FINANCIAL HIGHLIGHTS
(In thousands, except per share data)
(RESTATED 4)
AS OF AND FOR THE YEARS ENDED DECEMBER 31 2002 2001 CHANGE
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OPERATING RESULTS
Operating revenue $3,589,089 $3,561,445 1%
Operating income (loss) (1) 341,336 (23,177)
Income (loss) from continuing operations 170,098 (164,464)
Income (loss) from discontinued operations (2) (3,875) 284,270
Extraordinary loss (3) (9,229) (3,422)
---------------------------
Net income $156,994 $116,384
Diluted earnings per share:
Income (loss) from continuing operations $0.56 $(0.55)
Discontinued operations, net (2) (0.01)
0.95
Extraordinary loss, net (3) (0.03) (0.01)
---------------------------
Diluted earnings per share $0.52 $0.39
Cash dividends per share $0.41 $0.40 3%
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FINANCIAL POSITION
Total assets $3,414,938 $3,621,245
Total debt 835,475 1,155,193
Shareholders' equity 1,218,700 1,207,187
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CASH FLOWS
Cash from operations $381,049 $362,933 5%
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SHARE PRICE RANGE
(Traded on the New York Stock Exchange under the symbol SVM)
High price for the year $15.50 $14.20
Low price for the year 8.89 9.84
Closing price as of December 31, 11.10 13.80
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(1) The Company adopted Statement of Financial Accounting Standards (SFAS) No.
142, "Goodwill and Other Intangible Assets", which eliminates the
amortization of goodwill and intangible assets with indefinite lives
beginning in 2002. Had the provisions of SFAS 142 been applied to 2001,
amortization expense would have been reduced by $60 million ($42 million,
after-tax), or $0.14 per diluted share.
In the fourth quarter of 2001, the Company recorded a pretax charge of $345
million ($279 million, after-tax), related primarily to goodwill and asset
impairments and other items. The impact on diluted earnings per share of
this charge was $0.94.
(2) In the fourth quarter of 2001, the Company's Board of Directors approved a
series of actions related to the strategic review of its portfolio of
businesses that commenced earlier in 2001. These actions included the sale
in November 2001 of the Company's Management Services business as well as
the decision to exit certain non-strategic and under-performing businesses
including TruGreen LandCare Construction, Certified Systems, Inc. and
certain Terminix operations in Europe. During the third quarter of 2002,
the Company sold its remaining European Terminix operations. These
operations are classified as "Discontinued Operations" for all periods
presented.
(3) In 2002 and 2001, the Company repurchased a portion of its public debt
securities and in 2001 the Company prepaid some of its longer-term debt.
The net impact of these transactions was extraordinary losses of $9 million
($15 million pretax) and $3 million ($6 million pretax) in 2002 and 2001,
respectively. The Company intends to adopt SFAS 145 beginning in fiscal
2003. Adoption of this Statement in 2003 will result in the
reclassification of the extraordinary losses into income from continuing
operations.
(4) See the "Restatement" section in the Notes to the Consolidated Financial
Statements for the basis of the restatement and the financial statement
impact.
1
MANAGEMENT DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
2002 COMPARED WITH 2001
CONSOLIDATED REVIEW
The Company has restated its financial statements for 2001 and 2000 as well as
the previously reported 2002 quarterly results. See the "Restatement" section in
the Notes to the Consolidated Financial Statements for the basis of the
restatement and the financial statement impact. This Management Discussion and
Analysis reflects the impacts of the restatement.
Revenues for 2002 were $3.6 billion, one percent above 2001 with operating
income of $341 million. The Company recorded income from continuing operations
in 2002 of $170 million, a loss from discontinued operations of $4 million, and
a $9 million extraordinary loss from the early extinguishment of debt. Net
income was $157 million in 2002 and $116 million in 2001 and diluted earnings
per share were $.52 in 2002 and $.39 in 2001.
Diluted earnings per share from continuing operations was $.56 in 2002 compared
with a loss of $(.55) in 2001. There were three significant items in 2001 that
impact the comparability of the reported amounts with the 2002 figures. First,
diluted earnings per share from continuing operations for 2001 includes a charge
of $.94 per share ($345 million pretax) primarily related to goodwill and asset
impairments and other items. Second, as discussed further in the Notes to the
Consolidated Financial Statements, Statement of Financial Accounting Standards
(SFAS) No. 142, "Goodwill and Other Intangible Assets", requires that beginning
in 2002, goodwill and trade names no longer be amortized. SFAS 142 does not
permit the restatement of 2001 financial information to reflect the impact of
this Statement. The diluted earnings per share equivalent of reduced
amortization expense under SFAS 142 is $.14 ($60 million pretax) for 2001.
Third, in the fourth quarter of 2001, the Company received approximately $740
million of after-tax proceeds, net of expected cash payments relating to the
sale and exit of discontinued businesses.
In 2002, operating income was $341 million compared to an operating loss of $23
million in 2001. The 2001 figure includes a $345 million charge primarily
related to goodwill and asset impairments and other items. Additionally, the
reduced amortization expense under SFAS 142 was $60 million. Operating income
margins after adjusting for these items decreased to 9.5 percent of operating
revenue in 2002 from 10.7 percent in 2001. The decline in operating income
reflects strong growth at American Home Shield offset by reduced volume in the
heating, ventilation and air conditioning (HVAC) and plumbing businesses of ARS
and AMS, increased workers compensation and health insurance costs, as well as
increased expenditures related to enterprise-wide initiatives.
Cost of services rendered and products sold were unchanged compared to the prior
year and decreased as a percentage of revenue to 69.1 percent in 2002 from 69.6
percent in 2001. This decrease reflects a change in the mix of business as
TruGreen ChemLawn, Terminix, and American Home Shield increased in size in
relationship to the overall business of the Company. These businesses generally
operate at higher gross margin levels than the rest of the business, but also
incur somewhat higher selling and administrative expenses as a percentage of
revenue. Selling and administrative expenses increased 11 percent and increased
as a percentage of revenue to 21.2 percent from 19.3 percent in 2001. This
increase in selling and administrative expenses reflects increased expenditures
for marketing leadership and sales initiatives, as well as enterprise-wide
expenditures in procurement, technology and initiatives to measure and improve
customer and employee satisfaction.
Interest expense decreased from the prior year, reflecting reduced debt levels
resulting from the pay down of debt with the proceeds received from the sales of
the Management Services and certain European pest control businesses as well as
strong cash flows from operations. Interest income declined as a result of net
investment losses recorded on the American Home Shield investment portfolio in
2002 compared with net investment gains from this portfolio as well as venture
capital gains realized in 2001. Minority interest and other expense increased in
2002 because 2001 included minority interest income related to the ServiceMaster
Home Service Center initiative. In the first quarter of 2001 and until May 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 tax provision in 2002 reflects a lower effective tax rate based on benefits
received through the consolidation for tax purposes of the ServiceMaster Home
Service Center. As a result of the Company's acquisition of the minority
interest, it was able to reorganize the subsidiary in 2002 and utilize prior
year net operating losses of this subsidiary operation.
EXTRAORDINARY LOSS
In the second quarter of 2002, the Company repurchased a portion of its public
debt securities and recorded an extraordinary loss of $.03 per diluted share ($9
million after-tax) resulting from the early extinguishment of debt.
In the fourth quarter of 2001, the Company used a portion of the cash proceeds
from the sale of Management Services to pay down debt and recorded an
extraordinary loss of $.03 per diluted share ($9 million after-tax) resulting
from the early extinguishment of debt. This was partially offset by the
realization of gains ($.02 per diluted share; $6 million after-tax) resulting
from the repurchase of certain ServiceMaster corporate debt in the first
quarter.
2
As discussed in the Notes to the Consolidated Financial Statements, the Company
intends to adopt SFAS 145, "Rescission of FASB Statements No. 4, 44 and 64,
Amendment of FASB Statement No. 13, and Technical Corrections" in 2003. Adoption
of this Statement in 2003 will result in the reclassification of the
extraordinary loss resulting from extinguishment of debt into interest expense
within income from continuing operations.
KEY PERFORMANCE INDICATORS
The table below presents selected metrics related to customer counts and
customer retention for the three most profitable businesses of the Company.
These measures are presented on a rolling, twelve-month basis.
KEY PERFORMANCE
INDICATORS
As of December 31,
2002 2001
----------- -----------
TRUGREEN -
Growth in Full Program Contracts 2% -4%
Customer Retention Rate 59.3% 57.7%
TERMINIX -
Growth in Pest Control Customers 2% 25%
Pest Control Customer Retention 75.8% 77.8%
Rate
Growth in Termite Customers -% 30%
Termite Customer Retention Rate 89.0% 89.7%
AMERICAN HOME SHIELD -
Growth in Warranty Contracts 15% 14%
Customer Retention Rate 53.5% 52.4%
OUTLOOK
Economic uncertainty and world events contributing to consumer confidence being
at a ten-year low, make it particularly difficult for the Company to have
visibility to the full year results for 2003. If current conditions persist, the
Company expects to achieve mid single-digit earnings growth in 2003.
SEGMENT REVIEW (2002 VS. 2001)
SEGMENT RESULTS FOR 2002 REFLECT THE ELIMINATION OF GOODWILL AND TRADE NAME
AMORTIZATION REQUIRED UNDER SFAS 142. THEREFORE, FOR COMPARATIVE PURPOSES, 2001
RESULTS HAVE BEEN PRESENTED ON A PROFORMA BASIS AS IF SFAS 142 HAD BEEN IN
EFFECT FOR 2001 THEREBY EXCLUDING THE AMORTIZATION EXPENSE AFFECTED BY THE NEW
ACCOUNTING STANDARD. (SEE THE "BUSINESS SEGMENT REPORTING" NOTE IN THE NOTES TO
THE CONSOLIDATED FINANCIAL STATEMENTS). MANAGEMENTS DISCUSSION AND ANALYSIS
FOCUSES ON THE 2002 REPORTED AND THE 2001 PROFORMA AMOUNTS.
TRUGREEN SEGMENT
The TruGreen segment includes lawn care services performed under the TruGreen
ChemLawn brand name and landscape maintenance services provided under the
TruGreen LandCare brand name. The TruGreen segment reported revenues of $1.4
billion, slightly above the prior year. Operating income was $171 million, a
decrease of five percent compared to $181 million (proforma) in 2001.
Revenue in the lawn care business increased one percent over 2001, which
included a two percent increase in customer contracts over 2001. This increase
compares with a four percent decline in customer contracts in 2001. The Company
is realizing the benefit of improved customer retention as well as the impact
from new marketing strategies. In addition to telemarketing, which is the
primary channel used by TruGreen ChemLawn to sell its services, the business has
increased expenditures on direct mail and television advertising leading to
higher sales of new customers. Quality and other satisfaction initiatives have
resulted in the customer retention rate improving 160 basis points to 59.3
percent compared with 57.7 percent in 2001. Margins in the lawn care operations
declined slightly, reflecting increased expenditures in marketing and customer
retention initiatives, partially offset by margin improvements resulting from
revenue growth and the quality of service and Six Sigma initiatives.
Revenue in the landscape maintenance business declined one percent as a softer
economic environment contributed to a decline in the core maintenance business
as well as a decline in add-on services (e.g., seasonal flower plantings).
Despite the decline in the maintenance business, the contract base is more
profitable reflecting lower job costs, improved pricing, and a stronger customer
base. This business has strengthened and expanded its sales operations.
Operating income margins in the landscaping business declined primarily as a
result of higher workers compensation claims and increased expenditures for
field operations training. Management continues to focus on labor efficiency and
margin improvement through Six Sigma projects. Capital employed decreased two
percent, primarily reflecting improved working capital management resulting from
increased customer prepayments and elimination of excess equipment.
TERMINIX SEGMENT
The Terminix segment, which includes termite and pest control services, reported
a nine percent increase in revenue to $924 million from $845 million in 2001 and
operating income growth of four percent to $127 million from $123 million
(proforma) last year. Revenue growth was driven by the acquisition in October
2001 of Sears Termite & Pest Control as well as solid internal growth. As
expected by the Company, there has been a substantial decrease in profitable
pest control customers from the Sears name in certain markets. New sales in
these markets have not kept pace with cancellations and as a result, overall
customer retention rates have shown a decline. The Company has begun to
experience a reduction in revenue growth which is likely to continue into 2003.
In addition, as experienced during late 2002, operating margins have been
impacted by the near-term expenses associated with the rollout of Terminix's new
branch information system. The rollout of this system to the branches will
continue through 2004. The system will be an important tool in the Company's
efforts to improve sales productivity, customer service, cost efficiency and
regulatory compliance. Operating margins for the year decreased 80 basis points
reflecting the near term expenses related to the new information system as well
as increased expenditures for marketing and health insurance, partially offset
by improved branch efficiencies. Capital employed increased four percent to
support overall business growth.
3
AMERICAN HOME SHIELD SEGMENT
The American Home Shield segment, which provides home warranties to consumers
that cover HVAC, plumbing and other appliances, reported a 15 percent increase
in revenue to $424 million from $369 million in 2001 and operating income growth
of 84 percent to $48 million compared to $26 million (proforma) in 2001. Revenue
growth reflected increases in all sales channels, complemented by improved
customer retention. Operating margins improved as the segment benefited from
strong volume growth, improved management of service costs and reduced incidence
of claims resulting, in part, from less extreme weather trends. In light of the
favorable impact that the weather had on operating margins, management believes
margins will be somewhat lower in 2003. Capital employed increased 21 percent
reflecting the volume growth in the business resulting in an increased level of
required regulatory investments.
ARS/AMS SEGMENT
The ARS/AMS segment, which provides direct HVAC and plumbing services reported
revenue of $719 million, a decrease of 12 percent compared with $820 million in
2001. Operating income decreased 65 percent to $17 million, compared with $49
million (proforma) in the prior year. Industry wide there is a growing trend by
consumers to repair rather than replace defective equipment, reflecting
uncertainties in the economy, as well as a marked reduction in construction
activity. A decline in call volume for residential air conditioning and plumbing
service resulted in the Company's decrease in revenue and profit. Margins
declined in part due to higher marketing and insurance costs. In addition, lower
revenue led to reduced leverage of the fixed cost structure. ARS and AMS
continue their efforts towards a comprehensive rebuilding of marketing and sales
strategies by hiring a marketing leader and expanding the sales force and sales
training. Management has realigned its field operating structure to narrow the
span of control. The leaders of ARS are conducting a thorough review of
individual branches to determine their long-term profit potential and whether
under performing locations should be exited. Capital employed decreased four
percent, reflecting improved working capital management from a reduction in
accounts receivable days sales outstanding.
OTHER OPERATIONS SEGMENT
The Other Operations segment includes the Company's ServiceMaster Clean, Merry
Maids, and international operations as well as its headquarters functions.
Reported segment revenues of $149 million in 2002 compared with $158 million in
the prior year. The segment reported an operating loss of $23 million compared
with a loss of $342 million (proforma) in 2001. The 2001 results include a
charge of $345 million related primarily to goodwill and asset impairments and
other items.
The 2002 results reflect continuing growth in profit from the franchise
businesses, offset by higher costs related to enterprise initiatives and lower
profits from trade name licensing. Revenues from the franchise operations
decreased by one percent. ServiceMaster Clean revenue in 2001 included direct
management of a significant disaster restoration project at the Pentagon, which
was, in part, offset in 2002 by growth in the remaining franchise disaster
restoration business and acquisitions at Merry Maids. Operating margin
improvement in the franchise operations reflects the impact of prior year work
at the Pentagon which was at a lower margin and higher fee income, offset in
part by an increased mix of direct owned branches at Merry Maids, which carry
lower margins than the base franchise business.
Operating income in the Other Operations segment includes income from license
agreements for the use of Company-owned trade names in certain markets. In the
third quarter of 2002, the Company sold its Terminix operations in the United
Kingdom and entered into a two year licensing agreement with the buyer for the
use of the Terminix trade name in the United Kingdom. This agreement was valued
at $6 million and accordingly, a like amount was allocated from the purchase
price. In the fourth quarter of 2001, the Company sold its Management Services
business unit and the Company entered into a three-year licensing agreement with
ARAMARK for the use of the ServiceMaster trade name in certain markets. This
agreement was valued at $15 million and accordingly, a like amount was allocated
from the purchase price. The Company recorded the license fee income in the
fourth quarter of 2001 related to this agreement.
Total initial and recurring franchise fees (excluding the aforementioned trade
name license agreements) represented 2.5 percent of consolidated revenue in both
2002 and 2001 and related franchise operating expenses were 1.6 percent and 1.7
percent of consolidated operating expenses in 2002 and 2001, respectively.
Franchised revenue consist principally of continuing monthly fees based upon the
franchisee revenue and is recognized when the related franchise revenue is
reported from the franchisee and collectibility is assured. Franchise revenue
also includes initial franchise fees resulting from the sale of the franchise,
which are fixed and are recognized as revenue when collectibility is assured and
all material services or conditions relating to the sale have been substantially
performed. Total initial and recurring franchise fee income (excluding the
aforementioned trade name license agreements) comprised 11.3 percent and 10.2
percent of consolidated operating income in 2002 and 2001, respectively. The
portion of total franchise fee income related to initial fees received from the
sales of franchises was not material to the Company's consolidated financial
statements for all periods.
The Other Operations segment increased expenditures in 2002 on technology and
major operational initiatives to improve operating efficiency and build greater
customer and employee satisfaction. Capital employed in this segment includes
the discontinued operations and therefore is significantly reduced from the
prior year, reflecting the prior year divestitures of businesses.
DISCONTINUED OPERATIONS
During the third quarter of 2002, the Company sold its Terminix operations in
the United Kingdom. The impact of this sale was not material to the consolidated
financial statements.
In 2001 the Company sold its Management Services business to ARAMARK Corporation
for approximately $800 million. The all-cash transaction closed on November 30,
2001 and the Company recorded an after-tax gain of $404 million from this sale.
(A portion of Management Services was not sold as part
4
of this transaction and represented a $15 million loss upon disposition). In
addition, the Company exited several non-strategic and under-performing
businesses including TruGreen LandCare Construction, Certified Systems Inc.
(CSI), and certain Terminix Europe operations. The TruGreen LandCare
Construction operations were sold to Environmental Industries, Inc. (EII) in
certain markets. EII managed the wind-down of the contracts in the remaining
markets. The Company also sold all of its customer contracts relating to CSI
(the Company's professional employer organization) to AMS Staff Leasing, N.A.,
Inc.
Reported "Discontinued operations" for all periods presented include the
operating results of the sold and discontinued businesses noted above and 2001
also includes the gain from the sale of Management Services, net of losses from
the disposition of other entities.
In the fourth quarter of 2002, the purchaser of the Company's European pest
control and property services operations made a claim for a purchase price
adjustment (relating to the 2001 sale), relating to an alleged breach of certain
conditions in the purchase agreement. In the course of responding to that claim,
the Company discovered that personnel of the former operations had made
unsupported monthly adjustments to certain accounts. The Company subsequently
agreed to an adjustment to the purchase price consisting of an $8 million cash
payment and the cancellation of a previously reserved note receivable of $7
million. This $8 million charge was recorded in 2002.
The components of discontinued operations are as follows:
(In thousands) 2002 2001 2000
- -----------------------------------------------------------------
Management
Services income* $ - $33,172 $40,683
Income (loss) from
other discontinued
operations 965 (72,115) (115)
Gain on sale of
Management Services,
net of losses
from disposition of
other entities (4,840) 323,213 -
- -----------------------------------------------------------------
Discontinued
operations ($3,875) $284,270 $40,568
- -----------------------------------------------------------------
* This business was sold on November 30, 2001, consequently the 2001 results
reflect eleven months of operations.
2001 COMPARED WITH 2000
CONSOLIDATED REVIEW
Revenues for 2001 increased four percent to $3.6 billion. The Company reported
an operating loss in 2001 of $23 million compared to operating income of $321
million in 2000. The Company reported a loss from continuing operations in 2001
of $164 million (after the $279 million after-tax impact of the charge), income
from discontinued operations of $284 million, and a $3 million extraordinary
loss from the early extinguishment of debt. Net income was $116 million in 2001
and $154 million in 2000 and diluted earnings per share was $.39 in 2001 and
$.50 in 2000.
Diluted earnings per share from continuing operations was a loss of $(.55) in
2001 compared to income of $.41 in 2000. As previously noted, diluted earnings
per share from continuing operations for 2001 includes a charge of $.94 per
diluted share ($345 million pretax) primarily related to goodwill and asset
impairments and other items.
In 2001, the Company reported an operating loss of $23 million compared to
operating income of $321 million in 2000. The 2001 figure includes a $345
million charge primarily related to goodwill and asset impairments and other
items. In addition, both 2001 and 2000 include amortization expense that has
been eliminated under SFAS 142. Operating income margins on a comparable basis
after adjusting for the charge and SFAS 142 decreased to 10.7 percent in 2001
from 11.1 percent in 2000. The events of September 11th and the already weakened
economy contributed to earnings pressure during the third and fourth quarters of
2001 by bringing caution and changes in consumer buying behavior. The Company
experienced the downturn in the economy as customers began deferring the
replacement of HVAC units, landscape and lawn care customers showed a reduced
propensity to purchase enhancements and there were increased skips in maid
service.
On a consolidated basis, costs of services rendered and products sold increased
two percent and decreased as a percentage of revenue to 69.6 percent from 71.1
percent in 2000. Selling and administrative expenses increased 14 percent and
increased as a percentage of revenue to 19.3 percent from 17.6 percent in 2000.
Interest expense decreased from 2000, primarily due to reduced debt levels from
improved cash flows, debt retirements with the proceeds from the Management
Services sale, and the sale of certain of the Company's accounts receivable
throughout the year. Interest income decreased primarily due to a lower level of
investment gains realized, net of impairment losses in 2001.
Minority interest and other expense reflected $19 million more expense than 2000
due to reduced minority interest income of $8 million related to the
ServiceMaster Home Service Center venture, increased minority interest expense
of $8 million related to the equity security issued in the Allied Bruce
acquisition, and a $3 million loss recorded in 2001 on the Company's sale of
receivables. Throughout 2000 and until May 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 2001, this minority interest income
totaled $6 million, compared with $14 million in 2000. In May 2001, the
cumulative operating losses of ServiceMaster Home Service Center began exceeding
the funding provided by Kleiner Perkins. As a result, all of the operating
losses after May of 2001 had been absorbed in the Company's financial statements
without an offset at the minority interest income line.
EXTRAORDINARY LOSS
In the fourth quarter of 2001, the Company used a portion of the cash proceeds
from the sale of Management Services to pay down debt balances and recorded an
extraordinary loss of $.03 per diluted share ($9 million after-tax) resulting
from the
5
early extinguishment of debt. This was partially offset by the realization of
gains ($.02 per diluted share; $6 million after-tax) resulting from the
repurchase of corporate debt in the first quarter.
As previously discussed, the Company intends to adopt SFAS 145 in 2003, which
will result in the reclassification of the extraordinary loss into interest
expense within income from continuing operations.
SEGMENT REVIEW (2001 VS. 2000)
2001 AND 2000 RESULTS HAVE BEEN PRESENTED ON A PROFORMA BASIS AS IF SFAS 142 HAD
BEEN IN EFFECT FOR 2001 AND 2000 THEREBY EXCLUDING THE AMORTIZATION EXPENSE
AFFECTED BY THE NEW ACCOUNTING STANDARD. (SEE THE "BUSINESS SEGMENT REPORTING"
NOTE IN THE NOTES TO THE FINANCIAL STATEMENTS). MANAGEMENTS DISCUSSION AND
ANALYSIS FOCUSES ON THE 2001 AND 2000 PROFORMA AMOUNTS.
TRUGREEN SEGMENT
This segment's results for both 2001 and 2000 exclude the discontinued TruGreen
LandCare Construction business. The TruGreen segment reported revenue of $1.4
billion, consistent with 2000. Operating income decreased three percent to $181
million (proforma) from $187 million (proforma) in 2000.
Revenue in the lawn care business was consistent with 2000, reflecting the
realization of price increases and growth in ancillary services, offset by a
decrease in customer counts. The lawn care operations' results were negatively
impacted by winter weather conditions that persisted much later in the first
quarter of 2001 than in 2000, resulting in reduced production levels and lower
margins from sub-optimal labor utilization and fixed cost leverage. In addition,
management was optimistic that the selling season, which had been delayed due to
adverse weather in March and April, would rebound in the second and third
quarters. However, sales were below expectations and margins in the lawn care
operations were unfavorably impacted by a cost structure that was in place to
support a higher anticipated level of demand.
Landscape maintenance revenue increased one percent compared to 2000. Revenue
growth was negatively affected by management's decision to enforce stricter
profitability standards on contract sales and renewals as well as soft sales in
enhancement services. Operating margins in the landscaping operations increased
reflecting improved labor efficiency, offset in part by higher plant and
material costs. Capital employed decreased five percent primarily reflecting
continued improvement of working capital and the reduction of excess equipment
levels.
TERMINIX SEGMENT
The Terminix segment reported a 16 percent increase in revenue to $845 million
from $728 million in 2000 and operating income growth of 25 percent to $123
million (proforma) from $98 million (proforma) in 2000. The strong growth
reflects the impact of acquisitions, the continued migration of the customer
base to termite baiting systems, improved customer retention, and the impact of
price increases. In January 2001, the Company acquired the Allied Bruce Terminix
Companies, the largest Terminix franchise and the fourth largest pest control
company in the United States. In October 2001, the Company completed the
acquisition of certain assets of Sears Termite and Pest Control, Inc. The
improvement in Terminix's operating margins reflects the benefit of
acquisitions, in particular an increased mix of higher margin termite baiting
sales, as well as the impact of price increases and ongoing productivity
improvements. Capital employed increased 15 percent primarily due to
acquisitions, offset in part by higher prepaid contracts and improved working
capital management.
AMERICAN HOME SHIELD SEGMENT
The American Home Shield segment reported a 17 percent increase in revenue to
$369 million compared to $315 million in 2000 reflecting double-digit growth in
all sales channels. Operating income increased 25 percent to $26 million
(proforma) compared to $21 million (proforma) in 2000. Operating margin
improvement reflected a decrease in the incidence of claims and expanded use of
network contractors with negotiated lower rates, partially offset by a greater
mix of higher cost claims. Capital employed decreased four percent, resulting
from improved management of working capital.
ARS/AMS SEGMENT
The ARS/AMS segment reported revenue growth of four percent to $820 million,
compared to $787 million in 2000. Operating income decreased ten percent to $49
million (proforma), compared to $55 million (proforma) in 2000. Revenue growth
was supported primarily by acquisitions and price increases. Call volume for
residential plumbing and HVAC services was below management's expectations and
was impacted by cooler weather, a softening economic environment and a slow-down
in construction activity. Of all the businesses in ServiceMaster, ARS/AMS has
the largest mix of non-recurring revenue and is most affected by new
construction, and consequently appears to be most impacted by the condition of
the economy. In an effort to mitigate the impact of the volume shortfall on
operating margins, the Company implemented a detailed cost reduction program in
the second and third quarters of 2001. In addition, in order to focus on
improving performance, the Company discontinued acquisition activity in the
fourth quarter of 2001. Capital employed increased three percent, primarily
reflecting the impact of acquisitions.
OTHER OPERATIONS SEGMENT
Revenues in the Other Operations segment decreased 30 percent to $158 million
from $226 million, primarily reflecting divestitures in 2000. The operating loss
in 2001 of $342 million (proforma) compared with operating income of $19 million
(proforma) in 2000. 2001 results include a charge of $345 million primarily
related to goodwill and asset impairments and other items.
In 2001, the Company recognized $15 million of license fee income related to a
three-year licensing agreement with ARAMARK for the use of the ServiceMaster
trade name in certain markets. This fee income was offset by increased
expenditures in ServiceMaster Home Service Center and corporate support
functions.
The franchise operations, ServiceMaster Clean and Merry Maids, achieved
double-digit revenue and profit growth,
6
reflecting growth in disaster restoration services (which included a significant
level of direct managed disaster restoration work at the Pentagon in 2001), the
benefit of successful marketing programs, national account relationships, and
employee retention initiatives. Total initial and recurring franchise fees
(excluding the aforementioned licensing fee) represented 2.5 percent of
consolidated revenue in both 2001 and 2000 and 1.7 percent of consolidated
operating expenses in both 2001 and 2000. Total franchise fee income comprised
10.2 percent and 9.8 percent of consolidated operating income in 2001 and 2000,
respectively.
2002 FINANCIAL POSITION AND CASH FLOWS
Net cash provided from operations was $381 million in 2002, $18 million higher
than 2001 and $224 million in excess of 2002 net income. The increase reflects
lower working capital usage. This improvement included better receivable and
payables management, most notably in the TruGreen ChemLawn and ARS businesses.
Property additions increased $19 million, reflecting the net purchase price
relating to the residual value guarantees of leases for five assisted living
facilities sold in the second quarter. Cash used for acquisitions declined to
$13 million from $56 million in 2001 reflecting the reduction or curtailment of
acquisitions at Terminix and ARS.
CASH AND DEBT LEVELS
Cash and marketable securities totaled approximately $303 million at December
31, 2002. In 2002, the Company repurchased a portion of its publicly traded debt
with a principal amount of $252 million, including approximately $218 million
repurchased in a tender offer during the second quarter of 2002. The Company has
completed the debt reduction program announced in October 2001. As a result of
continued strong cash flows and the application of the net proceeds received
from the Company's 2001 dispositions, total debt was reduced by $320 million for
the twelve months ended December 31, 2002. This represents a reduction in debt
outstanding of approximately $1.0 billion over the last two years and the
Company's lowest level in over five years. The debt repurchase allowed the
Company the opportunity to lengthen its maturity profile by focusing the
majority of the repurchase on debt with shorter maturities. Approximately 67
percent of the Company's debt now matures beyond five years and 42 percent
beyond fifteen years. The Company's next significant debt maturity is not until
2005.
The Company is party to a number of debt agreements which require it to maintain
certain financial and other covenants, including limitations on indebtedness
(debt cannot exceed 3.5 times EBITDA) and interest coverage ratio (EBITDA needs
to exceed four times interest expense). 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 December 31, 2002, the Company was in compliance with
the covenants related to these debt agreements and based on its operating
outlook for 2003 expects to be able to maintain compliance in the future. The
Company does not have any debt agreements that contain put rights or provide for
acceleration of maturity as a result of a change in credit rating.
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. The Company has a committed revolving credit facility for $490
million, which will expire in December 2004. As of December 31, 2002, the
Company had issued approximately $136 million of letters of credit under the
facility and had unused commitments of approximately $354 million. The Company
also has $550 million of senior unsecured debt and equity securities available
for issuance under an effective shelf registration statement.
In 2001, the Company entered into an agreement to ultimately sell, on a
revolving basis, certain receivables to unrelated third party purchasers. At
December 31, 2002 and 2001, there were no receivables outstanding that had been
sold to third parties. The agreement is a 364-day facility that is renewable at
the option of the purchasers. The Company may sell up to $65 million of its
receivables to these purchasers in the future and therefore has immediate access
to cash proceeds from these sales. The amount of the eligible receivables varies
during the year based on seasonality of the business and will at times limit the
amount available to the Company.
The Company maintains operating lease facilities with banks totaling $95 million
which provide for the acquisition and development of properties to be leased by
the Company. There are residual value guarantees of these properties up to 82
percent of the fair market value of the properties. At December 31, 2002 there
was approximately $72 million funded under these facilities. Of the $95 million
in facilities, $80 million expires in October 2004 and $15 million expires in
January 2008. Approximately $15 million of these leases that involve constructed
properties have been included on the balance sheet as assets with related debt
as of December 31, 2002 and 2001.
The majority of the Company's vehicle fleet is leased through operating leases.
The lease terms are non-cancelable for the first twelve month term, then are
month-to-month leases, cancelable at the Company's option. There are residual
value guarantees (ranging from 70 percent to 87 percent depending on the
agreement) on these vehicles, which historically have not resulted in
significant net payments to the lessors. At December 31, 2002, there was
approximately $257 million of residual value relating to the Company's fleet.
The following table presents the Company's obligations and commitments:
(IN MILLIONS) Total < 1 Yr 2-3 Yrs 4-5 Yrs > 5 yrs
- -----------------------------------------------------------------
Debt balances $835 $31 $175 $70 $559
Non-cancelable
operating
leases 261 63 90 57 51
- -----------------------------------------------------------------
Total amount $1,096 $94 $265 $127 $610
- -----------------------------------------------------------------
As of December 31, 2002, the Company had approximately $136 million of letters
of credit issued under its bank credit
7
facility and approximately $26 million of annually renewable surety bonds
outstanding that primarily support obligations the Company has under insurance
programs. If the surety bonds are not renewed, the Company expects to replace
them with letters of credit issued under its bank credit facility.
DISCONTINUED OPERATIONS
The assets and liabilities related to discontinued businesses have been
classified in separate captions on the Consolidated Statements of Financial
Position. This includes the assets and liabilities specifically related to the
CSI, LandCare Construction, and Terminix Europe businesses. The decrease in
assets of the discontinued operations reflects the sale of equipment and
receivable collections. The decline in liabilities from discontinued operations
represents the settlement of insurance claims and other cash payments. The
remaining liabilities primarily represent the obligations related to long-term
insurance claims and litigation exposures.
CONTINUING OPERATIONS
Receivables are slightly below the level last year reflecting improved
collections and days sales outstanding at several businesses. Deferred customer
acquisition costs increased reflecting growth in the volume of baiting contracts
written at Terminix. The Company capitalizes sales commissions and other direct
contract acquisition costs relating to termite baiting and pest contracts, as
well as home warranty agreements. Property and equipment decreased slightly,
reflecting general business growth offset by depreciation expense on
larger-scale technology projects. The Company does not have any material capital
commitments at this time.
Deferred revenue increased reflecting growth in warranty contracts written at
American Home Shield, increased volume in termite baiting contracts and customer
prepayments in the lawn care business.
As of the date of the Company's acquisition of ARS in 1999, certain members of
management acquired, at fair market value, equity interests in the HVAC and
plumbing operations. In the fourth quarter of 2002, the Company repurchased, at
fair market value, these shares. The Company continues to maintain minority
investors in Terminix. This minority ownership reflects an interest issued to
the prior owners of the Allied Bruce Terminix Companies in connection with that
acquisition. This equity security is convertible into eight million
ServiceMaster common shares. The ServiceMaster shares are included in the shares
used for the calculation of diluted earnings per share.
Total shareholders' equity increased one percent to $1.2 billion, reflecting
earnings partially offset by dividends paid to shareholders. Cash dividends paid
to shareholders totaled $123 million, or $.41 per share, compared to $.40 per
share in 2001. The total amount of cash dividends increased four percent from
the prior year primarily reflecting the per share increase.
In January 2003, the Company paid a cash dividend of $.105 per share and in
March 2003, declared a second quarter cash dividend of $.105 per share payable
on April 30, 2003. The timing and amount of future dividend increases are at the
discretion of the Board of Directors and will depend on, among other things, the
Company's capital structure objectives and cash requirements. In July 2000, the
Board of Directors authorized $350 million for share repurchases. In 2002, the
Company repurchased $52 million of its shares. There remains approximately $229
million available for repurchases under the July 2000 authorization. Decisions
relating to any future share repurchases will depend on various factors such as
the Company's commitment to maintain investment grade credit ratings and other
strategic investment opportunities.
QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
The economy and its impact on discretionary consumer spending, labor wages, fuel
prices, insurance costs and medical inflation rates could be significant to
future operating earnings.
The Company does not hold or issue financial instruments for trading or
speculative purposes. The Company has entered into specific financial
arrangements in the normal course of business to manage certain market risks,
with a policy of matching positions and limiting the terms of contracts to
relatively short durations. The effect of financial instrument transactions is
not material to the Company's financial statements.
The Company generally maintains the majority of its debt at fixed rates. Over 95
percent of total debt at December 31, 2002 and December 31, 2001 was at a fixed
rate. The payments on the approximately $72 million of funding outstanding under
the Company's real estate operating lease facilities as well as its vehicle
fleet and equipment operating leases (approximately $257 million in residual
value) are tied to floating interest rates. Nonetheless, the Company believes
its exposure to interest rate fluctuations is not significant to its overall
results of operations.
The Company has several debt and lease agreements where the interest rate or
rent payable under the agreements automatically adjusts based on changes in the
Company's credit ratings. While the Company is not currently expecting a change
in its credit ratings, based on amounts outstanding at December 31, 2002, a one
rating category improvement in the Company's credit ratings would reduce expense
on an annualized basis by approximately $0.7 million. A one rating category
reduction in the Company's credit ratings would increase expense on an
annualized basis by approximately $1.3 million.
The following table summarizes information about the Company's fixed rate debt
instruments as of December 31, 2002 and presents the principal cash flows and
related weighted-average interest rates by expected maturity dates. The fair
value of the Company's fixed rate debt was approximately $880 million at
December 31, 2002.
Expected Maturity Date
----------------------------------
There-
(In millions) 2003 2004 2005 2006 2007 after Total
- -----------------------------------------------------------------
Fixed rate debt $31 $24 $151 $11 $59 $559 $835
Avg. Rate 4.2% 4.8% 8.2% 6.0% 6.7% 7.5% 7.2%
- -----------------------------------------------------------------
CRITICAL ACCOUNTING POLICIES
The preparation of the consolidated financial statements requires management to
make certain estimates and assumptions required under generally accepted
accounting
8
principles which may differ from the actual results. The more significant areas
requiring the use of management estimates relate to the allowance for
receivables, accruals for self-insured retention limits related to medical,
workers compensation, auto and general liability insurance, settlement of home
warranty claims, the possible outcomes of outstanding litigation, the useful
lives for depreciation and amortization expense and the valuation of tangible
and intangible assets.
The allowance for receivables is developed based on several factors including
overall customer credit quality, historical write-off experience and specific
account analysis that project the ultimate collectibility of the account. As
such, these factors may change over time causing the reserve level to vary.
The Company carries insurance policies on insurable risks. The Company generally
has self-insured retention limits and has obtained insured layers of coverage
above such self-insured retention limits. Accruals for self-insurance losses are
recorded based on the Company's claims experience and actuarial assumptions. The
establishment of appropriate reserves is an inherently uncertain process.
Reserve estimates are regularly reviewed and updated using the most current
information available. Any resulting adjustments, which could be material, are
reflected in the period identified.
Tangible (fixed) and intangible assets with finite lives are depreciated and
amortized, on a straight-line basis, over their estimated useful lives. These
lives are based on the Company's previous experience for similar assets, the
potential market obsolescence and other industry and business data. The Company
also periodically reviews the assets for impairment and a loss would be
recorded, if and when, the Company determines that the book value of the asset
exceeds the true value to the Company. Changes in the estimated useful lives or
in asset values could cause the Company to adjust its book value or future
expense accordingly. The Company also reviews its goodwill and trade names at
least once a year for impairment. An impairment loss would be recorded, if and
when, the Company determines that the expected present value of the future cash
flows is less than the book value.
Revenues from lawn care, pest control, liquid and fumigation termite
applications, as well as heating/air conditioning and plumbing services are
recognized as the services are provided. Revenues from landscaping services are
recognized as they are earned based upon monthly contractual arrangements or
when services are performed for non-contractual arrangements. Revenues from the
Company's commercial installation contracts, primarily relating to HVAC, are
recognized on the percentage of completion method in the ratio that total
incurred costs bear to total estimated costs. The Company eradicates termites
through the use of baiting stations, as well as through non-baiting methods
(e.g., fumigation or liquid treatment). Termite services using baiting stations
as well as home warranty services typically are sold through annual contracts
for a one-time, upfront payment. Direct costs of these contracts (service costs
for termite contracts and claim costs for warranty contracts) are expensed as
incurred. The Company recognizes revenue over the life of these contracts in
proportion to the expected direct costs. Revenue from trade name licensing
arrangements is recognized when earned. Franchised revenues consist principally
of monthly fee revenue which is recognized when the related franchise revenue is
reported from the franchisee and collectibility is assured. Franchise revenue
also includes initial franchise fees resulting from the sale of the franchise,
which are fixed and are recognized as revenue when collectibility is assured and
all material services or conditions relating to the sale have been substantially
performed.
Customer acquisition costs, which are incremental and direct costs of obtaining
the customer, are deferred and amortized over the life of the contract in
proportion to revenue recognized. These costs include sales commissions and
direct selling costs which can be shown to have resulted in a successful sale.
FORWARD-LOOKING STATEMENTS
THE COMPANY'S ANNUAL REPORT CONTAINS STATEMENTS CONCERNING FUTURE RESULTS AND
OTHER MATTERS THAT MAY BE DEEMED TO BE "FORWARD-LOOKING STATEMENTS" WITHIN THE
MEANING OF THE PRIVATE SECURITIES LITIGATION REFORM ACT OF 1995. THE COMPANY
INTENDS THAT THESE FORWARD-LOOKING STATEMENTS, WHICH LOOK FORWARD IN TIME AND
INCLUDE EVERYTHING OTHER THAN HISTORICAL INFORMATION, BE SUBJECT TO THE SAFE
HARBORS CREATED BY SUCH LEGISLATION. THE COMPANY NOTES THAT THESE
FORWARD-LOOKING STATEMENTS INVOLVE RISKS AND UNCERTAINTIES THAT COULD AFFECT ITS
RESULTS OF OPERATIONS, FINANCIAL CONDITION OR CASH FLOWS. FACTORS THAT COULD
CAUSE ACTUAL RESULTS TO DIFFER MATERIALLY FROM THOSE EXPRESSED OR IMPLIED IN A
FORWARD-LOOKING STATEMENT INCLUDE THE FOLLOWING (AMONG OTHERS): EXTREME WEATHER
CONDITIONS THAT AFFECT THE DEMAND FOR THE COMPANY'S SERVICES; COMPETITION IN THE
MARKETS SERVED BY THE COMPANY; LABOR SHORTAGES OR INCREASES IN WAGE RATES;
UNEXPECTED INCREASES IN OPERATING COSTS, SUCH AS HIGHER INSURANCE, HEALTH CARE
OR FUEL PRICES; INCREASED GOVERNMENTAL REGULATION OF TELEMARKETING; GENERAL
ECONOMIC CONDITIONS IN THE UNITED STATES, ESPECIALLY AS THEY MAY AFFECT HOME
SALES OR CONSUMER SPENDING LEVELS; TIME AND EXPENSES ASSOCIATED WITH INTEGRATING
AND WINDING DOWN BUSINESSES; AND OTHER FACTORS DESCRIBED FROM TIME TO TIME IN
DOCUMENTS FILED BY THE COMPANY WITH THE SECURITIES AND EXCHANGE COMMISSION.
9
FIVE YEAR FINANCIAL SUMMARY
(Restated 1) (Restated 1) (Restated 1) (Restated 1)
2002 2001 2000 1999 1998
(In thousands, except per share data) unaudited unaudited
- -----------------------------------------------------------------------------------------------------------------------------------
OPERATING RESULTS:
Operating revenue $3,589,089 $3,561,445 $3,421,802 $3,063,668 $2,185,352
Operating income 341,336 (23,177) 320,851 245,672 296,530
PERCENTAGE OF OPERATING REVENUE 9.5% (1.0%) 9.4% 8.0% 13.6%
Non-operating expense 77,770 121,718 103,733 86,981 77,644
Provision for income taxes 93,468 19,569 92,844 67,628 90,510
------------------------------------------------------------------------
Income from continuing operations 170,098 (164,464) 124,274 91,063 128,376
Discontinued operations, net (3,875) 284,270 40,568 61,626 51,601
Extraordinary loss, net of income taxes (9,229) (3,422) - - -
Cumulative effect of accounting change,
net of income taxes - - (11,161) - -
------------------------------------------------------------------------
Net income $156,994 $116,384 $153,681 $152,689 $179,977
Earnings per share:
Basic $0.52 $0.39 $0.51 $0.50 $0.62
Diluted:
Income from continuing operations $0.56 $(0.55) $0.41 $0.29 $0.43
Discontinued operations, net (0.01) 0.95 0.13 0.20 0.17
Extraordinary loss, net (0.03) (0.01) - - -
Cumulative effect of accounting change - - (0.04) - -
------------------------------------------------------------------------
Diluted earnings per share $0.52 $0.39 $0.50 $0.49 $0.60
Shares used to compute basic earnings per share 300,383 298,659 302,487 307,637 289,315
Shares used to compute diluted earnings per share 314,112 298,659 305,518 314,406 298,887
Shares outstanding, net of treasury shares 298,253 300,531 298,474 307,530 289,030
Cash dividends per share $0.41 $0.40 $0.38 $0.36 $0.33
Share price range:
High price $15.50 $14.20 $14.94 $22.00 $25.50
Low price $8.89 $9.84 $8.25 $10.13 $16.00
Financial Position (at year end):
Current assets $919,174 $1,119,050 $693,019 $705,661 $461,758
Current liabilities 839,064 805,298 675,902 712,520 608,289
Working capital 80,110 313,752 17,117 (6,859) (146,531)
Current ratio 1.1 - 1 1.4 - 1 1.0 - 1 1.0 - 1 .8 - 1
Total assets $3,414,938 $3,621,245 $3,939,710 $3,819,687 $2,882,242
Total liabilities 2,095,929 2,311,381 2,753,226 2,567,372 1,861,217
TOTAL DEBT OUTSTANDING 835,475 1,155,193 1,833,556 1,769,298 1,127,783
Minority interest 100,309 102,677 5,933 2,934 -
Shareholders' equity 1,218,700 1,207,187 1,180,551 1,249,381 1,021,025
(1) See the "Restatement" section in the Notes to the Consolidated Financial
Statements for the basis of the restatement and financial statement impact.
10
CONSOLIDATED STATEMENTS OF INCOME
(In thousands, except per share data)
(Restated 6) (Restated 6)
For years ended December 31, 2002 2001 2000
- -----------------------------------------------------------------------------------------------------------------------------------
OPERATING REVENUE $3,589,089 $3,561,445 $3,421,802
OPERATING COSTS AND EXPENSES:
Cost of services rendered and products sold 2,481,226 2,480,472 2,431,912
Selling and administrative expenses 761,085 688,429 601,835
Goodwill, trade name and other intangible amortization (1) 7,442 70,890 67,204
Charge (credit) for impaired assets and other items (2) (2,000) 344,831 -
- -----------------------------------------------------------------------------------------------------------------------------------
Total operating costs and expenses 3,247,753 3,584,622 3,100,951
- -----------------------------------------------------------------------------------------------------------------------------------
OPERATING INCOME 341,336 (23,177) 320,851
NON-OPERATING EXPENSE (INCOME)
Interest expense 77,519 128,033 136,831
Interest and investment income (6,431) (11,972) (19,861)
Minority interest and other expense (income), net 6,682 5,657 (13,237)
- -----------------------------------------------------------------------------------------------------------------------------------
INCOME FROM CONTINUING OPERATIONS BEFORE INCOME TAXES 263,566 (144,895) 217,118
Provision for income taxes 93,468 19,569 92,844
- -----------------------------------------------------------------------------------------------------------------------------------
INCOME FROM CONTINUING OPERATIONS BEFORE EXTRAORDINARY
ITEMS AND CUMULATIVE EFFECT OF ACCOUNTING CHANGE 170,098 (164,464) 124,274
Discontinued operations, net of income taxes (3) (3,875) 284,270 40,568
Extraordinary loss, net of income taxes (4) (9,229) (3,422) -
Cumulative effect of accounting change, net of income taxes (5) - - (11,161)
- -----------------------------------------------------------------------------------------------------------------------------------
NET INCOME $156,994 $116,384 $153,681
- -----------------------------------------------------------------------------------------------------------------------------------
BASIC EARNINGS PER SHARE:
Income from continuing operations before extraordinary items
and cumulative effect of accounting change $0.57 ($0.55) $0.41
Discontinued operations, net (3) (0.01) 0.95 0.13
Extraordinary loss, net (4) (0.03) (0.01) -
Cumulative effect of accounting change, net (5) - - (0.04)
- -----------------------------------------------------------------------------------------------------------------------------------
BASIC EARNINGS PER SHARE $0.52 $0.39 $0.51
- -----------------------------------------------------------------------------------------------------------------------------------
DILUTED EARNINGS PER SHARE:
Income from continuing operations before extraordinary items
and cumulative effect of accounting change $0.56 ($0.55) $0.41
Discontinued operations, net (3) (0.01) 0.95 0.13
Extraordinary loss, net (4) (0.03) (0.01) -
Cumulative effect of accounting change, net (5) - - (0.04)
- -----------------------------------------------------------------------------------------------------------------------------------
DILUTED EARNINGS PER SHARE $0.52 $0.39 $0.50
- -----------------------------------------------------------------------------------------------------------------------------------
(1) The Company adopted Statement of Financial Accounting Standards (SFAS) No.
142, "Goodwill and Other Intangible Assets", which eliminates the
amortization of goodwill and intangible assets with indefinite lives
beginning in 2002. Had the provisions of SFAS 142 been applied to 2001 and
2000, amortization expense would have been reduced by $60 million ($42
million after-tax, $0.14 per diluted share) in 2001 and $58 million ($40
million after-tax, $0.13 per diluted share) in 2000.
(2) The Company recorded a pretax charge of $345 million ($279 million,
after-tax) or $.94 per diluted share in the fourth quarter of 2001, related
primarily to goodwill and asset impairments as well as other items.
(3) In the fourth quarter of 2001, the Company's Board of Directors approved a
series of actions related to the strategic review of its portfolio of
businesses that commenced earlier in 2001. These actions included the sale
in November 2001 of the Company's Management Services business as well as
the decision to exit non-strategic and under performing businesses
including TruGreen LandCare Construction and Certified Systems, Inc., as
well as certain Terminix operations in Europe. During the third quarter of
2002, the Company sold its remaining European Terminix operations. These
operations are classified in "Discontinued operations" for all periods
presented. See "Portfolio Review and Dispositions in 2001" section in the
Notes to the Consolidated Financial Statements.
(4) In 2002 and 2001, the Company repurchased a portion of its public debt
securities and in 2001 the Company prepaid some of its longer-term debt.
The net impact of these transactions was extraordinary losses of $9 million
($15 million pretax) and $3 million ($6 million pretax) in 2002 and 2001,
respectively. The Company intends to adopt SFAS 145 beginning in fiscal
2003. Adoption of this Statement in 2003 will result in the
reclassification of the extraordinary losses into income from continuing
operations.
(5) In 2000, the Company changed its method of accounting for revenue from its
termite baiting contracts. The cumulative effect of this accounting change
as of January 1, 2000 was $11.1 million ($18.9 million pretax).
(6) See the "Restatement" section in the Notes to the Consolidated Financial
Statements for the basis of the restatement and the financial statement
impact.
See accompanying Notes to the Consolidated Financial Statements.
11
CONSOLIDATED STATEMENTS OF FINANCIAL POSITION
(In thousands)
(Restated 1)
As of December 31, 2002 2001
- ------------------------------------------------------------------------------------------------------------------------
ASSETS:
CURRENT ASSETS:
Cash and cash equivalents $227,409 $402,644
Marketable securities 75,194 72,429
Receivables, less allowances of $27,616 and $28,397, respectively 332,186 340,935
Inventories 67,748 68,036
Prepaid expenses and other assets 39,464 34,734
Deferred customer acquisition costs 48,419 46,004
Deferred taxes and income taxes receivable 123,100 90,200
Assets of discontinued operations 5,654 64,068
- ------------------------------------------------------------------------------------------------------------------------
Total Current Assets 919,174 1,119,050
- ------------------------------------------------------------------------------------------------------------------------
PROPERTY AND EQUIPMENT:
At cost 413,939 469,140
Less: accumulated depreciation (219,062) (272,930)
- ------------------------------------------------------------------------------------------------------------------------
Net Property and Equipment 194,877 196,210
- ------------------------------------------------------------------------------------------------------------------------
OTHER ASSETS:
Goodwill 1,919,780 1,904,178
Intangible assets, primarily trade names 257,781 261,136
Notes receivable 55,770 59,204
Long-term securities and other assets 67,556 81,467
- ------------------------------------------------------------------------------------------------------------------------
TOTAL ASSETS $3,414,938 $3,621,245
- ------------------------------------------------------------------------------------------------------------------------
LIABILITIES AND SHAREHOLDERS' EQUITY:
CURRENT LIABILITIES:
Accounts payable 92,121 97,251
Accrued liabilities:
Payroll and related expenses 99,504 83,182
Self-insured claims and related expenses 84,521 63,819
Other 102,380 131,780
Deferred revenues 397,290 343,873
Liabilities of discontinued operations 32,113 50,449
Current portion of long-term debt 31,135 34,944
- ------------------------------------------------------------------------------------------------------------------------
Total Current Liabilities 839,064 805,298
- ------------------------------------------------------------------------------------------------------------------------
LONG-TERM DEBT 804,340 1,120,249
LONG-TERM LIABILITIES
Deferred taxes 312,500 233,000
Liabilities of discontinued operations 28,800 50,600
Other long-term obligations 111,225 102,234
- ------------------------------------------------------------------------------------------------------------------------
Total Long-Term Liabilities 452,525 385,834
- ------------------------------------------------------------------------------------------------------------------------
MINORITY INTEREST 100,309 102,677
COMMITMENTS AND CONTINGENCIES (See Note)
SHAREHOLDERS' EQUITY
Common stock $0.01 par value, authorized 1 billion shares; issued
316,024 and 314,538, respectively 3,160 3,145
Additional paid-in capital 1,054,272 1,039,228
Retained earnings 355,893 322,103
Accumulated other comprehensive loss (849) (2,496)
Restricted stock (1,988) (581)
Treasury stock (191,788) (154,212)
- ------------------------------------------------------------------------------------------------------------------------
Total Shareholders' Equity 1,218,700 1,207,187
- ------------------------------------------------------------------------------------------------------------------------
TOTAL LIABILITIES AND SHAREHOLDERS' EQUITY $3,414,938 $3,621,245
- ------------------------------------------------------------------------------------------------------------------------
(1) See the "Restatement" section in the Notes to the Consolidated Financial
Statements for the basis of the restatement and the financial statement
impact.
See accompanying Notes to the Consolidated Financial Statements
12
CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY
(In thousands)
Additional Accumulated
Common Paid-in Retained Comprehensive Treasury Restricted Total
Stock Capital Earnings Income Stock Stock Equity
- ------------------------------------------------------------------------------------------------------------------------------------
BALANCE DECEMBER 31, 1999 (As Previously
Reported) $ 3,132 $1,033,568 $ 241,701 $ (1,821) $ (68,287) $ (2,577) $1,205,716
Prior period adjustment (1) 1,214 43,666 (4,028) 40,852
- ------------------------------------------------------------------------------------------------------------------------------------
BALANCE JANUARY 1, 2000 (Restated 1) $ 3,132 $1,034,782 $ 285,367 $ (5,849) $ (68,287) $ (2,577) $1,246,568
====================================================================================================================================
Net Income 2000 (Restated 1) 153,681 153,681
Other comprehensive income, net of tax
Net unrealized gains on securities,
net of reclassification adjustment (2) 3,169 3,169
Foreign currency translation (6,597) (6,597)
- ------------------------------------------------------------------------------------------------------------------------------------
Total comprehensive income 153,681 (3,428) 150,253
Shareholder dividends (114,321) (114,321)
Shares issued under options,
debentures, grant plans and
other (2,099 shares) (981) 18,887 748 18,654
Treasury shares purchased (12,637 shares) (135,633) (135,633)
Shares issued for acquisitions
(1,482 shares) 5 (1,514) 16,539 15,030
====================================================================================================================================
BALANCE DECEMBER 31, 2000 (Restated 1) $3,137 $1,032,287 $324,727 $(9,277) $(168,494) $(1,829) $1,180,551
====================================================================================================================================
Net Income 2001 (Restated 1) 116,384 116,384
Other comprehensive income, net of tax
Net unrealized (loss) on securities,
net of reclassification adjustment (2) (4,359) (4,359)
Foreign currency translation 11,140 11,140
- ------------------------------------------------------------------------------------------------------------------------------------
Total comprehensive income 116,384 6,781 123,165
Shareholder dividends (119,008) (119,008)
Shares issued under options
debentures, grant plans and
other (2,142 shares) 8 6,941 15,590 1,248 23,787
Treasury shares purchased (124 shares) (1,308) (1,308)
====================================================================================================================================
BALANCE DECEMBER 31, 2001 (Restated 1) $3,145 $1,039,228 $322,103 $(2,496) $(154,212) $(581) $1,207,187
====================================================================================================================================
Net Income 2002 156,994 156,994
Other comprehensive income, net of tax
Net unrealized (loss) on securities,
net of reclassification adjustment (2) (3,869) (3,869)
Foreign currency translation 5,516 5,516
- ------------------------------------------------------------------------------------------------------------------------------------
Total comprehensive income 156,994 1,647 158,641
Shareholder dividends (123,204) (123,204)
Shares issued under options,
debentures, grant plans and
other (2,706 shares) 15 15,044 14,482 (1,407) 28,134
Treasury shares purchased (4,985 shares) (52,058) (52,058)
====================================================================================================================================
BALANCE DECEMBER 31, 2002 $3,160 $1,054,272 $355,893 $(849) $(191,788) $(1,988) $1,218,700
====================================================================================================================================
(1) See the "Restatement" section in the Notes to the Consolidated Financial
Statements for the basis for the restatement and the financial statement
impact.
(2) Disclosure of reclassification amounts (net of tax) relating to
comprehensive income:
2002 2001 2000
======================================================================================================================
Unrealized holding gains (losses) arising in period $(4,745) $(1,219) $12,106
Less:(Gains)losses realized 876 (3,140) (8,937)
- ----------------------------------------------------------------------------------------------------------------------
Net unrealized gains (losses) on securities $(3,869) $(4,359) $3,169
======================================================================================================================
See accompanying Notes to the Consolidated Financial Statements.
13
CONSOLIDATED STATEMENTS OF CASH FLOWS
(In thousands)
(Restated 1) (Restated 1)
For years ended December 31, 2002 2001 2000
- --------------------------------------------------------------------------------------------------------------------
CASH AND CASH EQUIVALENTS AT JANUARY 1 $ 402,644 $ 42,669 $ 49,565
CASH FLOWS FROM OPERATIONS:
NET INCOME 156,994 116,384 153,681
Adjustments to reconcile net income to net cash provided from operations:
(Income) loss from discontinued operations 3,875 (284,270) (40,568)
Charge for impaired assets and other items, net of tax (1,200) 279,393 --
Extraordinary loss 9,229 3,422 --
Cumulative effect of accounting change -- -- 11,161
Depreciation expense 50,434 49,913 48,320
Amortization expense 7,442 70,890 67,204
Deferred income tax expense 65,799 37,470 43,821
Change in working capital, net of acquisitions:
Receivables 13,282 (1,313) (3,584)
Inventories and other current assets (8,030) (14,677) (2,320)
Accounts payable (4,241) (4,445) (11,995)
Deferred revenues 49,849 35,750 21,129
Accrued liabilities 37,127 22,266 (23,403)
Tax refund from prior years payments -- 51,000 39,000
Other, net 489 1,150 721
====================================================================================================================
NET CASH PROVIDED FROM OPERATIONS 381,049 362,933 303,167
====================================================================================================================
CASH FLOWS FROM INVESTING ACTIVITIES:
Property additions (60,599) (41,709) (56,460)
Sale of equipment and other assets 4,615 9,838 13,576
Business acquisitions, net of cash acquired (13,003) (55,842) (144,834)
Proceeds from business sales -- -- 44,784
Notes receivable, financial investments and securities (2,117) (15,361) (22,398)
Proceeds from sale of Management Services -- 766,779 --
Proceeds from sale of European businesses 30,500 90,387 --
====================================================================================================================
NET CASH PROVIDED FROM (USED FOR) INVESTING ACTIVITIES (40,604) 754,092 (165,332)
====================================================================================================================
CASH FLOWS FROM FINANCING ACTIVITIES:
Net borrowings (payments) (345,142) (719,963) 11,266
Shareholders' dividends (123,204) (119,008) (114,321)
Purchase of ServiceMaster stock (52,058) (1,308) (135,633)
Other, net 19,140 13,970 12,769
====================================================================================================================
NET CASH USED FOR FINANCING ACTIVITIES (501,264) (826,309) (225,919)
====================================================================================================================
NET CASH PROVIDED FROM (USED FOR) DISCONTINUED OPERATIONS (14,416) 69,259 81,188
===================================================================================================================
CASH INCREASE (DECREASE) DURING THE YEAR (175,235) 359,975 (6,896)
====================================================================================================================
CASH AND CASH EQUIVALENTS AT DECEMBER 31 $ 227,409 $ 402,644 $ 42,669
====================================================================================================================
(1) See the "Restatement" section in the Notes to the Consolidated Financial
Statements for the basis for the restatement and the financial statement
impact.
See accompanying Notes to the Consolidated Financial Statements.
14
Notes to Consolidated Financial Statements
SIGNIFICANT ACCOUNTING POLICIES
SUMMARY: The consolidated financial statements include the accounts of
ServiceMaster and its majority-owned subsidiary partnerships and corporations,
collectively referred to as the Company. Intercompany transactions and balances
have been eliminated.
The preparation of the consolidated financial statements requires management to
make certain estimates and assumptions required under generally accepted
accounting principles ("GAAP") which may differ from the actual results. The
more significant areas requiring the use of management estimates relate to the
allowance for receivables, accruals for self-insured retention limits related to
medical, workers compensation, auto and general liability insurance, settlement
of home warranty claims, the possible outcomes of outstanding litigation, the
useful lives for depreciation and amortization expense, and the valuation of
tangible and intangible assets.
The allowance for receivables is developed based on several factors including
overall customer credit quality, historical write-off experience and specific
account analysis that project the ultimate collectibility of the account. As
such, these factors may change over time causing the reserve level to vary.
The Company carries insurance policies on insurable risks at levels which it
believes to be appropriate. The Company generally has self-insured retention
limits and has obtained insured layers of coverage above such self-insured
retention limits. Accruals for self-insurance losses are made based on the
Company's claims experience and actuarial assumptions. The establishment of
appropriate reserves is an inherently uncertain process. Reserve estimates are
regularly reviewed and updated using the most current information available. Any
resulting adjustments, which could be material, are reflected in the period
identified.
Tangible (fixed) and intangible assets with finite lives are depreciated and
amortized on a straight-line basis, over their estimated useful lives. These
lives are based on the Company's previous experience for similar assets, the
potential for market obsolescence and other industry and business data. In
accordance with Statement of Financial Accounting Standards (SFAS) No. 144,
"Accounting for the Impairment or Disposal of Long-Lived Assets", these assets
are tested for recoverability whenever events or changes in circumstances
indicate that their carrying amounts may not be recoverable. In performing this
test, if the undiscounted future cash flows from the asset are less than the
carrying amount of the asset, an impairment loss would be recognized based on
the asset's fair value, and the carrying amount of the asset would be reduced
accordingly.
In accordance with SFAS No. 142, "Goodwill and Other Intangible Assets", the
Company does not amortize its goodwill or indefinite-lived intangible assets.
The Company tests these assets for impairment, at a minimum, on an annual basis
by applying a fair-value based test.
REVENUES: Revenues from lawn care, pest control, liquid and fumigation termite
applications, as well as heating/air conditioning and plumbing services are
recognized as the services are provided. Revenues from landscaping services are
recognized as they are earned based upon monthly contractual arrangements or
when services are performed for non-contractual arrangements. Revenues from the
Company's commercial installation contracts, primarily relating to HVAC, are
recognized on the percentage of completion method in the ratio that total
incurred costs bear to total estimated costs. The Company eradicates termites
through the use of baiting stations, as well as through non-baiting methods
(e.g., fumigation or liquid treatment). Termite services using baiting stations
as well as home warranty services typically are sold through annual contracts
for a one-time, upfront payment. Direct costs of these contracts (service costs
for termite contracts and claim costs for warranty contracts) are expensed as
incurred. The Company recognizes revenue over the life of these contracts in
proportion to the expected direct costs. Revenue from trade name licensing
arrangements is recognized when earned. Franchised revenues (which in the
aggregate represent less than three percent of consolidated revenue) consist
principally of continuing monthly fees based upon the franchisee revenue.
Monthly fee revenue is recognized when the related franchise revenue is reported
from the franchisee and collectibility is assured. Franchise revenue also
includes initial franchise fees resulting from the sale of the franchise, which
are fixed and are recognized as revenue when collectibility is assured and all
material services or conditions relating to the sale have been substantially
performed. Total franchise fee income (excluding trade name licensing) comprised
11.4 percent, 10.2 percent and 9.8 percent of consolidated operating income in
2002, 2001 and 2000, respectively. The portion of total franchise fee income
related to initial fees received from the sale of a franchise were immaterial to
the Company's consolidated financial statements for all periods.
The Company had $397 million and $344 million of deferred revenues at December
31, 2002 and 2001, respectively, which consist primarily of payments received
for annual contracts relating to home warranty, termite baiting and lawn care
services. The revenue related to these services is recognized as the service is
performed over the contractual period.
DEFERRED CUSTOMER ACQUISITION COSTS: Customer acquisition costs, which are
incremental and direct costs of obtaining the customer, are deferred and
amortized over the life of the contract in proportion to revenue recognized.
These costs include sales commissions and direct selling costs which can be
shown to have resulted in a successful sale.
INTERIM REPORTING: TruGreen ChemLawn has significant seasonality to its
business. In the winter and early spring, this business sells a series of lawn
applications to customers which are rendered primarily in March through October.
The Company incurs incremental selling expenses at the beginning of the year
that directly relate to successful sales in which the revenues will be
recognized in later quarters. This business also defers, on an interim basis,
pre-season advertising costs and annual repairs and maintenance procedures that
are performed in the first quarter. These costs are deferred and recognized in
proportion to the contract revenue over the production season, and are not
deferred beyond the calendar year-end.
15
Notes to Consolidated Financial Statements
ADVERTISING: As discussed in the "Interim Reporting" note above, TruGreen's
pre-season advertising costs are deferred and recognized in proportion to the
contract revenue over the year. These costs are not deferred beyond the calendar
year-end. Beginning in 2002, the cost of direct-response advertising at Terminix
is capitalized and amortized over its expected period of future benefits. This
direct-response advertising consists primarily of direct-mail promotions, for
which the cost is capitalized and amortized over the one-year customer contract
life. At December 31, 2002, approximately $1.3 million of direct response
advertising costs were deferred and recorded in prepaid expenses. For all other
advertising, the Company expenses the cost of advertising the first time the
advertising takes place.
INVENTORY VALUATION: Inventories are valued at the lower of cost (first-in,
first-out basis) or market. Inventory costs include material, labor, and related
overhead and handling costs. Raw materials represent less than one percent of
the inventory value at December 31, 2002. The remaining inventory is finished
goods to be used on the customers' premises or sold to franchisees.
DEPRECIATION AND AMORTIZATION: Buildings and equipment used in the business are
stated at cost and depreciated over their estimated useful lives using the
straight-line method for financial reporting purposes. The estimated useful
lives for building and improvements range from 10 to 40 years, while the
estimated useful lives for equipment range from three to 10 years. Leasehold
improvements relating to leased facilities are depreciated over the remaining
life of the lease. Technology equipment as well as software and development have
an estimated useful life of three to seven years. Intangible assets consist
primarily of goodwill ($1.9 billion), trade names ($239 million) and other
intangible assets ($19 million). As required by SFAS 142 beginning in 2002,
goodwill is not subject to amortization and intangible assets with indefinite
useful lives are not amortized until their useful lives are determined to be no
longer indefinite. Goodwill and intangible assets that are not subject to
amortization are subject to at least an annual assessment for impairment by
applying a fair-value based test. Estimated fair value is determined for each
reporting unit by utilizing the expected present value of the future cash flows
of the units. The Company completed its initial assessment of goodwill
impairment in the second quarter of 2002. The Company has also completed its
annual assessment of impairment as of October 1. These assessments concluded
that there were no impairment issues. The Company performs impairment testing on
an annual basis and may test for impairment on a more frequent basis if
management believes events have occurred or circumstances have changed resulting
in a reporting unit's fair value being reduced below its book value. Intangible
assets with finite lives ($19 million and $23 million at December 31, 2002 and
2001, respectively) are amortized on a straight-line basis over their estimated
useful lives.
As discussed in the "Portfolio Review and Strategic Actions" Note to the
Consolidated Financial Statements, in the course of completing its portfolio
review, the Company recorded impairment charges in 2001 related to goodwill of
TruGreen LandCare and the United Kingdom Terminix operations. The Company
computed the impairment of the associated goodwill by utilizing a discounted
cash flow methodology, in which the present value of the future expected cash
flows of the businesses, were compared to the book values. The impairment losses
recorded were the excess of the book values over the discounted cash flows.
As required by SFAS 144 "Accounting for the Impairment or Disposal of Long-Lived
Assets", the Company's long-lived assets, including fixed assets and intangible
assets (other than goodwill), are tested for recoverability whenever events or
changes in circumstances indicate that their carrying amounts may not be
recoverable. No recovery problems have been indicated by these comparisons.
Based on these reviews, when the undiscounted future cash flows from the asset
are less than the carrying amount of the asset, an impairment loss is recognized
based on the asset's fair value, and the carrying amount of the asset is reduced
accordingly.
FAIR VALUE OF FINANCIAL INSTRUMENTS AND CREDIT RISK: The carrying amounts of
cash and cash equivalents, receivables, accounts payable, and accrued
liabilities approximate fair value because of the short maturity of these
instruments. The carrying amounts of long-term receivables approximate fair
value as the effective rates for these instruments are comparable to market
rates at year-end. The carrying amount of marketable and long-term securities
also approximate fair value as unrealized gains and losses on investments
accounted for at market value are reported net-of-tax as a component of
accumulated comprehensive income (loss). The carrying amount of debt is $835
million and $1.2 billion and the estimated fair value is approximately $880
million and $1.1 billion at December 31, 2002 and 2001, respectively. The
estimated fair value of debt is based upon borrowing rates currently available
to the Company for long-term borrowings with similar terms and maturities.
The Company does not hold or issue financial instruments for trading or
speculative purposes. The Company has entered into specific financial
arrangements in the normal course of business to manage certain market risks,
with a policy of matching positions and limiting the terms of contracts to
relatively short durations. The effect of financial instrument transactions is
not material to the Company's consolidated financial statements.
Financial instruments, which potentially subject the Company to financial and
credit risk, consist principally of investments and receivables. Investments
consist primarily of publicly traded debt and common equity securities. The
Company periodically reviews its portfolio of investments to determine whether
there has been an other than temporary decline in the value of the investments
from factors such as deterioration in the financial condition of the issuer or
the market(s) in which it competes. As a result of such a review, the Company
wrote down the value of its investment portfolio by $4 million, pretax in 2001.
Receivables have little concentration of credit risk due to the large number of
customers and the dispersion across geographical areas. The Company maintains an
allowance for losses based upon the expected collectibility of receivables.
INCOME TAXES: The Company accounts for income taxes under the SFAS 109,
"Accounting for Income Taxes." This statement uses an asset and liability
approach for the expected future tax
16
Notes to Consolidated Financial Statements
consequences of events that have been recognized in the Company's financial
statements or tax returns. Deferred income taxes are provided to reflect the
differences between the tax bases of assets and liabilities and their reported
amounts in the financial statements.
EARNINGS PER SHARE: Basic earnings per share is based on the weighted-average
number of common shares outstanding during the year. The weighted average common
shares for the diluted earnings per share calculation include the incremental
effect related to outstanding options whose market price is in excess of the
exercise price and shares potentially issuable 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, while the
diluted shares in the denominator include the shares issuable upon conversion of
the debentures. The effects of outstanding stock options whose market price is
in excess of the exercise price and shares potentially issuable under
convertible securities have not been included in the 2001 diluted loss per share
calculation as their effect would have been anti-dilutive.
STOCK-BASED COMPENSATION: Beginning in 2003, the Company will account for
employee stock options as compensation expense in accordance with SFAS 123,
"Accounting for Stock-Based Compensation." SFAS 148, "Accounting for Stock-Based
Compensation - Transition and Disclosure, an amendment of FASB Statement No.
123", provides alternative methods of transitioning to the fair value based
method of accounting for employee stock options as compensation expense. The
Company will use the "prospective method" of SFAS 148 and expense the fair value
of new employee option grants awarded subsequent to 2002. If the Company
continues its historical pattern of option granting, the impact would be
approximately $.005 per share in 2003, increasing to approximately $.03 per
share over five years.
Prior to 2003, the Company has accounted for employee share options under the
intrinsic method of Accounting Principles Board Opinion 25, as permitted under
GAAP. Accordingly, no compensation cost has been recognized in the accompanying
financial statements related to these options. Had compensation expense for
employee options been determined under the fair value based method of SFAS 123,
proforma reported net income and net earnings per share would reflect the
following:
(In thousands, except per share data) 2002 2001 2000
========================================================================
Net income as reported $156,994 $116,384 $153,681
Deduct: total stock-based
compensation expense
determined under fair value
based method, net
of related tax effects (7,576) (7,613) (8,170)
- ------------------------------------------------------------------------
Proforma net income $149,418 $108,771 $145,511
Basic Earnings Per Share::
As reported $.52 $.39 $.51
Proforma .50 .36 .48
Diluted Earnings Per Share:
As reported $.52 $.39 $.50
Proforma .49 .36 .48
========================================================================
SEE THE "SHAREHOLDERS' EQUITY" NOTE TO THE CONSOLIDATED FINANCIAL STATEMENTS FOR
A DESCRIPTION OF THE ASSUMPTIONS USED TO COMPUTE THE ABOVE STOCK BASED
COMPENSATION EXPENSE.
NEWLY ADOPTED ACCOUNTING PRINCIPLES: In June 2001, the Financial Accounting
Standards Board issued SFAS 142 "Goodwill and Other Intangible Assets". SFAS 142
requires that after December 31, 2001, existing goodwill will not be amortized
and intangible assets with indefinite useful lives will not be amortized until
their useful lives are determined to be no longer indefinite. In accordance with
SFAS 142, the Company discontinued the amortization of goodwill and indefinite
lived intangible assets effective January 1, 2002. Goodwill and intangible
assets that are not amortized are subject to at least an annual assessment for
impairment by applying a fair-value-based test. The Company completed its
initial assessment of goodwill impairment in the second quarter of 2002. The
Company has also completed its annual assessment of impairment as of October 1.
These assessments concluded that there were no impairment issues.
NEWLY ISSUED ACCOUNTING STATEMENTS AND POSITIONS: In April 2002, the Financial
Accounting Standards Board (FASB) issued SFAS 145, "Rescission of FASB
Statements No. 4, 44, and 64, Amendment of FASB Statement No. 13, and Technical
Corrections". The primary impact to the Company of this Statement is that it
rescinds SFAS 4 which required all material gains and losses from the
extinguishment of debt to be classified as extraordinary items. SFAS 145
requires that the more restrictive criteria of APB Opinion No. 30 will be used
to determine whether such gains or losses are extraordinary. The Company intends
to adopt this Statement in its fiscal year 2003, as required by the Statement.
Adoption of this Statement will result in the reclassification of the
extraordinary losses into income from continuing operations included in the
accompanying Consolidated Statements of Income.
In June 2002, the FASB issued SFAS 146, "Accounting for Costs Associated with
Exit or Disposal Activities". This Statement requires recording costs associated
with exit or disposal activities at their fair values when a liability has been
incurred. Under previous guidance, certain exit costs were accrued upon
management's commitment to an exit plan, which is generally before an actual
liability has been incurred. The provisions of this Statement are effective for
exit or disposal activities that are initiated after December 31, 2002.
17
Notes to Consolidated Financial Statements
In November 2002, the FASB issued Interpretation No. 45 (FIN 45), "Guarantor's
Accounting and Disclosure Requirements for Guarantees, Including Indirect
Guarantees of Indebtedness of Others". FIN 45 elaborates on the existing
disclosure requirements for most guarantees, including loan guarantees, such as
standby letters of credit. It also clarifies that at the time a company issues a
guarantee, the company must recognize an initial liability for the fair value,
or market value, of the obligations it assumes under that guarantee and must
disclose that information in its interim and annual financial statements. FIN 45
will be effective for the Company on a prospective basis to guarantees issued or
modified after December 31, 2002. The Company is assessing the impact of this
Statement on the Company's financial position and results of operations. The
disclosure requirements in this interpretation have been adopted by the Company.
In January 2003, the FASB issued FASB Interpretation No. 46, "Consolidation of
Variable Interest Entities" (FIN 46). Under this Interpretation, certain
entities known as "Variable Interest Entities" (VIE) must be consolidated by the
"primary beneficiary" of the entity. The primary beneficiary is generally
defined as having the majority of the risks and rewards arising from the VIE.
For VIE's in which a significant (but not majority) variable interest is held,
certain disclosures are required. The Company is required to apply the
requirements of FIN 46 starting with its third quarter 2003 Form 10-Q filing.
The Company is presently assessing the impact of this Interpretation, however,
it is not expected to have a material impact on the Consolidated Financial
Statements. Based on information as of December 31, 2002, adoption of this
Interpretation in 2003 could result in approximately $5 million to $60 million
of real estate operating leases being included on the balance sheet as assets
with associated debt.
BUSINESS SEGMENT REPORTING
The business of the Company is conducted through five operating segments:
TruGreen, Terminix, American Home Shield, ARS/AMS and Other Operations. Due to
the Company's sale of its Management Services business unit and its exit from
other businesses in 2001, certain operations have become more significant for
segment reporting purposes. In addition, the Company's management and reporting
structure changed during 2002. As a result, the Company has expanded its
business segment reporting which will allow for better ongoing visibility into
the components of the business. The companies that previously were reported in
the Home Maintenance & Improvement segment have been further broken out into
American Home Shield and the combination of ARS/AMS. The franchise operations,
ServiceMaster Clean and Merry Maids, formerly in the Home Maintenance &
Improvement segment, are reported in the Other Operations segment. In accordance
with Statement of Financial Accounting Standards No. 131, the Company's
reportable segments are strategic business units that offer different services.
The TruGreen segment provides residential and commercial lawn care and
landscaping services through the TruGreen ChemLawn and TruGreen LandCare
companies. As a result of the decision in the fourth quarter of 2001 to exit the
LandCare Construction business, the results of the construction operations are
now included in discontinued operations for all periods. The Terminix segment
provides termite and pest control services to residential and commercial U.S.
customers. The American Home Shield segment provides home warranties to
consumers that cover heating, ventilation, air conditioning (HVAC), plumbing and
certain appliances. This segment also includes home inspection services provided
by AmeriSpec. The American Residential Services, (ARS) and American Mechanical
Services (AMS) segment provides HVAC and plumbing services provided under the
ARS, AMS and Rescue Rooter brand names. The Other Operations segment includes
the franchise operations of ServiceMaster Clean and Merry Maids, which provide
disaster restoration and cleaning services as well as the Company's headquarters
operations which provides various technology, marketing, finance and other
support services to the business units.
Information regarding the accounting policies used by the Company is described
in the Significant Accounting Policies. The Company derives substantially all of
its revenues from customers in the United States with less than one percent
generated in foreign markets. Operating expenses of the business units consist
primarily of direct costs. Identifiable assets are those used in carrying out
the operations of the business unit and include intangible assets directly
related to its operations.
Segment information for the years ended December 31, 2002, 2001, and 2000 is
presented below. As discussed in the "Restatement" Note, the information for
2001 and 2000 has been restated.
SFAS 142, "Goodwill and Other Intangible Assets", eliminates the amortization of
goodwill and intangible assets with indefinite lives beginning in 2002. The
table below also presents "Proforma" information for 2001 and 2000 which
eliminates amortization expense related to goodwill and intangible assets with
indefinite lives, so that these periods are presented on a comparable basis to
the 2002 information.
18
Notes to Consolidated Financial Statements
BUSINESS SEGMENT TABLE
(In thousands) 2002 % Change 2001 % Change 2000
===========================================================================================================================
OPERATING REVENUE:
TruGreen $ 1,372,984 0% $ 1,368,770 0% $ 1,365,470
Terminix 924,384 9 845,453 16 728,299
American Home Shield 423,526 15 368,951 17 315,266
ARS/AMS 718,892 (12) 820,177 4 787,026
Other Operations 149,303 N/A 158,094 (30) 225,741
- ---------------------------------------------------------------------------------------------------------------------------
Total Operating Revenue $ 3,589,089 1% $ 3,561,445 4% $ 3,421,802
===========================================================================================================================
OPERATING INCOME:
TruGreen $ 171,235 11% $ 154,301 (4%) $ 160,982
Terminix 127,441 23 103,925 26 82,176
American Home Shield 47,890 104 23,512 29 18,272
ARS/AMS 17,342 (57) 39,978 (14) 46,444
Other Operations (1) (22,572) N/A (344,893) N/A 12,977
- ---------------------------------------------------------------------------------------------------------------------------
Total Operating Income (1) $ 341,336 N/A $ (23,177) N/A $ 320,851
===========================================================================================================================
OPERATING INCOME - SFAS 142 PROFORMA:
TruGreen $ 171,235 (5%) $ 180,676 (3%) $ 186,856
Terminix 127,441 4 122,979 25 98,215
American Home Shield 47,890 84 25,993 25 20,751
ARS/AMS 17,342 (65) 49,210 (10) 54,607
Other Operations (1) (22,572) N/A (341,582) N/A 18,655
- ---------------------------------------------------------------------------------------------------------------------------
Total Operating Income - SFAS 142 Proforma (1) $ 341,336 N/A $ 37,276 N/A $ 379,084
===========================================================================================================================
CAPITAL EMPLOYED: (2)
TruGreen $ 1,011,846 (2%) $ 1,031,387 (5%) $ 1,090,099
Terminix 620,863 4 594,970 15 518,010
American Home Shield 100,026 21 82,374 (4) 86,236
ARS/AMS 416,068 (4) 431,756 3 417,931
Other Operations 5,681 N/A 324,570 (64) 907,764
- ---------------------------------------------------------------------------------------------------------------------------
Total Capital Employed $ 2,154,484 (13%) $ 2,465,057 (18%) $ 3,020,040
===========================================================================================================================
IDENTIFIABLE ASSETS:
TruGreen $ 1,070,031 (1%) $ 1,082,135 (9%) $ 1,192,942
Terminix 841,437 2 823,333 20 685,126
American Home Shield 376,059 16 323,229 10 292,587
ARS/AMS 489,366 (6) 519,026 1 514,408
Other Operations 638,045 (27) 873,522 (30) 1,254,647
- ---------------------------------------------------------------------------------------------------------------------------
Total Identifiable Assets $ 3,414,938 (6%) $ 3,621,245 (8%) $ 3,939,710
===========================================================================================================================
DEPRECIATION & AMORTIZATION EXPENSE:
TruGreen $ 25,163 (53%) $ 53,140 2% $ 52,339
Terminix 11,150 (64) 30,822 7 28,875
American Home Shield 5,583 (26) 7,516 4 7,253
ARS/AMS 9,166 (49) 18,048 7 16,857
Other Operations 6,814 (40) 11,277 11 10,200
- ---------------------------------------------------------------------------------------------------------------------------
Total Depreciation & Amortization Expense $ 57,876 (52%) $ 120,803 5% $ 115,524
===========================================================================================================================
CAPITAL EXPENDITURES:
TruGreen $ 11,803 107% $ 5,709 (76%) $ 28,030
Terminix 17,013 63 10,427 47 7,075
American Home Shield 4,794 (40) 8,033 104 3,935
ARS/AMS 5,658 (20) 7,093 (15) 8,342
Other Operations 21,331 104 10,447 (22) 9,078
- ---------------------------------------------------------------------------------------------------------------------------
Total Capital Expenditures $ 60,599 45% $ 41,709 (26%) $ 56,460
===========================================================================================================================
(1) In the fourth quarter of 2001, the Company recorded a pretax charge of $345
million, related primarily to goodwill and asset impairments as well as
other items.
(2) Capital employed represents the segments total assets less liabilities
(exclusive of debt balances).
The following table summarizes the previously amortized goodwill and trade names
by segment at December 31 that, beginning on January 1, 2002 are no longer
amortized. See the "Acquisition" and "Dispositions" Notes to the Consolidated
Financial Statements for information relating to goodwill acquired and amounts
impaired or part of a discontinued operation.
(In thousands) 2002 % Change 2001 % Change 2000
================================================================================================
TruGreen $ 916,216 1% $ 910,573 (3%) $ 934,318
Terminix 709,955 1 705,608 25 563,943
American Home Shield 72,085 - 72,085 (3) 74,277
ARS/AMS 347,968 - 347,863 4 334,857
Other Operations 112,106 5 106,599 N/A 382,073
- ------------------------------------------------------------------------------------------------
Total $ 2,158,330 1% $ 2,142,728 (6%) $ 2,289,468
================================================================================================
19
Notes to Consolidated Financial Statements
RESTATEMENT
The Company has restated its consolidated financial statements for the years
ended December 31, 2001 and 2000. Subsequent to the issuance of the Company's
2001 consolidated financial statements, management determined that the
historical accounting treatment relating to the items below required revision.
The table below presents the net income and equity impacts from the restatement.
Net Net Beginning
($ IN MILLIONS, EXCEPT PER SHARE DATA) Income Income Equity
2001 2000 2000
-------- -------- ----------
CONTINUING OPERATIONS:
AHS deferred acquisition costs $(8.5) $(6.1) $(30.0)
Trade name license fee 9.0 - -
Insurance (TruGreen) 3.7 (3.7) -
Other, net (0.6) (5.8) (20.7)
Tax adjustment from reincorporation (0.8) (0.8) 35.0
-------- -------- ----------
INCOME/EQUITY IMPACT $2.8 $(16.4) $(15.7)
EPS IMPACT $0.01 $(0.05)
DISCONTINUED OPERATIONS:
INCOME/EQUITY IMPACT * $(41.5) $(3.7) $59.4
EPS IMPACT $(0.14) $(0.01)
* PRIMARILY REPRESENTS THE TAX ADJUSTMENT FROM REINCORPORATION
A summary of the significant effects of the restatement is as follows:
2001 2000
------------------------------------------------------------
As Previously As Previously
(In thousands, except per share data) Reported (1) As Restated Reported (1) As Restated
- ----------------------------------------------------------------------------------------------------------
FOR THE YEAR ENDED DECEMBER 31
Operating revenue $ 3,539,187 $ 3,561,445 $ 3,420,371 $ 3,421,802
Operating income (38,336) (23,177) 340,354 320,851
Income from continuing operations before
income taxes (152,264) (144,895) 241,762 217,118
Income from continuing operations before
extraordinary items and cumulative
effect of accounting change (167,313) (164,464) 140,690 124,274
Discontinued operations, net 325,768 284,270 44,298 40,568
Extraordinary loss, net (3,422) (3,422) -- --
Cumulative effect of accounting change -- -- (11,161) (11,161)
- ----------------------------------------------------------------------------------------------------------
Net income $ 155,033 $ 116,384 $ 173,827 $ 153,681
==========================================================================================================
Diluted earnings per share:
Income from continuing operations before
extraordinary items $(0.52) ($0.55) $0.46 $0.41
Discontinued operations, net 1.05 0.95 0.15 0.13
Extraordinary loss, net (0.01) (0.01) - -
Cumulative effect of accounting change - - (0.04) (0.04)
- ----------------------------------------------------------------------------------------------------------
Diluted earnings per share $ 0.51 $0.39 $0.57 $0.50
==========================================================================================================
AS OF DECEMBER 31
Current assets $ 1,131,824 $ 1,119,050
Net property, plant, and equipment 180,937 196,210
Other long-term assets 2,361,978 2,305,985
- ----------------------------------------------------------------------------------------------------------
Total assets $ 3,674,739 $ 3,621,245
==========================================================================================================
Current liabilities $ 796,113 $ 805,298
Long-term debt 1,105,518 1,120,249
Long-term liabilities 449,470 385,834
Minority interest 102,677 102,677
Total shareholders' equity 1,220,961 1,207,187
- ----------------------------------------------------------------------------------------------------------
Total liabilities and shareholders' equity $ 3,674,739 $ 3,621,245
==========================================================================================================
(1) During the third quarter of 2002, the Company sold its Terminix operations
in the United Kingdom. The financial results from these operations have
been reclassified from "Continuing Operations" to "Discontinued Operations"
for all periods presented. Amounts as restated include this
reclassification in order to conform with the 2002 presentation.
20
Notes to Consolidated Financial Statements
AMERICAN HOME SHIELD DEFERRED ACQUISITION COSTS
In July 2002, the Company changed its method of accounting for deferred customer
acquisition costs in its American Home Shield business from SFAS No. 60,
"Accounting and Reporting by Insurance Enterprises," pursuant to which the
Company believed it was appropriate to amortize deferred acquisition costs over
the expected customer life to FASB Technical Bulletin No. 90-1, "Accounting for
Separately Priced Extended Warranty and Product Maintenance Contracts," pursuant
to which deferred acquisition costs are amortized over the initial contract
life.
The new method of accounting reduced after-tax earnings by $.03 per diluted
share in 2002, but had no material impact on cash flow in current or future
years. In the second quarter of 2002, the Company recorded a cumulative charge
of $45 million ($.14 per diluted share) to effect this change.
Following discussions with the Staff of the Securities and Exchange Commission,
the Company has restated prior years to account for deferred acquisition costs
in accordance with FASB Technical Bulletin No. 90-1. The effect of this
restatement is to reduce net income by $8.5 million or $.03 per diluted share in
2001, and $6.1 million or $.02 per diluted share in 2000. In addition, this
change results in a reduction of retained earnings of $30 million at January 1,
2000.
TRADE NAME LICENSE FEE
In connection with the sale of its Management Services business in the fourth
quarter of 2001, the Company entered into a three-year licensing arrangement
with ARAMARK Corporation for the use of the ServiceMaster trade name. This
agreement was valued at $15 million and accordingly, a like amount was allocated
from the purchase price. The Company intended to recognize this amount over the
three-year contractual period, and as such, recognized $2 million related
thereto in each of the first and second quarters of 2002. In November 2002, the
Company announced that it had determined that it was appropriate to recognize
the entire $15 million licensing fee in the fourth quarter of 2001. The effect
of this correction is to increase net income by $9 million and earnings per
share by $.03 in 2001, and to reduce net income by $2.5 million and earnings per
share by $.01 in the first half of 2002.
INSURANCE (TRUGREEN)
In January 2002, the Company reported that it had recognized a $9 million pretax
expense in 2001 relating to a revised estimate of the 2000 insurance reserve
requirements. Net income has been restated for this item which results in an
increase to income from continuing operations of $3.7 million (or $.01) in 2001
and a decrease to income from continuing operations of the same amount in 2000.
The remaining adjustment results in a decrease to income from discontinued
operations of $1.1 million.
REINCORPORATION TAX
Prior to 1997, the Company was in partnership form and therefore was not a
federal taxpayer. Consequently, the Company did not record deferred tax balances
reflecting the differences between the book and tax basis of its assets and
liabilities. When the Company converted to corporate form in 1997, it realized a
significant step-up in the tax basis of its assets, which was largely reflected
as an increase in the basis of the tax intangibles and provided for significant
tax deductions over the next 15 years. In accounting for this event in 1997, the
Company recorded the net deferred tax asset associated with differences between
the book and tax basis of its assets and liabilities. As it related to
intangible assets, the Company made a determination that the tax basis of
intangibles equaled the overall book balance of intangible assets on an
enterprise basis. Subsequently it was determined that intangible assets needed
to be considered at the individual business unit level which resulted in a
situation where tax basis exceeded book basis. This created a deferred tax
asset. The Company restated the financial statements to reflect the deferred tax
asset as if it had been recorded in 1997.
This change results in an increase to retained earnings as of January 1, 2000 of
$92.6 million, and an increase to the tax provision for continuing operations of
$.8 million in both 2001 and 2000 and an increase to the tax provision for
discontinued operations of $.8 million and $1.2 million in 2001 and 2000,
respectively. This restatement also results in an increase to the tax provision
relating to the gain on certain businesses sold in 2001 of $45.8 million. The
net impact of these items was to increase deferred tax assets by $33.4 million
and equity by $43.2 million as of December 31, 2001.
OTHER, NET
Other items primarily relate to adjustments in accruals, timing of revenue and
expense items and other miscellaneous items. The Company also determined it was
appropriate to expense the costs associated with telephone directory placements
when the directory is published rather than expensing the cost over the contract
period. In addition, certain operating leases of constructed properties have
been included in the balance sheet as assets with associated debt. The financial
statements have been restated from the amounts previously reported for these
items.
21
Notes to Consolidated Financial Statements
GOODWILL AND INTANGIBLE ASSETS
In June 2001, the Financial Accounting Standards Board issued SFAS 142,
"Goodwill and Other Intangible Assets". SFAS 142 requires that after December
31, 2001, existing goodwill will no longer be amortized and intangible assets
with indefinite useful lives will not be amortized until their useful lives are
determined to be no longer indefinite. In accordance with SFAS 142, the Company
discontinued the amortization of goodwill and indefinite lived intangible assets
effective January 1, 2002. Goodwill and intangible assets that are not amortized
are subject to at least an annual assessment for impairment by applying a
fair-value-based test. The Company completed its initial assessment of goodwill
impairment in the second quarter of 2002. The Company has also completed its
annual assessment of impairment as of October 1. These assessments concluded
that there were no impairment issues. In accordance with SFAS 142, the following
table provides summarized transitional information for the years ended December
31, 2002, 2001 and 2000, with the 2001 and 2000 information presented on an
adjusted basis to reflect the elimination of amortization expense required under
SFAS 142:
(IN THOUSANDS, EXCEPT PER SHARE DATA) 2002 2001 2000
- -------------------------------------------------------------------------------
Reported operating income $ 341,336 ($ 23,177) $ 320,851
Add back: Goodwill and trade name
amortization -- 60,453 58,233
- -------------------------------------------------------------------------------
Operating income as adjusted under
SFAS 142 $ 341,336 $ 37,276 $ 379,084
===============================================================================
Reported income from continuing
operations before extraordinary loss
and cumulative effect of accounting
change $ 170,098 ($164,464) $ 124,274
Add back: Goodwill and trade name
amortization, net of tax -- 41,590 40,244
- -------------------------------------------------------------------------------
Income from continuing
operations before extraordinary
loss and cumulative effect of
accounting change as adjusted
under SFAS 142 170,098 (122,874) 164,518
Discontinued operations, net of taxes (3,875) 284,270 40,568
Extraordinary loss, net of taxes (9,229) (3,422) -
Cumulative effect of accounting
change, net of taxes - - (11,161)
- -------------------------------------------------------------------------------
Net income as adjusted under
SFAS 142 $ 156,994 $ 157,974 $ 193,925
===============================================================================
Reported basic earnings per share
from continuing operations before
extraordinary loss and cumulative
effect of accounting change $0.57 ($0.55) $0.41
Add back: Goodwill and trade name
amortization, net of tax - 0.14 0.13
- -------------------------------------------------------------------------------
Basic earnings per share
from continuing
operations before extraordinary
loss and cumulative effect of
accounting change as adjusted
under SFAS 142 0.57 (0.41) 0.54
Discontinued operations, net (0.01) 0.95 0.13
Extraordinary loss, net (0.03) (0.01) -
Cumulative effect of accounting
change, net - - (0.04)
- -------------------------------------------------------------------------------
Basic earnings per share as adjusted
under SFAS 142 $0.52 $0.53 $0.64
===============================================================================
Reported diluted earnings per share
from continuing operations before
extraordinary loss and cumulative
effect of accounting change $0.56 ($0.55) $0.41
Add back: Goodwill and trade name
amortization, net of tax - 0.14 0.13
- -------------------------------------------------------------------------------
Diluted earnings per share
from continuing
operations before extraordinary
loss and cumulative effect of
accounting change as adjusted
under SFAS 142 0.56 (0.41) 0.54
Discontinued operations, net (0.01) 0.95 0.13
Extraordinary loss, net (0.03) (0.01) -
Cumulative effect of accounting
change, net - - (0.04)
- -------------------------------------------------------------------------------
Diluted earnings per share as adjusted
under SFAS 142 $0.52 $0.53 $0.63
===============================================================================
The following table summarizes goodwill and intangible assets as of December 31:
(IN THOUSANDS) 2002 2001 2000
======================================================================
Goodwill (1) $1,919,780 1,904,178 2,043,179
Trade names (1) 238,550 238,550 246,289
Other intangible assets 78,284 74,197 61,517
Accumulated amortization (2) (59,053) (51,611) (44,014)
- ----------------------------------------------------------------------
Net other intangibles 19,231 22,586 17,503
- ----------------------------------------------------------------------
Total $2,177,561 $2,165,314 $2,306,971
======================================================================
(1) Not subject to amortization
(2) Amortization expense of $7 million, $10 million and $9 million was recorded
in 2002, 2001 and 2000, respectively. Annual amortization expense of
approximately $6 - $8 million is expected over the next five years.
INCOME TAXES
The reconciliation of income tax computed at the U.S. federal statutory tax rate
to the Company's effective income tax rate for continuing operations is as
follows:
2002 2001 2000
===============================================================
Tax at U.S.
Federal statutory rate 35.0% (35.0%) 35.0%
State and local income
taxes net of U.S. federal
benefit 3.6 1.4 4.3
Net operating loss and
tax credits (3.7) (1.7) (0.7)
Impairment of non-deductible
goodwill - 43.5 -
Non-deductible amortization
expense - 2.7 2.5
Other 0.6 2.6 1.7
- ---------------------------------------------------------------
Effective rate 35.5% 13.5% 42.8%
===============================================================
The effective tax rate for discontinued operations was 39.4%, 44.7%, and 43.9%
for 2002, 2001, and 2000, respectively. The difference between these rates and
the federal statutory tax rate of 35% reflects state taxes, net of federal
benefit, the impairment of non-deductible goodwill in 2001, and permanent items,
primarily amortization expense in 2001 and 2000. The effective tax rate for
extraordinary items and the cumulative effect of accounting change was 40.0%,
41.1% and 41.1% for 2002, 2001 and 2000, respectively.
22
Notes to Consolidated Financial Statements
Income tax expense from continuing operations is as follows:
(In thousands) 2002
-----------------------------------
CURRENT DEFERRED TOTAL
U.S. federal $33,718 $48,838 $82,556
State and local 359 10,553 10,912
- ------------------------------------------------------------
$34,077 $59,391 $93,468
============================================================
2001
-----------------------------------
Current Deferred Total
U.S. federal $38,619 $(22,267) $16,352
State and local 7,174 (3,957) 3,217
- ------------------------------------------------------------
$45,793 $(26,224) $19,569
============================================================
2000
-----------------------------------
Current Deferred Total
U.S. federal $43,406 $35,217 $78,623
State and local 7,782 6,439 14,221
- ------------------------------------------------------------
$51,188 $41,656 $92,844
============================================================
Deferred income tax expense results from timing differences in the recognition
of income and expense for income tax and financial reporting purposes. Deferred
income tax balances reflect the net tax effects of temporary differences between
the carrying amounts of assets and liabilities for financial reporting and
income tax purposes. The deferred tax asset primarily reflects the impact of
future tax deductions related to the Company's accruals. Management believes
that, based upon its lengthy and consistent history of profitable operations, it
is probable that its deferred tax assets will be realized, primarily from the
generation of future taxable income. The deferred tax liability primarily
reflects the basis differences related to intangible assets. In 2002, the
Company adopted SFAS 142 which eliminated the requirement to record goodwill
amortization expense in the financial statements. The Company continues to
amortize the intangible assets for tax purposes which yields an annual tax
benefit of approximately $50 million. The tax benefit is reflected in the
Consolidated Statement of Financial Position as an increase in the deferred tax
liability. Significant components of the Company's deferred tax balances are as
follows:
(In thousands) 2002 2001
=================================================================
Deferred tax assets (liabilities):
Current:
Prepaid expenses and other $(4,500) $(5,700)
Receivables allowances 11,400 11,100
Accrued insurance and
related expenses 16,800 17,200
Other accrued expenses 92,500 56,600
- -----------------------------------------------------------------
Total current asset 116,200 79,200
=================================================================
Long-Term:
Long-term assets (1) (302,700) (237,100)
Insurance expenses 26,800 38,800
Other long-term obligations (36,600) (34,700)
- -----------------------------------------------------------------
Total long-term liability (312,500) (233,000)
=================================================================
Net deferred tax liability $(196,300) $(153,800)
=================================================================
(1) The deferred tax liability relates primarily to the difference in the tax
versus book basis of intangible assets. This liability does not represent
expected future cash payments until a business unit of the Company is sold.
Total tax payments in 2002 were $27 million. In 2001, the Company received net
tax refunds of $1 million, and in 2000, the Company made total tax payments of
$38 million, net of refunds.
ACQUISITIONS
Acquisitions have been accounted for using the purchase method and, accordingly,
the results of operations of the acquired businesses have been included in the
Company's consolidated financial statements since their dates of acquisition.
The assets and liabilities of these businesses were recorded in the financial
statements at their estimated fair values as of the acquisition dates.
CURRENT YEAR
During 2002, the Company acquired several small companies, primarily in the pest
control and lawn care businesses. The net purchase price of these acquisitions
was $18 million. The Company recorded goodwill of $12 million and other
intangible assets of $4 million related to these acquisitions.
PRIOR YEARS
In January 2001, the Company acquired the Allied Bruce Terminix Companies, the
largest Terminix franchise and the fourth largest pest control company in the
United States. The total consideration consisted of an equity interest in the
Terminix subsidiary valued at $100 million, which is convertible into eight
million ServiceMaster common shares, and longer-term cash payments due over nine
years totaling $25 million. Approximately $122 million of goodwill was recorded
related to this acquisition.
During 2001, the Company acquired several small companies, primarily in the pest
control and heating/air conditioning and plumbing businesses. The net purchase
price of these acquisitions was $64 million. All of these companies were
acquired before June 30, 2001 (the date that SFAS 141 became effective).
Approximately $56 million of goodwill was recorded relating to these
acquisitions.
In October 2001, the Company acquired certain assets of Sears Termite and Pest
Control, Inc., a company that provides pest control services and protection
against termite damage to residential customers located primarily in the
Southeast. The cash paid after assuming the liabilities to remediate the
premises owned by current customers was not material. Approximately $54 million
was recorded as goodwill and $6 million assigned to other intangible assets
which will be amortized over three to seven years.
During 2000, the Company acquired many small companies, primarily in the lawn
care, HVAC and plumbing, pest control and landscaping businesses. The net
purchase price was $207 million, of which approximately $162 million was
recorded as goodwill.
23
Notes to Consolidated Financial Statements
Supplemental cash flow information regarding the Company's acquisitions is as
follows:
(in thousands) 2002 2001 2000
==================================================================
Purchase price $18,850 $245,646 $246,886
Less liabilities
assumed (1,207) (54,790) (39,588)
- ------------------------------------------------------------------
Net purchase price $17,643 $190,856 $207,298
==================================================================
Net cash paid
for acquisitions $13,003 $55,842 $144,834
Shares issued - - 15,030
Seller financed debt 4,640 35,014 47,434
Minority ownership
in Terminix - 100,000 -
- ------------------------------------------------------------------
Payment for
acquisitions $17,643 $190,856 $207,298
==================================================================
DISPOSITIONS
During the second quarter of 2002, the Company completed the sale of its
ownership interest in five assisted living facilities. These properties were
financed through an operating lease arrangement, whereby, the Company guaranteed
a portion of the residual value of the properties. In the fourth quarter of
2001, a $13.5 million reserve was established representing the amount by which
the residual value guarantees exceeded the value of bids to purchase the
facilities at that time. The final sales price was significantly greater than
these bid levels and the Company realized a gain of $3.6 million from the sale
on the assisted living properties in 2002, which is included in operating
income.
During the third quarter of 2002, the Company sold its remaining Terminix
operations in the United Kingdom. The sale was not material to the Company's
operating results. Related to this sale, the Company entered into a two year
licensing agreement with the buyer for the use of Terminix trade name in the
United Kingdom. This agreement was valued at $6 million and accordingly, a like
amount was allocated from the purchase price.
PORTFOLIO REVIEW AND DISPOSITIONS IN 2001
In October 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 earlier in 2001. In the fourth quarter of 2001, the Company sold
its Management Services business to ARAMARK Corporation for approximately $800
million and recorded an after-tax gain of $404 million. (A portion of Management
Services was not sold as part of this transaction and represented a $15 million
loss upon disposition). Also in the fourth quarter of 2001, the Company's Board
of Directors approved the exit of non-strategic and under-performing businesses
including TruGreen LandCare Construction, Certified Systems Inc. (CSI), and
certain Terminix operations in Europe. The Company sold its TruGreen LandCare
Construction operations to Environmental Industries, Inc. (EII) in certain
markets and EII managed 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. In the fourth quarter of
2001, the Company sold certain subsidiaries of its European pest control and
property services operations.
In the fourth quarter of 2002, the purchaser of the Company's European pest
control and property services operations made a claim for a purchase price
adjustment (relating to the 2001 sale), relating to an alleged breach of certain
conditions in the purchase agreement. In the course of responding to that claim,
the Company discovered that personnel of the former operations had made
unsupported monthly adjustments to certain accounts. The Company subsequently
agreed to an adjustment to the purchase price consisting of an $8 million cash
payment and the cancellation of a previously reserved note receivable of $7
million. This $8 million charge was recorded in 2002.
At December 31, 2002, the Company has certain assets on its financial statements
relating to discontinued operations, primarily receivables. Management is
actively collecting the outstanding receivables. The Company believes that the
remaining assets are presented at their net realizable value.
Reported "Discontinued operations" for all periods presented include the
operating results of the sold and discontinued businesses noted above and the
2001 results include the gain from the sale of Management Services, net of
losses from the disposition of other entities. The operating results and
financial position of discontinued operations are as follows:
(in thousands, except per share data)
Operating Results: 2002 2001 2000
=================================================================
Operating revenue $40,692 $2,271,376 $2,550,244
Income (loss) from
discontinued
operations before
income taxes 1,600 (27,232) 72,328
Provision for income
taxes 635 11,711 31,760
- -----------------------------------------------------------------
Income from
discontinued
operations 965 (38,943)
Gain on sale of
Management Services,
net of losses from
disposition of other
entities
(4,840) 323,213 -
=================================================================
Income from
discontinued
operations ($3,875) $284,270 $40,568
=================================================================
Diluted earnings
per share from
discontinued
operations ($0.01) $0.95 $0.13
=================================================================
Financial Position: 2002 2001
=================================================================
Current assets $5,300 $46,700
Property, plant and equipment 400 12,300
Long-term assets - 5,100
- -----------------------------------------------------------------
Total assets $5,700 $64,100
- -----------------------------------------------------------------
Current liabilities $32,200 $50,400
Long-term liabilities 28,800 50,600
- -----------------------------------------------------------------
Total liabilities $61,000 $101,000
=================================================================
In the fourth quarter of 2001, the Company recorded a pretax charge primarily
related to goodwill and asset impairments and other items totaling $345 million.
Reserves and accrual balances remain on the financial statements relating to
these operations. Cash payments incurred for the wind-down of LandCare
construction contracts, lease termination costs, workers compensation and health
claims as well as professional service fees have been made during 2002. During
the second quarter of 2002, the Company completed the sale of its ownership
interest in five assisted living facilities. These properties were financed
through an operating lease
24
Notes to Consolidated Financial Statements
arrangement, whereby, the Company guaranteed a portion of the residual value of
the properties. At December 31, 2001, a $13.5 million reserve was established
representing the amount by which the residual value guarantees exceeded the
value of bids to purchase the facilities at that time. The final sales price was
significantly greater than these bid levels and the Company realized a gain of
$3.6 million from the sale on the assisted living properties.
The table below summarizes the activity during the twelve months ended December
31, 2002 for the remaining liabilities from the discontinued operations and the
reserves for items recorded in the fourth quarter of 2001. The Company believes
that the remaining reserves continue to be adequate and reasonable.
Balance at Cash Balance at
Dec. 31, Payments Income/ Dec. 31,
(in thousands) 2001 or Other (Expense) 2002
- --------------------------------------------------------------------------------
Remaining liabilities
from discontinued
operations
LandCare Construction $34,100 $22,700 $(2,600) $14,000
Certified Systems, Inc. 23,800 13,700 (3,500) 13,600
Management Services 7,400 1,300 4,500 1,600
International businesses 19,600 20,100(1) (21,900)(1) 21,400
Other 16,100 6,300 (600) 10,400
Reserves related to
strategic actions in the
fourth quarter of 2001 $36,000 $14,900 $5,600 $15,500
(1) The liabilities of this business assumed by the buyer of the sold operations
totaled $19.6 million. During 2002, the Company recorded accruals in connection
with sold operations and a cash adjustment to the purchase price of the 2001
dispositions.
The Company recorded a $3.2 million charge in the second quarter of 2002 in
operating income relating to the retirement agreement of a key executive. This
severance will be paid out over three years.
DISPOSITIONS IN 2000
In September 2000, the Company completed the sales of two non-core businesses.
The Company's interior plant care business was sold for $44 million in cash. In
addition, the Company sold its Diversified Health Services unit, a business that
manages long-term care facilities. Neither transaction had a material impact on
the Company's operating results.
COMMITMENTS AND CONTINGENCIES
The Company carries insurance policies on insurable risks at levels which it
believes to be appropriate. The Company generally has self-insured retention
limits and has obtained fully insured layers of coverage above such self-insured
retention limits. Accruals for self-insurance losses and warranty claims in the
American Home Shield business are made based on the Company's claims experience
and actuarial assumptions. The Company has certain liabilities with respect to
existing or potential claims, lawsuits, and other proceedings. The Company
accrues for these liabilities when it is probable that future costs will be
incurred and such costs can be reasonably estimated.
In the ordinary course of conducting its business activities, the Company
becomes involved in judicial, administrative and regulatory proceedings
involving both private parties and governmental authorities. These proceedings
included general and commercial liability actions and a small number of
environmental proceedings. The Company does not expect any of these proceedings
to have a material adverse effect on its financial condition or results of
operations.
EMPLOYEE BENEFIT PLANS
Discretionary contributions to qualified profit sharing and non-qualified
deferred compensation plans were made in the amount of $9.2 million in 2002,
$8.9 million in 2001 and $9.3 million in 2000. Under the Employee Share Purchase
Plan, the Company contributed $.9 million in 2002, $.8 million in 2001 and $.8
million in 2000. These funds defrayed part of the cost of the shares purchased
by employees.
MINORITY INTEREST OWNERSHIP AND RELATED PARTIES
The Company continues to maintain minority investors in Terminix. This minority
ownership reflects an interest issued to the prior owners of the Allied Bruce
Terminix Companies in connection with that acquisition. This equity security is
exchangeable into eight million ServiceMaster common shares. The ServiceMaster
shares are included in the shares used for the calculation of diluted earnings
per share. As of the date of the Company's acquisition of ARS in 1999, certain
members of management acquired, at fair market value, equity interests in the
HVAC and plumbing operations. In the fourth quarter of 2002, the Company
repurchased at fair value the shares of ARS for approximately $3 million.
Kleiner Perkins Caufield & Byers (KP) purchased a minority interest in
ServiceMaster Home Service Center (SMHSC) in January 2000 for $15 million and
exercised an option to purchase an additional $5 million in January 2001. In May
2000 certain members of ServiceMaster management purchased a minority interest
in SMHSC for approximately $1 million. The Company had allocated losses in SMHSC
to KP's minority interest in 2000 and 2001 based on its relative priority in
liquidation until such interest was reduced to zero in 2001. In December 2001,
the Company acquired, at fair value ($20 million), the minority interest SMHSC
held by KP. The entire purchase price to KP was allocated to goodwill. The
Company also purchased management's ownership is SMHSC for approximetely $1
million.
Also in 2001, and in connection with the sale and disposition of the TruGreen
LandCare construction operations, the Company repurchased at fair value the
shares of TruGreen that were previously purchased by management earlier in the
year. The purchase and sales prices of the shares were at identical amounts of
$12 million, which was charged to the minority interest liability.
In January 2001, Jonathan P. Ward, President and Chief Executive Officer of
ServiceMaster, purchased from ServiceMaster a 5.50 percent convertible debenture
due January 9, 2011, with a face value of $1.1 million. The Company loaned Mr.
Ward the entire amount of the purchase price through a 5.50 percent full
recourse loan due January 9, 2011. In May 2001, Mr. Ward purchased a second 5.50
percent convertible debenture due May 10, 2011, with a face value of $1.1
million. The Company loaned 50 percent of the purchase price of this second
debenture with a 5.50 percent full recourse loan due May 10, 2011. Each
debenture becomes convertible into 20,000 shares of ServiceMaster common stock
on December 31, in each of the years 2001 through 2005. The Company has treated
these transactions under variable plan accounting and the impact to the
financial statements was immaterial in 2002 and 2001.
25
Notes to Consolidated Financial Statements
LONG-TERM DEBT
Long-term debt includes the following:
(In thousands) 2002 2001
- -------------------------------------------------------
8.45% maturing in 2005 $137,499 $250,000
6.95% maturing in 2007 49,225 100,000
7.88% maturing in 2009 179,000 193,000
7.10% maturing in 2018 79,473 149,000
7.45% maturing in 2027 195,000 195,000
7.25% maturing in 2038 82,650 88,150
International borrowings - 36,519
Other 112,628 143,524
Less current portion (31,135) (34,944)
- -------------------------------------------------------
Total long-term debt $804,340 $1,120,249
=======================================================
The Company is party to a number of debt agreements which require it to maintain
certain financial and other covenants, including limitations on indebtedness
(debt cannot exceed 3.5 times earnings before interest, taxes, depreciation, and
amortization (EBITDA)) and interest coverage ratio (EBITDA needs to exceed four
times interest expense). 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 December 31, 2002, the Company was in compliance with the covenants
related to these debt agreements and based on its operating outlook for 2003,
expects to be able to maintain compliance in the future.
The Company does not have any debt agreements that contain put rights or provide
for acceleration of maturity as a result of a change in credit rating. However,
the Company has a number of debt agreements which contain standard ratings-based
"pricing grids" where the interest rate payable under the agreement changes as
the Company's credit rating changes. While the Company does not expect a
negative change in credit ratings, the impact on interest expense resulting from
changes in credit ratings is not expected to be material to the Company.
Since August 1997, ServiceMaster has issued $1.1 billion of unsecured debt
securities pursuant to registration statements filed with the Securities and
Exchange Commission. As of December 31, 2002, ServiceMaster had $550 million of
senior unsecured debt securities and equity interests available for issuance
under an effective shelf registration statement.
In the second quarter of 2002, the Company recorded an extraordinary loss on
early extinguishment of $9 million after-tax, or $.03 per diluted share,
resulting from the repurchase of its publicly traded debt with a principal
amount of $252 million including approximately $218 million repurchased in a
tender offer.
In the fourth quarter of 2001, the Company repaid prior to maturity, its 10.81
percent notes maturing 2001-2002, 6.65 percent notes maturing 2002-2004 and its
7.4 percent notes maturing in 2006. In connection with the early retirement of
these notes, the Company paid "make-whole" premiums of $17 million pretax. In
addition, during 2001, the Company repurchased, prior to maturity, approximately
$123.9 million of its public debt and recognized a pretax gain of approximately
$11 million.
The Company has a committed revolving bank credit facility for up to $490
million that expires in December 2004. The facility can be used for general
Company purposes. As of December 31, 2002, the Company had issued approximately
$136 million of letters of credit under the facility and had unused commitments
of approximately $354 million. At the Company's current credit ratings, the
interest rate under the facility is LIBOR plus 125 to 150 basis points depending
upon usage.
As of December 31, 2002, the Company had approximately $26 million of annually
renewable surety bonds outstanding that primarily support obligations the
Company has under insurance programs. If the surety bonds are not renewed, the
Company expects to replace them with letters of credit issued under its bank
credit facility.
The Company is exposed to interest rate fluctuations on its floating rate debt.
As of year-end, the Company had no floating rate borrowings. The Company has,
from time to time, entered into interest rate swap or similar arrangements to
mitigate its exposure to interest rate fluctuations, and does not, as a matter
of policy, enter into hedging contracts for trading or speculative purposes. As
of December 31, 2002, no interest rate swaps were outstanding.
Cash interest payments were $76 million in 2002, $128 million in 2001 and $130
million in 2000. Average rates paid on the revolving credit facility were 5.0
percent in 2001 and 6.6 percent in 2000. There were no material borrowings under
the facility in 2002. Future scheduled long-term debt payments are $31.1 million
in 2003 (average rate of 4.2 percent), $24.3 million in 2004 (average rate of
4.8 percent), $151.3 million in 2005 (average rate of 8.2 percent), $10.6
million in 2006 (average rate of 6.0 percent) and $59.1 million in 2007 (average
rate of 6.7 percent).
The Company leases certain property and equipment under various operating lease
arrangements. Most of the property leases provide that the Company pay taxes,
insurance and maintenance applicable to the leased premises. As leases for
existing locations expire, the Company would normally expect to renew the leases
or substitute another location and lease.
The majority of the Company's vehicle fleet is leased through operating leases.
Lease terms are non-cancelable for the first 12 month term and then are month-to
- -month leases, cancelable at the Company's option. There are residual value
guarantees (ranging from 70 percent to 87 percent depending on the agreement) on
these vehicles, which historically have not resulted in significant net payments
to the lessors. There are no net payments reflected in the future minimum lease
obligation as the leases are cancelable and there are no expected net payments
due under the guarantees. At December 31, 2002 there was approximately $257
million of residual value relating to the Company's fleet.
Rental expense for 2002, 2001 and 2000 was $159 million, $160 million and $147
million, respectively. Future long-term
26
Notes to Consolidated Financial Statements
noncancelable operating lease payments are $63.0 million in 2003, $49.7 million
in 2004, $39.8 million in 2005, $31.8 million in 2006, $25.2 million in 2007 and
$51.5 million thereafter.
The Company maintains operating lease facilities with banks totaling $95 million
which provide for the acquisition and development of properties to be leased by
the Company. The Company has guaranteed the residual value of the properties
under the leases up to 82 percent of the fair market value at the commencement
of the lease. At December 31, 2002, approximately $72 million was funded under
these facilities. Of the $95 million in facilities, $80 million expires in
October 2004 and $15 million expires in January 2008. Approximately $15 million
of these leases that involve constructed properties have been recorded on the
balance sheet as capital leases with related assets and debt recorded as of
December 31, 2002 and 2001.
CASH AND MARKETABLE SECURITIES
Cash, money market funds and certificates of deposits, with maturities of three
months or less, are included in the Statements of Financial Position caption
"Cash and Cash Equivalents." Marketable securities are designated as available
for sale and recorded at current market value, with unrealized gains and losses
reported in a separate component of shareholders' equity. The Company's
investments consist primarily of publicly traded debt and common equity
securities.
As of December 31, 2002, the aggregate market value of the Company's short- and
long-term investments in debt and equity securities was $116.7 million and the
aggregate cost basis was $119.1 million.
Interest and dividend income received on cash and marketable securities was
$10.6 million, $9.7 million, and $10.0 million, in 2002, 2001, and 2000,
respectively. Gains and losses on sales of investments, as determined on a
specific identification basis, are included in investment income in the period
they are realized. The Company periodically reviews its portfolio of investments
to determine whether there has been an other than temporary decline in the value
of the investments from factors such as deterioration in the financial condition
of the issuer or the market(s) in which it competes. As a result of such a
review, the Company wrote down the value of its investment portfolio by $4
million, pretax in 2001.
RECEIVABLE SALES
In 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 to a wholly-owned, bankruptcy-remote subsidiary, ServiceMaster Funding
LLC. ServiceMaster Funding LLC has entered into an agreement to transfer, on a
revolving basis, an undivided percentage ownership interest in a pool of
accounts receivable to unrelated third party purchasers. ServiceMaster Funding
LLC retains an undivided percentage interest in the pool of accounts receivable
and bad debt losses for the entire pool are allocated first to this retained
interest. The Company recorded a $3 million pretax loss in 2001 related to this
program which was recorded in minority interest expense. At December 31, 2002,
there were no 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. The agreement is a 364-day facility that is
renewable at the option of the purchasers. The Company may sell up to $65
million of its receivables to these purchasers in the future and therefore has
immediate access to cash proceeds from these sales. The amount of the eligible
receivables varies during the year based on seasonality of the business and will
at times limit the amount available to the Company.
COMPREHENSIVE INCOME
Comprehensive income, which encompasses net income, unrealized gains on
marketable securities, and the effect of foreign currency translation is
disclosed in the Statement of Shareholders' Equity.
(In thousands) 2002 2001 2000
- -------------------------------------------------------------
Unrealized holding
gains (losses)
arising in period $(7,941) $(3,601) $20,553
Tax expense (3,196) (2,382) 8,447
- -------------------------------------------------------------
Net of tax amount $(4,745) $(1,219) $12,106
=============================================================
Gains (losses) realized $(1,460) $3,845 $15,173
Tax expense (584) 705 6,236
- -------------------------------------------------------------
Net of tax amount $(876) $3,140 $8,937
=============================================================
Accumulated comprehensive income included the following components as of
December 31:
(In thousands) 2002 2001 2000
- -------------------------------------------------------------
Unrealized gains
(losses) on securities $(1,036) $2,832 $7,192
Foreign currency
translation 187 (5,329) (16,469)
- -------------------------------------------------------------
Total $(849) $(2,496) $(9,277)
=============================================================
SHAREHOLDERS' EQUITY
The Company has authorized one billion shares of common stock with par value of
$.01 and 11 million shares of preferred stock. There were no shares of preferred
stock issued or outstanding.
The Company has an effective shelf registration statement to issue shares of
common stock in connection with future, unidentified acquisitions. This
registration statement allows the Company to issue registered shares much more
efficiently when acquiring privately held companies. The Company plans to use
the shares over time in connection with purchases of small acquisitions. There
were approximately 4.7 million shares available for issuance under this
registration statement at December 31, 2002.
As of December 31, 2002, there were 37.3 million Company shares available for
issuance upon the exercise of employee options outstanding and future grants.
Share options are issued at a price not less than the fair market value on the
grant date and expire within ten years of the grant date. Certain options may
permit the holder to pay the option exercise price by tendering Company shares
that have been owned by the holder without restriction for an extended period.
Share grants carry a
27
Notes to Consolidated Financial Statements
vesting period and are restricted as to the sale or transfer of the shares.
Beginning in 2003, the Company will account for employee stock options as
compensation expense in accordance with SFAS 123, "Accounting for Stock-Based
Compensation." SFAS 148, "Accounting for Stock-Based Compensation - Transition
and Disclosure, an amendment of FASB Statement No. 123", provides alternative
methods of transitioning to the fair value based method of accounting for
employee stock options as compensation expense. The Company will use the
"prospective method" of SFAS 148 and expense the fair value of new employee
option grants awarded subsequent to 2002. If the Company continues its
historical pattern of option granting, the impact would be approximately $.005
per share in 2003, growing to approximately $.03 per share over five years.
Prior to 2003, the Company has accounted for employee share options under the
intrinsic method of Accounting Principles Board Opinion 25, as permitted under
GAAP. Accordingly, no compensation cost has been recognized in the accompanying
financial statements related to these options. See the "Stock-Based
Compensation" note in the "Significant Accounting Policies" section for the
proforma net income and earnings per share under the fair value based method of
SFAS 123. In computing this proforma impact, the fair value of each option is
estimated on the date of grant based on the Black-Scholes option pricing model
with the following weighted-average assumptions in 2002, 2001 and 2000:
risk-free interest rates of 4.5 percent, 4.8 percent and 6.1 percent,
respectively; distribution yields of 3.2 percent 3.7 percent and 4.1 percent,
respectively; and average expected lives of six to seven years. The options
granted to employees in 2002, 2001 and 2000 have weighted-average fair values of
$3.51, $2.41 and $2.19, respectively and vest ratably over five years. The
Company has estimated the value of these options assuming a single
weighted-average expected life for the entire award.
Options and grant transactions during the last three years are summarized below:
Share Price Weighted Avg. Share Price
Options Range Exercise Price Grants Range
================================================================================================================================
Total exercisable, December 31, 1999 10,180,246 $2.24 - 87.55 $11.20 - -
Total outstanding, December 31, 1999 23,773,529 $2.24 - 87.55 $13.37 713,830 $2.86 - 7.96
================================================================================================================================
TRANSACTIONS DURING 2000
Granted to employees 4,326,164 $8.48 - 12.55 $9.75 - -
Exercised or vested (591,517) $2.24 - 14.55 $5.04 (231,474) $2.86 - 7.96
Terminated or resigned (992,847) $2.25 - 81.60 $16.86 - -
- --------------------------------------------------------------------------------------------------------------------------------
Total exercisable, December 31, 2000 12,208,351 $2.25 - 87.55 $12.37 - -
Total outstanding, December 31, 2000 26,515,329 $2.25 - 87.55 $12.84 482,356 $2.86 - 7.96
================================================================================================================================
TRANSACTIONS DURING 2001
Granted to employees 5,184,141 $9.10 - 12.52 $10.63 - -
Exercised or vested (864,418) $2.25 - 11.41 $6.52 (171,518) $2.86 - 7.96
Terminated or resigned (1,503,167) $2.25 - 87.55 $17.27 - -
- --------------------------------------------------------------------------------------------------------------------------------
Total exercisable, December 31, 2001 15,237,607 $2.25 - 77.56 $12.36 - -
Total outstanding, December 31, 2001 29,331,885 $2.25 - 77.56 $12.40 310,838 $2.86 - 7.96
================================================================================================================================
TRANSACTIONS DURING 2002
Granted to employees 4,939,141 $9.09 - 15.10 $13.08 179,000 $10.51-13.80
Exercised or vested (1,586,248) $2.25 - 14.55 $7.60 (129,533) $2.86 - 7.96
Terminated or resigned (871,439) $5.14 - 73.53 $16.37 - -
- --------------------------------------------------------------------------------------------------------------------------------
Total exercisable, December 31, 2002 18,089,830 $2.25 - 77.56 $13.05 - -
Total outstanding, December 31, 2002 31,813,339 $2.25 - 77.56 $12.64 360,305 $2.86 - 13.80
================================================================================================================================
28
Notes to Consolidated Financial Statements
Options outstanding at December 31, 2002:
Number Weighted Average Weighted Number Weighted
Range of Outstanding Remaining Average Exercisable Average
Exercise Prices at 12/31/02 Life Exercise Price at 12/31/02 Exercise Price
=======================================================================================================================
$2.25 - 6.44 813,696 2.0 Years $6.43 813,696 $6.43
7.41 - 10.78 11,684,161 4.0 Years 9.58 5,796,771 9.18
10.80 - 15.94 12,853,267 6.0 Years 12.32 6,282,043 11.78
16.12 - 22.33 6,098,288 6.0 Years 18.18 4,836,464 18.21
27.20 - 77.56 363,927 4.0 Years 42.88 360,856 42.88
- -----------------------------------------------------------------------------------------------------------------------
$2.25 - 77.56 31,813,339 5.0 Years $12.64 18,089,830 $13.05
=======================================================================================================================
EARNINGS PER SHARE
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 effects of
outstanding stock options whose market price is in excess of the exercise price
and shares potentially issuable under convertible securities have not been
included in the 2001 diluted loss per share calculation as their effect would
have been anti-dilutive. As a result, diluted earnings per share is the same as
basic earnings per share. Had the Company recognized income from continuing
operations in 2001, incremental shares attributable to the assumed exercise of
outstanding options and conversion of debentures would have increased diluted
shares outstanding by 12.7 million shares, and the after-tax interest expense
related to convertible debentures that would have been added to net income in
the numerator totaled $4.8 million.
The following table reconciles both the numerator and the denominator of the
basic earnings per share from continuing operations computation to the numerator
and the denominator of the diluted earnings per share from continuing operations
computation.
(In thousands, except per
share data)
FOR YEAR ENDED 2002 For year ended 2001 For year ended 2000
CONTINUING OPERATIONS: INCOME SHARES EPS Loss Shares EPS Income Shares EPS
====================================================================================================================================
Basic EPS $170,098 300,383 $0.57 $(164,464) 298,659 $(0.55) $124,274 302,487 $0.41
Effect of Dilutive
Securities, net of tax:
Options 5,529 - 3,031
Convertible
Debentures 4,780 8,200 - - - -
- ------------------------------------------------------------------------------------------------------------------------------------
Diluted EPS $174,878 314,112 $0.56 $(164,464) 298,659 $(0.55) $124,274 305,518 $0.41
====================================================================================================================================
29
Notes to Consolidated Financial Statements
QUARTERLY OPERATING RESULTS (UNAUDITED)
As discussed in the Notes to the Consolidated Financial Statements, the Company
has restated its consolidated financial statements for the years ended December
31, 2001 and 2000 as well as the previously reported 2002 quarterly results. The
impact of the restatement on operating revenue, gross profit, income from
continuing operations and earnings per share is presented below.
For interim accounting purposes, TruGreen ChemLawn incurs pre-season advertising
costs and annual repair and maintenance procedures that are performed in the
first quarter. These costs are deferred and recognized as expense in proportion
to the related revenues. Full year results are not affected. The quarterly
information for 2002, 2001 and 2000 has been restated to treat certain costs
that were previously deferred as period costs. There was no impact on full-year
results for 2002, 2001 and 2000 as a result of this change.
The table below excludes extraordinary items and the cumulative effect of
accounting changes. These items are as follows. In the second quarter of 2002,
the Company recorded an extraordinary loss from the early extinguishment of debt
of $.03 per diluted share ($9 million after-tax). In 2001, also related to the
early extinguishment of debt, the Company recorded an extraordinary loss of $.03
per diluted share ($9 million after-tax) in the fourth quarter and an
extraordinary gain of $.02 per diluted share ($6 million after-tax) in the first
quarter.
In 2000, the Company changed its method of accounting for revenue from its
termite baiting contracts. The cumulative effect of this accounting change as of
January 1, 2000 was $11.1 million ($18.9 million pretax).
(in thousands, except
per share data) AS PREVIOUSLY AS RESTATED % As Previously As Restated % As Previously As Restated
REPORTED Reported Reported
2002 2002 Chg 2001 (1) 2001 Chg 2000 (1) 2000
====================================================================================================================================
CONTINUING OPERATIONS:
Operating Revenue:
First Quarter $733,385 $734,263 2% $719,591 $722,861 1% $712,105 $714,865
Second Quarter 1,032,807 1,034,937 1 1,015,687 1,020,034 5 974,528 976,081
Third Quarter 1,013,484 1,010,661 3 981,552 981,284 3 955,081 953,895
Fourth Quarter N/A 809,228 (3) 822,357 837,266 8 778,657 776,961
====================================================================================================================================
$3,589,089 1% $3,539,187 $3,561,445 4% $3,420,371 $3,421,802
====================================================================================================================================
Gross Profit:
First Quarter $203,135 $188,202 7% $193,924 $175,085 7% $180,924 $163,858
Second Quarter 346,050 359,769 4 332,577 344,643 6 316,159 326,129
Third Quarter 323,456 335,252 4 306,063 321,774 2 300,766 316,755
Fourth Quarter N/A 224,640 (6) 217,006 239,471 31 195,428 183,148
====================================================================================================================================
$1,107,863 2% $1,049,570 $1,080,973 9% $993,277 $989,890
====================================================================================================================================
Income from Continuing
Operations:
First Quarter $23,785 $11,858 N/A $17,006 $734 (94%) $27,104 $13,322
Second Quarter 60,750 71,437 44 45,019 49,735 (8) 49,469 54,239
Third Quarter 57,810 66,988 49 35,730 45,042 (11) 42,231 50,659
Fourth Quarter N/A 19,815 N/A (265,068) (259,975) N/A 21,886 6,054
====================================================================================================================================
$170,098 N/A $(167,313) $(164,464) N/A $140,690 $124,274
====================================================================================================================================
Basic Earnings Per Share:
First Quarter $0.08 $0.04 N/A $0.06 $ - (100%) $0.09 $0.04
Second Quarter 0.20 0.24 41 0.15 0.17 (6) 0.16 0.18
Third Quarter 0.19 0.22 47 0.12 0.15 (12) 0.14 0.17
Fourth Quarter N/A 0.07 N/A (0.89) (0.87) N/A 0.07 0.02
====================================================================================================================================
$0.57 N/A $(0.56) $(0.55) N/A $0.47 $0.41
====================================================================================================================================
Diluted Earnings Per Share:
First Quarter $0.08 $0.04 N/A $0.06 $ - (100%) $0.09 $0.04
Second Quarter 0.20 0.23 44 0.15 0.16 11 0.16 0.18
Third Quarter 0.19 0.22 47 0.12 0.15 (12) 0.14 0.17
Fourth Quarter N/A 0.07 N/A (0.84) (0.87) N/A 0.07 0.02
====================================================================================================================================
$0.56 N/A $(0.52) $(0.55) N/A $0.46 $0.41
====================================================================================================================================
DISCONTINUED OPERATIONS:
Income from Discontinued
Operations:
First Quarter $(43) $(217) $6,218 $5,258 $8,950 $8,463
Second Quarter 200 295 5,694 4,225 16,846 15,993
Third Quarter 527 1,095 10,393 7,490 8,555 8,753
Fourth Quarter N/A (5,048) 303,463 267,297 9,947 7,359
====================================================================================================================================
$(3,875) $325,768 $284,270 $44,298 $40,568
====================================================================================================================================
Diluted Earnings Per Share:
First Quarter $ - $ - $0.02 $0.02 $0.03 $0.03
Second Quarter - - 0.02 0.01 0.05 0.05
Third Quarter - - 0.03 0.02 0.03 0.03
Fourth Quarter N/A (0.02) 0.97 0.89 0.03 0.02
====================================================================================================================================
$(0.01) $1.05 $0.95 $0.14 $0.13
====================================================================================================================================
(1) During the third quarter of 2002, the Company sold its Terminix operations
in the United Kingdom. The financial results from these operations have
been reclassified from "Continuing Operations" to "Discontinued Operations"
for all periods presented.
2002 2001 2000
- -------------------------------------------------------------------------------
CASH DIVIDENDS PER SHARE:
First Quarter $0.10 0% $0.10 11% $0.09
Second Quarter 0.10 0 0.10 11 0.09
Third Quarter 0.105 5 0.10 0 0.10
Fourth Quarter 0.105 5 0.10 0 0.10
===============================================================================
$0.41 3% $0.40 5% $0.38
===============================================================================
30
REPORT OF INDEPENDENT AUDITORS
To the Shareholders of The ServiceMaster Company
We have audited the accompanying consolidated statements of financial position
of The ServiceMaster Company and subsidiaries (the "Company") as of December 31,
2002 and 2001, and the related consolidated statements of income, shareholders'
equity, and cash flows for each of the three years in the period ended December
31, 2002. These financial statements are the responsibility of the Company's
management. Our responsibility is to express an opinion on these financial
statements based on our audits.
We conducted our audits in accordance with auditing standards generally accepted
in the United States of America. Those standards require that we plan and
perform the audit to obtain reasonable assurance about whether the financial
statements are free of material misstatement. An audit includes examining, on a
test basis, evidence supporting the amounts and disclosures in the financial
statements. An audit also includes assessing the accounting principles used and
significant estimates made by management, as well as evaluating the overall
financial statement presentation. We believe that our audits provide a
reasonable basis for our opinion.
In our opinion, such consolidated financial statements present fairly, in all
material respects, the financial position of The ServiceMaster Company and
subsidiaries as of December 31, 2002 and 2001, and the results of their
operations and their cash flows for each of the three years in the period ended
December 31, 2002, in conformity with accounting principles generally accepted
in the United States of America.
As discussed in the Restatement note to the consolidated financial statements,
the accompanying 2001 and 2000 consolidated financial statements have been
restated.
As discussed in the Newly Adopted Accounting Principles note to the consolidated
financial statements, effective January 1, 2002, the Company adopted SFAS No.
142, Goodwill and Other Intangible Assets.
Deloitte & Touche LLP
Chicago, Illinois
March 26, 2003