SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934
For the Quarterly Period Ended March 27, 1998
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
Commission File No. 1-12188
SODEXHO MARRIOTT SERVICES, INC.
(Formerly Marriott International, Inc.)
Delaware 52-0936594
(State of Incorporation) (I.R.S. Employer Identification Number)
10400 Fernwood Road
Bethesda, Maryland 20817
--------------------------------------
(Address of Principal Executive Offices)
(301) 380-3100
------------------------------------------------
(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, and (2) has been subject to such filing requirements
for the past 90 days.
Yes [X] No [ ]
Shares outstanding
Class at April 30, 1998
------------------- ------------------
Common Stock $1.00 61,861,652
par value per share
SODEXHO MARRIOTT SERVICES, INC.
INDEX
Page No.
----------
Glossary of Terms
Forward-Looking Statements 1
Business 1
Pro Forma Results of Operations 6
Part I. Financial Information (Unaudited):
Condensed Consolidated Statements of Income -
Twelve Weeks Ended March 27, 1998 and March 28, 1997 8
Condensed Consolidated Balance Sheets -
as of March 27, 1998 and January 2, 1998 9
Condensed Consolidated Statements of Cash Flows -
Twelve Weeks Ended March 27, 1998 and March 28, 1997 10
Condensed Consolidated Statements of Comprehensive Income-
Twelve Weeks Ended March 27, 1998 and March 28, 1997 11
Condensed Consolidated Statement of Stockholders' (Deficit) Equity-
as of March 27, 1998 and January 2, 1998 12
Notes to Condensed Consolidated Financial Statements 13
Management's Discussion and Analysis of Results of Operations
and Financial Condition 25
Part II. Other Information and Signatures:
Legal Proceedings 32
Changes in Securities 32
Defaults Upon Senior Securities 32
Submission of Matters to a Vote of Security Holders 32
Other Information 32
Exhibits and Reports on Form 8-K 33
Signatures 34
GLOSSARY OF TERMS
The glossary below contains terms that are used throughout the document. In
certain places in this document, where deemed meaningful for the reader's
understanding, these definitions may be repeated.
The Acquisition. On March 27, 1998, the Company acquired Sodexho North
America, and Sodexho paid the Company $304 million, in exchange for
approximately 48.3% of the shares of the Company's common stock that were issued
and outstanding immediately after the Transactions.
Adjusted Net Tangible Assets. The amount by which stockholders' equity
exceeds intangible assets with certain adjustments.
Annual Report. The Company's Annual Report on Form 10-K for the fiscal
year ended January 2, 1998.
The Company. Sodexho Marriott Services, Inc., formerly Marriott
International, Inc. (together with its consolidated subsidiaries).
Discontinued Operations. The Company's lodging business segment.
Distributed Operations. The lodging, senior living services, and
distribution services businesses taken collectively.
The Distribution. On March 27, 1998, the Company distributed all of the
assets and liabilities of the Company's lodging, senior living services, and
distribution services businesses to its stockholders in a tax-free transaction.
MII. New Marriott MI, Inc. was subsequently renamed Marriott
International, Inc. (together with its subsidiaries).
MDS. Marriott Distribution Services, the Company's distribution services
business.
MMS. Marriott Management Services, the remaining line of business in the
contract services segment, food service and facilities management, which has
become the principal business of the Company.
MSLS. Marriott Senior Living Services, the Company's senior living
services business.
New Marriott MI, Inc. Subsequently renamed Marriott International, Inc.,
conducts business in the lodging segment, MDS and MSLS.
Other Contract Services. MDS and MSLS which for the first quarter of
1998 and 1997 comprise part of the Company's continuing operations.
R&I Costs. Restructuring and integration costs related to the
Transactions.
The Refinancing. On March 27, 1998, the Company and its indirect
subsidiary, RHG Finance Corporation, tendered for a total of $720 million
principal amount of their respective outstanding publicly held debt, and the
Company refinanced its commercial paper and indebtedness outstanding under its
revolving credit facility, which together totaled $950 million.
Retained Business. All operations not distributed.
Reverse Stock Split. On March 27, 1998, the Company's common stock
underwent a reverse one-for-four stock split.
Sodexho. Sodexho Alliance, S.A., a worldwide food and management services
organization headquartered in France.
Sodexho North America. Sodexho Financiere du Canada and subsidiaries and
International Catering Corporation and subsidiaries (also known as Sodexho USA)
taken collectively.
The Transactions. The Distribution, Acquisition, and Refinancing taken
collectively.
FORWARD-LOOKING STATEMENTS
This report by Sodexho Marriott Services, Inc. (together with its consolidated
subsidiaries, the "Company") contains forward-looking statements within the
meaning of the federal securities laws. These statements are based on the
Company's current expectations and relate to anticipated future events that are
not historical facts, such as the Company's business strategies and their
intended results.
The forward-looking statements included in this report are subject to numerous
risks and uncertainties that could cause the Company's future activities and
results of operations to differ materially from those expressed or implied in
the forward-looking statements. These risks and uncertainties, which are
further discussed in Management's Discussion and Analysis of Results of
Operations and Financial Condition, include: (i) the ability of the Company to
adapt to recent changes in its corporate structure related to the Transactions,
(ii) the potential adverse impact of the Company's substantial indebtedness,
(iii) competition in the food services and facilities management industries,
(iv) the effects of general economic conditions, (v) the ability of the Company
to retain clients and obtain new clients in light of the Transactions, and other
factors described from time to time in the Company's filings with the Securities
and Exchange Commission including those set forth in Exhibit 99 filed herein.
As a result of these risks and uncertainties, readers are cautioned not to place
undue reliance on the forward-looking statements included in this report or that
may be made elsewhere from time to time by, or on behalf of, the Company. The
Company assumes no obligation to update any forward-looking statements.
BUSINESS
The Company was formerly named Marriott International, Inc. Upon consummation
of the Transactions, which occurred on March 27, 1998, the last day of the first
quarter of 1998, Marriott International, Inc. was renamed Sodexho Marriott
Services, Inc. The subsidiaries listed below represent the current direct
subsidiaries of the Company. Each of these direct subsidiaries, in turn, has
one or more subsidiaries.
. Sodexho Marriott Operations, Inc. (a newly formed entity);
. Sodexho Financiere du Canada (acquired in the transaction described in Note 3
of the condensed consolidated financial statements); and
. Sodexho Marriott Services Canada, Ltd. (formerly Marriott Corporation of
Canada, Ltd.).
There are two main operating subsidiaries of Sodexho Marriott Operations, Inc.:
. Sodexho Marriott Management, Inc. (formerly Marriott Management Services
Corp.) and its subsidiaries; and
. International Catering Corporation (acquired in the transaction described in
Note 3 of the condensed consolidated financial statements) and its
subsidiaries.
Sodexho Financiere du Canada and subsidiaries and International Catering
Corporation and subsidiaries are collectively referred to as Sodexho North
America. Similarly, the former Marriott Corporation of Canada, Ltd. and
subsidiaries and the former Marriott Management Services Corp. and subsidiaries
are collectively referred to as MMS.
1
As of March 27, 1998, the principal business of the Company changed from lodging
and contract services to food and facilities management services. This change
was the result of the Distribution and the Acquisition. In connection with the
Acquisition and Distribution, the Company refinanced its debt. The Transactions
are explained in detail in the Company's definitive proxy statement dated
February 12, 1998 for a Special Meeting of Stockholders commenced on March 17,
1998 and adjourned to March 20, 1998, and are summarized in Item 1 of the
Company's Report on Form 8-K filed on April 3, 1998 and in Notes 2, 3, and 5 of
the condensed consolidated financial statements included in this report. Due to
the extensive changes in the Company's business that resulted from the
Transactions, the Company is providing for informational purposes the following
description of its business as it now exists.
GENERAL
The Company is the leading provider in North America of outsourced food and
facilities management services, including businesses, health care facilities,
colleges and universities, and primary and secondary schools. Food services
include food and beverage procurement, preparation and menu planning, as well as
the operation and maintenance of food service and catering facilities, generally
on a client's premises. Facilities management services include plant
maintenance, energy management, groundskeeping, and housekeeping and custodial
services.
INDUSTRY AND MARKETPLACE
The food and facilities management services industry is rapidly changing. Major
industry dynamics are:
. Stable industry revenues from an existing client base.
. Continued growth in the outsourcing of food service and facilities management
as a result of (i) focus by customers on core competencies and outsourcing of
their non-core services, (ii) general economic growth, and (iii) increasing
cost pressures.
. Increasing market penetration by large, well-capitalized participants due to
their ability to provide (i) more cost-effective services as a result of
economies of scale, (ii) a broader range of services than local and regional
participants, and (iii) national and international coverage to large clients.
. An increase in the retail orientation of contract catering due to the
proliferation of alternative retail outlets, including fast food operations,
for consumers.
. Strong industry dynamics towards a "one stop shopping" alternative for all
outsourcing needs, including food service and facilities management.
. Minimal capital requirements due to several factors, including low capital
expenditures because operations are generally conducted at client sites using
client equipment; low fixed costs, permitting rapid response to market
conditions; and predictable cash flow from client payments, reducing or
eliminating working capital needs.
2
MARKET POSITION
The Company has its origins in two well-established food service providers, MMS
and Sodexho North America. The Company is the market leader in the North
American contract food services industry, which the Company's management
believes is generally underpenetrated by contractors. Market leadership makes
the Company well positioned to grow faster than the overall market. The Company
has a unique opportunity to leverage its position as the market leader in food
service by cross-selling its facilities management services to existing food-
service-only clients. Management of the Company believes that the facilities
management industry remains even more underpenetrated by contractors than the
contract food services industry.
With the similar and complementary businesses of the two combined operations,
management of the Company believes it has the capabilities to continue its
market leadership.
The Company operates primarily in four sectors:
. Health Care. The health care industry continues its transformation from a
fee-for-service to a managed care and capitated rate environment. This market
dynamic has shifted the risk and burden of cost control from insurance
providers to the health care institutions themselves, forcing them to focus
not only on the cost component of clinical care, but also on the cost of all
services including food and facilities management. These cost pressures are
driving the trend toward consolidation of health care institutions and
guaranteed cost contracts for hospital services. Management of the Company
believes that the health care market remains significantly underpenetrated.
. Corporate. Although the market for food service in business and industry is
relatively highly penetrated, customers are responding favorably to the
growth in retail orientation by food service contractors. The market for
multi-service national providers (food and facilities) is growing as
corporations are moving toward outsourcing all of their non-core services on
a multi-site and multi-service basis. This represents an opportunity to
leverage from food contracting to the less developed facilities management
market. The government market is expected to increase as federal departments
and agencies implement large-scale outsourcing of non-core functions.
. Education. The campus dining marketplace continues to shift from residential
board plans to more retail-oriented operations driven by (i) the growing
proportion of non-resident day and evening students on campuses, (ii) the
taste and service preferences of today's young consumers and (iii) colleges'
desires to provide their students with greater flexibility. Traditional
straight-line cafeterias are being replaced by scatter systems and food
courts. These trends, coupled with cost pressures, are causing public and
private institutions to consider outsourcing as a viable choice.
. Schools. The current fiscal climate is forcing school districts to minimize
costs while improving the performance of non-instructional areas. Over the
last several years, 150-200 school systems per year have decided to begin
outsourcing their food services. Also, new federal laws require that school
meals meet more stringent food specifications and production techniques to
comply with "Dietary Standards" guidelines. Most school districts have
3
obtained waivers of compliance with the new guidelines until July 1998.
Thereafter, some school districts may turn to contractors to help comply with
guidelines.
COMPETITION
The food and facilities management services business in North America is
comprised of a large number of local, regional and national service providers.
The Company's strongest competition comes from larger, well-capitalized
participants due to their ability to provide (i) cost-effective services as a
result of economies of scale, (ii) a broader range of services than local and
regional participants and (iii) national coverage to large clients.
Many educational institutions, health care providers and businesses consider
cost to be an important factor when selecting companies to provide food and
facilities management services. The Company expects to be a successful low-cost
services provider due to its (i) significant purchasing economies of scale for
food service and facilities management supplies, (ii) sophisticated site labor
management controls, (iii) low administrative overhead and (iv) strong
information and accounting system which allows the Company's management and
clients to monitor costs. The timing and realization of additional synergies
will be dependent on the successful integration of Sodexho North America.
Clients also consider the quality of food and facilities management services to
be an important factor in addition to price. Accordingly, the Company's
competitive profile will also depend on its ability to maintain a level of
quality in keeping with client expectations.
EMPLOYEES
The Company has approximately 100,000 employees on its payroll in the U.S. and
Canada, and manages approximately 60,000 people on its clients' payrolls. The
Company's corporate headquarters, located in Bethesda, Maryland, has
approximately 250 employees. An estimated 8,800 non-management employees are
represented by organized labor unions for collective bargaining purposes. The
Company believes its relations with its employees are positive.
PROPERTIES
The Company occupies approximately 42,800 square feet for its headquarters
office space in Bethesda, Maryland in a building leased by the Company from
Marriott International, Inc. (MII). In addition, all of the Company's operating
divisions lease their headquarters office space in Avon, Connecticut (Health
Care Services); Bethesda, Maryland (Corporate Services); Altamonte Springs,
Florida (Education Services); and Downers Grove, Illinois (School Services).
These operating division leases generally run for initial terms of three to five
years and generally have renewal options. The Company also has a long-term
lease for its office facility in Buffalo, New York, where all of the centralized
accounting and processing activities for North America will take place. The
Company owns three laundry facilities (Walla Walla, Washington, Tucson, Arizona,
and Phoenix, Arizona) and leases three additional laundry facilities
(Birmingham, Alabama, Gilroy, California, and Compton, California). As a result
of the Acquisition, the Company also occupies approximately one-half of an
80,000 square-foot office building that it owns in Waltham,
4
Massachusetts; approximately 25,000 square feet of office and warehouse space in
Trumbull, Connecticut; approximately 15,000 square feet of office space in
Mobile, Alabama; approximately 20,000 square feet of building space in
Sunnyvale, California; and approximately 15,000 square feet of building space in
Alston, Massachusetts. The Company owns a 30,000 square foot office building in
Montreal, Canada.
5
PRO FORMA RESULTS OF OPERATIONS
As of March 27, 1998, the assets, liabilities and business operations of the
Company changed substantially due to the Transactions described fully in Notes
2, 3 and 5 to the condensed consolidated financial statements. As a result of
these changes, there are substantial differences in comparability between the
Company's historical operating results presented in Part I of this document and
the Company's ongoing operations. To assist readers in understanding the
present operations of the Company, management believes it is meaningful and
relevant to set forth in this report not only the actual results of operations
for the twelve weeks ended March 27, 1998 and the comparable period in 1997, but
also the pro forma operating results for those same periods. The pro forma
operating results were prepared as if the Transactions occurred at the beginning
of each period. Therefore, the pro forma operating results only include the
Company's Retained Business and the operations of Sodexho North America.
The pro forma statements of operations do not necessarily reflect results which
may occur in the future.
SODEXHO MARRIOTT SERVICES, INC.
PRO FORMA RESULTS OF OPERATIONS
($ in millions, except per share amounts)
(Unaudited)
Twelve weeks ended
---------------------------------
March 27, March 28,
1998 1997
-------------- --------------
SALES........................................................ $ 1,024 $ 986
OPERATING COSTS AND EXPENSES................................. 976 942
--------- ---------
OPERATING PROFIT BEFORE CORPORATE EXPENSES
AND INTEREST........................................... 48 44
Corporate expenses........................................... (17) (16)
Interest expense, net........................................ (22) (22)
--------- ---------
INCOME BEFORE INCOME TAXES............................... 9 6
Provision for income taxes................................... 5 4
--------- ---------
PRO FORMA NET INCOME..................................... $ 4 $ 2
========= =========
PRO FORMA EARNINGS PER SHARE - NET INCOME
BASIC.................................................... $ .07 $ .04
========= =========
DILUTED.................................................. $ .07 $ .04
========= =========
Pro forma sales include the combined actual sales of the food and facilities
management services business of MMS ($790 million and $763 million,
respectively) and Sodexho North America ($234 million and $223 million,
respectively). Pro forma operating profit before corporate expenses and
interest reflects approximately $3.7 million of amortization expense for the
intangible assets related to the Acquisition. Pro forma corporate expenses
include the combined corporate overhead of both businesses, with no synergies
assumed or integration costs included; however, an estimate of $1.6 million was
included for both periods presented representing incremental costs to operate
as a separate public company.
6
Pro forma interest expense, net, represents the estimated costs as if the
Refinancing and the interest rate agreements had been in place on the first day
of both periods presented. An effective income tax rate of 55.3% and 62.8%
were used for the first quarter of 1998 and 1997, respectively. Pro forma
results do not include any extraordinary charges related to the Refinancing.
Pro forma basic earnings per share were calculated on a share base of 61.9
million for both 1998 and 1997, which represents the number of shares
outstanding on March 27, 1998. Pro forma diluted earnings per share were
calculated on a share base of 62.5 million and 62.4 million for 1998 and 1997,
respectively. The dilutive shares are due to stock option plans and deferred
stock incentive plans.
7
PART I FINANCIAL INFORMATION
Item 1. Financial Statements
- ----------------------------
SODEXHO MARRIOTT SERVICES, INC.
CONDENSED CONSOLIDATED STATEMENTS OF INCOME
($ in millions, except per share amounts)
(Unaudited)
Twelve weeks ended
---------------------------------
March 27, March 28,
1998 1997
-------------- --------------
SALES...................................................................... $ 1,111 $ 1,154
OPERATING COSTS AND EXPENSES............................................... 1,078 1,108
----------- ----------
OPERATING PROFIT BEFORE CORPORATE EXPENSES
AND INTEREST......................................................... 33 46
Corporate expenses......................................................... (37) (27)
Interest expense........................................................... (25) (19)
Interest income............................................................ 9 5
----------- ----------
(LOSS) INCOME FROM CONTINUING OPERATIONS BEFORE INCOME TAXES........... (20) 5
(Benefit) Provision for income taxes....................................... (9) 1
----------- ----------
(LOSS) INCOME FROM CONTINUING OPERATIONS............................... (11) 4
----------- ----------
Discontinued operations....................................................
Income from discontinued operations, net of applicable income tax
expense of $64 and $49............................................... 94 73
Costs associated with effecting the distribution, net of applicable
income tax benefit of $9............................................. (17) -
----------- ----------
INCOME BEFORE EXTRAORDINARY ITEM....................................... 66 77
Extraordinary item, net of applicable income tax benefit of $28............ (43) -
----------- ----------
NET INCOME............................................................. $ 23 $ 77
=========== ==========
(LOSS) EARNINGS PER SHARE - CONTINUING OPERATIONS
BASIC.................................................................. $ (.34) $ .13
=========== ==========
DILUTED................................................................ $ (.34) $ .12
=========== ==========
EARNINGS PER SHARE - NET INCOME
BASIC.................................................................. $ .73 $ 2.44
=========== ==========
DILUTED................................................................ $ .73 $ 2.31
=========== ==========
See notes to condensed consolidated financial statements.
8
SODEXHO MARRIOTT SERVICES, INC.
CONDENSED CONSOLIDATED BALANCE SHEETS
($ in millions)
(Unaudited)
March 27, January 2,
1998 1998
------------ ----------
ASSETS
Current Assets
Cash and equivalents.................................................... $ 76 $ 139
Accounts and notes receivable........................................... 346 487
Other................................................................... 128 344
--------- ---------
Total current assets 550 970
Property and equipment, net................................................ 84 505
Intangible assets.......................................................... 579 388
Other assets............................................................... 113 395
Net noncurrent assets of discontinued operations........................... - 2,948
--------- ---------
$ 1,326 $ 5,206
========= =========
LIABILITIES AND STOCKHOLDERS' (DEFICIT)/EQUITY
Current Liabilities
Current portion of long-term debt....................................... $ 36 $ -
Accounts payable........................................................ 176 548
Other current liabilities............................................... 274 601
Payable to affiliates for excess net tangible assets.................... 50 -
Net current liabilities of discontinued operations...................... - 56
--------- ---------
Total current liabilities 536 1,205
Long-term debt............................................................. 1,213 1,519
Other long-term liabilities................................................ 110 709
Liability for convertible subordinated debt................................ 28 310
Stockholders' (Deficit)/Equity
Preferred stock, no par value, 1 million shares authorized; no shares
issued................................................................. - -
Common stock, $1 par value, 300 million and 75 million shares
authorized; 62 million and 32 million shares issued and outstanding.... 62 32
Additional paid-in capital.............................................. 1,321 805
Retained (deficit) earnings............................................. (1,954) 822
Accumulated other comprehensive income.................................. 10 (12)
Treasury stock, at cost................................................. - (184)
--------- ---------
Total stockholders' (deficit)/equity (561) 1,463
--------- ---------
Total liabilities and stockholders' (deficit)/equity $ 1,326 $ 5,206
========= =========
See notes to condensed consolidated financial statements.
9
SODEXHO MARRIOTT SERVICES, INC.
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
($ in millions)
(Unaudited)
Twelve weeks ended
---------------------------------
March 27, March 28,
1998 1997
-------------- --------------
OPERATING ACTIVITIES
(Loss) Income from continuing operations................................ $ (11) $ 4
Adjustments to reconcile to cash provided by continuing operations:
Depreciation and amortization....................................... 22 25
Income taxes and other.............................................. (50) 20
Working capital changes............................................. 41 23
Changes in discontinued operations.................................. 131 61
---------- ----------
Cash provided by operating activities............................... 133 133
---------- ----------
INVESTING ACTIVITIES
Capital expenditures.................................................... (63) (44)
Dispositions............................................................ 28 -
Cash of distributed operations.......................................... (478) -
Acquisitions............................................................ 24 -
Discontinued operations................................................. (113) (81)
Other................................................................... (47) (34)
---------- ----------
Cash used in investing activities....................................... (649) (159)
---------- ----------
FINANCING ACTIVITIES
Issuances of long-term debt............................................. 1,820 883
Payments for extinguishment of debt..................................... (70) -
Repayments of long-term debt............................................ (1,739) (5)
Proceeds received from Sodexho.......................................... 304 -
Issuances of common stock............................................... 31 8
Dividends paid.......................................................... (11) (10)
Purchases of treasury stock............................................. (55) (67)
---------- ----------
Cash provided by financing activities................................... 280 809
---------- ----------
(DECREASE) INCREASE IN CASH AND EQUIVALENTS................................ (236) 783
---------- ----------
CASH AND EQUIVALENTS, beginning of period
Continuing operations................................................... 139 128
Discontinued operations................................................. 173 140
---------- ----------
Total beginning cash.................................................... 312 268
---------- ----------
CASH AND EQUIVALENTS, end of period
Continuing operations................................................... 76 899
Discontinued operations................................................. - 152
---------- ----------
Total ending cash....................................................... $ 76 $ 1,051
========== ==========
See notes to condensed consolidated financial statements.
10
SODEXHO MARRIOTT SERVICES, INC.
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME
($ in millions)
(Unaudited)
Twelve weeks ended
---------------------------------
March 27, March 28,
1998 1997
-------------- --------------
Net Income................................................................. $ 23 $ 77
Other comprehensive income, net of tax
Foreign currency translation adjustments.................................. (5) (5)
Unrealized gains on investments........................................... 3 1
---------- ----------
Total other comprehensive income........................................... (2) (4)
---------- ----------
Comprehensive Income....................................................... $ 21 $ 73
========== ==========
See notes to condensed consolidated financial statements.
11
SODEXHO MARRIOTT SERVICES, INC.
CONSOLIDATED STATEMENT OF STOCKHOLDERS' (DEFICIT)/EQUITY
(amounts in millions)
(Unaudited)
Accumulated
Number Additional Retained Other Treasury
of Common Paid-In (Deficit) Comprehensive Stock,
Shares Stock Capital Earnings Income at cost Total
-------- -------- ------------ ----------- --------------- ---------- -------
Balance, January 2, 1998 32 $ 32 $ 805 $ 822 $ (12) $(184) $ 1,463
Other Comprehensive
income (2) (2)
Net income 23 23
Distribution (2,715) 24 (2,691)
Shares issued to Sodexho
related to Acquisition 30 30 549 579
Purchases of treasury stock (35) (35)
Cancellation of treasury stock 59 59
Stock options and other (33) (84) 160 43
---- ----- -------- -------- ------ ------- --------
Balance, March 27, 1998 62 $ 62 $ 1,321 $(1,954) $ 10 $ - $ (561)
==== ===== ======== ======== ====== ======= ========
See notes to condensed consolidated financial statements.
12
SODEXHO MARRIOTT SERVICES, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
1. Summary of Significant Accounting Policies
------------------------------------------
Basis of Presentation
The accompanying condensed consolidated financial statements of Sodexho
Marriott Services, Inc. (together with its consolidated subsidiaries, the
"Company") have been prepared without audit. Certain information and
footnote disclosures normally included in financial statements presented in
accordance with generally accepted accounting principles have been
condensed or omitted. The Company believes the disclosures made are
adequate to make the information presented not misleading. However, the
condensed consolidated financial statements should be read in conjunction
with the consolidated financial statements and notes thereto included in
the Company's Annual Report.
In the opinion of the Company, the accompanying condensed consolidated
financial statements reflect all adjustments (which include only normal
recurring adjustments) necessary to present fairly the financial position
of the Company as of March 27, 1998 and January 2, 1998, and the results of
operations for the twelve weeks ended March 27, 1998 and March 28, 1997.
Interim results are not necessarily indicative of fiscal year performance
because of the impacts of the Transactions described in Notes 2, 3 and 5,
as well as seasonal and short-term variations. All material intercompany
transactions and balances between Sodexho Marriott Services, Inc. and its
subsidiaries have been eliminated.
Fiscal Year
As of March 27, 1998, the Company's fiscal year ended on the Friday nearest
to December 31; however, on April 15, 1998, the Board of Directors approved
the change of the Company's fiscal year to end on the Friday nearest to
August 31. As allowed under the transition rules for registrants, the
Company's next financial statement filing will be a transitional Form 10-K
for the period January 3, 1998 through August 28, 1998.
Use of Estimates
The preparation of financial statements in conformity with generally
accepted accounting principles requires management to make estimates and
assumptions that affect the reported amounts of assets and liabilities and
disclosure of contingent assets and liabilities at the date of the
financial statements and the reported amounts of revenue and expenses
during the reporting period. Actual results could differ from these
estimates.
Client Investments
Included in other assets are client investments, which represent amounts
provided by the Company to clients at contract inception for the purchase
of property and equipment pertaining to the contract and are amortized over
the life of the related contract. When a contract terminates prior to its
scheduled termination date, the client generally must repay any unamortized
client investment balance to the Company.
13
Intangibles
Intangibles consist primarily of customer contracts and goodwill. Customer
contracts are amortized on a straight-line basis over the estimated
remaining lives of the customer relationships ranging from 8 to 20 years.
Goodwill represents the excess cost over the fair value of businesses
acquired and is amortized on a straight-line basis over periods ranging
from 30 to 40 years. The carrying value of goodwill and other intangibles
is evaluated periodically as it relates to the operating performance and
future undiscounted cash flows of each operating business acquired.
Revenue Recognition
Revenues are recognized at the time services are rendered or products are
delivered. Revenues include reimbursements for food and payroll costs
incurred on behalf of customers under contracts in which the Company
manages food service programs for a fee. Losses, if any, are provided for
at the time management determines the cost will ultimately exceed contract
revenue for the duration of the contract.
Interest Rate Agreements
From time to time, the Company enters into various interest rate agreements
for the purpose of hedging the Company's interest rate risk. The agreements
are contracts to exchange floating rate for fixed rate interest payments or
guarantee a fixed interest rate over the life of the agreements without the
exchange of the underlying notional amounts. The notional amounts of the
contracts do not affect total assets or liabilities of the Company. The
notional amounts of interest rate agreements are used to measure interest
to be paid or received and do not represent the amount of exposure to
credit loss. The differential paid or received on interest rate agreements
is recognized as an adjustment to interest expense. All of the Company's
interest rate agreements are for purposes other than trading.
Concentration of Credit Risk
Concentration of credit risk with respect to accounts receivable is limited
because a large number of customers make up the Company's customer base,
thus spreading trade credit risk. In addition, the Company closely monitors
accounts receivable. The Company generally does not require collateral and
maintains reserves for potential uncollectible amounts which, in the
aggregate, have not exceeded management expectations.
Reverse Stock Split
On March 27, 1998, the Company's common stock underwent a reverse one-for-
four stock split. The information contained herein has been restated to
reflect this reverse stock split.
Reclassifications
Certain amounts in the prior period financial statements have been
reclassified to conform with the current period's presentation.
2. Distributed Operations
-----------------------
On March 27, 1998, the Company distributed to its stockholders, on a pro
rata basis, all outstanding shares of New Marriott MI, Inc., a wholly owned
subsidiary of the Company, in a tax-free distribution (the "Distribution").
New Marriott MI, Inc., subsequently renamed
14
Marriott International, Inc. (together with subsidiaries, MII) conducts
business in the lodging segment and two of the three lines of business in
the contract services segment - MSLS and MDS. The lodging, MDS and MSLS
businesses, are collectively referred to as Distributed Operations. The
third line of business in the contract services segment, MMS, has become
the principal business of the Company.
As a result of the Distribution, the accompanying condensed consolidated
financial statements have been restated to present the results of
operations, cash flows and financial position of the Company's lodging
business segment as discontinued operations. Other Contract Services, which
comprise part of MII's ongoing operations, have not been treated as
discontinued operations.
Operating results for Distributed Operations were:
For the Twelve Weeks Ended
- --------------------------------------------------------------------------------
March 27, 1998 March 28, 1997
------------------------------ -------------------------------
($ in millions,
except per Other Contract Other Contract
share amounts) Lodging Services Lodging Services
----------- ----------------- ----------- ------------------
Sales.......... $ 1,774 $ 321 $ 1,450 $ 349
Income before
income taxes... $ 158 $ 5 $ 122 $ 14
Income taxes... $ 64 * $ 49 *
Net income..... $ 94 * $ 73 *
Basic earnings
per share...... $ 2.46 * $ 2.28 *
Diluted
earnings per
share.......... $ 2.46 * $ 2.08 *
Assets of
distributed
operations..... $ 4,117 $ 936 $ 2,490 $ 1,303
* Disclosure not required.
All intercompany transactions have been eliminated from the amounts above.
Excluded from operating results of Distributed Operations are corporate
expenses of $23 million and $21 million for the twelve weeks ended March
27, 1998 and March 28, 1997, respectively, and corporate assets of $640
million and $1.2 billion as of March 27, 1998 and March 28, 1997,
respectively, related to those operations.
15
3. Acquisition
-----------
Immediately after the Distribution, on March 27, 1998, Sodexho transferred
to the Company Sodexho North America having an estimated value of
approximately $275 million and made a cash payment of $304 million at the
same time in exchange for 29,949,925 shares of the Company's common stock,
after giving effect to the one-for-four reverse stock split, discussed in
Note 12. The purchase price includes approximately $3 million in
transaction costs. As a result of the issuance of new shares of the
Company's common stock to Sodexho in connection with the Acquisition, the
stockholders who owned 100 percent of the Company immediately prior to the
Distribution owned approximately 51% immediately thereafter.
The Acquisition has been accounted for using the purchase method of
accounting. As valuations have not yet been completed, the purchase price
has been allocated to the assets acquired and liabilities assumed based on
a preliminary estimate of fair values as follows:
($ in millions)
---------------
Current assets ....................................... $ 141
Other assets ......................................... 52
Customer contracts ................................... 120
Current liabilities .................................. (135)
Payable to Sodexho for excess net tangible assets .... (20)
Other liabilities .................................... (7)
Acquisition reserve .................................. (29)
Debt ................................................. (73)
Deferred taxes, net .................................. (9)
Goodwill ............................................. 238
--------
Subtotal ........................................ 278
Cash contributed to the Company ...................... 304
--------
Total purchase price ............................ $ 582
========
Immediately after the Acquisition, the Company refinanced the $73 million
of debt assumed, as discussed in Note 5.
4. Restructuring and Integration Costs
-----------------------------------
Restructuring costs represent costs, such as employee termination benefits
and office closure costs, that are incurred to terminate certain duplicate
activities. The acquisition reserve of $29 million disclosed in Note 3
principally represents costs associated with termination benefits for
approximately 400 employees and office closure costs related to the former
Sodexho North America operations. As of March 27, 1998, the Company
recorded $7 million in restructuring charges related to termination
benefits for approximately 50 employees and office closure costs related
to MMS.
Integration costs represent costs incurred to integrate the activities of
Sodexho North America with those of MMS. The integration costs include,
among other items, training and relocating employees, incremental overhead
during the integration phase, systems modifications, and other one-time
costs. During the twelve weeks ended March 27, 1998, the Company had
recorded approximately $3 million in integration costs. The Company expects
to incur
16
approximately $33 million and $8 million in additional integration costs
through August 28, 1998 and in fiscal 1999, respectively.
5. The Refinancing
---------------
The Secured Facility consists of a $235 million revolving credit facility
and a $500 million six-year term loan facility. It bears interest at rates
based on a bank prime rate, the Federal Fund rate, or LIBOR, payable in
arrears quarterly. The Company is currently paying interest at 5.69% plus
1.125%. Of the revolving credit facility, up to $100 million may be used to
cover letters of credit. As of March 27, 1998, the Company had letters of
credit outstanding of $13 million. The facility is collateralized by liens
on the inventory, accounts receivable, and stock of the principal
subsidiaries of Sodexho Marriott Operations, Inc. As of March 27, 1998,
$107 million of borrowing capacity was available under this facility.
The Guaranteed Facility is a $620 million seven-year term loan. It bears
interest at rates based on a bank prime rate, the Federal Fund rate, or
LIBOR, payable in arrears quarterly. The Company is currently paying
interest at 5.69% plus .45%. The Company pays Sodexho an annual fee of
0.5%, or $3 million, to serve as guarantor of the loan.
Additional credit facilities totaling about $8 million from the Canadian
operations of both MMS and Sodexho remained in place. As of March 27, 1998,
approximately $6 million of borrowing capacity was available under these
facilities.
On March 27, 1998, the Company borrowed $615 million and $620 million under
the Secured Facility and Guaranteed Facility, respectively. The proceeds
were used to purchase $713 million of the Company's publicly held debt, as
discussed in the following paragraph, and to repay its $950 million
outstanding obligations under the Company's existing $1.5 billion credit
facility, which was cancelled immediately after such repayment. Also, the
Company repaid debt of $73 million assumed in the Acquisition. The $304
million received from Sodexho (see Note 3) was used in conjunction with the
debt proceeds to fund the debt repayments. The Company also received a
letter of credit for $13 million under the Secured Facility on March 27,
1998 for which it paid the bank a commission fee of 1.125%.
In connection with the Distribution, the Company tendered for $720 million
principal amount of its outstanding publicly held debt, $600 million
related to the Series A through D Senior Notes and $120 million related to
the Renaissance Hotel Group (RHG) Financing. Approximately $593 million
of the Series A through D Senior Notes were tendered at a premium of $45
million. The untendered Series A through D Senior Notes will remain a
liability of the Company.
17
Face Amount Untendered Debt
Prior to Tender at
March 28, March 27,
1997 1998
----------------- -----------------
Series A............... $ 150 $ 2
B............... 200 1
C............... 150 3
D............... 100 1
------- ------
$ 600 $ 7
======= ======
Approximately $117 million of the $120 million in RHG Finance outstanding
Guaranteed Notes was tendered at a premium of $20 million. The Company paid
an additional $3.5 million in cash to MII representing the untendered RHG
debt that has become a liability of MII. The debt extinguishment was
financed through the Secured Facility and the Guaranteed Facility discussed
above, as well as the $304 million received from Sodexho in connection with
the Acquisition.
As part of the Distribution, the Company and MII agreed that total
indebtedness retained by the Company after the Distribution would equal
$1.444 billion. As the Company's indebtedness totaled $1.698 billion after
effecting the Distribution, MII paid the Company the difference of $254
million, which was used by the Company to repay debt.
The resulting extraordinary charge for costs associated with the early
extinguishment of this debt was $43 million, net of $28 million in taxes,
or $1.36 per basic and diluted share.
The Company's borrowing agreements contain various covenants which, among
other things, require the Company to meet certain financial ratios and
tests. The agreements also contain limitations on payments of dividends.
6. Interest Rate Agreements
------------------------
As of March 27, 1998, the Company had no interest rate agreements; however,
the Company subsequently entered into three agreements to guarantee a fixed
rate for interest payments over the life of the agreements. The following
table summarizes the interest rate agreements the Company entered into
subsequent to March 27, 1998:
($ in millions)
Notional
Amount Term
---------- ---------------
LIBOR fixed at 5.7-5.8% $400 5/29/98-8/31/01
LIBOR fixed at 5.84% $300 5/29/98-8/31/02
LIBOR fixed at 5.90% $200 5/29/98-2/28/05
----
Total interest rate $900
agreements ====
18
The fixing of the interest rates for the above periods reduces the
Company's exposure to the uncertainty of floating interest rates. The
Company has elected to set the underlying debt at the three month LIBOR
rate at the beginning of the quarter, which matches the reset period for
the interest rate hedge agreements.
7. Earnings Per Share From Continuing Operations
---------------------------------------------
The following table illustrates the reconciliation of the earnings and
number of shares used in the calculations of basic and diluted earnings per
share from continuing operations (in millions, except per share amounts).
Amounts have been restated for both periods to reflect the one-for-four
reverse stock split, discussed in Note 12.
Twelve weeks ended
------------------------
March 27, March 28,
(amounts in millions, except per share amounts) 1998 1997
----------- -----------
Computation of Basic (Loss) Earnings Per Share From
Continuing Operations
(Loss) Income from continuing operations............ $ (8) $ 4
Weighted average shares outstanding................. 31.7 31.6
------- -------
Basic (Loss) Earnings Per Share From
Continuing Operations.............................. $ (.25) $ .13
======= =======
Computation of Diluted (Loss) Earnings Per Share
from Continuing Operations
(Loss) Income from continuing operations............ $ (8) $ 4
Weighted average shares outstanding................. 31.7 31.6
Effect of Dilutive Securities
Employee stock option plan......................... - 1.0
Deferred stock incentive plan...................... - .8
------- -------
Shares for diluted (loss) earnings per share from
continuing operations............................. 31.7 33.4
------- -------
Diluted (Loss) earnings per share from
continuing operations............................. $ (.25) $ .12
======= =======
The effect of dilutive securities is computed using the treasury stock
method and average market prices during the period. Due to the loss from
continuing operations for the first quarter of 1998, there were 3.5 million
and .9 million shares related to employee stock option plans and deferred
stock incentive plans, respectively, which could potentially dilute basic
earnings per share in the future that were not included in the computation
of diluted earnings
19
per share because to do so would have been anti-dilutive. For both periods
presented, inclusion of the convertible subordinated debt, 1.2 million
shares, in the calculation was anti-dilutive. The if-converted method is
used for convertible subordinated debt.
In the first quarter of 1997, approximately 730,000 options to purchase
shares of common stock were outstanding but were not included in the
computation of diluted earnings per share from continuing operations
because the exercise prices of the options were greater that the average
market price of the common shares.
8. Related Party Agreements
------------------------
Agreements between the Company and MII
For the purposes of governing certain of the ongoing relationships between
the Company and MII after the Distribution and to provide for an orderly
transition, the Company and MII have entered into various agreements
including the Employee Benefits and Other Employment Matters Allocation
Agreement (see Note 10), Liquid Yield Option Notes (LYONs) Allocation
Agreement (see Note 9), Tax Sharing Agreement, Trademark License Agreement,
Noncompetition Agreement, Employee Benefit Services Agreement, Procurement
Services Agreement, Distribution Services Agreement and other transitional
services agreements. Effective on March 27, 1998, these agreements provide,
among other things, that MII assumes sponsorship of certain of the
Company's employee benefit plans and insurance programs as well as succeeds
to the Company's liability to LYONs holders under the LYONs Indenture, a
portion of which has been assumed by the Company.
The Tax Sharing Agreement provides that MII will be liable for all income
taxes of the Company through March 27, 1998. For all periods following
March 27, 1998, the Company is liable for income taxes on its operations.
In accordance with the Trademark License Agreement, the Company is
obligated to pay MII a license fee of $1 million per year, payable
quarterly in advance, for use of the "Marriott" name for four years.
The agreements that the Company and MII have entered into for the
additional transitional services are for services substantially similar to
the scope of services provided prior to the Distribution. The terms and
conditions of the agreements were negotiated by the parties at arm's
length. The anticipated annual payments from MII to the Company are
approximately $3 to $4 million and from the Company to MII are
approximately $70 to $80 million (excluding cost reimbursements for food
and supplies purchased from MII).
As part of the Transactions, the Company entered into an agreement with MII
that established a reasonable amount of Adjusted Net Tangible Assets for
the Retained Business immediately prior to the consummation of the
Transactions.
The Distribution Agreement between the Company and MII provided that the
Adjusted Net Tangible Assets of the Retained Business was to equal $103
million immediately prior to the consummation of the Transactions. Within
60 days after the Distribution on March 27, 1998, MII will deliver to the
Company a statement that includes a consolidated balance sheet of the
20
Retained Business. The Company will then have another 30 days after the
receipt of the statement to either accept the Adjusted Net Tangible Assets
amount or to describe any proposed adjustments.
Upon the acceptance of the Adjusted Net Tangible Assets amount by the
Company or the resolution in writing of any disputes, Company will pay MII
the amount, together with interest, by which the Adjusted Net Tangible
Assets amount is greater than $103 million. The amount accrued as of March
27, 1998 is $30 million based on the Company's estimate of the amount to be
paid in June 1998.
Agreements between the Company and Sodexho
For the purposes of governing certain of the ongoing relationships between
Sodexho and the Company after the Acquisition and to provide for an orderly
transition, Sodexho and the Company have entered into various agreements
including the Royalty Agreement and the Assistance Agreement.
In accordance with the Royalty Agreement, the Company is obligated to pay
Sodexho, as compensation for use of the "Sodexho" name, an annual royalty
equal to .05% of the annual gross revenues of the Company during the first
three years of the Royalty Agreement. Thereafter, Sodexho and the Company
will negotiate in good faith to determine the royalty fee.
The Assistance Agreement between Sodexho and the Company sets forth certain
services that are to be provided by Sodexho to the Company, including
services related to purchasing activities, catering and site support
services, marketing, management and administration, legal and fiscal
matters, human relations, communications and cash management. Through
August 31, 1998, there will not be a fee. The fee for the period from
September 1, 1998 through August 31, 1999 will be .05% of gross revenues
and the fee for all periods thereafter will be .15% of gross revenues.
Annually, the independent directors of the Company who are not affiliated
with the Company or Sodexho will review a joint report prepared by the
managements of Sodexho and the Company, which will describe the services
provided by Sodexho under the Royalty Agreement and the Assistance
Agreement and estimate the fair market value of the benefits received by
the Company. If the fees paid by the Company to Sodexho are determined by
the Board to be in excess of fair value, Sodexho will reimburse the Company
for such excess, plus interest.
As part of the Transactions, the Company entered into an agreement with
Sodexho that established a reasonable amount of Adjusted Net Tangible
Assets for the Acquired Companies immediately prior to the consummation of
the Transactions.
The Agreement and Plan of Merger, as amended, between the Company and
Sodexho provided that the Adjusted Net Tangible Assets of the Sodexho North
America was to equal a negative $35 million immediately prior to the
consummation of the Transactions. Following delivery of the Closing Date
Statement, the Company will have 30 days to either accept the Adjusted Net
Tangible Assets amount or to describe any proposed adjustments.
21
Upon the acceptance of the Adjusted Net Tangible Assets amount by the
Company or the resolution in writing of any disputes, Company will pay
Sodexho the amount, together with interest, by which the Adjusted Net
Tangible Assets amount is less than negative $35 million. The amount
accrued as of March 27, 1998 is $20 million based on the Company's estimate
of the amount to be paid in June 1998.
9. Liability for Convertible Subordinated Debt
-------------------------------------------
In 1996, the Company issued Liquid Yield Option Notes (LYONs) with a face
value of $540 million. These LYONs were issued at a discount representing a
yield to maturity of 4.25% until due in 2011.
In connection with the Distribution, pursuant to the LYONs Allocation
Agreement, MII assumed responsibility for all of the debt obligations
evidenced by the LYONs and became successor to the Company in accordance
with the terms of the LYONs Indenture. The Company assumed responsibility
for nine percent of the LYONs equal to its pro rata share of the relative
equity values of the Company and MII shortly prior to the Distribution. MII
remains liable for any payments the Company fails to make on the Company's
allocated portion. All payments made by the Company on the LYONs are deemed
to have been made on account of MII's obligations to the holders of the
LYONs. Sodexho is the guarantor of the obligations of the Company under the
LYONs Allocation Agreement and the LYONs Indenture.
Upon consummation of the Distribution, each LYON became convertible into
2.19 shares of Company Common Stock (after giving effect to the Reverse
Stock Split discussed in Note 12), 8.76 shares of MII Common Stock, and
8.76 shares of MII Class A Common Stock.
At the option of the holder, MII may be required to redeem each LYON on
March 25, 1999, or March 25, 2006, for $603.71 or $810.36 per LYON,
respectively. In such event, MII may elect to redeem the LYONs for cash,
common stock, or any combination thereof.
The LYONs are redeemable by the obligor at any time on or after March 25,
1999, for cash equal to the issue price plus accrued original issue
discount. The Company's obligations under the LYONs are subordinated to
both the Company's and MII's Senior Indebtedness.
10. Employee Stock Plans and Deferred Compensation Plans
----------------------------------------------------
The Company's 1998 Conversion Awards
Under the Employee Benefits Allocation Agreement (see Note 8), the Company
agreed to grant certain conversion awards (1998 Conversion Awards)
denominated in shares of the Company's Common Stock to employees who
remained as employees of the Company after the Distribution. The 1998
Conversion Awards replace all awards that such employees were granted under
the predecessor plan which were outstanding on March 27, 1998. All 1998
Conversion Awards are subject to substantially the same terms and
conditions as provided under the predecessor plan. Employees received
conversion awards under the plan covering a total of approximately 2.9
million shares of the Company's Common Stock, after giving effect to the
Reverse Stock Split.
22
ICC Conversion Options
As part of the Acquisition, the Company agreed to grant certain conversion
options (ICC Conversion Options) denominated in shares of the Company's
Common Stock to holders of options outstanding under the International
Catering Corporation 1996 Stock Option Plan (ICC Plan) as of March 27,
1998. Each holder of an outstanding option under the ICC Plan had
approximately 42% of that option settled in cash by Sodexho and was granted
an ICC Conversion Option for the remaining 58% of the options. The ICC
Conversion Option allows the holder to purchase such number of shares of
the Company's Common Stock at such exercise price as would preserve the
financial value of the original options. Each ICC Conversion Option is
subject to substantially similar terms and conditions as provided in the
recipient's corresponding award under the ICC Plan. Employees received ICC
Conversion Options covering 361,655 shares of the Company's Common Stock,
after giving effect to the Reverse Stock Split.
Shares Available Under the SMS Comprehensive Stock Plans
As of March 27, 1998, no shares are available for issuance under the SMS
1993 Stock Plan, other than the shares reserved for conversion awards. The
SMS 1998 Stock Plan provides that no more than 10 million shares of SMS
Common Stock are available for issuance of awards to cover the 1998
Conversion Awards, the ICC Conversion Options and future awards for the
Company's employees.
11. New Accounting Standards
------------------------
On January 3, 1998, the Company adopted Statement of Financial Accounting
Standards (FAS) No. 130, "Reporting Comprehensive Income," by presenting a
consolidated statement of comprehensive income. The Company also adopted
FAS No. 131, "Disclosures about Segments of an Enterprise and Related
Information," as of January 3, 1998 and will present the necessary segment
disclosures in its August 28, 1998 Form 10-K.
12. Stockholders' Deficit/Equity
----------------------------
As part of the Transactions, each stockholder of the Company retained its
shares of common stock and, for each share of common stock held on the
Special Meeting Record Date, was entitled to receive one share of common
stock of MII and one share of Class A common stock of MII. Immediately
after the Distribution on March 27, 1998, every four shares of the
Company's common stock combined into one share of common stock pursuant to
a one-for-four Reverse Stock Split. The accompanying financial statements
have been restated to give retroactive effect to the Reverse Stock Split.
The Company's charter authorizes the issuance of 300 million shares of
common stock with a par value of $1, and 1 million shares of preferred
stock, without par value. As of March 27, 1998, no shares of preferred
stock had been issued.
The Company issued to Sodexho approximately 48.3% of the shares of common
stock, 29,949,925 shares, immediately after the Transactions in exchange
for $304 million in cash and the business of Sodexho North America. See
Note 3.
23
Stockholders of the Company's common stock are entitled to one,
noncumulative vote per share on all matters submitted to Stockholders.
During the three-year period following the Distribution, any transfer or
issuance of equity securities that would result in any stockholder having
beneficial ownership of 50% or more of the outstanding equity securities is
prohibited. The Company's common stock has no preferences or preemptive,
conversion or exchange rights.
13. Pro Forma Financial Data
------------------------
Summarized below are unaudited pro forma consolidated results of operations
of the Company for the twelve weeks ended March 27, 1998, and March 28,
1997, as if the Distribution, Acquisition, and Refinancing had occurred at
the beginning of the respective periods (in millions, except per share
amounts).
Twelve weeks ended
----------- -----------
March 27, March 28,
1998 1997
----------- -----------
SALES................................... $ 1,024 $ 986
======== ========
INCOME BEFORE EXTRAORDINARY ITEM........ $ 4 $ 2
======== ========
NET INCOME.............................. $ 4 $ 2
======== ========
EARNINGS PER SHARE--NET INCOME
BASIC................................ $ .07 $ .04
======== ========
DILUTED.............................. $ .07 $ .04
======== ========
24
Item 2. Management's Discussion and Analysis of Results of Operations and
- --------------------------------------------------------------------------
Financial Condition
-------------------
RESULTS OF OPERATIONS
INTRODUCTION
- ------------
For all but the last day of the first quarter of 1998, the Company had been
structured as two separate business segments: lodging and contract services.
Contract services was further divided into three lines of business: MMS--food
and facilities management, MSLS--senior living services, and MDS--distribution
services.
On March 27, 1998, the last day of the first quarter of 1998, the Company
completed the Distribution. These Distributed Operations collectively formed a
new company named New Marriott MI, Inc., which was later renamed Marriott
International, Inc. (MII). The lodging business has been presented as
discontinued operations, under the requirements of APB Opinion No. 30. MSLS and
MDS have not been presented as discontinued operations.
Immediately after the Distribution, the Company acquired Sodexho North America
and Sodexho paid $304 million to the Company, in exchange for approximately
48.3% of the shares of the Company.
Simultaneously, the Company completed the cash tender offers and consent
solicitations for the Company's outstanding Senior Notes and Guaranteed Notes.
The Company also repaid its indebtedness outstanding under its revolving credit
bank facility and repaid debt assumed in the Acquisition. The Refinancing was
funded by new debt, in the form of $620 million of Guaranteed Debt, $500
million of Senior Term Debt, $115 million of Senior Revolving Debt and the $304
million cash contribution from Sodexho.
Following the discussion of historical results of operations, there is a
discussion of pro forma results of operations based upon the information in
Note 13. The following discussion deals with the historical results of
operations of the Company for the first quarter of 1998 and 1997, and separately
addresses discontinued operations.
HISTORICAL RESULTS OF OPERATIONS
- --------------------------------
Twelve Weeks Ended March 27, 1998 Compared to Twelve Weeks Ended March 28, 1997
- -------------------------------------------------------------------------------
Continuing Operations - MMS
- ---------------------------
The Company reported a sales decrease of 4% from $1.15 billion to $1.11 billion.
Excluding the reported sales of MSLS and MDS, which collectively decreased $27
million, or 8%, to $321 million, and the reported sales of $42 million of the
United Kingdom operations sold in October 1997, sales rose $27 million, or 4%,
to $790 million. This increase was driven by solid growth in Corporate
Services, double-digit growth in School Services and growth in Education
Services. Corporate Services continues to expand the use of the Company's
Crossroads Cuisine concept,
25
which has improved per check averages. School Services' results are favorable
due to more operating days in this quarter due to the timing of spring break and
Easter. Education Services' sales have grown due to new business and
contractually allowed rate increases.
The Company reported an operating profit (before corporate expenses and
interest) decrease of 28% from $46 million to $33 million. Excluding the
reported operating profit of MSLS and MDS, which collectively decreased $9
million, or 64%, to $5 million, and the reported operating loss of the United
Kingdom operations sold in October 1997, operating profit decreased $4 million,
or 15%, to $28 million. This decrease was driven by $3 million of integration
and restructuring costs which are discussed below. The remaining decrease of $1
million, attributable to the Company's on-going business, is due to the timing
of expenses.
Continuing Operations--MSLS and MDS
- -----------------------------------
MSLS reported higher sales, and solid profit growth in the 1998 first quarter,
before the impact of a sale of 29 senior living communities in June 1997.
Results were boosted by contributions from 20 senior living communities added
since the beginning of 1997. Occupancy for comparable communities remained at
95% in the quarter.
MDS generated higher profits in the 1998 first quarter, despite lower sales.
Profits improved considerably compared to 1997, as the Company completed the
integration of a major restaurant customer.
Corporate Expenses and Interest
- -------------------------------
Corporate expenses increased $10 million, or 37%, to $37 million, largely due to
restructuring and integration costs of $7 million, and year 2000 software
modification costs of $3 million.
Interest expense increased $6 million, or 32%, to $25 million, largely due to
increased commercial paper outstanding used to finance the Company's second
quarter 1997 acquisition of RHG partially offset by Host Marriott's assumption
of $187 million of mortgage debt associated with the June 1997 sale of 29 senior
living communities.
Interest income nearly doubled from $5 million to $9 million reflecting higher
note receivable balances throughout the quarter.
Income Taxes
- ------------
The Company has utilized an effective tax rate of 44.5% on continuing operations
for the first quarter of 1998 based upon its estimated effective tax rate for
the eight month period ended August 28, 1998. This rate differs from the
applicable statutory rate due primarily to non-deductible goodwill arising from
the acquisition of Sodexho North America and tax credits related to Distributed
Operations. For the first quarter of 1997, the effective tax rate was 39.0%.
26
Discontinued Operations--Lodging
- --------------------------------
Lodging reported a 31% increase in operating profit, compared to a sales
increase of 22% for the 1998 first quarter versus the 1997 first quarter.
Results reflected room rate growth at U.S. hotels well in excess of inflation,
the acquisition of Renaissance Hotel Group N.V. (RHG), contributions from new
units, and expansion of the Company's vacation club resorts business. The
lodging business' revenue per available room (REVPAR) grew by an average of 7%
in the first quarter across all brands, and the average room rates for these
properties rose nearly 9%. Occupancy in the 1998 quarter declined by more than
one percentage point to 77%, primarily due to softness in the economy-lodging
sector and at certain resort properties.
PRO FORMA - RESULTS OF OPERATIONS
- ---------------------------------
Twelve Weeks Ended March 27, 1998 Compared to Twelve Weeks Ended March 28, 1997
- -------------------------------------------------------------------------------
Pro forma results of operations have been presented in both the forepart of this
document and in Note 13 to the condensed consolidated financial statements.
Pro forma sales increased $38 million, or 4%, to $1.0 billion, and pro forma
operating profit (before corporate expenses and interest) increased $4 million,
or 9% to $48 million. This performance was driven by growth in the Corporate
and Education sectors. Results were depressed by lower than expected profits in
the health care sector, which were down slightly versus last year, reflecting
the continuing financial pressures in the nation's health care industry.
Pro forma interest expense was assumed to be constant as the average debt
balance assumed was the actual debt balance as of March 27, 1998. Pro forma
corporate expenses increased $1 million, or 6%, to $17 million principally due
to timing of expenses. The pro forma effective income tax rate decreased from
62.8% to 55.3% due to the decreasing proportion of the nondeductible goodwill
and intangibles amortization expense relative to income before income taxes.
LIQUIDITY AND CAPITAL RESOURCES
Cash flow activity for the first quarter of 1998 reflected the impact of the
Transactions, and resulted in a decrease in cash and cash equivalents of $236
million versus an increase in the first quarter of 1997 of $783 million.
Cash inflow from operating activities was $133 million for the first quarter of
1998, principally due to Discontinued Operations, which had a net cash inflow
from operating activities of $131 million for the first quarter of 1998.
Cash outflow from investing activities of $649 million was driven by a net cash
outflow of $478 million which resulted from the Distribution. Discontinued
Operations had a net cash outflow from investing activities of $113 million
first quarter of 1998. Capital expenditures were $63
27
million in the first quarter of 1998 versus $44 million in 1997. Capital
requirements are minimal due to several factors, including low capital
expenditures resulting from the fact that operations are generally conducted at
client sites using client equipment, low fixed costs, and predictable cash flow
from clients that has the effect of reducing or eliminating working capital
needs. In addition, there is increasing market penetration by large participants
due to their ability to provide (i) more cost-effective services as a result of
economies of scale, (ii) a broader range of services than local and regional
participants, and (iii) national and international coverage to large clients.
Financing activities resulted in a cash inflow of $280 million. Concurrent with
the Distribution, the Company acquired Sodexho North America, pursuant to which
Sodexho paid $304 million to the Company, in exchange for approximately 48.3% of
the shares of the Company. As part of the Distribution, the Company and MII
agreed that total indebtedness retained by the Company after the Distribution
would equal $1.444 billion. As the Company's indebtedness totaled $1.698
billion after effecting the Distribution, MII paid the Company $254 million,
which was used by the Company to repay debt. Therefore, the post-Distribution
indebtedness retained by the Company totaled $1.444 billion, a portion of which
was repaid with the $304 million received from Sodexho.
On March 27, 1998, the Company received $615 million and $620 million under the
Secured Facility and Guaranteed Facility, respectively. The proceeds were used
to purchase $713 million of the Company's publicly held debt, as described in
Note 5, and to repay its $950 million outstanding obligations under the
Company's existing $1.5 billion credit facility, which was cancelled immediately
after such repayment. Costs associated with the early extinguishment of debt
was $71 million pretax, $43 million after tax.
The Secured Facility consists of a $235 million revolving credit facility and a
$500 million six-year term loan facility. It bears interest at rates based on a
bank prime rate (as defined), the Federal Fund rate, or LIBOR, payable in
arrears quarterly. The Company is currently paying interest at 5.69% plus
1.125%. Of the revolving facility, up to $100 million may be used to cover
letters of credit. As of March 27, 1998, the Company had outstanding letters of
credit of $13 million. The facility is collateralized by liens on the
inventory, accounts receivable, and stock of the principal subsidiaries of
Sodexho Marriott Operations, Inc.
The Guaranteed Facility is a $620 million seven-year term loan. It bears
interest at rates based on a bank prime rate, the Federal Fund rate, or LIBOR,
payable in arrears quarterly. The Company is currently paying interest at 5.69
% plus .45%. Sodexho is the guarantor of the loan for a fee of .05% of the
principal balance outstanding.
Additional credit facilities totaling about $8 million from the Canadian
operations of both MMS and Sodexho remained in place.
The allocation of debt and other liabilities, including contingent liabilities,
between the Company and MII reflects the economic arrangements reached, on an
arm's length basis, among MII, the Company, and Sodexho in connection with the
Transaction. Following the Transactions, the Company is substantially more
leveraged. As of March 27, 1998, the Company's total borrowing availability was
approximately $113 million.
28
The Company paid dividends of $11 million and $10 million during the first
quarter of 1998 and 1997, respectively. The Company expects to pay quarterly
dividends, subject to the restrictive covenants contained in its debt agreements
limiting the payment of dividends. In general, these covenants will not permit
the Company to pay dividends to stockholders (i) in an amount greater than 40%
of the Company's net income (or 45% when the ratio of the Company's consolidated
EBITDA (as defined in debt agreement) is less than 4 but not less than 3) and
(ii) prior to the fiscal quarter ended November 30, 1998. This restriction will
no longer apply when such ratio is less than 3. The payment and amount of cash
dividends is at the sole discretion of the Company's Board of Directors.
The Company expects that, principally due to the significant leverage of the
Company following the Transactions, the Company's long-term unsecured debt
ratings would be below investment grade. The Company's substantial indebtedness
may limit its capacity to respond to market conditions or to meet its
contractual or financial obligations. Furthermore, the ability of the Company
to satisfy its obligations will be dependent upon its future performance, which
will be subject to prevailing economic conditions and to financial, business and
other factors, including factors beyond the control of the Company. If the
Company does not make required payments of interest and principal when due,
certain debt could be accelerated and the lenders thereunder would be entitled
to exercise their remedies, including foreclosing on collateral. These events,
if they there were to occur, would have a material adverse effect on the
Company.
In view of the increased leverage of the Company, any new financings and
refinancings by the Company, if available at all, may be at higher interest
rates and may contain terms significantly less advantageous than would have been
available to the Company absent the Transactions. In addition, the Company's
debt contains restrictive covenants and events of default, and requires grants
of security and guarantees by subsidiaries of the Company, that will limit the
Company's ability to incur additional debt and engage in other activities.
There can be no assurance that such restrictions will not adversely affect the
Company's ability to finance its future operations or capital needs or to engage
in other business activities that may be in the interest of the Company.
Management carefully monitors the actual cash flows on a daily basis, and
continuously updates its cash flow forecast (which takes into account
management's estimate of the impact of the seasonality of the Company's
businesses). Management believes that it can address short-term liquidity
needs, such as the payable due to affiliates for excess Adjusted Net Tangible
Assets without experiencing a liquidity shortage.
FINANCIAL CONDITION
The balance sheets for March 27, 1998 and January 2, 1998 are not comparable due
to the impact of the Transactions. The January 2, 1998 balance sheet contains
the Retained Business and the Distributed Operations. The March 27, 1998
balance sheet contains the Retained Business and Sodexho North America.
There were no significant fluctuations between the balance sheets of the
underlying Retained Business. The Acquisition resulted in additional goodwill
and identifiable intangibles of $359 million. The Refinancing resulted in lower
debt balances of approximately $300 million, primarily due to the cash payment
of $304 million from Sodexho which was used by the Company to repay
29
debt. The liability for convertible subordinated debt was reduced to $28 million
to reflect the assumption of nine percent of the LYONs which is equal to the
Company's pro rata share of the relative equity values of the Retained Business
and the Distributed Operations prior to the Distribution.
As of March 27, 1998, the Company had a Stockholders' Deficit of $561 million.
OTHER INFORMATION
Year 2000
- ---------
The arrival of the next millennium presents challenges for all companies. The
Company, like most businesses, must modify its computer software and replace
some computer hardware so that its computer systems will function properly prior
to, during, and beyond the year 2000. The Company has assembled a team to
ensure that risk assessment, remediation plans, remediation, testing, and
implementation are accomplished in a timely manner. The team has completed an
inventory of the Company's computer software and hardware, and has completed the
assessment, remediation and testing of some significant computer systems. The
Company anticipates that it will complete the testing phase of its internally
developed software by March 1999. The Company is contacting its major third
party suppliers in an effort to obtain their certification of Year 2000
compliance or their plans for remediation. There can be no assurance that the
systems of other parties upon which the Company's businesses also rely will be
converted on a timely basis. The Company could be materially adversely affected
by the failure of its systems and applications or those operated by other
parties to properly address the Year 2000 issue.
Where the Company manages equipment for its clients and that equipment has
embedded microprocessors, the Company expects that the upgrade and replacement
costs will be borne by the clients.
Costs incurred during the first quarter of 1998 primarily relate to systems that
support the distributed and discontinued operations. Management is in the
process of finalizing its assessment of the cost of remediating the Company's
systems and does not expect these costs to have a material impact on the
Company's business, operations, or financial condition.
Integration and Restructuring
- -----------------------------
Integration and restructuring actions, such as those taken in the current year
and which may be taken in future years, reflect the Company's efforts to change
in anticipation of marketplace trends. These actions are intended to integrate
and realign resources for more effective and efficient execution of operating
strategies. The anticipated cost savings are expected to be used to pay down
debt and fund activities to enhance the Company's competitive position. The
integration, now underway, resulted in charges totaling $3 million during the
first quarter of 1998. The Company expects to incur approximately $33 million
and $8 million in additional integration costs during the transition period and
fiscal 1999, respectively. Restructuring actions totaling approximately $36
million were recorded in the first quarter of 1998, $7 million of which was
recorded as a charge to operations.
30
When completed, these actions are expected to generate annual cost savings of
approximately $60 million pretax. Two-thirds of these anticipated savings
relate to greater purchasing economies, while the remaining one-third relates to
the elimination of duplicate functions and facilities. Management believes that
synergies will be achieved by the end of fiscal 2001.
Seasonality
- -----------
In two of the sectors in which the Company operates, Education Services and
Schools Services, there are predictable seasonal variations that result from the
school year. Revenues and profits are typically higher in the fall and spring,
and lower during the summer and winter holidays.
31
PART II -- OTHER INFORMATION
Item 1. Legal Proceedings
- --------------------------
There are no material legal proceedings pending against the Company.
Item 2. Changes in Securities
- ------------------------------
In connection with the Transactions that were completed on March 27, 1998,
the Company amended its charter and bylaws, which amendments resulted in
certain changes to the rights of holders of Common Stock of the Company.
These changes were approved by the stockholders of the Company at the
Special Meeting of Stockholders commenced on March 17, 1998 and adjourned
to March 20, 1998 (the "Special Meeting"). For a summary of the material
changes to the Company's charter and bylaws, see "Description of the SMS
Capital Stock--Comparison of Stockholders' Rights Upon Amendment of the
Company Charter and Company Bylaws" on pages 130 through 133 of the
Definitive Proxy Statement (the "Proxy Statement") prepared for the Special
Meeting. Such section of the Proxy Statement is incorporated by reference
into this report.
Item 3. Defaults Upon Senior Securities
- ----------------------------------------
None.
Item 4. Submission of Matters to a Vote of Security Holders
- ------------------------------------------------------------
See Item 5(a) of the Company's report on Form 8-K filed on April 3, 1998
for information regarding the voting results of the matters considered by
the Company's stockholders at the Special Meeting.
Item 5. Other Information
- --------------------------
None.
32
Item 6. Exhibits and Reports on Form 8-K
- -----------------------------------------
(a) Exhibits
Exhibit
No. Descriptions
------- -----------------------------------------
27 Financial Data Schedule of the Registrant
99 Forward-Looking Statements
(b) Reports on Form 8-K
None.
33
SIGNATURES
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.
SODEXHO MARRIOTT SERVICES, INC.
/s/ Lawrence E. Hyatt
May 11, 1998 -----------------------------------------------
Senior Vice President, Chief Financial Officer
/s/ Lota S. Zoth
-----------------------------------------------
Vice President, Chief Accounting Officer
34