SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
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)
2300 Warrenville Road, Downers Grove, Illinois 60515-1700
(Address of principal executive offices) (Zip Code)
630-271-1300
(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.
TABLE OF CONTENTS
Page
NO.
THE SERVICEMASTER COMPANY (Registrant) -
PART I. FINANCIAL INFORMATION
Consolidated Statements of Income for the three
months ended March 31, 2002 and March 31, 2001 2
Consolidated Statements of Financial Position
as of March 31, 2002 and December 31, 2001 3
Consolidated Statements of Cash Flows for the three months
ended March 31, 2002 and March 31, 2001 4
Notes to Consolidated Financial Statements 5
Management Discussion and Analysis of Financial Position
and Results of Operations 10
PART II. OTHER INFORMATION
Item 6: Exhibits and Reports on Form 8-K 15
Signature 16
1
PART I. FINANCIAL INFORMATION
THE SERVICEMASTER COMPANY
Consolidated Statements of Income
(In thousands, except per share data)
Three Months Ended
March 31,
2002 2001
----------- -----------
Operating Revenue ........................................................ $ 747,282 $ 735,721
Operating Costs and Expenses:
Cost of services rendered and products sold .............................. 542,794 540,928
Selling and administrative expenses....................................... 134,936 117,697
Goodwill, trade name and other intangible amortization (1)................ 2,536 17,566
--------- ---------
Total operating costs and expenses ....................................... 680,266 676,191
--------- ---------
Operating Income ......................................................... 67,016 59,530
Memo: Operating Income excluding goodwill and trade name amortization (1) 67,016 74,642
Non-operating Expense (Income):
Interest expense ......................................................... 22,541 34,574
Interest and investment income ........................................... (3,647) (3,518)
Minority interest and other expense (income), net ........................ 1,570 (1,774)
--------- ---------
Income from Continuing Operations before Income Taxes..................... 46,552 30,248
Provision for income taxes................................................ 17,457 12,457
--------- ---------
Income from Continuing Operations before Extraordinary Gain............... 29,095 17,791
Memo: Income from Continuing Operations before Extraordinary Gain and
excluding goodwill and trade name amortization (1) .................. 29,095 28,091
Income from discontinued operations, net of income taxes (2) ............. - 5,433
Extraordinary gain, net of income taxes (3) .............................. - 6,003
--------- ---------
Net Income ............................................................... $ 29,095 $ 29,227
========= =========
Per Share:(4)
Basic and Diluted Earnings Per Share:
Income from continuing operations before extraordinary gain .............. $ .10 $ .06
Memo: Income from Continuing Operations before Extraordinary Gain
and excluding goodwill and trade name amortization (1).................... $ .10 $ .09
Discontinued operations, net (2) ......................................... - .02
Extraordinary gain (3) ................................................... - .02
--------- ---------
$ .10 $ .10
========= =========
Dividends per share ...................................................... $ .10 $ .10
========= =========
(1) The Company adopted SFAS 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 $15.1 million
($10.3 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 the year. 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
LandCare Construction and Certified Systems, Inc. as well as certain other
operations. These operations are included in "Discontinued operations" in 2001.
(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.
(4) Basic earnings per share are calculated based on 300,173 shares and 297,790
shares for the three months ended March 31, 2002 and 2001, respectively. Diluted
earnings per share are calculated based on 315,285 and 309,831 shares for the
three months ended March 31, 2002 and 2001, respectively. These shares include
the incremental effect related to outstanding options whose market price is in
excess of the exercise price as well as shares potentially issuble under
convertible securities. In computing diluted earnings per share, the after-tax
interest expense related to convertible debentures is added back to net income
in the numerator.
See Notes to Consolidated Financial Statements
2
THE SERVICEMASTER COMPANY
Consolidated Statements of Financial Position
(In thousands)
As of
March 31, December 31,
Assets 2002 2001
------------ -------------
Current Assets:
Cash and cash equivalents .............................................. $ 337,427 $ 421,550
Marketable securities .................................................. 57,766 61,561
Receivables, less allowance of $27,925 and $27,951 respectively ........ 362,075 366,284
Inventories ............................................................ 80,052 71,336
Prepaid expenses and other assets ...................................... 256,754 169,327
Deferred taxes ......................................................... 62,520 60,600
----------- -----------
Total Current Assets ............................................ 1,156,594 1,150,658
----------- -----------
Property and Equipment:
At cost ............................................................. 472,318 473,651
Less: accumulated depreciation ...................................... 286,805 284,679
----------- -----------
Net property and equipment ........................................ 185,513 188,972
----------- -----------
Other Assets:
Intangible assets, primarily trade names and goodwill................... 2,171,720 2,167,723
Assets of discontinued operations ...................................... 17,257 33,398
Notes receivable, long-term securities, and other assets ............... 135,644 133,988
----------- -----------
Total Assets .................................................... $ 3,666,728 $ 3,674,739
=========== ===========
Liabilities and Shareholders' Equity
Current Liabilities:
Accounts payable ....................................................... $ 124,659 $ 123,800
Accrued liabilities:
Payroll and related expenses ........................................ 77,444 83,973
Insurance and related expenses ...................................... 41,675 40,019
Income taxes payable ................................................ 16,217 24,243
Other ............................................................... 113,825 133,291
Deferred revenues ...................................................... 442,200 373,916
Current portion of long-term debt ...................................... 54,131 35,159
----------- -----------
Total Current Liabilities ....................................... 870,151 814,401
----------- -----------
Long-Term Debt ......................................................... 1,039,394 1,105,518
Long-Term Liabilities:
Deferred tax liability ............................................ 263,103 263,000
Liabilities of discontinued operations ............................ 58,109 75,159
Other long-term obligations ....................................... 99,197 93,023
----------- -----------
Total Long-Term Liabilities .................................... 420,409 431,182
----------- -----------
Minority Interest ...................................................... 102,164 102,677
Commitments and Contingencies
Shareholders' Equity:
Common stock $0.01 par value, authorized 1 billion shares; issued
and outstanding 301,578 and 300,531 shares, respectively .......... 3,016 3,005
Additional paid-in capital ............................................. 1,044,385 1,037,969
Retained earnings ...................................................... 336,925 337,232
Accumulated other comprehensive income ................................. (1,055) (1,888)
Restricted stock ....................................................... (1,240) (1,285)
Treasury stock ......................................................... (147,421) (154,072)
----------- -----------
Total Shareholders' Equity ...................................... 1,234,610 1,220,961
----------- -----------
Total Liabilities and Shareholders' Equity ...................... $ 3,666,728 $ 3,674,739
=========== ===========
See Notes to Consolidated Financial Statements
3
THE SERVICEMASTER COMPANY
Consolidated Statements of Cash Flows
(In thousands)
Three Months Ended
March 31,
2002 2001
----------- ------------
Cash and Cash Equivalents at January 1 .................................... $ 421,550 $ 57,948
Cash Flows from Operations:
Net Income ................................................................ 29,095 29,227
Adjustments to reconcile net income to net cash flows from operations:
Income from discontinued operations ............................... - (5,433)
Extraordinary gain ................................................ - (6,003)
Depreciation expense .............................................. 13,003 13,170
Amortization expense .............................................. 2,536 17,566
Tax refund from prior years payments ................................. - 21,000
Deferred income tax expense .......................................... 19,153 13,918
Change in working capital, net of acquisitions:
Receivables ................................................... (4,224) (8,758)
Sale of receivables ........................................... - 75,500
Inventories and other current assets .......................... (96,848) (102,992)
Accounts payable .............................................. 2,819 (22,552)
Deferred revenues ............................................. 74,784 70,946
Accrued liabilities ........................................... (12,284) (14,734)
Other, net ....................................................... 1,511 2,609
--------- ---------
Net Cash Provided from Operations ......................................... 29,545 83,464
--------- ---------
Memo: Net Cash Provided from (Used for) Operations
(Excluding Prior Year Sale of Receivables and Tax Refunds) ......... 29,545 (13,036)
Cash Flows from Investing Activities:
Property additions .................................................. (9,669) (9,921)
Sale of equipment and other assets .................................. 866 3,188
Business acquisitions, net of cash acquired ......................... (5,310) (13,825)
Proceeds from business sales and minority interests ................. - 5,371
Notes receivable, financial investments and securities .............. 7,310 (6,265)
--------- ---------
Net Cash Used for Investing Activities .................................... (6,803) (21,452)
--------- ---------
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 3,109
--------- ---------
Net Cash Used for Financing Activities .................................... (77,175) (97,332)
--------- ---------
Cash Provided from (Used for) Discontinued Operations ..................... (29,690) 10,081
--------- ---------
Cash Decrease During the Period ........................................... (84,123) (25,239)
--------- ---------
Cash and Cash Equivalents at March 31 ..................................... $ 337,427 $ 32,709
========= =========
See Notes to Consolidated Financial Statements
4
THE SERVICEMASTER COMPANY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Note 1: The consolidated financial statements include the accounts of
ServiceMaster and its significant subsidiaries, collectively referred to as "the
Company". Intercompany transactions and balances have been eliminated in
consolidation.
Note 2: The consolidated financial statements included herein have been
prepared by the Company pursuant to the rules and regulations of the Securities
and Exchange Commission. Certain information and footnote disclosures normally
included in financial statements prepared in accordance with generally accepted
accounting principles have been condensed or omitted pursuant to such rules and
regulations. However, the Company believes that the disclosures are adequate to
make the information presented not misleading. The Company suggests that these
consolidated financial statements be read in conjunction with the consolidated
financial statements and the notes thereto included in the Company's latest
Annual Report to Shareholders and the Annual Report to the Securities and
Exchange Commission on Form 10-K for the year ended December 31, 2001. In the
opinion of the Company, all adjustments necessary to present fairly the
financial position of The ServiceMaster Company as of March 31, 2002 and
December 31, 2001, and the results of operations and cash flows for the three
month periods ended March 31, 2002 and 2001 have been included. As further
discussed in Note 4, in January 2002, the Company adopted Statement of Financial
Accounting Standards No. 142, "Goodwill and Other Intangible Assets". The
preparation of the financial statements requires management to make certain
estimates and assumptions required under generally accepted accounting
principles which may differ from the actual results. There has been no change
since December 31, 2001 in the Company's Critical Accounting Policies as
described in the Company's latest Annual Report to Shareholders. The results of
operations for any interim period are not necessarily indicative of the results
which might be obtained for a full year.
Note 3: 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 and Certified Systems Inc. (CSI), as well as
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. and has almost completed the wind-down of its remaining operations.
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 Company has classified and separated the results of these discontinued
business units, (including Management Services, TruGreen LandCare Construction,
Certified Systems Inc., and the European pest control and property services
entities) as Discontinued Operations in the accompanying financial statements.
5
In the fourth quarter of 2001, the Company recorded reserves related to the
aforementioned strategic actions and the costs to exit the discontinued
operations. The Company believes that the reserves continue to be adequate and
reasonable. The table below summarizes the activity during the three months
ended March 31, 2002:
(in thousands) Balance at Cash Balance at
Dec. 31, 2001 Payments Mar. 31, 2002
Reserves related to strategic actions in the fourth
quarter of 2001 (a) $36,000 $300 $35,700
Remaining liabilities from discontinued operations (b)
LandCare Construction $33,700 $6,900 $26,800
Certified Systems, Inc. 23,800 3,700 20,100
Management Services 11,400 1,800 9,600
Other 6,300 4,700 1,600
(a) Includes accruals for residual value guarantees on leased properties,
severance for former executives and terminated employees, and other costs.
(b) Includes the existing liabilities of the discontinued operations as well as
the costs recorded in the fourth quarter of 2001 related to exiting these
operations. Cash payments made in the first quarter related to the
wind-down of LandCare Construction contracts, lease termination costs,
workers' compensation payments and legal costs.
Note 4: In June 2001, the Financial Accounting Standards Board issued
Statement of Financial Accounting Standards No.142, "Goodwill and Other
Intangible Assets" (SFAS 142). 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. Goodwill and intangible assets that are
not amortized will be 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.
The following table provides summarized financial information for the three
month 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
----------- ----------
Income from continuing operations before extraordinary
gain as reported $ 29,095 $ 17,791
Add back: Goodwill and trade name amortization, net of tax - 10,300
Net income from continuing operations before extraordinary ---------------- ----------------
gain as adjusted under SFAS 142 $ 29,095 $ 28,091
================ ================
Net income as reported $ 29,095 $ 29,227
Add back: Goodwill and trade name amortization, net of tax - 10,300
---------------- ----------------
Net income as adjusted under SFAS 142 $ 29,095 $ 39,527
================ ================
BASIC AND DILUTED EARNINGS PER SHARE:
- -------------------------------------
Earnings per share from continuing operations before
extraordinary gain as reported $ 0.10 $ 0.06
Add back: Goodwill and trade name amortization, net of tax - 0.03
Earnings per share from continuing operations before ---------------- ----------------
extraordinary gain as adjusted under SFAS 142 $ 0.10 $ 0.09
================ ================
Earnings per share as reported $ 0.10 $ 0.10
Add back: Goodwill and trade name amortization, net of tax - 0.03
---------------- ----------------
Earnings per share as adjusted under SFAS 142 $ 0.10 $ 0.13
================ ================
6
The following table summarizes goodwill and intangible assets.
As of As of
(in thousands) March 31, 2002 December 31, 2001
Covenants not to compete $ 139,197 $ 138,445
Accumulated amortization (62,017) (59,952)
----------------- -------------------
Net covenants not to compete 77,180 78,493
Other intangibles 7,298 6,639
Accumulated amortization (898) (427)
----------------- -------------------
Net other intangibles 6,400 6,212
Trade names (1) 238,550 238,550
Goodwill (1), (2) 1,849,590 1,844,468
----------------- -------------------
Total $ 2,171,720 $ 2,167,723
================= ===================
(1) Not subject to amortization.
(2) For the three months ended March 31, 2002 approximately $5.0 million
of additional goodwill was recorded.
NOTE 5: 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 been considered outstanding for purposes of
the diluted earnings per share calculations. In computing diluted earnings per
share, the after-tax interest expense related to convertible debentures is added
back to net income in the numerator, while the diluted shares in the denominator
include the shares issuable upon conversion of the debentures.
The following chart reconciles both the numerator and the denominator of the
basic earnings per share computation to the numerator and the denominator of the
diluted earnings per share computation.
(IN THOUSANDS, EXCEPT PER SHARE DATA) Three Months Three Months
Ended March 31, 2002 Ended March 31, 2001
-------------------------------- ------------------------------
INCOME SHARES EPS INCOME SHARES EPS
-------- -------- ---- -------- -------- ----
Basic earnings per share from
continuing operations before
extraordinary gain in 2001 $29,095 300,173 $0.10 $17,791 297,790 $0.06
======== =======
Effect of dilutive securities, net of tax:
Options - 6,912 - 3,941
Convertible securities 1,195 8,200 1,192 8,100
---------- --------- ---------- ---------
Diluted earnings per share from
continuing operations before
extraordinary gain in 2001 $30,290 315,285 $0.10 $18,983 309,831 $0.06
========== ========= ======== ========== ========= =======
NOTE 6: In the 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
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)
7
The decrease in interest paid in 2002 is primarily due to reduced debt levels
reflecting debt retirements with a portion of 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 there is an increased
cash level after the debt paydowns that have been completed. The increase in tax
payments is due to a significant tax payment resulting from the gain on the sale
of the Management Services business. There was also a prior year $21 million tax
refund related to over-payments made in 2000.
NOTE 7: Total comprehensive income was $29.9 million and $19.3 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 8: 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, 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 9: 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.
NOTE 10: The business of the Company is primarily conducted through three
operating segments: TruGreen, Terminix, and Home Maintenance and Improvement. In
accordance with Statement of Financial Accounting Standards No. 131 (SFAS 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
8
the LandCare Construction business, the results of the construction
operations are now included in discontinued operations. The Terminix segment
provides termite and pest control services to residential and commercial U.S.
customers. The Home Maintenance and Improvement segment includes American
Residential Services, (ARS) and American Mechanical Services (AMS) that provide
heating, ventilation, air conditioning (HVAC) and plumbing services as well as
American Home Shield which provides home warranties to consumers that cover
HVAC, plumbing and other appliances. The segment also includes the two franchise
operations, ServiceMaster Clean and Merry Maids, which provide disaster
restoration and cleaning services.
The Other Operations segment includes entities that are managed separately from
the three major units and aggregated together in accordance with SFAS 131 due to
their size or developmental nature. This segment includes ServiceMaster Home
Service Center, an initiative that has developed valuable marketing, call center
and technology competencies and has built an infrastructure that allows
customers the ability to purchase all of the Company's services through a single
point of contact; the Company's international operations which include the
retained Terminix operations in the United Kingdom and Ireland; and the
Company's headquarters operations.
Segment information as of and for the three months ended March 31, 2002 and 2001
is presented below.
2002 2001
------------------------------ ------------------------------
Operating Operating
Revenue Income Revenue Income (1)
- ---------------------------------------------------------------------------------------------------------------------
TruGreen $ 229,143 $ 24,621 $ 229,755 $ 29,032
Terminix 220,050 36,253 195,772 29,884
Home Maintenance
and Improvement 280,927 17,737 291,013 23,796
Other Operations 17,162 (11,595) 19,181 (8,070)
- ---------------------------------------------------------------------------------------------------------------------
Total $ 747,282 $ 67,016 $ 735,721 $ 74,642
- ---------------------------------------------------------------------------------------------------------------------
Capital Identifiable Capital Identifiable
Employed Assets Employed Assets
- ---------------------------------------------------------------------------------------------------------------------
TruGreen $ 1,046,503 $ 1,197,320 $ 1,097,730 $ 1,252,405
Terminix 617,091 846,044 625,496 788,529
Home Maintenance
and Improvement 676,886 1,055,266 660,468 983,755
Other Operations and
Discontinued Operations 89,819 568,098 633,136 1,021,794
- ---------------------------------------------------------------------------------------------------------------------
Total $ 2,430,299 $ 3,666,728 $ 3,016,830 $ 4,046,483
- ---------------------------------------------------------------------------------------------------------------------
(1) The Company adopted SFAS 142, "Goodwill and Other Intangible Assets", which
eliminates the amortization of goodwill and intangible assets with indefinite
lives beginning in 2002. For comparative purposes, 2001 segment results have
been restated to exclude the amortization expense affected by the new accounting
standard.
The following table summarizes by segment goodwill and trade names that are
not subject to amortization:
March 31, December 31,
2002 2001
------------------- --------------------
TruGreen $ 895,744 $ 895,744
Terminix 666,986 661,864
Home Maintenance
and Improvement 505,410 505,410
Other Operations 20,000 20,000
------------- -------------
Total $ 2,088,140 $ 2,083,018
------------- -------------
9
MANAGEMENT DISCUSSION AND ANALYSIS
RESULTS OF OPERATIONS
FIRST QUARTER 2002 COMPARED TO FIRST QUARTER 2001
- -------------------------------------------------
Revenue for the first quarter totaled $747 million, two percent above the prior
year. Reported operating income was $67 million in 2002 compared with $60
million in 2001. Statement of Financial Accounting Standards No. 142, "Goodwill
and Other Intangible Assets" (SFAS 142), requires that beginning in 2002,
goodwill and trade names will no longer be amortized. SFAS 142 does not permit
the restatement of 2001 financial information to reflect the impact of this
Statement. For comparability purposes, however, the Company has provided memo
line presentation of certain 2001 information as adjusted to reflect the
elimination of goodwill and trade name amortization. Operating income, with 2001
adjusted for SFAS 142 was $75 million, reflecting a decrease of 10 percent in
2002 with margins decreasing from 10.1 percent to 9.0 percent. The decline in
operating income reflects strong growth at Terminix and American Home Shield
offset by lower volume in the HVAC and plumbing businesses of ARS and AMS, a
reduced deferral of seasonal costs compared to the prior year at TruGreen, as
well as increased investments for Company-wide initiatives. Reported diluted
earnings per share from continuing operations was $.10 compared to $.06 in 2001.
Adjusting for SFAS 142, 2001 diluted earnings per share from continuing
operations would have been $.09. Further adjusting 2001 to reflect the pro forma
impact on interest expense assuming proceeds received from dispositions late in
2001 were used to repay debt, diluted earnings per share from continuing
operations for 2001 would have been $.11.
Consistent with its previous guidance, the Company anticipates earnings per
share for 2002 to be in the range of $.60 to $.63. The Company continues to
estimate a cost in 2002 of $20 million related to the implementation of Six
Sigma and initiatives to measure customer and employee satisfaction, with an
offsetting return on these initiatives of approximately $15 million in 2002.
This outlook also reflects a reduction in earnings from certain non-operating
items compared to 2001 levels, including the elimination of $6 million in
minority interest income as well as a reduction of approximately $8 million in
investment income generated through venture capital and other portfolio gains.
Earnings per share growth in the second half of the year is expected to be
stronger than the first half as the growth and savings related to the
investments are expected to materialize later in the year.
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.
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.
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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%
Note: The Company adopted SFAS 142, "Goodwill and Other Intangible Assets",
which eliminates the amortization of goodwill and intangible assets with
indefinite lives beginning in 2002. For comparative purposes, 2001 segment
results have been restated to exclude the amortization expense affected by the
new accounting standard.
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, consistent with the prior year.
Operating income decreased to $25 million from $29 million last year, primarily
reflecting a reduced level of snow removal business and the timing of certain
seasonal expenses. Revenue in the lawn care business was slightly above the
prior year. Although customer count levels in April 2002 do not reflect growth
from 2001 (see table above), during the first four months of this year the
business has overcome a four percent degradation in customer counts that
occurred from early 2001 to late in the 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 margins in the lawn
care operations declined, primarily reflecting a reduction in deferred seasonal
costs, as the prior year deferral was based on a higher level of expected
revenues than what actually materialized. 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 margins in the landscaping services 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. Capital
employed decreased five percent, primarily reflecting stronger working capital
management and a decline in intangibles and fixed assets.
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The Terminix segment, which includes the domestic termite and pest control
services, reported a 12 percent increase in revenue to $220 million from $196
million in 2001 and operating income growth of 21 percent to $36 million from
$30 million last year. 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. 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 margins improved over the prior year reflecting improved branch
efficiencies, the integration of acquisitions, and continuing growth and
acceptance of termite baiting treatments. Capital employed decreased one percent
reflecting a higher level of deferred revenue, offset in part by acquisitions.
The Home Maintenance and Improvement segment includes heating, ventilation, air
conditioning (HVAC), and plumbing services provided under the American
Residential Services (ARS), Rescue Rooter, and American Mechanical Services
(AMS) (for commercial accounts) brand names; home systems and appliance warranty
contracts offered through American Home Shield; and the franchised operations,
ServiceMaster Clean and Merry Maids. The segment reported revenue of $281
million, a decrease of three percent from $291 million last year. Operating
income decreased 25 percent to $18 million compared to $24 million last year.
Performance in the segment was supported by double-digit revenue and profit
growth at American Home Shield offset by a decline in volume of air conditioning
and plumbing services in the ARS and AMS businesses. American Home Shield
reported 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
margins improved reflecting increased pricing and a decrease in the incidence of
claims. The combined ARS and AMS operations reported revenues and profits
significantly below the prior year. 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 franchise
operations achieved solid revenue and profit growth, primarily driven by strong
disaster restoration results and increased franchise sales at ServiceMaster
Clean and growth in the direct-owned branch operations at Merry Maids. Capital
employed increased two percent.
Other Operations consists of the Company's international operations;
ServiceMaster Home Service Center; and the Company's headquarters operations.
Revenues declined to $17 million from $19 million in the prior year, reflecting
the divestiture of certain small operations in the prior year. This segment
shows a net operating expense, which increased from the prior year reflecting
the increased investments in Company-wide initiatives including purchasing,
marketing, and Six Sigma initiatives. Capital employed in this segment includes
the discontinued operations and therefore is significantly reduced from the
prior year, reflecting the divestitures of the businesses made in the prior
year.
Cost of services rendered and products sold increased slightly for the quarter
and decreased as a percentage of revenue to 72.6 percent in 2002 from 73.5
percent in 2001. Selling and administrative expenses increased 15 percent and
increased as a percentage of revenue to 18.1 percent from 16.0 percent in 2001.
The increase in selling and administrative expenses reflects increased sales and
marketing expenses and investments in certain Company-wide initiatives.
Interest expense decreased from the prior year, primarily due to reduced debt
levels as a portion of the proceeds received from the Management Services sale
were used to pay down debt. Minority interest and other expense/income reflected
$3 million more expense than last year 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 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. The
operating losses incurred in the first quarter of 2002
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from ServiceMaster Home Service Center have been absorbed in the accompanying
financial statements without an offset at the minority interest income line.
The tax provision reflects a lower effective tax rate compared to 2001,
primarily reflecting the benefit of the utilization of prior year net operating
losses of a subsidiary operation.
FINANCIAL POSITION
- ------------------
Net cash provided from operations for the quarter totaled $30 million, an
improvement of $43 million before the impact of the Company's prior year
accounts receivable securitization program and tax refunds. This reflects a
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 $337 million at March 31,
2002 reflecting a portion of the proceeds from the sale of Management Services.
The Company still holds approximately $275 million in discretionary cash and is
expected 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 is 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 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.
Accounts receivable decreased from year-end levels, 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.
Prepaids and other assets have increased from year-end reflecting the
seasonality in the lawn care business and the increased volume of warranty
contracts written at American Home Shield. The lawn care operation defers
marketing and other costs that are incurred earlier in the year, but are
directly associated with revenues realized in subsequent quarters of the current
year. These costs are then amortized over the balance of the current lawn care
production season, as the related revenues are recognized. The Company also
capitalizes sales commission and other direct
13
contract acquisition costs relating to termite baiting and pest as well as 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 structure objectives. The Company has not undertaken material
share repurchases in 2001 and 2002. 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.
The Company notes that statements that look forward in time, which include
everything other than historical information, involve risks and uncertainties
that affect the Company's results of operations. Factors which could cause
actual results to differ materially from those expressed or implied in a
forward-looking statement include the following (among others): weather
conditions adverse to certain of the Company's residential and commercial
services businesses; the entry of additional competitors in any of the markets
served by the Company; labor shortages; unexpected changes in operating costs;
the condition of the U.S. economy; the cost and length of time associated with
integrating or winding down businesses and other factors listed from time to
time in the Company's filings 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
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.
15
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 10, 2002
THE SERVICEMASTER COMPANY
(Registrant)
By: /s/Steven C. Preston
------------------------------------
Steven C. Preston
Executive Vice President and Chief Financial Officer
16