UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q/A
X QUARTERLY REPORT UNDER SECTION 13 OR 15(d) OF
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THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended March 31, 2002
--------------
TRANSITION REPORT PURSUANT TO SECTION 13 OR
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15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the transition period from to
Commission file number 1-14762
THE SERVICEMASTER COMPANY
(Exact name of registrant as specified in its charter)
Delaware 36-3858106
(State or other jurisdiction of (IRS Employer Identification No.)
incorporation or organization)
3250 Lacey Road, Downers Grove, Illinois 60515-1700
(Address of principal executive offices) (Zip Code)
630-663-2000
(Registrant's telephone number, including area code)
Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the registrant was
required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days. Yes X No .
--- ---
Indicate the number of shares outstanding of each of the issuer's classes of
common stock: 301,826,000 shares of common stock on May 7, 2002.
Explanatory Note:
This amendment is being filed to reflect the restatement of the Company's
unaudited condensed consolidated financial statements, as discussed in Note 2
thereto, and other information related to such restated financial statements.
TABLE OF CONTENTS
Page
NO.
THE SERVICEMASTER COMPANY (Registrant) -
PART I. FINANCIAL INFORMATION
Item 1 : Financial Statements
Condensed Consolidated Statements of Income for the three months
ended March 31, 2002 (Restated) and March 31, 2001 (Restated) 2
Condensed Consolidated Statements of Financial Position
as of March 31, 2002 (Restated) and December 31, 2001 (Restated) 4
Condensed Consolidated Statements of Cash Flows for the three months
ended March 31, 2002 (Restated) and March 31, 2001 (Restated) 5
Notes to Condensed Consolidated Financial Statements (Restated) 6
Item 2: Management Discussion and Analysis of Financial
Condition and Results of Operations 16
PART II. OTHER INFORMATION
Item 6: Exhibits and Reports on Form 8-K 21
Signature 22
Exhibit 99.1: Certification of Chief Executive Officer Pursuant
to Section 1350 of Chapter 63 of Title 18 of the
United States Code 25
Exhibit 99.2: Certification of Chief Financial Officer Pursuant
to Section 1350 of Chapter 63 of Title 18 of the
United States Code 26
1
PART I. FINANCIAL INFORMATION
THE SERVICEMASTER COMPANY
CONDENSED CONSOLIDATED STATEMENTS OF INCOME (UNAUDITED)
(IN THOUSANDS, EXCEPT PER SHARE DATA)
Three Months Ended
March 31,
2002 2001
(Restated 4) (Restated 4)
----------- ---------------
OPERATING REVENUE ........................................ $ 734,263 $ 722,861
OPERATING COSTS AND EXPENSES:
Cost of services rendered and products sold .............. 530,811 530,481
Selling and administrative expenses ...................... 161,602 140,769
Goodwill, trade name and other intangible amortization (1) 2,154 17,282
--------- ---------
Total operating costs and expenses ....................... 694,567 688,532
--------- ---------
OPERATING INCOME ......................................... 39,696 34,329
NON-OPERATING EXPENSE (INCOME):
Interest expense ......................................... 22,541 34,574
Interest and investment income ........................... (2,932) (1,249)
Minority interest and other expense, net ................. 1,570 (1,774)
--------- ----------
INCOME FROM CONTINUING OPERATIONS BEFORE INCOME TAXES .... 18,517 2,778
Provision for income taxes................................ 6,659 2,044
---------- ----------
INCOME FROM CONTINUING OPERATIONS BEFORE EXTRAORDINARY
ITEMS................................................ 11,858 734
Income from discontinued operations, net of income taxes (2) (217) 5,258
Extraordinary gain, net of income taxes (3)............... - 6,003
---------- ----------
NET INCOME................................................ $ 11,641 $ 11,995
========== ==========
PER SHARE:
BASIC EARNINGS PER SHARE:
Income from continuing operations before extraordinary items $0.04 $ -
Discontinued operations, net (2) ......................... - 0.02
Extraordinary gain (3).................................... - 0.02
---------- ----------
$0.04 $0.04
========== ==========
SHARES 300,173 297,790
DILUTED EARNINGS PER SHARE:
Income from continuing operations before extraordinary items $0.04 $ -
Discontinued operations, net (2) ......................... - 0.02
Extraordinary gain (3).................................... - 0.02
---------- ----------
$0.04 $0.04
========== ==========
SHARES 307,085 301,731
Dividends per share....................................... $0.10 $0.10
========== ==========
2
(1) The Company adopted Statement of Financial Accounting Standards (SFAS) No.
142, "Goodwill and Other Intangible Assets", which eliminates the amortization
of goodwill and intangible assets with indefinite lives beginning in 2002. Had
the provisions of SFAS 142 been applied to 2001, amortization expense would have
been reduced by $14.8 million ($10.1 million, after-tax).
(2) In the fourth quarter of 2001, the Company's Board of Directors approved a
series of actions related to the strategic review of its portfolio of businesses
that commenced earlier in 2001. These actions included the sale in November 2001
of the Company's Management Services business as well as the decision to exit
certain non-strategic and under-performing businesses including TruGreen
LandCareConstruction and Certified Systems, Inc., as well as certain Terminix
operations in Europe. During the third quarter of 2002, the Company sold its
remaining European Terminix operations. These operations are classified in
"Discontinued operations" for all periods presented.
(3) In the first quarter of 2001, the Company purchased a portion of its public
debt securities and recognized an extraordinary gain on the early extinguishment
of debt. The Company intends to adopt SFAS 145 beginning in fiscal 2003.
Adoption of SFAS 145 in 2003 will result in the reclassification of the
extraordinary gain into income from continuing operations.
(4) See Note 2 in the Notes to the Condensed Consolidated Financial Statements
for the basis of the restatement and the financial statement impact.
SEE NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
3
THE SERVICEMASTER COMPANY
CONDENSED CONSOLIDATED STATEMENTS OF FINANCIAL POSITION (UNAUDITED)
(IN THOUSANDS) As of Mar. 31, As of Dec. 31,
ASSETS 2002 (Restated 1) 2001 (Restated 1)
----------- -----------
CURRENT ASSETS:
Cash and cash equivalents ................................................ $ 318,858 $ 402,644
Marketable securities .................................................... 68,884 72,429
Receivables, less allowance of $29,247 and $28,397, respectively ......... 340,447 340,935
Inventories .............................................................. 75,980 68,036
Prepaid expenses, deferred costs and other assets ........................ 140,735 80,738
Deferred taxes and income taxes receivable ............................... 111,599 90,200
Assets of discontinued operations ........................................ 44,088 64,068
----------- -----------
Total Current Assets .............................................. 1,100,591 1,119,050
----------- -----------
PROPERTY AND EQUIPMENT:
At cost ............................................................... 467,467 469,140
Less: accumulated depreciation ........................................ (274,537) (272,930)
----------- -----------
Net property and equipment .......................................... 192,930 196,210
----------- -----------
OTHER ASSETS:
Goodwill ................................................................. 1,907,292 1,904,178
Intangible assets, primarily trade names ................................. 260,489 261,136
Notes receivable ......................................................... 59,177 59,204
Long-term securities and other assets .................................... 84,470 81,467
----------- -----------
Total Assets ...................................................... $ 3,604,949 $ 3,621,245
=========== ===========
LIABILITIES AND SHAREHOLDERS' EQUITY
CURRENT LIABILITIES:
Accounts payable ......................................................... $ 94,984 $ 97,251
Accrued liabilities:
Payroll and related expenses .......................................... 77,323 83,182
Self-insured claims and related expenses .............................. 66,260 63,819
Other ................................................................. 114,897 131,780
Deferred revenues ........................................................ 422,139 343,873
Liabilities of discontinued operations ................................... 59,159 50,449
Current portion of long-term debt ........................................ 54,131 34,944
----------- -----------
Total Current Liabilities ......................................... 888,893 805,298
----------- -----------
LONG-TERM DEBT ........................................................... 1,054,125 1,120,249
LONG-TERM LIABILITIES:
Deferred taxes ...................................................... 233,146 233,000
Liabilities of discontinued operations .............................. 18,753 50,600
Other long-term obligations ......................................... 103,021 102,234
----------- -----------
Total Long-Term Liabilities ...................................... 354,920 385,834
----------- -----------
MINORITY INTEREST ........................................................ 102,165 102,677
COMMITMENTS AND CONTINGENCIES
SHAREHOLDERS' EQUITY:
Common stock $0.01 par value, authorized 1 billion shares; issued
314,992 and 314,538 shares, respectively ............................ 3,150 3,145
Additional paid-in capital ............................................... 1,046,448 1,039,228
Retained earnings ........................................................ 304,342 322,103
Accumulated other comprehensive loss ..................................... (1,003) (2,496)
Restricted stock ......................................................... (536) (581)
Treasury stock ........................................................... (147,555) (154,212)
----------- -----------
Total Shareholders' Equity ........................................ 1,204,846 1,207,187
----------- -----------
Total Liabilities and Shareholders' Equity ....................... $ 3,604,949 $ 3,621,245
=========== ===========
(1) See Note 2 in the Notes to the Condensed Consolidated Financial Statements
for the basis of the restatement and the financial statement impact.
SEE NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
4
THE SERVICEMASTER COMPANY
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED)
(IN THOUSANDS)
Three Months Ended
March 31,
2002 2001
(Restated 1) (Restated 1)
------------ ----------
CASH AND CASH EQUIVALENTS AT JANUARY 1 ....................................... $ 402,644 $ 42,669
CASH FLOWS FROM OPERATIONS:
NET INCOME ................................................................... 11,641 11,995
Adjustments to reconcile net income to net cash flows from operations:
(Income) loss from discontinued operations ........................... 217 (5,258)
Extraordinary gain ................................................... - (6,003)
Depreciation expense ................................................. 12,205 11,234
Amortization expense ................................................. 2,154 17,282
Deferred income tax expense .......................................... 8,890 3,699
Change in working capital, net of acquisitions:
Receivables ...................................................... (5,835) (14,519)
Sale of receivables .............................................. -- 75,500
Inventories and other current assets ............................. (70,938) (72,708)
Accounts payable ................................................. (1,293) (10,583)
Deferred revenues ................................................ 78,265 71,999
Accrued liabilities .............................................. (11,299) (24,977)
Tax refund from prior years payments ............................. -- 21,000
Other, net ....................................................... 1,830 2,245
--------- ---------
NET CASH PROVIDED FROM OPERATIONS ............................................ 25,837 80,906
--------- ---------
CASH FLOWS FROM INVESTING ACTIVITIES:
Property additions ..................................................... (9,652) (8,332)
Sale of equipment and other assets ..................................... 790 1,923
Business acquisitions, net of cash acquired ............................ (4,412) (13,825)
Notes receivable, financial investments and securities ................. 7,060 (6,292)
--------- ---------
NET CASH USED FOR INVESTING ACTIVITIES ....................................... (6,214) (26,526)
--------- ---------
CASH FLOWS FROM FINANCING ACTIVITIES:
Net payments of debt ................................................... (54,127) (69,296)
Purchase of ServiceMaster stock ........................................ -- (1,308)
Shareholders' dividends ................................................ (29,402) (29,837)
Other, net ............................................................. 6,354 3,557
--------- ---------
NET CASH USED FOR FINANCING ACTIVITIES ....................................... (77,175) (96,884)
--------- ---------
--------- ---------
CASH PROVIDED FROM (USED FOR) DISCONTINUED OPERATIONS ........................ (26,234) 17,919
--------- ---------
CASH DECREASE DURING THE PERIOD .............................................. (83,786) (24,585)
--------- ---------
CASH AND CASH EQUIVALENTS AT MARCH 31 ........................................ $ 318,858 $ 18,084
========= =========
(1) See Note 2 in the Notes to the Condensed Consolidated Financial Statements
for the basis of the restatement and the financial statement impact.
SEE NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
5
THE SERVICEMASTER COMPANY
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
NOTE 1: The condensed consolidated financial statements include the accounts of
ServiceMaster and its subsidiaries, collectively referred to as "the Company".
Intercompany transactions and balances have been eliminated in consolidation.
NOTE 2: The condensed consolidated financial statements have been prepared by
the Company in accordance with generally accepted accounting principles and
pursuant to the rules and regulations of the Securities and Exchange Commission.
The Company suggests that the condensed quarterly consolidated financial
statements be read in conjunction with the consolidated financial statements and
the notes thereto included in the Company's most recent Annual Report to
Shareholders and the Annual Report to the Securities and Exchange Commission on
Form 10-K. The condensed consolidated financial statements reflect all
adjustments, which are in the opinion of management, necessary for the fair
presentation of the financial position, results of operations and cash flows for
the interim periods. The results of operations for any interim period are not
necessarily indicative of the results which might be obtained for a full year.
RESTATEMENT
The Company has restated its consolidated financial statements for the year
ended December 31, 2001 as well as the previously reported quarterly results for
2002 and 2001. Subsequent to the original issuance of these condensed
consolidated financial statements, management determined that the historical
accounting treatment relating to the items below required revision. The table
below presents the net income impacts from the restatement.
Three Months Three Months
Ended Ended
(In millions, except per share data) March 31, 2002 March 31, 2001
--------------------------------------------------------------------
Continuing Operations:
AHS deferred acquisition costs $ - $ (4.2)
Trade name license fee (1.2) -
Interim accounting (TruGreen) (11.8) (14.9)
Other, net (0.2) 3.0
Tax adjustment from reincorporation - (0.2)
--------------------------------------------------------------------
Income Impact $ (13.2) $ (16.3)
Diluted EPS Impact $ (0.04) $ (0.05)
Discontinued Operations:
Income Impact $ (0.2) $ (1.0)
Diluted EPS Impact $ - $ -
Cumulative effect of accounting
change:
Income Impact $ 44.6 $ -
Diluted EPS Impact $ 0.15 $ -
A summary of the significant effects of the restatement is as follows:
Three Months Ended Three Months Ended
March 31, 2002 March 31, 2001
-----------------------------------------------------------------
As Previously As Previously
(in thousands, except per share data) Reported (1) As Restated Reported (1) As Restated
--------------------------------------------- --------------- --------------- -- --------------- --------------
Operating revenue $733,385 $734,263 $719,591 $722,861
Operating income 60,762 39,696 58,197 34,329
Income from continuing operations before
income taxes 40,298 18,517 28,915 2,778
Income from continuing operations before
extraordinary items and cumulative effect
of accounting change 25,027 11,858 17,006 734
Discontinued operations, net (43) (217) 6,218 5,258
Extraordinary gain, net - - 6,003 6,003
Cumulative effect of accounting change, net (44,577)
===============================================================================================================
Net income $(19,593) $11,641 $29,227 $11,995
===============================================================================================================
6
Diluted earnings per share:
Income from continuing operations before
extraordinary items and cumulative effect
of accounting change $0.08 $0.04 $0.06 $ -
Discontinued operations, net - - 0.02 0.02
Extraordinary gain, net - - 0.02 0.02
Cumulative effect of accounting change, net (0.15)
===============================================================================================================
Diluted earnings per share $(0.06) $0.04 $0.10 $0.04
===============================================================================================================
As of As of
March 31, 2002 December 31, 2001
-----------------------------------------------------------------
As Previously As Previously
Reported (1) As Restated Reported (1) As Restated
-----------------------------------------------------------------
Current assets $1,140,556 $1,100,591 $1,131,824 $1,119,050
Net property, plant, and equipment 178,198 192,930 180,937 196,210
Other long-term assets 2,347,974 2,311,428 2,361,978 2,305,985
---------------------------------------------------------------------------------------------------------------
Total assets $3,666,728 $3,604,949 $3,674,739 $3,621,245
===============================================================================================================
Current liabilities $858,067 $888,893 $796,113 $805,298
Long-term debt 1,039,394 1,054,125 1,105,518 1,120,249
Long-term liabilities 432,493 354,920 449,470 385,834
Minority interest 102,165 102,165 102,677 102,677
Total shareholders' equity 1,234,610 1,204,846 1,220,961 1,207,187
---------------------------------------------------------------------------------------------------------------
Total liabilities and shareholders' equity $3,666,728 $3,604,949 $3,674,739 $3,621,245
===============================================================================================================
1) During the third quarter of 2002, the Company sold its Terminix operations
in the United Kingdom. The financial results from these operations have
been reclassified from "Continuing Operations" to "Discontinued Operations"
for all periods presented. Amounts as restated include this
reclassification. The amount for 2002 reflects the cumulative effect of the
change in accounting principle at American Home Shield.
AMERICAN HOME SHIELD DEFERRED ACQUISITION COSTS
In July 2002, the Company changed its method of accounting for deferred customer
acquisition costs in its American Home Shield business from SFAS No. 60,
"Accounting and Reporting by Insurance Enterprises," pursuant to which the
Company believed it was appropriate to amortize deferred acquisition costs over
the expected customer life to FASB Technical Bulletin No. 90-1, "Accounting for
Separately Priced Extended Warranty and Product Maintenance Contracts," pursuant
to which deferred acquisition costs are amortized over the initial contract
life.
The new method of accounting reduced after-tax earnings by $.03 per diluted
share in 2002, but had no material impact on cash flow in current or future
years. In the second quarter of 2002, the Company retroactively recorded to the
first quarter of 2002 a cumulative charge of $45 million ($.15 per diluted
share) to effect this change.
Following discussions with the Staff of the Securities and Exchange Commission,
the Company has restated prior years to account for deferred acquisition costs
in accordance with FASB Technical Bulletin No. 90-1. The effect of this
restatement is to eliminate the cumulative charge for the accounting change and
reduce full year income from continuing operations by $8.5 million or $.03 per
diluted share in 2001, and $6.1 million or $.02 per diluted share in 2000. In
addition, this change results in a reduction of retained earnings of $30 million
at January 1, 2000. This restatement reduced income from continuing operations
by $4.2 million for the first quarter of 2001.
TRADE NAME LICENSE FEE
In connection with the sale of its Management Services business in the fourth
quarter of 2001, the Company entered into a three-year licensing arrangement
with ARAMARK Corporation for the use of the ServiceMaster trade name. This
agreement was valued at $15 million and accordingly, a like amount was allocated
from the purchase price. The Company intended to recognize this amount over the
three-year contractual period, and as such, recognized $2 million related
thereto in each of the first and second quarters of 2002. In November 2002, the
Company announced that it had determined that it was appropriate to recognize
the entire $15 million licensing fee in the fourth quarter of 2001. The effect
of this correction is to increase full year income from continuing operations by
$9 million and diluted earnings per share by $.03 in 2001, and to reduce income
from continuing operations by $1.2 million in the first quarter of 2002.
7
INSURANCE (TRUGREEN)
In January 2002, the Company reported that it had recognized a $9 million pretax
expense in 2001 relating to a revised estimate of the 2000 insurance reserve
requirements. Net income has been restated for this item which results in an
increase to full year income from continuing operations of $3.7 million (or
$.01) in 2001 and a decrease to income from continuing operations of the same
amount in 2000. The remaining adjustment results in a decrease to full year
income from discontinued operations of $1.1 million in 2000. This restatement
impacted the fourth quarter of 2001.
REINCORPORATION TAX
Prior to 1997, the Company was in partnership form and therefore was not a
federal taxpayer. Consequently, the Company did not record deferred tax balances
reflecting the differences between the book and tax basis of its assets and
liabilities. When the Company converted to corporate form in 1997, it realized a
significant step-up in the tax basis of its assets, which was largely reflected
as an increase in the basis of the tax intangibles and provided for significant
tax deductions over the next 15 years. In accounting for this event in 1997, the
Company recorded the net deferred tax asset associated with differences between
the book and tax basis of its tangible assets and liabilities. As it related to
intangible assets, the Company made a determination that the tax basis of
intangibles equaled the overall book balance of intangible assets on an
enterprise basis. Subsequently it was determined that intangible assets needed
to be considered at the individual business unit level which resulted in a
situation where tax basis exceeded book basis in certain units. This difference
created an additional deferred tax asset. The Company restated the financial
statements to reflect the deferred tax asset as if it had been recorded in 1997.
This change results in an increase to retained earnings as of January 1, 2000 of
$92.6 million, and an increase to the full year tax provision for continuing
operations of $.8 million in both 2001 and 2000 and an increase to the full year
tax provision for discontinued operations of $.8 million and $1.2 million in
2001 and 2000, respectively. This restatement also results in an increase to the
tax provision relating to the gain on certain businesses sold in the fourth
quarter of 2001 of $45.8 million. The net impact of these items was to increase
deferred tax assets by $33.4 million and equity by $43.2 million as of December
31, 2001. This restatement increased the tax provision in the first quarter of
2001 by $.2 million for continuing operations and $.3 million for discontinued
operations.
OTHER, NET
Other items primarily relate to adjustments in accruals, timing of revenue and
expense items and other miscellaneous items. The Company also determined it was
appropriate to expense the costs associated with telephone directory placements
when the directory is published rather than expensing the cost over the contract
period. In addition, certain operating leases of constructed properties have
been included in the balance sheet as assets with associated debt. The financial
statements have been restated from the amounts previously reported for these
items. The restatement related to these items resulted in income from continuing
operations decreasing by $.2 million and increasing by $3.0 million for the
first quarter of 2002 and 2001, respectively. Income from discontinued
operations decreased by $.2 million and $.7 million for the first quarter of
2002 and 2001, respectively.
INTERIM ACCOUNTING
TruGreen ChemLawn incurs pre-season advertising costs and annual repair and
maintenance procedures in the first quarter. These costs are deferred and
recognized as expense in proportion to the related revenues. Full-year results
are not affected. The quarterly information for 2002 and 2001 has been restated
to treat certain costs that were previously deferred, as current period costs.
There was no impact on full-year results for 2002 and 2001 as a result of this
change. The restatement resulted in income from continuing operations decreasing
by $11.8 million and $14.9 million for the first quarter of 2002 and 2001,
respectively.
NOTE 3: The Company has identified the most important accounting policies in
order to portray its financial condition and results of operations. These relate
primarily to revenue recognition and the deferral of customer acquisition costs.
The following revenue recognition policies have not changed since year-end.
Revenues from lawn care, non-baiting termite, pest control, heating/air
conditioning and plumbing services are recognized as the services are provided.
Revenues from landscaping services are recognized based upon agreed monthly
contract payments or when services are performed for non-contractual
arrangements. Revenues from the Company's commercial installation contracts,
primarily relating to HVAC, are
8
recognized on the percentage of completion method in the ratio that total
incurred costs bear to total estimated costs. Fees from home warranty and
termite baiting contracts are recognized as revenues over the life of the
contract in proportion to the direct costs (service or claim), which are
expensed as incurred. Franchised revenues (which in aggregate represents
approximately three percent of consolidated totals) consist of initial franchise
fees and continuing monthly fees based upon the franchisee revenue. Revenue is
recognized when reported from the franchisee and collectibility is assured.
Customer acquisition costs, which are incremental and direct costs of obtaining
the customer, relating to several of the Company's contracts are deferred and
amortized over the life of the contract, in proportion to revenue recognized.
These costs include sales commissions and direct selling costs which can be
shown to have resulted in a successful sale.
TruGreen ChemLawn has significant seasonality to its business. In the winter and
early spring, this business sells a series of lawn applications to customers
which are rendered primarily in March through October. The Company incurs
incremental selling expenses at the beginning of the year that directly relate
to successful sales in which the revenues will be recognized in later quarters.
This business also defers, on an interim basis, pre-season advertising costs and
annual repairs and maintenance procedures that are performed in the first
quarter. These costs are deferred and recognized approximately in proportion to
the contract revenue over the production season, and are not deferred beyond the
calendar year-end.
As noted above, TruGreen's pre-season advertising costs are deferred and
recognized approximately in proportion to the contract revenue over the year.
These costs are not deferred beyond the calendar year-end. Beginning in 2002,
the cost of direct-response advertising at Terminix is capitalized and amortized
over its expected period of future benefits. This direct-response advertising
consists primarily of direct-mail promotions, for which the cost is capitalized
and amortized over the one-year customer contract life.
The preparation of the financial statements requires management to make certain
estimates and assumptions required under generally accepted accounting
principles which may differ materially from the actual results. Disclosures in
the 2001 Annual Report presented the significant areas that require the use of
management's estimates and discussed how management formed its judgment. The
areas discussed included the allowance for receivables, accruals for
self-insured retention limits related to medical, workers compensation, auto and
general liability insurance, the possible outcome of litigation and the useful
lives for depreciation and amortization expense and the valuation of tangible
and intangible assets. There have been no changes in these areas or
methodologies in 2002.
NOTE 4: The Company carries insurance policies on insurable risks which it
believes to be appropriate. The Company generally has self-insured retention
limits and has obtained fully insured layers of coverage above such self-insured
retention limits. Accruals for self-insurance losses are made based on the
Company's claims experience and actuarial assumptions. The Company has certain
liabilities with respect to existing or potential claims, lawsuits, and other
proceedings. The Company accrues for these liabilities when it is probable that
future costs will be incurred and such costs can be reasonably estimated.
The Company believes that other legal proceedings and currently pending
litigation arising in the ordinary course of business will not have a material
effect on the consolidated financial statements.
NOTE 5: In June 2001, the Financial Accounting Standards Board (FASB) issued
Statement of Financial Accounting Standards (SFAS) 142, "Goodwill and Other
Intangible Assets". SFAS 142 requires that after December 31, 2001, existing
goodwill will no longer be amortized and intangible assets with indefinite
useful lives will not be amortized until their useful lives are determined to be
no longer indefinite. In accordance with SFAS 142, the Company discontinued the
amortization of goodwill and indefinite lived intangible assets effective
January 1, 2002. Goodwill and intangible assets that are not amortized are
subject to at least an annual assessment for impairment by applying a
fair-value-based test. The Company expects to complete its impairment testing
during the second quarter of 2002. Given the Company's past policy of assessing
enterprise-level goodwill, which utilized a discounted cash flow methodology,
the Company does not expect any impairment charges upon its completion of the
impairment review. Estimated fair value was determined for each reporting unit
by utilizing the expected present value of the future cash flows of the units.
In all instances, the estimated fair value of the reporting units exceeded their
book values. In accordance with SFAS
9
142, the following table provides summarized transitional information for the
periods ended March 31, 2002 and 2001, with the 2001 information presented on an
adjusted basis to reflect the elimination of amortization expense required under
SFAS 142:
Three Months Ended
March 31,
--------------------------------
(in thousands, except per share data) 2002 2001
--------------- -------------
Reported operating income $39,696 $34,329
Add back: Goodwill and trade name
amortization - 14,829
--------------- -------------
Operating income as adjusted under
SFAS 142 $39,696 $49,158
=============== =============
Reported income from continuing
operations before extraordinary
gain $11,858 $734
Add back: Goodwill and trade name
amortization, net of tax - 10,145
--------------- -------------
Income from continuing operations
before extraordinary gain as
adjusted under SFAS 142 11,858 10,879
Discontinued operations, net of taxes (217) 5,258
Extraordinary gain, net of taxes - 6,003
--------------- -------------
Net income as adjusted under SFAS 142 $11,641 $22,140
=============== =============
Reported basic earnings per share from
continuing operations before
extraordinary gain $0.04 $ -
Add back: Goodwill and trade name
amortization, net of tax - 0.03
--------------- -------------
Basic earnings per share from continuing
operations before extraordinary gain as
adjusted under SFAS 142 0.04 0.04
Discontinued operations, net - 0.02
Extraordinary gain, net - 0.02
--------------- -------------
Basic earnings per share as adjusted
under SFAS 142 $0.04 $0.07
=============== =============
Reported diluted earnings per share
from continuing operations before
extraordinary gain $0.04 $ -
Add back: Goodwill and trade name
amortization, net of tax - 0.03
--------------- -------------
Diluted earnings per share from continuing
operations before extraordinary gain as
adjusted under SFAS 142 0.04 0.04
Discontinued operations, net - 0.02
Extraordinary gain, net - 0.02
--------------- -------------
Diluted earnings per share as adjusted
under SFAS 142 $0.04 $0.07
=============== =============
The following table summarizes goodwill and intangible assets.
(IN THOUSANDS) As of As of
March 31, December 31,
2002 2001
------------- ----------------
Goodwill (1) $1,907,292 $1,904,178
Trade names (1) 238,550 238,550
Other intangible assets 75,719 74,197
Accumulated amortization (2) (53,780) (51,611)
------------- ----------------
Net other intangibles 21,939 22,586
------------- ----------------
Total $2,167,781 $2,165,314
============= ================
(1) Not subject to amortization.
(2) Annual amortization expense of approximately $6 - $8 million is expected
over the next five years.
10
NOTE 6: In April 2002, the FASB issued SFAS 145, "Rescission of FASB Statements
No. 4, 44, and 64, Amendment of FASB Statement No. 13, and Technical
Corrections". The primary impact to the Company of SFAS 145 is that it rescinds
SFAS 4 which required all material gains and losses from the extinguishment of
debt to be classified as extraordinary items. SFAS 145 requires that the more
restrictive criteria of APB Opinion No. 30 will be used to determine whether
such gains or losses are extraordinary. The Company intends to adopt SFAS 145 in
its fiscal year 2003, as required by SFAS 145. Adoption of SFAS 145 will result
in the reclassification of the extraordinary gains/losses into income from
continuing operations included in the accompanying Condensed Consolidated
Statements of Income.
NOTE 7: On October 3, 2001 the Company's Board of Directors approved a series of
strategic actions which were the culmination of an extensive portfolio review
process that was initiated in the first quarter of 2001. The goal of the
portfolio review was to increase shareholder value by creating a focused and
aligned company that provides the greatest return and growth potential. The
Company determined it could best achieve these goals with a portfolio of
businesses which support the business strategy to become America's Home Service
Company and have attractive cash flow and return characteristics. As part of
this determination, in the fourth quarter of 2001, the Company sold its
Management Services business to ARAMARK Corporation for approximately $800
million. Also in the fourth quarter of 2001, the Company's Board of Directors
approved the exit of non-strategic and under-performing businesses including
TruGreen LandCare Construction, Certified Systems Inc. (CSI), and certain other
small operations. The Company sold its TruGreen LandCare Construction operations
to Environmental Industries, Inc. (EII) in certain markets and entered into an
agreement with EII to manage the wind-down of commercial landscaping
construction contracts in the remaining markets. In addition, the Company sold
all of its customer contracts relating to the exit of CSI (the Company's
professional employer organization), to AMS Staff Leasing, N.A., Inc. The
Company also completed, in the fourth quarter of 2001, the sale of certain
subsidiaries of its European pest control and property services operations. The
results of these discontinued business units have been separated and classified
as Discontinued Operations in the accompanying financial statements.
The Company continues to carry certain assets on its financial statements
relating to these operations. Management is actively selling the remaining
equipment and collecting the outstanding receivables. The Company believes that
the remaining assets are presented at their net realizable value. In addition,
reserves and accrual balances remain on the financial statements relating to
these operations. Cash payments incurred for the wind-down of LandCare
construction contracts, lease termination costs, workers compensation and health
claims as well as professional service fees have been made in the first three
months of 2002. The remaining balances are outlined in the table below.
In the fourth quarter of 2001, the Company recorded a charge for asset
impairments and other items which included accruals for residual value
guarantees on leased properties, severance for former executives and terminated
employees, and other costs. During the second quarter of 2002, the Company
completed the sale of its ownership interest in five assisted living facilities.
These properties were financed through a synthetic lease arrangement, whereby,
the Company guaranteed the residual value of the properties. At year-end, a
$13.5 million reserve was established representing the amount by which the
residual value guarantees exceeded the value of bids to purchase the facilities
at that time. The final sales price was significantly greater than these bid
levels and the Company realized a gain of $3.6 million from the sale on the
assisted living properties.
The table below summarizes the activity during the three months ended March 31,
2002 for the remaining liabilities from the discontinued operation and the
reserves for items recorded in the fourth quarter of 2001. The Company believes
that the remaining reserves continue to be adequate and reasonable.
11
(IN THOUSANDS) Balance at Cash Balance at
December 31, Payments Income/ March 31,
2001 or Other (Expense) 2002
--------------- ----------- ---------- --------------
Remaining liabilities from
discontinued operations
LandCare Construction $34,100 $7,300 $(300) $27,100
Certified Systems, Inc. 23,800 3,700 - 20,100
Management Services 7,400 1,300 - 6,100
International businesses 19,600 6,400 (1) - 13,200
Other 16,100 4,700 - 11,400
Reserves related to strategic
actions in the fourth
quarter of 2001 $36,000 $300 $ - $35,700
(1) The liabilities of this business were assumed by the buyer of the sold
operations. No cash payments were required.
NOTE 8: Basic earnings per share is computed by dividing income available to
common stockholders by the weighted-average number of shares outstanding for the
period. The weighted average common shares for the diluted earnings per share
calculation includes the incremental effect related to outstanding options whose
market price is in excess of the exercise price. Shares potentially issuable
under convertible securities have not been considered outstanding in the diluted
earnings per share calculations for both periods as their impact is
anti-dilutive.
The following table reconciles both the numerator and the denominator of the
basic earnings per share from continuing operations computation to the numerator
and the denominator of the diluted earnings per share from continuing operations
computation.
(IN THOUSANDS, EXCEPT PER SHARE DATA) Three Months Three Months
Ended March 31, 2002 Ended March 31, 2001
-------------------------------- ------------------------------
CONTINUING OPERATIONS: INCOME SHARES EPS INCOME SHARES EPS
---------------------- -------- -------- ------ -------- -------- ----
Basic earnings per share $11,858 300,173 $0.04 $734 297,790 $-
====== ====
Effect of dilutive securities, net of tax:
Options 6,912 3,941
---------- --------- ---------- ---------
Diluted earnings per share $11,858 307,085 $0.04 $734 301,731 $-
========== ========= ====== ========== ========= ====
NOTE 9: In the Condensed Consolidated Statements of Cash Flows, the caption Cash
and Cash Equivalents includes investments in short-term, highly-liquid
securities having a maturity of three months or less. Supplemental information
relating to the Condensed Consolidated Statements of Cash Flows for the three
months ended March 31, 2002 and 2001 is presented in the following table:
(IN THOUSANDS)
2002 2001
----------- -----------
CASH PAID OR (RECEIVED) FOR:
Interest expense......................... $ 28,969 $ 46,703
Interest and dividend income............. $ (3,198) $ (2,157)
Income taxes............................. $ 28,090 $ (19,761)
The decrease in interest paid in 2002 is primarily due to reduced debt levels
reflecting debt retirements utilizing the proceeds from the sale of Management
Services. The increase in interest income received is also due to the proceeds
received from the Management Services sale as the Company maintained significant
cash levels throughout the year. The tax payment in 2002 resulted from the gain
on the sale of the Management Services business which compared to the prior year
tax refund of $21 million related to prior year over-payments.
NOTE 10: Total comprehensive income was $13.1 million and $.3 million for the
three months ended March 31, 2002 and 2001, respectively. Total comprehensive
income includes primarily net income, changes in unrealized gains and losses on
marketable securities and translation balances.
NOTE 11: On March 23, 2001, the Company entered into an agreement which provides
for the ongoing revolving sale of a designated pool of accounts receivable of
TruGreen and Terminix. At March 31, 2002,
12
there were no outstanding receivables sold to third parties under this
agreement. However, the Company may sell its receivables in the future which
would provide an alternative funding source.
Under this agreement, the Company sells, on a revolving basis, certain of its
accounts receivable to a wholly-owned, bankruptcy-remote subsidiary,
ServiceMaster Funding Company LLC which has entered into an agreement to
transfer, on a revolving basis, an undivided percentage ownership interest in a
pool of accounts receivable to an unrelated third party purchaser. ServiceMaster
Funding Company LLC retains an undivided percentage interest in the pool of
accounts receivable. Bad debt losses for the entire pool are allocated first to
this retained interest. This agreement is a 364-day facility renewable at the
option of the purchasers.
For the three months ended March 31, 2002, there were no receivables sold to
Falcon Asset Securitization Corporation under this agreement. For the three
months ended March 31, 2001, $127.9 million of net accounts receivable had been
sold to ServiceMaster Funding Company LLC. ServiceMaster Funding Company LLC in
turn sold an undivided interest to Falcon Asset Securitization Corporation under
this agreement. Net cash proceeds of $75.3 million were received in 2001 on the
sale and were used to pay down bank revolving credit debt. As of March 31, 2001,
the amount of the retained interest in the receivables was $52.4 million and was
classified as accounts receivable. The above amounts include receivables from
the sold Management Services segment, which were approximately two thirds of the
receivables sold. The retained interest in the accounts receivable sold are
valued at the carrying amount of the retained accounts receivable net of
applicable loss reserves, which approximates fair value. Management monitors the
change in the outstanding retained interest and makes adjustments to its
carrying amount based on actual and projected losses. Any changes in interest
rates would only have a minimal impact on the value of the residual interest due
to the short-term nature of the receivables.
The Company, as agent for the purchaser, retains servicing responsibilities for
the sold receivables. The fees received by the Company for these services during
the first quarter of 2001, were at fair market value, therefore, no related
assets or liabilities have been recorded. The loss on sale arising from the
securitization transactions in the first quarter of 2001 was immaterial.
NOTE 12: In the first quarter of 2001, the Company repurchased a portion of its
public debt securities and recognized a $6 million after-tax extraordinary gain
on the early extinguishment of debt. The Company intends to adopt SFAS 145
beginning in fiscal 2003. Adoption of SFAS 145 will result in the
reclassification of the extraordinary gain into income from continuing
operations.
NOTE 13: The business of the Company is conducted through five operating
segments: TruGreen, Terminix, American Home Shield, ARS/AMS and Other
Operations. Due to the Company's sale of its Management Services business unit
and its exit from other businesses in 2001, certain operations have become more
significant for segment reporting purposes. As a result, the Company has
expanded its business segment reporting which will allow for better ongoing
visibility into the components of the business. The companies that previously
were reported in the Home Maintenance & Improvement segment have been further
broken out into American Home Shield and the combination of ARS/AMS. The
franchise operations, ServiceMaster Clean and Merry Maids, formerly in the Home
Maintenance & Improvement segment, are reported in the Other Operations segment.
In accordance with Statement of Financial Accounting Standards No. 131, the
Company's reportable segments are strategic business units that offer different
services. The TruGreen segment provides residential and commercial lawn care and
landscaping services through the TruGreen ChemLawn and TruGreen LandCare
companies. As a result of the decision in the fourth quarter of 2001 to exit the
LandCare Construction business, the results of the construction operations are
now included in discontinued operations for all periods. The Terminix segment
provides termite and pest control services to residential and commercial U.S.
customers. The American Home Shield segment provides home warranties to
consumers that cover heating, ventilation, air conditioning (HVAC), plumbing and
certain appliances. This segment also includes home inspection services provided
by AmeriSpec. The American Residential Services, (ARS) and American Mechanical
Services (AMS) segment provides HVAC and plumbing services provided under the
ARS, AMS and Rescue Rooter brand names. The Other Operations segment includes
the franchise operations of ServiceMaster Clean and Merry Maids, which provide
disaster restoration and cleaning services as well as the Company's headquarters
operations which provides various technology, marketing, finance and other
support services to the business units.
13
Segment information is presented below. As discussed in Note 2 in the Notes to
the Condensed Consolidated Financial Statements, the information for 2002 and
2001 has been restated.
SFAS 142, "Goodwill and Other Intangible Assets", eliminates the amortization of
goodwill and intangible assets with indefinite lives beginning in 2002. The
table below also presents "Proforma" information for 2001 which eliminates
amortization expense related to goodwill and intangible assets with indefinite
lives, so that these periods are presented on a comparable basis to the 2002
information.
14
(IN THOUSANDS) Three Months Three Months Three Months
Ended March 31, Ended March 31, Ended March 31,
2002 2001 2001
Reported Reported Proforma
----------------------------------------------------------------------------------------------------------------------------
Operating Revenue:
TruGreen $229,143 $229,755
Terminix 220,273 196,788
American Home Shield 85,916 73,162
ARS/AMS 165,091 191,172
Other Operations 33,840 31,984
--------------------------------------------------------------------------------------------------
Total Operating Revenue $734,263 $722,861
==================================================================================================
Operating Income:
TruGreen $6,524 $(458) $6,137
Terminix 37,936 29,925 34,307
American Home Shield 3,355 1,127 1,736
ARS/AMS (2,886) 5,269 7,488
Other Operations (5,233) (1,534) (510)
------------------------------------------------------------------------------------------------------------------------
Total Operating Income $39,696 $34,329 $49,158
========================================================================================================================
As of As of
March 31, 2002 Dec. 31, 2001
------------------------------------------------------------------------------------------------------------------------
Identifiable Assets:
TruGreen $1,170,483 $1,082,135
Terminix 835,984 823,333
American Home Shield 336,969 323,229
ARS/AMS 503,240 519,026
Other Operations (and discontinued businesses) 758,273 873,522
--------------------------------------------------------------------------------------------------
Total Identifiable Assets $3,604,949 $3,621,245
==================================================================================================
The following table summarizes the previously amortized goodwill and trade names
by segment that, beginning on January 1, 2002 are no longer amortized.
March 31, December 31,
2002 2001
------------ -------------
TruGreen $910,617 $910,573
Terminix 708,388 705,608
American Home Shield 72,085 72,085
ARS/AMS 347,967 347,863
Other Operations 106,785 106,599
------------ -------------
Total $2,145,842 $2,142,728
============ =============
15
MANAGEMENT DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
RESULTS OF OPERATIONS
FIRST QUARTER 2002 COMPARED TO FIRST QUARTER 2001
CONSOLIDATED REVIEW
The Company has restated its financial statements for 2001 as well as the
previously reported 2002 quarterly results. See Note 2 of the Notes to the
Condensed Consolidated Financial Statements for the description of the
restatement and the financial statement impact. This Management Discussion and
Analysis reflects the impacts of the restatement.
Revenue for the first quarter of 2002 was $734 million, two percent above 2001,
and first quarter 2002 operating income was $40 million compared to $34 million
in 2001. The Company reported income from continuing operations in 2002 of $12
million and a loss from discontinued operations of $.2 million. Net income was
$12 million in both 2002 and 2001 and diluted earnings per share were $.04 in
both 2002 and 2001. The $.04 per diluted share reported for 2001 consisted of
$.02 income from discontinued operations and $.02 extraordinary gain from the
early extinguishment of debt.
Diluted earnings per share from continuing operations were $.04 in 2002 compared
with a break-even quarter in 2001. As discussed further in Note 4 of the Notes
to the Condensed Consolidated Financial Statements, Statement of Financial
Accounting Standards (SFAS) No. 142, "Goodwill and Other Intangible Assets",
requires that beginning in 2002, goodwill and trade names no longer be
amortized. SFAS 142 does not permit the restatement of the 2001 financial
information to reflect the impact of SFAS 142. The diluted earnings per share
equivalent of reduced amortization expense under SFAS 142 is $.03 ($15 million
pretax) for the first quarter of 2001.
First quarter operating income in 2002 was $40 million compared to $34 million
in 2001. The 2001 figure includes $15 million of amortization expense that has
been eliminated under SFAS 142. Operating margins after adjusting for the
amortization expense eliminated under SFAS 142 decreased to 5.4 percent of
revenue in 2002 from 6.8 percent in 2001. The decrease in operating income
reflects strong growth at Terminix and American Home Shield offset by lower
volume in the heating, ventilation, and air conditioning (HVAC) and plumbing
businesses of ARS and AMS, as well as increased expenditures for Company-wide
initiatives.
Cost of services rendered and products sold increased slightly for the quarter
and decreased as a percentage of revenue to 72.3 percent in 2002 from 73.4
percent in 2001. Selling and administrative expenses increased 15 percent and
increased as a percentage of revenue to 22.0 percent of revenue from 19.5
percent in 2001. The increase in selling and administrative expenses reflects
increases in sales and marketing expenses and expenditures on certain
enterprise-wide initiatives.
Interest expense decreased from 2001, primarily due to reduced debt levels as a
portion of the proceeds received from the sales of the Management Services and
certain European pest control businesses were used to pay down debt. Minority
interest and other expense/income reflected $3 million more expense than 2001
primarily due to minority interest income related to the ServiceMaster Home
Service Center initiative that occurred in 2001. In the first quarter of 2001,
the operating losses totaling $4.5 million of ServiceMaster Home Service Center
had been offset through minority interest income (below the operating income
line) because of investments in the venture made by Kleiner Perkins Caufield &
Byers. In December 2001, the Company acquired the minority interest in the
ServiceMaster Home Service Center held by Kleiner Perkins and management. The
operating losses incurred in the first quarter of 2002 from ServiceMaster Home
Service Center have been included in the accompanying financial statements
without an offset at minority interest income in the consolidated statements of
income.
The tax provision in 2002 reflects a lower effective tax rate than 2001 based on
benefits received through the consolidation for tax purposes of the
ServiceMaster Home Service Center. As a result of the
16
Company's acquisition of the minority interest, it was able to reorganize the
subsidiary in 2002 and utilize prior year net operating losses of this
subsidiary operation.
OTHER DEVELOPMENTS
The Company has successfully begun implementing Six Sigma, a methodology to
support continuous improvement of business processes. Over 2,500 employees have
received varying levels of training within the program with 27 black belts
devoted full-time to the program. The initial wave of projects will roll out
through June, with another group of black belts beginning training in May and a
second wave of projects to follow. By the end of the year, the Company projects
to have a run rate of approximately 100 Six Sigma projects.
In February, the Company launched a pilot program with Home Depot in three
markets (Orlando, Memphis and Sacramento) as it continues to explore new
channels through which to market home services. The pilot program services
include lawn care, landscape maintenance, termite and pest control, plumbing
repair, drain cleaning and fixture installation, home warranties and carpet and
upholstery cleaning. Early results in this retail setting have been encouraging.
The pilot program is currently scheduled to end on December 31, 2002.
KEY PERFORMANCE INDICATORS
The table below presents selected metrics related to customer counts and
customer retention for the three most profitable businesses of the Company.
These measures are presented on a rolling, twelve month basis in order to avoid
seasonal anomalies.
KEY PERFORMANCE INDICATORS
As of March 31,
2002 2001
----------------- ----------------
TRUGREEN -
Growth in Full Program Contracts 0% 0%
(AS OF APRIL 19, 2002)
Customer Retention Rate 63.2% 62.3%
(AS OF APRIL 19, 2002)
TERMINIX -
Growth in Pest Control Customers 11% 16%
Pest Control Customer Retention Rate 77.1% 75.9%
Growth in Termite Customers 8% 20%
Termite Customer Retention Rate 89.9% 88.4%
AMERICAN HOME SHIELD -
Growth in Warranty Contracts 15% 9%
Customer Retention Rate 52.6% 50.5%
SEGMENT REVIEW
SEGMENT RESULTS FOR 2002 REFLECT THE ELIMINATION OF GOODWILL AND TRADE NAME
AMORTIZATION REQUIRED UNDER SFAS 142. THEREFORE, FOR COMPARATIVE PURPOSES, 2001
RESULTS HAVE BEEN PRESENTED ON A PROFORMA BASIS AS IF SFAS 142 HAD BEEN IN
EFFECT FOR 2001 THEREBY EXCLUDING THE AMORTIZATION EXPENSE AFFECTED BY THE NEW
ACCOUNTING STANDARD. (SEE THE BUSINESS SEGMENT REPORTING IN NOTE 13 IN THE NOTES
TO THE CONDENSED CONSOLIDATED FINANCIAL STATEMENTS). MANAGEMENTS DISCUSSION AND
ANALYSIS FOCUSES ON THE 2002 REPORTED AND THE 2001 PROFORMA AMOUNTS.
The TruGreen segment includes lawn care operations performed under the TruGreen
ChemLawn brand name and landscape maintenance services provided under the
TruGreen LandCare brand name. This segment's results for both 2002 and 2001
exclude the discontinued TruGreen LandCare Construction business. The TruGreen
segment reported revenue of $229 million, slightly below 2001. Operating income
increased to $7 million from $6 million (proforma) in 2001, primarily reflecting
increased production in the
17
lawn care operations, partially offset by a reduced level of snow removal
business in the landscape operations. Revenue in the lawn care business
increased two percent over 2001. Although customer count levels in April 2002 do
not reflect growth from 2001 (see table above), during the first four months of
2002 the business has overcome a four percent degradation in customer counts
that occurred from early 2001 to late in that year. These improvements reflect
new, more focused marketing strategies and quality of service initiatives which
began during the fall of 2001, resulting in higher sales of new customers and
improving retention of existing customers. Telemarketing is the primary channel
employed by TruGreen ChemLawn to sell its services. Increasing telemarketing
restrictions have continued to present a challenge, but management is addressing
this challenge by improving the quality of the call lists and by employing more
sophisticated segmentation techniques. The Company is also increasing its use of
direct mail marketing, with encouraging results. Operating income margins in the
lawn care operations improved, reflecting the impact of the revenue growth in
the quarter. Revenue in the landscape maintenance operations declined primarily
reflecting a reduction in snow removal services. The core maintenance business
experienced a slight increase in the number of contracts. Operating income
margins in the landscaping business declined primarily reflecting the decreased
volume of higher margin snow removal business. This business is focusing on
various initiatives to improve its cost structure including more aggressive and
controlled bidding of plants and materials, a vehicle reduction program, and
labor efficiency programs.
The Terminix segment, which includes the domestic termite and pest control
services, reported a 12 percent increase in revenue to $220 million from $197
million in 2001 and operating income growth of 11 percent to $38 million from
$34 million (proforma) in 2001. Revenue growth was supported by new sales,
improved customer retention in both the termite and pest control business, and
from the Sears Termite & Pest Control acquisition completed in the fourth
quarter of 2001. The improved customer retention rates for both pest control and
termite services reflect the benefits of training and quality programs and
increased customer service representatives in the branches. Operating income
margins declined slightly from 2001 primarily reflecting the timing of certain
overhead expenditures, partially offset by improved branch-level margins, the
integration of acquisitions, and continuing growth and acceptance of higher
margin termite baiting treatments.
The American Home Shield segment, which provides home warranties to consumers
that cover HVAC, plumbing and other appliances, reported a 17 percent increase
in revenue to $86 million from $73 million in 2001. The increase in revenue
reflected double-digit growth in all of its sales channels, with improved
customer retention rates. The total number of customers surpassed the one
million mark for the first time in American Home Shield's history. Operating
income increased 93 percent to $3 million from $2 million (proforma) in 2001.
Operating margins improved substantially reflecting increased pricing and a
decrease in the incidence of claims.
The ARS/AMS segment provides direct HVAC and plumbing services under the
American Residential Services (ARS), Rescue Rooter, and American Mechanical
Services (AMS) (for commercial accounts) brand names. Revenue for the quarter
totaled $165 million in 2002, a decrease of 14% from $191 million in 2001. The
segment reported an operating loss of $3 million in 2002 compared with operating
income of $7 million (pro forma) in 2001. These operations experienced lower
construction activity in both the residential and commercial sectors. A softer
economic environment combined with mild weather led to lower demand for heating
and plumbing repairs and replacement service. With new leadership in place, this
business continues to focus on cost containment initiatives and is implementing
significant changes to its sales and marketing programs. The Other Operations
segment includes the Company's ServiceMaster Clean, Merry Maids, and
international operations as well as its headquarters functions. Reported segment
revenue of $34 million in 2002 compared with $32 million in 2001, primarily
reflecting growth in the ServiceMaster Clean and Merry Maids businesses.
Combined these franchise businesses achieved revenue and profit growth,
primarily driven by strong disaster restoration results and increased franchise
sales at ServiceMaster Clean and growth from acquisitions at Merry Maids. This
segment reported an operating loss of $5 million in 2002 compared with a loss of
$1 million (proforma) in 2001, reflecting increased expenditures in Company-wide
initiatives including purchasing, marketing, and Six Sigma initiatives.
FINANCIAL POSITION
Net cash provided from operations for the quarter totaled $26 million, an
improvement of $20 million before the impact of the Company's prior year
accounts receivable securitization program. This reflects a
18
significant reduction in the use of working capital, primarily at TruGreen
ChemLawn and American Home Shield as a result of increased customer prepayments
and improved management of accounts payable. Management believes that funds
generated from operations and other existing resources will continue to be
adequate to satisfy ongoing working capital needs of the Company.
Cash and marketable securities totaled approximately $388 million at March 31,
2002 reflecting a portion of the proceeds from the sale of Management Services.
The Company expects to make approximately $30 million in after-tax cash payments
for the remainder of 2002 for items related to discontinued operations and the
restructuring charge. In the first quarter, the Company made approximately $70
million in tax payments relating to the sale of Management Services. There were
other cash payments relating to the wind-down of the discontinued operations
which were offset by cash collected on assets remaining from these operations.
In addition to the $30 million in after-tax cash payments for the remainder of
2002, the Company is expecting to make approximately $17 million in after-tax
cash payments beyond 2002. The remainder of the discretionary cash is available
for the repayment of debt, which management continues to target for the second
quarter of 2002 for completion. Debt levels decreased by $47 million in the
quarter primarily reflecting the repurchase of a portion of the Company's public
debt.
There have been no material changes in the terms of the Company's financing
agreements since December 31, 2001. As described in the Company's latest Annual
Report to Shareholders, the Company is party to a number of debt agreements
which require it to maintain certain financial and other covenants, including
limitations on indebtedness and interest coverage ratio. In addition, under
certain circumstances, the agreements may limit the Company's ability to pay
dividends and repurchase shares of common stock. These limitations are not
expected to be a factor in the Company's future dividend and share repurchase
plans. Failure by the Company to maintain these covenants could result in the
acceleration of the maturity of the debt. At March 31, 2002, the Company was in
compliance with the covenants related to these debt agreements and based on its
operating outlook for the remainder of 2002, expects to be able to maintain
compliance in the future.
The assets and liabilities relating to the discontinued companies have been
classified in separate captions on the Condensed Consolidated Statements of
Financial Position. Assets of the discontinued operations have declined
reflecting cash collections on receivables and the sale of fixed assets. The
liabilities from discontinued operations has decreased reflecting cash outflows
related to the wind-down of contracts, lease termination costs, workers'
compensation payments and legal costs.
Receivables are approximately at the same level as year-end, reflecting good
collections and improved days sales outstanding at several companies.
Inventories increased over year-end levels as a result of normal seasonal
build-ups in the lawn care business. Prepaid expenses, deferred costs and other
assets increased from year end reflecting the seasonality in the lawn care
operations and the increased volume of warranty contracts written at American
Home Shield. The lawn care operations incur incremental selling expenses at the
beginning of the year that directly relate to successful sales in which the
revenues will be recognized in later quarters. This business also defers, on an
interim basis, pre-season advertising costs and annual repairs and maintenance
procedures that are performed in the first quarter. These costs are deferred and
recognized in proportion to the contract revenue over the production season, and
are not deferred beyond the calendar year-end. The Company also capitalizes
sales commissions and other direct contract acquisition costs relating to home
warranty contracts. Deferred revenues grew significantly reflecting increases in
customer prepayments for lawn care services and strong growth in warranty
contracts written at American Home Shield.
Capital expenditures which include recurring capital needs and information
technology projects are approximately at the same levels as prior year. The
Company has no material capital commitments at this time.
Total shareholders' equity was $1.2 billion at March 31, 2002 and December 31,
2001, reflecting earnings growth which was offset by cash dividends. Cash
dividends paid directly to shareholders totaled $29 million or $.10 per share
for the three months ended March 31, 2002. In April, the Company announced that
it has increased its quarterly cash dividend to $.105 per share payable on July
31, 2002 to shareholders of record on July 12, 2002. This quarterly dividend
payment represents an increase of 5% over the dividend rate paid for the prior
eight quarters. The Company approves its actual dividend payment on a quarterly
basis and continually reviews its dividend policy, share repurchase program and
other capital
19
structure objectives. The Company has not undertaken material share repurchases
during the first three months of 2002 or for the year ended 2001. Decisions
relating to any future share repurchases will take various factors into
consideration such as the Company's commitment to maintain investment grade
ratings, general business conditions, and other strategic investment
opportunities.
FORWARD LOOKING STATEMENTS
THE COMPANY'S FORM 10-Q/A FILING CONTAINS STATEMENTS CONCERNING FUTURE RESULTS
AND OTHER MATTERS THAT MAY BE DEEMED TO BE "FORWARD-LOOKING STATEMENTS" WITHIN
THE MEANING OF THE PRIVATE SECURITIES LITIGATION REFORM ACT OF 1995. THE COMPANY
INTENDS THAT THESE FORWARD-LOOKING STATEMENTS, WHICH LOOK FORWARD IN TIME AND
INCLUDE EVERYTHING OTHER THAN HISTORICAL INFORMATION, BE SUBJECT TO THE SAFE
HARBORS CREATED BY SUCH LEGISLATION. THE COMPANY NOTES THAT THESE
FORWARD-LOOKING STATEMENTS INVOLVE RISKS AND UNCERTAINTIES THAT COULD AFFECT ITS
RESULTS OF OPERATIONS, FINANCIAL CONDITION OR CASH FLOWS. FACTORS THAT COULD
CAUSE ACTUAL RESULTS TO DIFFER MATERIALLY FROM THOSE EXPRESSED OR IMPLIED IN A
FORWARD-LOOKING STATEMENT INCLUDE THE FOLLOWING (AMONG OTHERS): EXTREME WEATHER
CONDITIONS THAT AFFECT THE DEMAND FOR THE COMPANY'S SERVICES; COMPETITION IN THE
MARKETS SERVED BY THE COMPANY; LABOR SHORTAGES OR INCREASES IN WAGE RATES;
UNEXPECTED INCREASES IN OPERATING COSTS, SUCH AS HIGHER INSURANCE, HEALTH CARE
OR FUEL PRICES; INCREASED GOVERNMENTAL REGULATION OF TELEMARKETING; GENERAL
ECONOMIC CONDITIONS IN THE UNITED STATES, ESPECIALLY AS THEY MAY AFFECT HOME
SALES OR CONSUMER SPENDING LEVELS; TIME AND EXPENSES ASSOCIATED WITH INTEGRATING
AND WINDING DOWN BUSINESSES; AND OTHER FACTORS DESCRIBED FROM TIME TO TIME IN
DOCUMENTS FILED BY THE COMPANY WITH THE SECURITIES AND EXCHANGE COMMISSION.
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PART II. OTHER INFORMATION
ITEM 6(A): EXHIBITS
EXHIBIT NO. DESCRIPTION OF EXHIBIT
3(ii) Bylaws of The ServiceMaster Company, as amended through April 26, 2002
10.1 Letter agreement with Phil Rooney dated as of April 18, 2002
15.1 Letter re: unaudited interim financial information
99.1 Certification of Chief Executive Officer Pursuant to Section 1350 of Chapter 63
of Title 18 of the United States Code
99.2 Certification of Chief Financial Officer Pursuant to Section 1350 of Chapter 63
of Title 18 of the United States Code
ITEM 6(B): REPORTS ON FORM 8-K
A report on Form 8-K was filed on March 19, 2002, reporting under "Item 5. Other
Events". The purpose of the report was to provide under Item 7, previously
reported quarterly consolidated income statement results for 2001 and 2000
restated to present the results of continuing operations and discontinued
operations, as well as to disclose quarterly goodwill and trade name
amortization by segment.
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SIGNATURE
Pursuant to the requirements of the Securities Exchange Act of 1934, the
Registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
Date: May 14, 2003
THE SERVICEMASTER COMPANY
(Registrant)
By: /S/STEVEN C. PRESTON
------------------------------------------------------
Steven C. Preston
Executive Vice President and Chief Financial Officer
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CERTIFICATION OF CHIEF EXECUTIVE OFFICER
I, Jonathan P. Ward, certify that:
1. I have reviewed this quarterly report on Form 10-Q/A of The ServiceMaster
Company;
2. Based on my knowledge, this quarterly report does not contain any untrue
statement of a material fact or omit to state a material fact necessary to
make the statements made, in light of the circumstances under which such
statements were made, not misleading with respect to the period covered by
this quarterly report; and
3. Based on my knowledge, the financial statements, and other financial
information included in this quarterly report, fairly present in all
material respects the financial condition, results of operations and cash
flows of the registrant as of, and for, the periods presented in this
quarterly report.
Date: May 13, 2003
/S/ JONATHAN P. WARD
---------------------
Jonathan P. Ward
Chairman and Chief Executive Officer
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CERTIFICATION OF CHIEF FINANCIAL OFFICER
I, Steven C. Preston, certify that:
1. I have reviewed this quarterly report on Form 10-Q/A of The ServiceMaster
Company;
2. Based on my knowledge, this quarterly report does not contain any untrue
statement of a material fact or omit to state a material fact necessary to
make the statements made, in light of the circumstances under which such
statements were made, not misleading with respect to the period covered by
this quarterly report; and
3. Based on my knowledge, the financial statements, and other financial
information included in this quarterly report, fairly present in all
material respects the financial condition, results of operations and cash
flows of the registrant as of, and for, the periods presented in this
quarterly report.
Date: May 13, 2003
/S/ STEVEN C. PRESTON
----------------------
Steven C. Preston
Executive Vice President and Chief Financial
Officer
24