance of  businesses held pending sale and discontinued operations |       | $                      | —     |                   | $          | —       |       | $                              | —     |                                     | $          | —     |       | $ | (1,760 | ) | $ | (1,760 | ) |

 

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(1)                                  Presented below is a reconciliation of segmentoperating income to net income.

 
| ** **                                                                               | ** ** | **Successor**               | ** ** | ** ** | **Predecessor**             | ** ** |
|------------------------------------------------------------------------------------------|------------|-----------------------------|------------|------------|-----------------------------|------------|
| ** **                                                                               | ** ** | **Three**                   | ** ** | ** ** | **Three**                   | ** ** |
| ** **                                                                               | ** ** | **months ended**       | ** ** | ** ** | **months ended**       | ** ** |
| **(In thousands)**                                                                  | ** ** | **June 30, 2008** | ** ** | ** ** | **June 30, 2007** | ** ** |
| Segment Operating Income                                                                 |       | $                           | 114,179    |       |                        | $          | 134,032 |   |
| Non-operating expense (income):                                                          |       |                        |       |       |                        |       |
| Interest expense                                                                         |       | 83,425                      |       |       | 13,879                      |       |
| Interest and net investment income                                                       |       | (4,164                      | )          |       | (18,118                     | )          |
| Minority interest and other expense, net                                                 |       | 145                         |       |       | 1,472                       |       |
| Income from Continuing Operations before  Income Taxes                                   |       | $                           | 34,773     |       |                        | $          | 136,799 |   |
| Provision for income taxes                                                               |       | 13,947                      |       |       | 46,546                      |       |
| Income from Continuing Operations                                                        |       | $                           | 20,826     |       |                        | $          | 90,253 |   |
| Loss from businesses held pending sale and  discontinued operations, net of income taxes |       | (2,736                      | )          |       | (1,622                      | )          |
| Net Income                                                                               |       | $                           | 18,090     |       |                        | $          | 88,631 |   |

 

(2)                                Interest and net investment income isprimarily comprised of investment income and realized gains/losses on ourAmerican Home Shield (“AHS”) segment investment portfolio. Cash, short-term andlong-term marketable securities associated with regulatory requirements inconnection with AHS and for other purposes totaled approximately $358 millionas of June 30, 2008. As further described in “Operating and Non-OperatingExpenses”, AHS interest and net investment income was $3.5 million for thesecond quarter of 2008 and $15.1 million for the second quarter of 2007. Thebalance of interest and investment income primarily relates to (i) aportion of the earnings generated by ServiceMaster Acceptance Company LimitedPartnership, our financing subsidiary exclusively dedicated to providingfinancing to our franchisees and retail customers of our operating units; (ii) investmentincome from our employee deferred compensation trust (for which there is acorresponding and offsetting increase in compensation expense within operatingincome); and (iii) interest income on other cash balances.

 

(3)                                The Merger was accounted for using purchaseaccounting. This adjustment represents the aggregate, non-cash adjustments(other than amortization and depreciation) attributable to the application ofpurchase accounting.

 

(4)                                Includes (i) severance and employeeretention costs and costs related to the consolidation of our corporateheadquarters in Memphis, Tennessee, including the closing of our office inDowners Grove, Illinois, (ii) costs to exit leases and severance paymentsrelated to organizational changes within the TruGreen LandCare operations, (iii) Mergerrelated expenses and (iv) charges related to Fast Forward.

 

(5)                                The Company entered into a consultingagreement with CD&R under which CD&R will provide the Company withon-going consulting and management advisory services in exchange for a minimumannual management fee of $2 million. This fee is payable quarterly.

 

***TruGreen LawnCare Segment***

 

The TruGreen LawnCaresegment (“LawnCare”), which includes lawn, tree and shrub care services,reported a 0.5 percent increase in revenue, a 23.2 percent decrease inoperating income and a 1.7 percent decrease in Comparable Operating Performancefor the second quarter of 2008 compared to 2007. The modest increase in revenueresulted from an improved price realization offset by the impact of customercount declines. LawnCare experienced a 0.1 percent decline in new sales and a10 basis point decrease in its rolling twelve-month retention rate from lastyear resulting in an overall 2 percent decline in customer counts from lastyear’s level. The trends in new sales and retention were adversely affected bysoft consumer demand in the first half of 2008. LawnCare remains focused on theoverall quality of service delivery, including the Lawn Quality Audit (“LQA”)visits initiated during the second half of 2006. LawnCare is seeking to improvecustomer retention over the next several years as it expands the LQA program,focuses its efforts on reducing route manager turnover and continues to improveoverall communication with customers.

 

The 1.7 percent decrease inComparable Operating Performance for the second quarter of 2008 compared to2007 also reflects increased fuel and fertilizer costs offset, in part, byreduced overhead spending.

 

***TruGreen LandCare Segment***

 

The TruGreen LandCaresegment (“LandCare”), which includes landscape maintenance services, reported a25.3 percent decrease in revenue, a 26.7 percent decrease in operating loss anda 90.6 percent increase in Comparable Operating Performance for the secondquarter of 2008 compared to 2007. The decline in revenue included a 24.0percent decline in base 

 

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contract maintenance revenueand a 27.3 percent decrease in enhancement revenue. Second quarter 2008 revenuewas adversely impacted by branch closures completed during the third quarter of2007, as well as the impacts of LandCare’s efforts to improve the profitabilityof its customer base by pruning less profitable accounts, implementing stricterpricing on new sales, and increasing the average size of new proposals.Although the total base contract maintenance sales dollars declined for thesecond quarter of 2008, LandCare realized an improvement in the average valueper contract sold (higher value contracts tend to be more profitable).

 

Comparable OperatingPerformance improved $0.6 million for the second quarter of 2008 compared to2007 and also reflects improved materials and labor management on the basecontract maintenance portfolio and reduced overhead spending. These factorswere offset, in part, by increased fuel costs and $0.6 million of restructuringcharges in the second quarter of 2008.

 

***Terminix Segment***

 

The Terminix segment, whichincludes termite and pest control services, reported comparable revenue for thesecond quarter of 2008 compared to 2007. Revenue for the second quarter of 2008has been reduced by $1.0 million (non-cash) as a result of recording deferredrevenue at its fair value in connection with purchase accounting. Excludingthis impact of purchase accounting, revenue increased 0.5 percent for thesecond quarter of 2008 compared to 2007. Terminix reported a 4.6 percentdecrease in operating income and an 8.9 percent increase in ComparableOperating Performance for the second quarter of 2008 compared to 2007. Thesegment’s overall revenue results, excluding purchase accounting, reflectedmodest growth in pest control revenues and increases in termite contractrenewal revenue, offset by a decline in revenue from termite completions. Pestcontrol revenues increased 2.3 percent for the second quarter of 2008 ascompared to 2007, as the impact of acquisitions and price realization more thanoffset a slight decrease in new unit sales. A 2.9 percent increase in termiterenewal revenues for the second quarter of 2008 was supported by pricerealization and a 50 basis point improvement in termite customer retention.Revenue from termite completionsdeclined 3.3 percent for the second quarter of 2008, as reduced termite swarmactivity negatively impacted demand for services and due to reduced averagepricing on new termite treatments.

 

The growth in ComparableOperating Performance also reflects lower termite materials costs, effectivemanagement of seasonal staffing of production and sales labor, lower vehiclefleet counts, and reduced overhead spending, offset, in part, by increased fuelcosts.

 

***American Home Shield Segment***

 

TheAmerican Home Shield segment, which provides home warranties to consumers thatcover heating, ventilation, air conditioning, plumbing and other systems andappliances, reported a 7.4 percent increase in revenue for the second quarterof 2008 compared to 2007. Revenue for the second quarter of 2008 has beenreduced by $10.6 million (non-cash) as a result of recording deferred revenueat its fair value in connection with purchase accounting. Excluding this impactof purchase accounting, revenue increased 14.2 percent for the secondquarter of 2008 over the second quarter of 2007. American Home Shield reporteda 53.6 percent decrease in operating income and a 1.7 percentdecrease in Comparable Operating Performance for the second quarter of 2008over the second quarter of 2007. The increase in revenue, in part,resulted from higher contract costs in the quarter due to differences betweenyears in the timing of the incidence of warranty claims. American Home Shieldrecognizes revenue over the contract period in proportion to expected directcosts. Total new contract salesand renewal units, which are reported as earned revenue over the subsequenttwelve-month contract period, were comparable in the second quarter of 2008compared with 2007. Contract unit sales from customer renewals increased 5.9percent, reflecting a larger base of renewable customers and a 220 basis pointimprovement in retention. American Home Shield’s sales in the real estatechannel were significantly impacted by the continued softness in the homeresale market throughout most of the country with overall unit sales declinesof 15.9 percent through this channel.

 

Thedecrease in Comparable Operating Performance for the second quarter of 2008also includes an $11.6 million decrease in interest and net investment incomefrom the American Home Shield investment portfolio (primarily reflecting theunfavorable impact of realized losses on disposals of securities and other thantemporary declines in the value of certain investments) as compared to 2007 andincreased provisions for certain legal matters partially offset by beneficialimpacts of increases in prices and service fees per claim.

 

***Other Operations and Headquarters Segment***

 

This segment includes theoperations of ServiceMaster Clean and Merry Maids, as well as the Company’sheadquarters functions. The segment reported a 6.1 percent increase in revenuefor the second quarter of 2008 compared to 

 

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2007. The ServiceMasterClean and Merry Maids operations reported a combined 6.7 percent increase inrevenue for the second quarter of 2008. The growth in revenue resulted fromincreases in franchise revenues. The ServiceMaster Clean and Merry Maidsoperations reported a combined increase in operating income of 1.0 percentand an increase in Comparable Operating Performance of 19.3 percent, or $3.1million, for second quarter of 2008 compared to 2007. The increase in thesegment’s Comparable Operating Performance for the second quarter of 2008compared to 2007 of $11.9 million primarily reflects increased ComparableOperating Performance from the ServiceMaster Clean and Merry Maids operationsresulting from increased revenue, the decrease in Restructuring and Mergerrelated expenses incurred in 2008 and lower functional support costs.

 

***Discontinued Operations***

 

The components of loss frombusinesses held pending sale and discontinued operations, net of income taxes,and the reconciliation of operating loss to Adjusted EBITDA and ComparableOperating Performance for the three months ended June 30, 2008 and June 30,2007 are as follows:

 
| ** **                                                                                    | ** ** | **Successor**               | ** ** | ** ** | **Predecessor**             | ** ** |
|-----------------------------------------------------------------------------------------------|------------|-----------------------------|------------|------------|-----------------------------|------------|
| ** **                                                                                    | ** ** | **Three**                   | ** ** | ** ** | **Three**                   | ** ** |
| ** **                                                                                    | ** ** | **months ended**       | ** ** | ** ** | **months ended**       | ** ** |
| **(In thousands)**                                                                       | ** ** | **June 30, 2008** | ** ** | ** ** | **June 30, 2007** | ** ** |
| Operating income(loss)                                                                        |       | $                           | 1,766      |       |                        | $          | (2,704 | ) |
| Interest expense                                                                              |       | (29                         | )          |       | (17                         | )          |
| Impairment charge                                                                             |       | (6,317                      | )          |       | —                      |       |
| Pretax loss                                                                                   |       | (4,580                      | )          |       | (2,721                      | )          |
| Benefit from income taxes                                                                     |       | (1,844                      | )          |       | (1,099                      | )          |
| Loss from businesses held pending sale and  discontinued operations, net of income taxes      |       | $                           | (2,736     | )          |                        | $          | (1,622 | ) |
|                                                                                          |       |                        |       |       |                        |       |
| Operating income(loss)                                                                        |       | $                           | 1,766      |       |                        | $          | (2,704 | ) |
| Depreciation and amortization expense                                                         |       | —                      |       |       | 944                         |       |
| EBITDA before adding back interest and  investment income, net                                |       | 1,766                       |       |       | (1,760                      | )          |
| Interest and net investment income                                                            |       | —                      |       |       | —                      |       |
| Adjusted EBITDA                                                                               |       | 1,766                       |       |       | (1,760                      | )          |
| Non-cash option and restricted stock  expense                                                 |       | —                      |       |       | —                      |       |
| Non-cash charges attributable to purchase  accounting                                         |       | —                      |       |       | —                      |       |
| Comparable Operating Performance of  businesses held pending sale and discontinued operations |       | $                           | 1,766      |       |                        | $          | (1,760 | ) |

 

During the second quarter of 2008, the Company recorded a pre-taximpairment charge of $6.3 million as a result of a change in our fair valueestimate of InStar’s net assets based on changing market conditions and theongoing sales process.

 

**Six Months Ended June 30, 2008 Compared to 2007**

 

The Company reported revenue of $1,629.5 million for the six monthsended June 30, 2008, a $52.7 million or 3.1 percent decrease compared to2007. The revenue for the six months ended June 30, 2008 has been reducedby $33.4 million (non-cash) resulting from recording deferred revenue at itsfair value in connection with purchase accounting. Excluding this impact ofpurchase accounting, revenue for the six months ended June 30, 2008decreased $19.3 million or 1.1 percent, from 2007 levels, driven by the resultsof our business units as described in our “Segment Reviews for the Six MonthsEnded June 30, 2008 Compared to 2007”.

 

Operating income was $103.9 million in the six months ended June 30,2008 compared to operating income of $159.1 million in 2007. Loss fromcontinuing operations before income taxes was $71.3 million in the six monthsended June 30, 2008 compared to income from continuing operations beforeincome taxes of $153.6 million in 2007. The decrease in (loss) income fromcontinuing operations before income taxes of $224.9 million primarily reflectsthe net effect of:

 
| **(In  millions)**                                | ** ** | ** ** | ** ** |   |   |
|---------------------------------------------------|------------|------------|------------|--------|--------|
| Non-cash purchase accounting adjustments  (1)     |       |       |       | $      | (110.3 | ) |
| Increased interest expense (2)                    |       |       |       | (144.9 | )      |
| Decreased interest and net investment  income (3) |       |       |       | (28.1  | )      |
| Decreased merger related charges (4)              |       |       |       | 5.0    |   |
| Decreased restructuring charges (5)               |       |       |       | 8.0    |   |
| Improved segment results (6)                      |       |       |       | 45.4   |   |
|                                              |       |       |       | $      | (224.9 | ) |

 

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(1)           The net unfavorable impact of non-cash purchase accounting adjustmentsin the six months ended June 30, 2008 of $110.3 million consists primarilyof increased amortization of intangible assets of $88.2 million and a $33.4million reduction in revenue partially offset by reduced deferred customeracquisition expense of $13.9 million.

 

(2)           Represents an increase in interest expense as a result of the new debtstructure entered into upon the completion of the Transactions.

 

(3)           As further described in “Operating and Non-Operating Expenses”,represents a decrease in interest and net investment income primarilyreflecting (1) the unfavorable impact to investment gains and incomerealized on the American Home Shield investment portfolio due to realizedlosses on disposals of securities and other than  temporary declines in the value of certaininvestments and (2) lower investment income resulting from a decrease inthe market value of investments within an employee deferred compensation trust(for which there is a corresponding and offsetting decrease in compensationexpense within operating loss (income)).

 

(4)            Represents a decrease in charges related tothe Merger which cannot be capitalized as part of the purchase cost forfinancial reporting purposes.

 

(5)           Represents a decrease in restructuring charges primarily resulting fromFast Forward and the consolidation of the Company’s corporate headquarters intoits operations support center in Memphis, Tennessee.

 

(6)           Represents an increase in income from continuing operations beforeincome taxes, non-cash purchase accounting adjustments, interest expense,interest and net investment income, merger related charges and restructuringcharges supported by the improved results at Terminix, TruGreen LawnCare,TruGreen LandCare, American Home Shield and Other Operations and  Headquarters as described in our “SegmentReviews for the Six Months Ended June 30, 2008 Compared to 2007”.

 

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

 

The Company reported cost of services rendered and products sold of$1,007.1 million for the six months ended June 30, 2008 compared to$1,033.9 million in 2007. Excluding the non-cash reduction of revenue of$33.4 million resulting from recording deferred revenue at its fair value inconjunction with purchase accounting, as a percentage of revenue these costsdecreased to 60.6 percent for the six months ended June 30, 2008from 61.5 percent in 2007. This decrease primarily reflects the impact ofimproved labor efficiency at Terminix, offset by increases in fuel, fertilizerand other factor costs throughout the enterprise.

 

The Company reported selling and administrative expenses of $418.2million for the six months ended June 30, 2008 compared to$464.1 million in 2007. The six months ended June 30, 2008 include a$13.9 million (non-cash) decrease in selling and administrative expenses resultingfrom recording deferred customer acquisition costs at their fair value inconnection with purchase accounting. Excluding the impact of purchaseaccounting, these costs decreased as a percentage of revenue to26.0 percent for the six months ended June 30, 2008 from27.6 percent for 2007. The decrease in selling and administrative expensesas a percentage of revenue primarily reflects lower functional support costs,improved sales labor efficiency at TruGreen LawnCare and Terminix, and lowercompensation charges for the Company due primarily to a decrease in the marketvalue of investments within an employee deferred compensation trust (for whichthere is a corresponding and offsetting decrease within interest and netinvestment loss (income)).

 

Amortization expense was $92.6 million for the six months ended June 30,2008 compared to $4.6 million for 2007. The increase reflects$88.2 million of amortization for the six months ended June 30, 2008related to recording amortizable intangible assets of $844 million inpurchase accounting in connection with the Merger.

 

Non-operating expense totaled $175.2 million for the six monthsended June 30, 2008 compared with $5.5 million for 2007. This changeincludes a $144.9 million increase in interest expense for the six monthsended June 30, 2008, primarily resulting from the increased debt levelsrelated to the Merger, and a $28.1 million decrease in interest and netinvestment income for the six months ended June 30, 2008. Interest and netinvestment income was comprised of the following for the six months ended June 30,2008 and 2007:

 

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| ** **                                | ** ** | **Successor**               | ** ** | ** ** | **Predecessor**             | ** ** |
|-------------------------------------------|------------|-----------------------------|------------|------------|-----------------------------|------------|
| ** **                                | ** ** | **Six**                     | ** ** | ** ** | **Six**                     | ** ** |
| ** **                                | ** ** | **months ended**       | ** ** | ** ** | **months ended**       | ** ** |
| **(In millions)**                    | ** ** | **June 30, 2008** | ** ** | ** ** | **June 30, 2007** | ** ** |
| Realized gains (losses) (1)               |       | $                           | 7.2        |       |                        | $          | 23.1 |   |
| Impairments (2)                           |       | (8.2                        | )          |       | (0.9                        | )          |
| Deferred compensation trust (3)           |       | (2.7                        | )          |       | 2.8                         |       |
| Other                                     |       | 1.8                         |       |       | 1.2                         |       |
| Interest and net investment (loss) income |       | $                           | (1.9       | )          |                        | $          | 26.2 |   |

 

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(1)           Represents the net investment gains (losses) and the interest anddividend income realized on the American Home Shield investment portfolio.

 

(2)           Represents other than temporary declines in the value of certaininvestments in the American Home Shield investment portfolio.

 

(3)           Represents investment income (loss) resulting from a change in themarket value of investments within an employee deferred compensation trust (forwhich there is an offsetting adjustment in compensation expense withinoperating loss (income)).

 

The effective tax rate on (loss) income from continuing operations wasa benefit of 23.9 percent for the six months ended June 30, 2008 comparedto an expense of 34.7 percent for 2007. The change in the effective tax rate isprimarily due to state tax expense offsetting the statutory federal benefitgenerated due to losses in 2008 as a result of the Merger compared to state taxexpense increasing the effective tax rate in 2007. In addition, the 2007effective tax rate was impacted by a $4.2 million reduction in tax expenseresulting from the favorable resolution of state tax items related to a priornon-recurring transaction, as well as a $2.7 million reduction in tax expenseresulting from incremental deferred tax benefits that became recognizableduring the second quarter of 2007 upon the conversion of the minority equityinterests in Terminix into eight million shares of ServiceMaster common stock.There were no comparable favorable items impacting the effective tax rate in2008.

 

***Restructuring and MergerRelated Charges***

 

The Company is engaged in a reorganization and restructuring of certainof its businesses and support functions under Fast Forward. Among the purposesof Fast Forward is to eliminate layers and bureaucracy and simplify workprocesses in order to better align the Company’s work processes around itsoperational and strategic objectives. It is expected that Fast Forward will beeffected in phases. The first phase involved, among other things, a reductionin work force and various process improvements, including the closing ofAmerican Home Shield’s call center located in Santa Rosa, California. Thesecond phase is expected to include the organization of certain corporatesupport functions into Centers of Excellence which are expected to deliverhigher quality services to our business units at lower costs, the outsourcingto third party vendors of various business activities that currently arehandled internally, as well as other employee workforce reductions expected toresult in cost-savings. The first phase of Fast Forward was substantiallycompleted in the first quarter of 2008, and the second phase is expected tobegin implementation in the second half of 2008.

 

In connection with Fast Forward, the Company incurred costs in the sixmonths ended June 30, 2008 of approximately $6.7 million. Such costsinclude consulting fees of approximately $3.7 million and severance, leasetermination and other costs of approximately $3.0 million. No costsrelated to Fast Forward were incurred in the six months ended June 30,2007.

 

TheCompany expects that it will incur substantial additional costs in order toimplement the second phase of Fast Forward, but is currently unable to estimatethe aggregate amount or timing of such charges or the anticipated related cashoutlays.

 

The Company is on schedule with respect to realizing its previouslyforecasted savings from Fast Forward. The Company believes that it willultimately realize annual pretax savings of $60 million by the end of 2009.Most of these savings will benefit the selling, general and administrative linein the statement of operations.

 

The results for the six months ended June 30, 2007 includerestructuring charges related to the Company’s consolidation of its corporateheadquarters into its operations support center in Memphis, Tennessee and theclosing of its headquarters in Downers Grove, Illinois. The transition to Memphis was substantiallycompleted in 2007. Almost all costs 

 

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related to the transition were cashexpenditures, and, in accordance with GAAP, these costs were expensedthroughout the transition period. In the six months ended June 30, 2007,the Company recognized charges of approximately $15.3 million. These chargesconsisted of $11.4 million of employee retention and severance and $3.9 millionof recruiting and related costs.

 

Duringthe six months ended June 30, 2008, the Company incurred an additional$0.6 million relating to this relocation, which includes additional severanceand other costs.

 

During the six months ended June 30, 2008 and 2007, the Companyincurred Merger related charges totaling $0.4 million and $5.3 million,respectively. These Merger related charges include investment banking,accounting, legal and other costs associated with the Merger, which cannot becapitalized as part of the purchase cost for financial reporting purposes.

 

**SegmentReviews for the Six Months Ended June 30, 2008 Compared to 2007**

 

The following businesssegment reviews should be read in conjunction with the required footnotedisclosures presented in the Notes to the Condensed Consolidated FinancialStatements. This disclosure provides a reconciliation of segment operating(loss) income to (loss) income from continuing operations before income taxes,with net non-operating expenses as the only reconciling item. As noted insegment reviews for the second quarter 2008 compared to 2007, the Company usesAdjusted EBITDA and Comparable Operating Performance to facilitate operatingperformance comparisons from period to period.

 

Operating revenues andComparable Operating Performance by operating segment are as follows:

 
| ** **                                                                                    | ** ** | **Successor**               | ** ** | ** ** | **Predecessor**             | ** ** |
|-----------------------------------------------------------------------------------------------|------------|-----------------------------|------------|------------|-----------------------------|------------|
| ** **                                                                                    | ** ** | **Six**                     | ** ** | ** ** | **Six**                     | ** ** |
| ** **                                                                                    | ** ** | **months ended**       | ** ** | ** ** | **months ended**       | ** ** |
| **(In thousands)**                                                                       | ** ** | **June 30, 2008** | ** ** | ** ** | **June 30, 2007** | ** ** |
| Operating Revenue:                                                                            |       |                        |       |       |                        |       |
| TruGreen LawnCare                                                                             |       | $                           | 511,738    |       |                        | $          | 508,220 |   |
| TruGreen LandCare                                                                             |       | 162,529                     |       |       | 215,240                     |       |
| Terminix                                                                                      |       | 573,422                     |       |       | 573,500                     |       |
| American Home Shield                                                                          |       | 272,988                     |       |       | 281,227                     |       |
| Other Operations and Headquarters                                                             |       | 108,859                     |       |       | 104,045                     |       |
| Total Operating Revenue                                                                       |       | $                           | 1,629,536  |       |                        | $          | 1,682,232 |   |
| Comparable Operating Performance:                                                             |       |                        |       |       |                        |       |
| TruGreen LawnCare                                                                             |       | $                           | 68,599     |       |                        | $          | 68,877 |   |
| TruGreen LandCare                                                                             |       | 4,631                       |       |       | 785                         |       |
| Terminix                                                                                      |       | 129,012                     |       |       | 116,828                     |       |
| American Home Shield                                                                          |       | 42,203                      |       |       | 52,743                      |       |
| Other Operations and Headquarters                                                             |       | 1,702                       |       |       | (21,950                     | )          |
| Total Comparable Operating Performance                                                        |       | $                           | 246,147    |       |                        | $          | 217,283 |   |
|                                                                                          |       |                        |       |       |                        |       |
| Memo: Items included in Comparable  Operating Performance                                     |       |                        |       |       |                        |       |
| Restructuring charges and Merger related  expenses(1)                                         |       | $                           | 7,685      |       |                        | $          | 20,652 |   |
| Management fee(2)                                                                             |       | $                           | 1,000      |       |                        | $          | — |   |
|                                                                                          |       |                        |       |       |                        |       |
| Memo: Items excluded from Comparable  Operating Performance                                   |       |                        |       |       |                        |       |
| Comparable Operating Performance of InStar                                                    |       | $                           | (843       | )          |                        | $          | (3,601 | ) |
| Comparable Operating Performance of all  other discontinued operations                        |       | 1,472                       |       |       | 402                         |       |
| Comparable Operating Performance of  businesses held pending sale and discontinued operations |       | $                           | 629        |       |                        | $          | (3,199 | ) |

 

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(1)                               Comparable Operating Performance includes (i) severanceand employee retention costs and costs related to the consolidation of ourcorporate headquarters in Memphis, Tennessee, including the closing of ouroffice in Downers Grove, Illinois, (ii) costs to exit leases and severancepayments related to organizational changes within the TruGreen LandCareoperations, (iii) charges related to Fast Forward and (iv) Mergerrelated expenses. Substantially all of the restructuring charges and Mergerrelated expenses are included in the Comparable Operating Performance of theOther Operations and Headquarters segment.

 

(2)                               Represents a management fee payable toCD&R pursuant to a consulting agreement under which CD&R will providethe Company with on-going consulting and management advisory services for aminimum annual fee of $2 million.

 

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The following table presents reconciliations ofoperating income (loss) to Adjusted EBITDA and Comparable Operating Performancefor the periods presented.

 
| **(In thousands)**                                                                       | ** ** | **TruGreen  LawnCare** | ** ** | **TruGreen  LandCare** | ** ** | **Terminix** | ** ** | **American  Home Shield** | ** ** | **Other  Operations  and  Headquarters** | ** ** | **Total** | ** ** |
|-----------------------------------------------------------------------------------------------|------------|------------------------|------------|------------------------|------------|--------------|------------|--------------------------------|------------|------------------------------------------|------------|-----------|------------|
| **Successor six months ended June 30,  2008**                                            |       |                   |       |                   |       |         |       |                           |       |                                     |       |      |       |
| Operating income (loss)                                                                       |       | $                      | 21,854     |                   | $          | (602         | )          | $                              | 102,895    |                                     | $          | (8,291    | )          | $ | (11,979 | ) | $ | 103,877 |   |
| Depreciation and amortization expense                                                         |       | 46,711                 |       | 5,558                  |       | 29,891       |       | 25,442                         |       | 10,991                                   |       | 118,593   |       |
| EBITDA before adding back interest and net  investment income                                 |       | 68,565                 |       | 4,956                  |       | 132,786      |       | 17,151                         |       | (988                                     | )          | 222,470   |       |
| Interest and net investment income (loss)  (2)                                                |       | —                 |       | —                 |       | —       |       | (962                           | )          | (919                                     | )          | (1,881    | )          |
| Adjusted EBITDA                                                                               |       | 68,565                 |       | 4,956                  |       | 132,786      |       | 16,189                         |       | (1,907                                   | )          | 220,589   |       |
| Non-cash option and restricted stock  expense                                                 |       | —                 |       | —                 |       | —       |       | —                         |       | 3,401                                    |       | 3,401     |       |
| Non-cash charges (credits) attributable to  purchase accounting(3)                            |       | 34                     |       | (325                   | )          | (3,774       | )          | 26,014                         |       | 208                                      |       | 22,157    |       |
| Comparable Operating Performance                                                              |       | $                      | 68,599     |                   | $          | 4,631        |       | $                              | 129,012    |                                     | $          | 42,203    |       | $ | 1,702 |   | $ | 246,147 |   |
|                                                                                          |       |                   |       |                   |       |         |       |                           |       |                                     |       |      |       |
| Memo: Items included in Comparable  Operating Performance                                     |       |                   |       |                   |       |         |       |                           |       |                                     |       |      |       |
| Restructuring charges and merger related  expenses(4)                                         |       | $                      | 316        |                   | $          | 202          |       | $                              | 57         |                                     | $          | 448       |       | $ | 6,662 |   | $ | 7,685 |   |
| Management fee(5)                                                                             |       | $                      | —     |                   | $          | —       |       | $                              | —     |                                     | $          | —    |       | $ | 1,000 |   | $ | 1,000 |   |
|                                                                                          |       |                   |       |                   |       |         |       |                           |       |                                     |       |      |       |
| Memo: Items excluded from Comparable  Operating Performance                                   |       |                   |       |                   |       |         |       |                           |       |                                     |       |      |       |
| Comparable Operating Performance of InStar                                                    |       | $                      | —     |                   | $          | —       |       | $                              | —     |                                     | $          | —    |       | $ | (843 | ) | $ | (843 | ) |
| Comparable Operating Performance of all  other discontinued operations                        |       | —                 |       | —                 |       | —       |       | —                         |       | 1,472                                    |       | 1,472     |       |
| Comparable Operating Performance of businesses  held pending sale and discontinued operations |       | $                      | —     |                   | $          | —       |       | $                              | —     |                                     | $          | —    |       | $ | 629 |   | $ | 629 |   |
|                                                                                          |       |                   |       |                   |       |         |       |                           |       |                                     |       |      |       |
| **Predecessor six months ended June 30,  2007**                                          |       |                   |       |                   |       |         |       |                           |       |                                     |       |      |       |
| Operating income (loss)                                                                       |       | $                      | 61,220     |                   | $          | (2,060       | )          | $                              | 107,360    |                                     | $          | 27,299    |       | $ | (34,725 | ) | $ | 159,094 |   |
| Depreciation and amortization expense                                                         |       | 7,657                  |       | 2,845                  |       | 9,468        |       | 3,261                          |       | 5,716                                    |       | 28,947    |       |
| EBITDA before adding back interest and net  investment income                                 |       | 68,877                 |       | 785                    |       | 116,828      |       | 30,560                         |       | (29,009                                  | )          | 188,041   |       |
| Interest and net investment income(2)                                                         |       | —                 |       | —                 |       | —       |       | 22,183                         |       | 4,001                                    |       | 26,184    |       |
| Adjusted EBITDA                                                                               |       | 68,877                 |       | 785                    |       | 116,828      |       | 52,743                         |       | (25,008                                  | )          | 214,225   |       |
| Non-cash option and restricted stock  expense                                                 |       | —                 |       | —                 |       | —       |       | —                         |       | 3,058                                    |       | 3,058     |       |
| Non-cash charges attributable to purchase  accounting(3)                                      |       | —                 |       | —                 |       | —       |       | —                         |       | —                                   |       | —    |       |
| Comparable Operating Performance                                                              |       | $                      | 68,877     |                   | $          | 785          |       | $                              | 116,828    |                                     | $          | 52,743    |       | $ | (21,950 | ) | $ | 217,283 |   |
|                                                                                          |       |                   |       |                   |       |         |       |                           |       |                                     |       |      |       |
| Memo: Items included in Comparable  Operating Performance                                     |       |                   |       |                   |       |         |       |                           |       |                                     |       |      |       |
| Restructuring charges and merger related  expenses(4)                                         |       | $                      | —     |                   | $          | —       |       | $                              | —     |                                     | $          | —    |       | $ | 20,652 |   | $ | 20,652 |   |
| Management fee(5)                                                                             |       | $                      | —     |                   | $          | —       |       | $                              | —     |                                     | $          | —    |       | $ | — |   | $ | — |   |
|                                                                                          |       |                   |       |                   |       |         |       |                           |       |                                     |       |      |       |
| Memo: Items excluded from Comparable  Operating Performance                                   |       |                   |       |                   |       |         |       |                           |       |                                     |       |      |       |
| Comparable Operating Performance of InStar                                                    |       | $                      | —     |                   | $          | —       |       | $                              | —     |                                     | $          | —    |       | $ | (3,601 | ) | $ | (3,601 | ) |
| Comparable Operating Performance of all  other discontinued operations                        |       | —                 |       | —                 |       | —       |       | —                         |       | 402                                      |       | 402       |       |
| Comparable Operating Performance of  businesses held pending sale and discontinued operations |       | $                      | —     |                   | $          | —       |       | $                              | —     |                                     | $          | —    |       | $ | (3,199 | ) | $ | (3,199 | ) |

 

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(1)                                  Presented below is a reconciliation of segmentoperating (loss) income to net (loss) income.

 
| ** **                                                                               | ** ** | **Successor**               | ** ** | ** ** | **Predecessor**             | ** ** |
|------------------------------------------------------------------------------------------|------------|-----------------------------|------------|------------|-----------------------------|------------|
| ** **                                                                               | ** ** | **Six**                     | ** ** | ** ** | **Six**                     | ** ** |
| ** **                                                                               | ** ** | **months ended**       | ** ** | ** ** | **months ended**       | ** ** |
| **(In thousands)**                                                                  | ** ** | **June 30, 2008** | ** ** | ** ** | **June 30, 2007** | ** ** |
| Segment Operating (Loss) Income                                                          |       | $                           | 103,877    |       |                        | $          | 159,094 |   |
| Non-operating expense (income):                                                          |       |                        |       |       |                        |       |
| Interest expense                                                                         |       | 173,011                     |       |       | 28,143                      |       |
| Interest and net investment loss (income)                                                |       | 1,881                       |       |       | (26,184                     | )          |
| Minority interest and other expense, net                                                 |       | 277                         |       |       | 3,521                       |       |
| (Loss) Income from Continuing Operations  before Income Taxes                            |       | $                           | (71,292    | )          |                        | $          | 153,614 |   |
| (Benefit) Provision for income taxes                                                     |       | (17,024                     | )          |       | 53,313                      |       |
| (Loss) Income from Continuing Operations                                                 |       | $                           | (54,268    | )          |                        | $          | 100,301 |   |
| Loss from businesses held pending sale and  discontinued operations, net of income taxes |       | (3,484                      | )          |       | (3,121                      | )          |
| Net (Loss) Income                                                                        |       | $                           | (57,752    | )          |                        | $          | 97,180 |   |

 

(2)                                Interest and net investment income isprimarily comprised of investment income and realized gains/losses on ourAmerican Home Shield (“AHS”) segment investment portfolio. Cash, short-term andlong-term marketable securities associated with regulatory requirements inconnection with AHS and for other purposes totaled approximately $358 millionas of June 30, 2008. As further described in “Operating and Non-OperatingExpenses”, AHS interest and net investment (loss) income was ($1.0) millionfor the six months ended June 30, 2008 and $22.2 million for the sixmonths ended June 30, 2007. The balance of interest and net investmentincome primarily relates to (i) a portion of the earnings generated byServiceMaster Acceptance Company Limited Partnership, our financing subsidiaryexclusively dedicated to providing financing to our franchisees and retailcustomers of our operating units; (ii) investment income from our employeedeferred compensation trust (for which there is a corresponding and offsettingincrease in compensation expense within operating income); and (iii) interestincome on other cash balances.

 

(3)                                The Merger was accounted for using purchaseaccounting. This adjustment represents the aggregate, non-cash adjustments(other than amortization and depreciation) attributable to the application ofpurchase accounting.

 

(4)                                Includes (i) severance and employeeretention costs and costs related to the consolidation of our corporateheadquarters in Memphis, Tennessee, including the closing of our office inDowners Grove, Illinois, (ii) costs to exit leases and severance paymentsrelated to organizational changes within the TruGreen LandCare operations, (iii) Mergerrelated expenses and (iv) charges related to Fast Forward.

 

(5)                                The Company entered into a consultingagreement with CD&R under which CD&R will provide the Company withon-going consulting and management advisory services in exchange for a minimumannual management fee of $2 million. This fee is payable quarterly.

 

***TruGreen LawnCare Segment***

 

LawnCare reported a 0.7percent increase in revenue, a 64.3 percent decrease in operating income and a0.4 percent decrease in Comparable Operating Performance for the six monthsended June 30, 2008 compared to 2007. The revenue results were favorablyimpacted by additional seasonal sales of ice-melt materials and improved pricerealization offset by the impact of customer count declines. LawnCareexperienced a 6.2 percent decline in new sales and a 10 basis point decrease inits rolling twelve-month retention rate from last year resulting in an overall2 percent decline in customer counts from last year’s level. The trends in newsales and retention were adversely impacted by soft consumer demand in thefirst-half of 2008. The decrease in new sales was also impacted by poor weatherin early 2008.

 

The 0.4 percent decrease inComparable Operating Performance for the six months ended June 30, 2008compared to 2007 also reflects increased fuel and fertilizer costs offset, inpart, by reduced overhead spending.

 

***TruGreen LandCare Segment***

 

LandCare reported a 24.5percent decrease in revenue, a 70.8 percent decrease in operating loss and a489.9 percent increase in Comparable Operating Performance for the six monthsended June 30, 2008 compared to 2007. The decline in revenue included a21.9 percent decline in base contract maintenance revenue, a 22.7 percentdecrease in enhancement revenue, and a $7.9 million decrease in snowremoval service revenue. The revenue comparison was adversely impacted by 

 

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branch closures completedduring the third quarter of 2007, as well as the impacts of LandCare’s efforts toimprove the quality of its customer base with a better customer mix by pruningless profitable jobs, implementing stricter pricing on new sales, andincreasing the average size of new proposals and sales. Although the total basecontract maintenance sales dollars declined for the six months ended June 30,2008, LandCare realized a meaningful improvement in the average value percontract sold (higher value contracts tend to be more profitable).

 

The Comparable OperatingPerformance improvement of 489.9 percent for the six months ended June 30,2008 compared to 2007 is primarily due to improved materials and labormanagement on the base contract maintenance portfolio and reduced overheadspending. These factors were offset, in part, by increased fuel costs.

 

***Terminix Segment***

 

The Terminix segmentreported comparable revenue for the six months ended June 30, 2008compared to 2007. Revenue for the six months ended June 30, 2008 has beenreduced by $3.2 million (non-cash) as a result of recording deferred revenue atits fair value in connection with purchase accounting. Excluding this impact ofpurchase accounting, revenue increased 0.5 percent for the six monthsended June 30, 2008 compared to 2007. Terminix reported a 4.2 percentdecrease in operating income and a 10.4 percent increase in ComparableOperating Performance for the six months ended June 30, 2008 compared to2007. The segment’s overall revenue results, excluding purchase accounting,reflected modest growth in pest control revenues and increases in termitecontract renewals, offset, in part, by a decrease in revenue from termitecompletions. Pest control revenues increased 2.8 percent for the six monthsended June 30, 2008 compared to 2007, as the impact of acquisitions andprice realization more than offset a decrease in new unit sales. A 2.1 percentincrease in renewal revenues for the six months ended June 30, 2008 wassupported by price realization and a 50 basis point improvement in termitecustomer retention.Revenuefrom termite completions decreased 4.4 percent for the six months ended June 30,2008, as reduced termite swarm activity negatively impacted demand for servicesand due to reduced average pricing on new termite treatments.

 

The growth in ComparableOperating Performance also reflects lower termite materials costs, effectivemanagement of seasonal staffing of production and sales labor, lower vehiclefleet counts and reduced overhead spending, offset, in part, by increased fuelcosts.

 

***American Home Shield Segment***

 

The American Home Shieldsegment reported a 2.9 percent decrease in revenue for the six months ended June 30,2008 compared to 2007. Revenue for the six months ended June 30, 2008 hasbeen reduced by $30.2 million (non-cash) as a result of recording deferredrevenue at its fair value in connection with purchase accounting. Excludingthis impact of purchase accounting, revenue increased 7.8 percent for thesix months ended June 30, 2008 over the six months ended June 30,2007. American Home Shield reported a 130.4 percent decrease in operatingincome and a 20.0 percent decrease in Comparable Operating Performance forthe six months ended June 30, 2008 over the six months ended June 30,2007. The increase in revenue, in part, resulted from higher contractcosts in the six months ended June 30, 2008 due to differences betweenyears in the timing of the incidence of warranty claims. American Home Shieldrecognizes revenue over the contract period in proportion to expected directcosts. Total new contract salesand renewal units, which are reported as earned revenue over the subsequenttwelve-month contract period, decreased 1.2 percent. Contract unit sales fromcustomer renewals increased 6.0 percent, reflecting a larger base of renewablecustomers and a 220 basis point improvement in retention. American Home Shield’ssales in the real estate channel were significantly impacted by the continuedsoftness in the home resale market throughout most of the country with overallunit sales declines of 19.2 percent through this channel.

 

The decrease in ComparableOperating Performance for the six months ended June 30, 2008 also includesa $23.1 million decrease in interest and net investment income from theAmerican Home Shield investment portfolio (primarily reflecting the unfavorableimpact of realized losses on disposals of securities and other than temporarydeclines in the value of certain investments) as compared to 2007 and increasedprovisions for certain legal matters partially offset by the beneficial impactsof increases in prices and service fees per claim.

 

***Other Operations and Headquarters Segment***

 

The Other Operations andHeadquarters segment reported a 4.6 percent increase in revenue for the sixmonths ended June 30, 2008 compared to 2007. The ServiceMaster Clean andMerry Maids operations reported a combined 5.2 percent increase in revenue forthe six months ended June 30, 2008. The growth in revenue resulted fromstrong increases in disaster restoration services, offset in part by decreasesin product sales. The ServiceMaster Clean and Merry Maids operations reported acombined decrease in operating income of 5.3 percent and an increase inComparable Operating Performance of 

 

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14.6 percent, or $4.3million, for six months ended June 30, 2008 compared to 2007. The increasein the segment’s Comparable Operating Performance for the six months ended June 30,2008 compared to 2007 of $23.7 million primarily reflects the decrease inRestructuring and Merger related expenses incurred in 2008, increasedComparable Operating Performance from the ServiceMaster Clean and Merry Maidsoperations and lower functional support costs.

 

***Discontinued Operations***

 

The components of loss frombusinesses held pending sale and discontinued operations, net of income taxes,and the reconciliation of operating (loss) income to Adjusted EBITDA andComparable Operating Performance for the six months ended June 30, 2008and June 30, 2007 are as follows:

 
| ** **                                                                                    | ** ** | **Successor**               | ** ** | ** ** | **Predecessor**             | ** ** |
|-----------------------------------------------------------------------------------------------|------------|-----------------------------|------------|------------|-----------------------------|------------|
| ** **                                                                                    | ** ** | **Six**                     | ** ** | ** ** | **Six**                     | ** ** |
| ** **                                                                                    | ** ** | **months ended**       | ** ** | ** ** | **months ended**       | ** ** |
| **(In thousands)**                                                                       | ** ** | **June 30, 2008** | ** ** | ** ** | **June 30, 2007** | ** ** |
| Operating income(loss)                                                                        |       | $                           | 629        |       |                        | $          | (5,177 | ) |
| Interest expense                                                                              |       | (70                         | )          |       | (36                         | )          |
| Impairment charge                                                                             |       | (6,317                      | )          |       |                        |       |
| Pretax loss                                                                                   |       | (5,758                      | )          |       | (5,213                      | )          |
| Benefit from income taxes                                                                     |       | (2,274                      | )          |       | (2,092                      | )          |
| Loss from businesses held pending sale and  discontinued operations, net of income taxes      |       | $                           | (3,484     | )          |                        | $          | (3,121 | ) |
|                                                                                          |       |                        |       |       |                        |       |
| Operating income(loss)                                                                        |       | $                           | 629        |       |                        | $          | (5,177 | ) |
| Depreciation and amortization expense                                                         |       | —                      |       |       | 1,978                       |       |
| EBITDA before adding back interest and  investment income, net                                |       | 629                         |       |       | (3,199                      | )          |
| Interest and net investment income                                                            |       | —                      |       |       | —                      |       |
| Adjusted EBITDA                                                                               |       | 629                         |       |       | (3,199                      | )          |
| Non-cash option and restricted stock expense                                                  |       | —                      |       |       | —                      |       |
| Non-cash charges attributable to purchase  accounting                                         |       | —                      |       |       | —                      |       |
| Comparable Operating Performance of  businesses held pending sale and discontinued operations |       | $                           | 629        |       |                        | $          | (3,199 | ) |

 

During the second quarter of 2008, the Company recorded a pre-taximpairment charge of $6.3 million as a result of a change in our fair valueestimate of InStar’s net assets based on changing market conditions and theongoing sales process.

 

**FINANCIAL POSITION AND LIQUIDITY**

 

***Cash Flows from Operating Activitiesfrom Continuing Operations***

 

Net cash provided from operating activities fromcontinuing operations was $13.9 million in the six months ended June 30,2008 compared to $136.7 million in 2007.

 

The principal components (in millions) of thenet decrease for the six months ended June 30, 2008 were:

 
| Decrease in net income before merger  related charges, restructuring charges and non-cash charges |   | (60.4  | ) |
|---------------------------------------------------------------------------------------------------|--------|--------|---|
| Increase in restructuring payments                                                                |   | (10.2  | ) |
| Increase in working capital requirements                                                          |   | (52.2  | ) |
|                                                                                              |   | (122.8 | ) |

 

The decrease in net income before merger relatedcharges, restructuring charges and non-cash charges for the six months ended June 30,2008 was driven by increased interest payments offset by Comparable OperatingPerformance growth at Terminix, TruGreen LandCare and Other Operations andHeadquarters. The increase in working capital requirements for the six monthsended June 30, 2008 was driven primarily by a shift in the timing ofadvertising payments as compared to the 2007 period, increased seasonal inventorygrowth and increased tax assets reflecting the impact of future tax deductionsrelated to the Company’s net operating loss carryforwards generated in 2008offset by increased customer prepayments and accounts receivable collections.

 

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***Cash Flows from Investing Activitiesfrom Continuing Operations***

 

Net cash provided from investing activities fromcontinuing operations was $32.5 million in the six months ended June 30,2008. Amounts paid in connection with the Merger increased $17.4 million.Amounts paid in connection with the Merger in 2008 were primarily related topayments under change in control agreements.

 

Capital expenditures decreased to $18.1 million forthe six months ended June 30, 2008 from $24.2 million in the prior yearand included recurring capital needs and information technology projects. TheCompany anticipates that capital expenditures for the remainder of 2008 willtotal approximately $20 million to $30 million, reflecting thecontinuation of investments in information systems and productivity enhancingoperating systems. In addition, as further discussed hereunder in “Liquidity”,the Company expects to pay approximately $50 million to acquire assets inconnection with exiting certain of its fleet leases. The Company has noadditional material capital commitments at this time.

 

Acquisitions for the six months ended June 30,2008 totaled $10.0 million, compared with $25.2 million in 2007. Considerationpaid for tuck-in acquisitions consisted of cash payments and seller financeddebt. The Company expects to continue its tuck-in acquisition program at bothTerminix and LawnCare.

 

The change in notes receivable, financialinvestments and securities for the six months ended June 30, 2008 includesan increase in the net sale of marketable securities at American Home Shielddue in part to lowering the amount of excess reserves over minimum statutoryreserve requirements in certain states in accordance with our investmentpolicy, reduced statutory reserve requirements, and the sale of certainmarketable securities and the subsequent investment in repurchase agreements inan effort to limit our exposure to changing market conditions.

 

***Cash Flows from Financing Activitiesfrom Continuing Operations***

 

During the six months ended June 30, 2008 theCompany made borrowings and repayments of $182.0 million under our RevolvingCredit Facility. The borrowings reflect normal seasonal working capitalneeds. The Company also made scheduled principal payments of long-termdebt of $35.3 million in the six months ended June 30,2008. Borrowings and payments of debt during the six months ended June 30,2007 were primarily related to the funding of seasonal working capital needsthrough the Company’s revolving bank credit facility. Cash dividends paidto shareholders totaled $70.1 million for the six months ended June 30,2007. No dividends were paid to the Company’s shareholder in the first half of2008. During the six months ended June 30, 2007, the Company receivedproceeds of $36.3 million under an employee share purchase plan. Theemployee share purchase plan was terminated subsequent to the Merger.

 

***Liquidity***

 

The Merger was completed on the Closing Date.Following the completion of the Merger, the Company is highly leveraged, and avery substantial portion of the Company’s liquidity needs arise from debtservice on indebtedness incurred in connection with the Merger and from fundingthe Company’s operations, working capital and capital expenditures. Equitycontributions totaling $1,431 million from the Equity Sponsors, togetherwith (i) borrowings under the $1,150 million Interim Loan Facility, (ii) borrowingsunder a new $2,650 million senior secured term loan facility and (iii) cashon hand at ServiceMaster, were used, among other things, to finance theaggregate Merger Consideration, to make payments in satisfaction of otherequity-based interests in ServiceMaster under the Merger Agreement, to settleexisting interest rate swaps, to redeem or provide for the repayment of certainof the Company’s existing indebtedness and to pay related transaction fees andexpenses. In addition, letters of credit issued under a new $150 millionpre-funded letter of credit facility were used to replace and/or secure lettersof credit previously issued under a ServiceMaster credit facility that wasterminated as of the Closing Date. On the Closing Date, the Company alsoentered into, but did not draw under, the $500 million Revolving CreditFacility.

 

The agreements governing the Term Facilities, theInterim Loan Facility and the Revolving Credit Facility contain certaincovenants that limit or restrict the incurrence of additional indebtedness,liens, sales of assets, certain payments (including dividends) and transactionswith affiliates, subject to certain exceptions. The Company was in compliancewith the covenants under these agreements at June 30, 2008.

 

TheInterim Loan Facility matured on July 24, 2008. On the maturity date,outstanding amounts under the Interim Loan Facility were converted on a one toone basis into 10.75%/11.50% senior toggle notes due 2015 (“Permanent Notes”).The Permanent Notes were issued pursuant to a refinancing indenture. Inconnection with the issuance of Permanent Notes, ServiceMaster entered into aregistration rights agreement, pursuant to which ServiceMaster will be requiredto file with the SEC a registration statement with respect to the resale of thePermanent Notes.

 

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Through July 15, 2011, the Company may, at itsoption prior to the start of any interest period, elect to pay interest onoutstanding amounts under the Permanent Notes entirely in cash (“Cash Interest”),entirely by increasing the principal amount of the outstanding loans (“PIKInterest”), or 50% as Cash Interest and 50% as PIK Interest. Interest payableafter July 15, 2011 is payable entirely as cash interest. The Companyelected to pay interest payable on January 15, 2009 entirely as cashinterest. At the present time, the Company does not plan to elect its option topay PIK Interest through at least 2009.

 

Cashand short-and long-term marketable securities totaled approximately $390million at June 30, 2008, compared with approximately $469 million at December 31,2007. Approximately $358 million of the cash and short- and long-termmarketable securities balance as of June 30, 2008 is associated withregulatory requirements at American Home Shield and for other purposes. Forexample, the payment of ordinary and extraordinary dividends to ServiceMasterby our subsidiaries that are regulated as insurance, home warranty or similarcompanies, is subject to applicable state law limitations. AHS’ investmentportfolio has been invested in a combination of high quality, short durationfixed income securities and equities. The Company closely monitors the performanceof the investments.Inthe ordinary course of business the Company reviews the statutory reserverequirements to which its regulated entities are subject. These reviews mayresult in either identifying excess reserves over minimum statutory reserverequirements or a determination that the Company can satisfy certain regulatoryreserve requirements through alternate financial vehicles, both of which wouldenhance our liquidity.

 

The Company has an arrangement enabling it to sell,on a revolving basis and without recourse, certain receivables generated by ourTruGreen LawnCare and Terminix segments to unrelated third party purchasers.The Company may sell up to $50 million of its receivables to thesepurchasers in the future and therefore would have access to cash proceeds fromthese sales. The amount of the eligible receivables varies during the yearbased on seasonality of the business. For example, the amount available couldbe less than $50 million during winter and spring. During the three andsix months ended June 30, 2008, no receivables were sold to third partiesunder this arrangement. There is presently only one purchaser that isrequired to purchase receivables under the arrangement. If this purchaser wereto exercise its right to terminate its participation in the arrangement, whichit may do in the third quarter of each year, the amount of cash available tothe Company may be reduced or eliminated.

 

The Company maintains lease facilities with bankstotaling $65 million, which provide for the financing of branch propertiesto be leased by the Company. At June 30, 2008, approximately$65 million was funded under these facilities. Approximately $12 millionof these leases are treated as capital leases and have been included on thebalance sheet as assets with related debt as of June 30, 2008. The balanceof the funded amount is treated as operating leases. The Company has guaranteedthe residual value of the properties under the leases up to 73 percent ofthe fair market value at the commencement of the lease. At June 30, 2008,the Company’s residual value guarantee related to the leased assets totaled $53million for which the Company has recorded the estimated fair value of thisguarantee (approximately $0.1 million) in the Condensed ConsolidatedStatement of Financial Position. In connection with the closing of the Merger,the Company amended these leases effective July 24, 2007. Among themodifications, the Company extended the lease terms through July 24, 2010.The operating lease and capital lease classifications of these leases did notchange as a result of the modifications.

 

The majority of the Company’s vehicle fleet and someequipment are leased through operating leases. The lease terms arenon-cancelable for the first twelve-month term, and then are month-to-month,cancelable thereafter. There are residual value guarantees by the Company(ranging from 70 percent to 87 percent of the estimated terminalvalue at the inception of the lease depending on the agreement) relative tothese vehicles and equipment, which historically have not resulted insignificant net payments to the lessors. At June 30, 2008, there wasapproximately $161 million of residual value relating to the Company’sfleet and equipment leases. Approximately $52 million of this residual value iswith a lessor that has exercised its option to terminate the lease effective August 2008.The cost of acquiring the assets subject to these leases is expected to amountto approximately $50 million. The fair value of the assets under all ofthe fleet and equipment leases is expected to substantially mitigate theCompany’s guarantee obligations under the agreements. At June 30, 2008,the Company has recorded the estimated fair value of this guarantee ofapproximately $2.9 million in the Condensed Consolidated Statement ofFinancial Position.

 

The Company’s ongoing liquidity needs are expectedto be funded by net cash provided by operating activities and, as required,borrowings under the Revolving Credit Facility. We expect that cash providedfrom operations and available borrowings under the Revolving Credit Facilitywill provide sufficient funds to operate our business, make expected capitalexpenditures and meet our foreseeable liquidity requirements, including paymentof interest and principal on our debt. As of June 30, 2008, the Companyhad $500 million of remaining capacity available under the Revolving CreditFacility.

 

As a holding company, we depend on our subsidiariesto distribute funds to us so that we may pay our obligations and expenses,including our debt service obligations. The ability of our subsidiaries to makedistributions and dividends to us 

 

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depends on their operating results, cashrequirements and financial condition and general business conditions. Aspreviously described, certain of our subsidiaries are subject to legal andregulatory restrictions on the payment of dividends to us.

 

The Company’s 2007 Annual Report on Form 10-Kincluded disclosure of the Company’s contractual obligations and commitments asof December 31, 2007. The Company continues to make the contractuallyrequired payments and therefore, the 2008 obligations and commitments as listedin the December 31, 2007 Annual Report on Form 10-K have been reducedby the required payments. There were no material changes outside of ordinarycourse of business in the Company’s previously disclosed contractual obligationsand commitments during the six months ended June 30, 2008.

 

***Financial Position—ContinuingOperations***

 

Marketablesecurities decreased from year end levels reflecting the sale of certainmarketable securities and subsequent investment in repurchase agreements, whichare classified as cash and cash equivalents in our condensed consolidatedstatements of financial position, in an effort to limit our exposure tochanging market conditions.

 

Receivables and accounts payable increased fromyear-end levels as a result of increased seasonal activity.

 

Inventories increased from year-end levels,reflecting increased seasonal activity. Prepaid expenses and other assetsincreased from year-end primarily reflecting preseason advertising costs atTruGreen LawnCare and other advertising costs of the Company which are incurredearly in the year and deferred on an interim basis and recognized approximatelyin proportion to revenue over the balance of the year. Deferred customeracquisition costs increased, reflecting the seasonality in the lawn careoperations. In the winter and spring, this business sells a series of lawnapplications to customers, which are rendered primarily in March throughOctober. These direct and incremental selling expenses which relate to successfulsales are deferred and recognized over the production season and are notdeferred beyond the calendar year-end. The Company capitalizes salescommissions and other direct contract acquisition costs relating to termitebaiting and pest contracts, as well as home warranty agreements. These costsvary with and are directly related to a new sale, and are amortized over thelife of the related contract.

 

Property and equipment decreased from year-endlevels due to depreciation. As further discussed in “Liquidity”, the Companyexpects to pay approximately $50 million to acquire assets in connectionwith exiting certain of its fleet leases. The Company has no additionalmaterial capital commitments at this time.

 

Deferred revenue increased from year-end levels,reflecting the significant amount of customer prepayments recorded in the firstquarter (pre-season) at TruGreen LawnCare, growth in prepaid contracts writtenat American Home Shield, and growth in Termite Inspection and Protection Plancustomers at Terminix.

 

Accrued payroll and related expenses includeprovisions for payments due under change in control and severance agreementsand provisions for litigation reserves. Accrued payroll and related expenseshave decreased from year end levels, reflecting the payment during the firstsix months of incentive compensation related to 2007 performance and thepayment during the first six months of payments due under change in control andseverance agreements.

 

Other long-term obligations, primarily self-insuredclaims, decreased from year-end levels due primarily to reductions in ourobligations under the employee deferred compensation plan and a decrease in thefair value liability of our interest rate swap contracts.

 

Total shareholder’s equity was $1,255 million at June 30,2008 as compared to $1,304 million at December 31, 2007.

 

***Financial Position—DiscontinuedOperations***

 

The assets and liabilities related to businessesheld pending sale and discontinued businesses have been classified in aseparate caption on the Consolidated Statements of Financial Position. Assetsfrom the businesses held pending sale have decreased reflecting decreases inreceivables at the InStar business.

 

As part of the American Residential Services andAmerican Mechanical Services sale agreements, the Company guaranteedobligations to third parties with respect to bonds (primarily performance andlicense type), operating leases for which the Company has been released asbeing the primary obligor, real estate leased and operated by the buyers, andother guarantees of payment. At the present time, the Company does not believeit is probable that the buyers will default on their obligations subject toguarantee. The fair value of the Company’s obligations related to theseguarantees is not significant and 

 

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no liability has been recorded.

 

**Information Regarding Forward-Looking Statements**

 

This report includes forward-looking statements andcautionary statements. Some of the forward-looking statements can be identifiedby the use of forward-looking terms such as “believes,” “expects,” “may,” “will,”“should,” “would,” “could,” “seek,” “intends,” “plans,” “estimates,” “anticipates”or other comparable terms. These forward-looking statements include all mattersthat are not historical facts. They appear in a number of places throughoutthis report and include, without limitation, statements regarding our intentions,beliefs or current expectations concerning, among other things, our results ofoperations, financial condition, liquidity, prospects, growth strategies, theindustries in which we operate, customer retention, employee retention,communications improvements, the continuation of tuck-in acquisitions, ourplans and ability to make cash interest payments on our debt, restructuringsand reorganizations, including Fast Forward, and cost savings from suchrestructurings and reorganizations, and any expected charges or savings.

 

Forward-looking statements are subject to known andunknown risks and uncertainties, many of which may be beyond our control. Wecaution you that forward-looking statements are not guarantees of futureperformance or outcomes and that actual outcomes and performances, including,without limitation, 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 risks and uncertainties discussed in Item 1A—Risk Factors in ourAnnual Report on Form 10-K for the year ended December 31, 2007,could cause actual results and outcomes to differ materially from those in theforward-looking statements. Factors that could cause actual results andoutcomes to differ from those reflected in forward-looking statements include,without limitation:

 

·                  the effects of our substantial indebtednessand the limitations contained in the agreements governing such indebtedness;

 

·                  our ability to generate the significantamount of cash needed to service our debt obligations;

 

·                  our ability to secure sources of financing toallow for the leasing of our fleet of commercial vehicles;

 

·                  increases in interest rates;

 

·                  weather conditions and seasonality factorsthat affect the demand for our services;

 

·                  changes in the source and intensity ofcompetition in our markets;

 

·                  higher commodity prices and lack ofavailability, including fuel and fertilizer;

 

·                  increases in operating costs, such as higherinsurance premiums, self-insurance costs and health care;

 

·                  employee retention, labor shortages orincreases in compensation and benefits;

 

·                  the risk that the benefits from the Merger orFast Forward may not be fully realized or may take longer to realize thanexpected;

 

·                  changes or continued softness in generaleconomic conditions in the United States, especially as they may affect homeresales, consumer confidence or spending levels including as a result ofinflation, unemployment, interest rate fluctuations, mortgage foreclosures orsubprime credit dislocations;

 

·                changesin the type or mix of our service offerings or products;

 

·                governmentalregulation and the enforcement thereof, including telemarketing, potentialdirect mail or other marketing restrictions, the Termite Inspection ProtectionPlan and legal restrictions or bans on pesticides and fertilizers;

 

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·                thesuccess of our current restructuring initiatives, including the implementationof Centers of Excellence;

 

·                thenumber, type, outcomes and costs of legal or administrative proceedings;

 

·                possiblelabor organizing activities at the Company or its franchisees;

 

·                risksinherent in acquisitions and dispositions;

 

·                thetiming and structuring of our business process outsourcing and risks associatedwith such outsourcing; and

 

·                otherfactors described from time to time in documents that we file with theSecurities and Exchange Commission.

 

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

 

**Comparisons of results for currentand any prior periods are not intended to express any future trends, orindications of future, performance, unless expressed as such, and should onlybe viewed as historical data.**

 

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**ITEM 3. QUANTITATIVE ANDQUALITATIVE DISCLOSURES ABOUT MARKET RISK**

 

***Interest Rate Risk***

 

The Company is exposed to theimpact of interest rate changes and manages this exposure through the use ofvariable-rate and fixed-rate debt and by utilizing interest rate swaps. TheCompany does not enter into contracts for trading or speculative purposes. Themarket risk associated with debt obligations and other significant instrumentsas of June 30, 2008 has not materially changed from December 31, 2007(see Item 7A of our Annual Report on Form 10-K for the year ended December 31,2007) except as noted below.

 

In February 2008, the Company entered into two3-year interest rate swap agreements and one 4-year interest rate swapagreement, effective March 3, 2008. The total notional amount of the3-year agreements was $250 million and the total notional amount of the4-year swap agreement was $250 million. Under the terms of the agreements,the Company will pay a weighted average fixed rate of interest of approximately3.15% on the notional amount of the 3-year swap agreements and 3.48% on thenotional amount of the 4-year swap agreement. The Company will receive afloating rate of interest (based on three month LIBOR) on the notional amount.Therefore, the effective interest rate for $500 million of the term loansis fixed at a rate between 5.90% and 6.23%, including the borrowing margindescribed in Note 14 to the consolidated financial statements in the 2007Annual Report. In accordance with SFAS No. 133, “Accounting for DerivativeInstruments and Hedging Activities”, these interest rate swap agreements areclassified as cash flow hedges and, as such, the hedging instruments arerecorded on the balance sheet as either an asset or liability at fair value,with the effective portion of the changes in fair value attributable to thehedged risks recorded in other comprehensive income.

 

TheInterim Loan Facility matured on July 24, 2008. On the maturity date,outstanding amounts under the Interim Loan Facility were converted on a one toone basis into 10.75%/11.50% senior toggle notes due 2015 (“Permanent Notes”).The Permanent Notes were issued pursuant to a refinancing indenture. Inconnection with the issuance of Permanent Notes, ServiceMaster entered into aregistration rights agreement, pursuant to which ServiceMaster will be requiredto file with the SEC a registration statement with respect to the resale of thePermanent Notes.

 

The following table summarizes information about theCompany’s debt as of June 30, 2008 (after considering the effect of theinterest rate swap agreements), including the principal cash payments andrelated weighted-average interest rates by expected maturity dates.

 
| ** **                                  | ** ** | **Expected Year of Maturity** | ** ** | **Fair** | ** ** |
|---------------------------------------------|------------|----------------------------------------------|------------|----------|------------|
| **As of June 30, 2008** | ** ** | **2008**                                     | ** ** | **2009** | ** ** | **2010** | ** ** | **2011** | ** ** | **2012** | ** ** | **Thereafter** | ** ** | **Total** | ** ** | **Value** | ** ** |
| ** **                                  | ** ** | **($ in millions)**                | ** ** |
| **Debt:**                                   |       |                                         |       |     |       |   |   |   |   |   |   |   |   |   |   |   |   |
| Fixed rate                                  |       | $                                            | 8          |     | 18         |   | 13 |   | 7 |   | 3 |   | 1,390 |   | 1,439 |   | 1,296 |   |
| Average interest rate                       |       | 5.5                                          | %          | 5.8      | %          | 6.2 | % | 6.3 | % | 7.0 | % | 7.1 | % | 7.0 | % |   |   |
| Variable rate                               |       | $                                            | 13         |     | 27         |   | 39 |   | 27 |   | 27 |   | 2,623 |   | 2,756 |   | 2,267 |   |
| Average interest rate                       |       | 5.2                                          | %          | 5.2      | %          | 5.3 | % | 5.2 | % | 5.2 | % | 7.6 | % | 7.5 | % |   |   |
|                                        |       |                                         |       |     |       |   |   |   |   |   |   |   |   |   |   |   |   |
| **Interest Rate Swaps:**                    |       |                                         |       |     |       |   |   |   |   |   |   |   |   |   |   |   |   |
| Receive variable/pay fixed                  |       |                                         |       |     |       | $ | 530 |   | $ | 250 |   | $ | 250 |   |   |   |   |   |   |   |
| Average pay rate                            |       |                                         |       |     |       | 5.1 | % | 3.2 | % | 3.5 | % |   |   |   |   |   |   |
| Average receive rate                        |       |                                         |       |     |       | 2.5 | % | 2.8 | % | 2.8 | % |   |   |   |   |   |   |
|                                             |            |                                              |            |          |            |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |

 

***Fuel Price Risk***

 

The Company is exposed tomarket risk for changes in fuel prices through the consumption of fuel by itsvehicle fleet in the delivery of services to its customers. The Company usesapproximately 30 million gallons of fuel on an annual basis. A 10% change infuel prices would result in a change of approximately $12 million in theCompany’s annual fuel cost before considering the impact of fuel swapcontracts.

 

The Company uses fuel swapcontracts to mitigate the financial impact of fluctuations in fuel prices. Asof June 30, 2008, the Company had fuel swap contracts to pay fixed prices forfuel with an aggregate notional amount of $41.4 million, maturing through 2009.The estimated fair value of these contracts at June 30, 2008 was an asset of$10.9 million, substantially all of which relates to contracts maturing in2008. These fuel swap contracts provide a fixed price for approximately 66% ofthe Company’s estimated fuel usage for the second half of 2008.

 

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##### **ITEM 4T. CONTROLS AND PROCEDURES**

 

**Effectiveness of Disclosure Controls andProcedures.** ServiceMaster’s Chief Executive Officer,J. Patrick Spainhour, and ServiceMaster’s Senior Vice President and ChiefFinancial Officer, Steven J. Martin, have evaluated ServiceMaster’s disclosurecontrols and procedures (as defined in Rule 15d-15(e)) as of the end ofthe period covered by this Quarterly Report on Form 10-Q. ServiceMaster’sdisclosure controls and procedures include a roll-up of financial andnon-financial reporting that is consolidated in the principal executive officeof ServiceMaster in Memphis, Tennessee. Messrs. Spainhour and Martin haveconcluded that both the design and operation of ServiceMaster’s disclosurecontrols and procedures are effective.

 

**Changes in Internal Control over FinancialReporting.** No change in ServiceMaster’s internalcontrol over financial reporting occurred during the second quarter of 2008that has materially affected, or is reasonably likely to materially affect,ServiceMaster’s internal control over financial reporting.

 

**PART II - OTHER INFORMATION**

 

**ITEM 1A. RISK FACTORS**

 

There have been no material changes from the riskfactors previously disclosed in the Company’s Annual Report on Form 10-Kfor the year ended December 31, 2007.

 

**ITEM 6. EXHIBITS**

 
| **Exhibit No.** | ** ** | **Description of Exhibit**                                                                                                                                                                                                                                                                                                          |
|----------------------|------------|-----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| 4.1                  |       | Indenture, dated July 24, 2008, among  The ServiceMaster Company, the Subsidiary Guarantors from time to time parties  thereto and Wilmington Trust FSB, as trustee, is incorporated by reference to  Exhibit 4.1 to the registrant’s Current Report on Form 8-K dated  July 24, 2008                                |
|                 |       |                                                                                                                                                                                                                                                                                                                                          |
| 4.2                  |       | Exchange and Registration Rights Agreement,  dated July 24, 2008, among The ServiceMaster Company, the Subsidiary  Guarantors named therein and JPMorgan Chase Bank, N.A., as administrative  agent, is incorporated by reference to Exhibit 4.2 to the registrant’s  Current Report on Form 8-K dated July 24, 2008 |
|                 |       |                                                                                                                                                                                                                                                                                                                                          |
| 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 14, 2008 |                                              |                 |
|---------------------------------|---------------------------------------------------|----------------------|
|                            | THE SERVICEMASTER COMPANY                         |                 |
|                            | (Registrant)                                      |                 |
|                            |                                              |                 |
|                            | By:                                               | /s/ Steven J. Martin |
|                            | Steven J. Martin                                  |
|                            | Senior Vice President and Chief Financial Officer |
|                                 |                                                   |                      |  |

 

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