SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
__X__ QUARTERLY REPORT UNDER SECTION 13 OR 15(d) OF
THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended March 31, 1998
_____ TRANSITION REPORT PURSUANT TO SECTION 13 OR
15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the transition period from _____ to _____
Commission file number 1-14762
THE SERVICEMASTER COMPANY
(Exact name of registrant as specified in its charter)
Delaware 36-3858106
(State or other jurisdiction of (IRS Employer Identification No.)
incorporation or organization)
One ServiceMaster Way, Downers Grove, Illinois 60515-1700
(Address of principal executive offices) (Zip Code)
630-271-1300
(Registrant's telephone number, including area code)
Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the registrant was
required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days. Yes __X__ No _____.
Indicate the number of shares outstanding of each of the issuer's classes of
shares: 187,791,968 shares as of May 7, 1998.
This document consists of 11 pages, including the cover page.
TABLE OF CONTENTS
Page
No.
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THE SERVICEMASTER COMPANY (Registrant) -
Part I. Financial Information
- ------- ----------------------
Consolidated Statements of Income for the
three months ended March 31, 1998 and March 31, 1997 2
Consolidated Statements of Financial Position
as of March 31, 1998 and December 31, 1997 3
Consolidated Statements of Cash Flows for the
three months ended March 31, 1998 and March 31, 1997 4
Notes to Consolidated Financial Statements 5
Management Discussion and Analysis of Financial Position
and Results of Operations 7
Signature 11
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PART I. FINANCIAL INFORMATION
THE SERVICEMASTER COMPANY
Consolidated Statements of Income
(In thousands, except per share data)
Three Months Ended
March 31,
1998 1997
----------- -----------
Operating Revenue.............................................. $ 981,788 $ 817,136
Operating Costs and Expenses:
Cost of services rendered
and products sold.............................................. 794,797 657,145
Selling and administrative expenses............................ 117,218 101,391
----------- -----------
Total operating costs and expenses............................. 912,015 758,536
----------- -----------
Operating Income............................................... 69,773 58,600
Non-operating Expense (Income):
Interest expense............................................... 24,095 10,392
Interest and investment income................................. (3,435) (2,567)
Minority interest.............................................. - 2,148
----------- -------------
Income before Income Taxes..................................... 49,113 48,627
Provision for income taxes (pro forma in 1997)(1).............. 19,843 19,645
----------- -----------
Net Income (pro forma in 1997)(1).............................. $ 29,270 $ 28,982
=========== ===========
Per Share:
Basic (pro forma in 1997)(1)................................... $ .16 $ .13
===== =====
Diluted (pro forma in 1997)(1)................................. $ .15 $ .13
===== =====
Cash Distributions Per Share................................... $ .12 $ .11 1/3
===== =========
(1) The Company converted from partnership to corporate form on December 26,
1997. Prior to the conversion, the partnership entity was not subject to
federal and state income taxes, as its taxable income was allocated to the
Company's shareholders. The results shown above for the period ended March
31, 1997 have been restated to adjust the actual historical information for
that period to a basis that assumes that reincorporation had occurred as of
the beginning of that year. Actual net income for the period ended March
31, 1997, as previously reported (i.e., excluding the effects of pro forma
corporate income taxes), was $46,860 (basic and diluted net income per
share was $.22 and $.21, respectively).
(2) Basic earnings per share are calculated based on 186,597 shares in 1998 and
216,309 shares in 1997 while diluted earnings per share are calculated based
on 192,970 shares in 1998 and 224,429 shares in 1997. All share and per
share data have been restated to reflect the three-for-two share split
declared on May 9, 1997 and payable to shareholders of record as of June 11,
1997.
See Notes to Consolidated Financial Statements
2
THE SERVICEMASTER COMPANY
Consolidated Statements of Financial Position
(In thousands)
As of
March 31, December 31,
1998 1997
------------ ------------
Assets
Current Assets:
Cash and cash equivalents............................................ $ 32,860 $ 64,876
Marketable securities................................................ 64,459 59,248
Receivables, less allowances of $31,971
and $32,221, respectively......................................... 315,371 299,138
Inventories.......................................................... 57,364 48,157
Prepaid expenses and other assets.................................... 192,208 122,665
------------ -------------
Total current assets............................................. 662,262 594,084
------------ -------------
Property and Equipment:
At cost........................................................... 419,845 362,653
Less: accumulated depreciation................................... 237,076 204,383
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Net property and equipment....................................... 182,769 158,270
------------ -------------
Intangible assets, primarily trade names and goodwill,
net of accumulated amortization of $227,891
and $218,293, respectively........................................ 1,692,702 1,563,309
Notes receivable, long-term securities, and other assets............. 160,498 159,561
------------ -------------
Total assets.....................................................$ 2,698,231 $ 2,475,224
============ =============
Liabilities and Shareholders' Equity
Current Liabilities:
Accounts payable.....................................................$ 83,285 $ 84,673
Accrued liabilities.................................................. 289,605 270,667
Deferred revenues.................................................... 220,501 181,298
Current portion of long-term obligations............................. 33,741 21,539
------------ -------------
Total current liabilities........................................ 627,132 558,177
------------ -------------
Long-Term Debt....................................................... 1,379,936 1,247,845
Other Long-Term Obligations.......................................... 142,296 144,764
Commitments and Contingencies .......................................
Shareholders' Equity:
Common stock $0.01 par value, authorized 1 billion shares; issued
and outstanding 187,158 and 186,629 shares, respectively......... 1,872 1,866
Additional paid-in capital........................................... 531,094 519,424
Retained earnings.................................................... 72,146 65,000
Restricted stock..................................................... (4,048) (4,270)
Treasury stock....................................................... (52,197) (57,582)
------------- --------------
Total shareholders' equity....................................... 548,867 524,438
------------ -------------
Total liabilities and shareholders' equity.......................$ 2,698,231 $ 2,475,224
============ =============
See Notes to Consolidated Financial Statements
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THE SERVICEMASTER COMPANY
Consolidated Statements of Cash Flows
(In thousands)
Three Months Ended
March 31,
1998 1997
------------ ------------
Cash and Cash Equivalents at January 1................................ $ 64,876 $ 72,009
Cash Flows from Operations:
Net Income............................................................ 29,270 46,860
Adjustments to reconcile net income
to net cash provided from operations:
Depreciation................................................... 11,639 10,972
Amortization................................................... 9,598 7,428
Change in working capital, net of acquisitions:
Receivables.................................................. (12,535) (12,403)
Inventories and other current assets......................... (70,791) (65,210)
Accounts payable............................................. (2,394) 2,906
Deferred revenues............................................ 38,026 39,197
Accrued liabilities.......................................... 7,269 (642)
Other, net..................................................... 2,503 1,320
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Net Cash Provided from Operations..................................... 12,585 30,428
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Cash Flows from Investing Activities:
Business acquisitions, net of cash acquired....................... (106,481) (96,405)
Property additions................................................ (23,354) (12,970)
Payments to sellers of acquired businesses........................ (3,757) (1,062)
Notes receivable and financial investments........................ (1,012) (1,558)
Sale of equipment and other assets .............................. 748 553
Net purchases of investment securities............................ (639) (763)
-------------- -------------
Net Cash Used for Investing Activities................................ (134,495) (112,205)
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Cash Flows from Financing Activities:
Long-term borrowings, net......................................... 123,242 100,785
Payments of borrowings and other obligations...................... (10,586) (14,618)
Distributions to shareholders and shareholders' trust............. (22,124) (24,815)
Purchase of ServiceMaster shares.................................. (4,018) (10,151)
Proceeds from employee share option plans......................... 1,990 1,957
Other............................................................. 1,390 (208)
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Net Cash Provided from Financing Activities........................... 89,894 52,950
------------- ------------
Cash Decrease during the Period....................................... (32,016) (28,827)
------------- ------------
Cash and Cash Equivalents at March 31................................. $ 32,860 $ 43,182
============= =============
See Notes to Consolidated Financial Statements
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THE SERVICEMASTER COMPANY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Note 1: The consolidated financial statements include the accounts of
ServiceMaster and its significant subsidiaries, collectively referred to as "the
Company". Intercompany transactions and balances have been eliminated in
consolidation.
Note 2: The consolidated financial statements included herein have been prepared
by the Company pursuant to the rules and regulations of the Securities and
Exchange Commission. Certain information and footnote disclosures normally
included in financial statements prepared in accordance with generally accepted
accounting principles have been condensed or omitted pursuant to such rules and
regulations. However, the Company believes that the disclosures are adequate to
make the information presented not misleading. It is suggested that these
consolidated financial statements be read in conjunction with the financial
statements and the notes thereto included in the Company's latest Annual Report
to shareholders and the Annual Report to the Securities and Exchange Commission
on Form 10-K for the year ended December 31, 1997. In the opinion of the
Company, all adjustments, consisting only of normal and recurring adjustments,
necessary to present fairly the financial position of The ServiceMaster Company
as of March 31, 1998 and December 31, 1997, and the results of operations and
cash flows for the three months ended March 31, 1998 and 1997, have been
included. The preparation of the financial statements requires management to
make certain estimates and assumptions required under generally accepted
accounting principles which may differ from the actual results. The results of
operations for any interim period are not necessarily indicative of the results
which might be obtained for a full year.
Note 3: For interim accounting purposes, certain costs directly associated with
the generation of lawn care revenues are initially deferred and recognized as
expense as the related revenues are recognized. All such costs are fully
recognized within the fiscal year in which they are incurred.
Note 4: On May 9, 1997, the Company's Board of Directors declared a
three-for-two share split effective June 25, 1997, for shareholders of record on
June 11, 1997. All share and per share data have been restated for all periods
presented to reflect this three-for-two split.
Note 5: Basic earnings per share includes no dilution from options, debentures
or other financial instruments and is computed by dividing income available to
common stockholders by the weighted average number of shares outstanding.
Diluted earnings per share reflects the potential dilution of convertible
securities and options to purchase common stock. The following chart reconciles
both the numerator and the denominator of the basic earnings per share
computation to the numerator and denominator of the diluted earnings per share
computation.
Three months Three months
ended March 31, 1998 ended March 31, 1997
------------------------------- ---------------------------------
Pro forma
(in thousands, except per share data) Income Shares EPS Income Shares EPS
--------- -------- ------ --------- -------- ------
Basic earnings per share $ 29,270 186,597 $ 0.16 $ 28,982 216,309 $ 0.13
====== ======
Effect of dilutive securities, net of tax:
Options - 5,941 - 4,493
9% Convertible debenture - - 246 3,195
6% Convertible debenture 32 432 32 432
---------- -------- --------- --------
Diluted earnings per share $ 29,302 192,970 $ 0.15 $ 29,260 224,429 $ 0.13
========== ========= ====== ========= ======== ======
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Note 6: In the Consolidated Statements of Cash Flows, the caption Cash and Cash
Equivalents includes investments in short-term, highly-liquid securities having
a maturity of three months or less. Supplemental information relating to the
Consolidated Statements of Cash Flows for the three months ended March 31, 1998
and 1997 is presented in the following table. The increase in interest paid in
1998 is primarily due to overall higher debt balances relating to the WMX share
repurchase in April 1997 as well as the timing of payments on the public debt.
(In thousands)
1998 1997
--------- ---------
Cash paid or received for:
Interest expense............................................ $ 31,910 $ 11,205
Interest and dividend income................................ $ 2,007 $ 1,942
Note 7: Effective January 1, 1998, the Company adopted Statement of Financial
Accounting Standards No. 130, "Reporting Comprehensive Income". This statement
establishes standards for reporting and display of comprehensive income and its
components in financial statements. Total comprehensive income for the three
months ended March 31, 1998 and 1997 was $31.3 million and $24.7 million,
respectively, which included primarily net income and unrealized gains on
marketable securities.
In 1998, Statement of Position No. 98-1, "Accounting for the Costs of Computer
Software Developed or Obtained for Internal Use", and Statement of Position No.
98-5, "Reporting on the Costs of Start Up and Preoperating Activities", were
issued. These statements, which must be adopted no later than January 1999, have
not yet been implemented by the Company. The Company does not expect the
adoption of these statements to have a material impact to the financial
statements.
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THE SERVICEMASTER COMPANY
MANAGEMENT DISCUSSION AND ANALYSIS
RESULTS OF OPERATIONS
FIRST QUARTER 1998 COMPARED TO FIRST QUARTER 1997
- -------------------------------------------------
Revenues increased 20 percent over the first quarter of 1997 to $982 million
through a combination of acquisitions and solid growth from base operations.
Approximately half of the growth resulted from the formation of ServiceMaster
Employer Services through an acquisition of a professional employer organization
in August of 1997. This service line has a significant impact on revenues and
margins, because the entire payroll of the employees for whom services are
provided is recognized both as revenue and operating cost. As a result, the
margins are low in this business and reduce the Company's consolidated operating
income margin. Operating income increased 19 percent to $69.8 million while
margins decreased to 7.1 percent of revenue from 7.2 percent in 1997. Operating
margins excluding Employer Services increased to 7.8 percent of revenue,
reflecting improved operating efficiencies and the continued growth of the
higher margin businesses. Corporate earnings per share in the first quarter were
$.15 compared to pro forma corporate earnings per share of $.13 last year, an
increase of 15 percent. Pro forma information presents the results of operations
as if the Company had been a taxable corporation in both periods. On this same
basis, net income grew one percent, from $29.0 million to $29.3 million. Net
income growth was affected heavily by higher interest expense, resulting
primarily from the transaction with Waste Management Inc. (WMX) in which the
company repurchased WMX's 19 percent ownership interest in ServiceMaster (40.7
million shares) for $626 million on April 1, 1997. Earnings per share grew at a
faster rate than net income because the transaction reduced shares outstanding
significantly.
The Consumer Services' business unit achieved strong double digit increases in
revenues and profits. Strong growth in all five operating companies and the
addition of Rescue Rooter, an acquisition in the plumbing business, contributed
to an overall 21 percent increase in segment revenues. TruGreen-ChemLawn
operations started the year with excellent revenue growth and improved margins.
Impressive revenue increases across service lines reflected customer count
increases and favorable weather conditions. Another important development was
the entry into the commercial landscape business through acquisitions of four
regional companies during the quarter, which broadened the presence in the
commercial sector of the market. Terminix achieved strong increases in revenues
and profits and significantly improved margins reflecting favorable weather
conditions and strong growth in higher margin renewal business. American Home
Shield had very strong increases in both revenues and profits with double digit
increases in real estate and direct to consumer sales as well as strong renewal
growth. The franchise operations, Residential/Commercial and Merry Maids,
achieved strong growth with encouraging results in our company owned businesses.
The Management Services business unit reported a modest increase in revenue with
profits below last year. The Healthcare market achieved revenue growth although
profits were lower, reflecting investments in the business and continued
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competitive pressures in the acute care sector of the market. Profits in the
Education market increased reflecting improved margins from base business as
well as the favorable effect of the elimination of costs incurred last year
related to unwinding a large contract. The Business & Industry group reported
modest growth in revenue and profits comparable to last year.
Cost of services rendered and products sold increased 21 percent due primarily
to the addition of ServiceMaster Employer Services, as well as general business
growth. Cost of services increased as a percentage of revenue to 81.0 percent
from 80.4 percent in 1997. Excluding Employer Services, cost of services
increased only 9 percent and decreased as a percentage of revenue to 79.6
percent. This decrease primarily reflects the changing mix of the business as
Consumer Services increases in size in relationship to the overall business of
the Company as well as productivity improvements and the successful integration
of acquisitions at Consumer Services. The Consumer Services 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
revenues.
Selling and administrative expenses increased 16 percent due to general business
growth and acquisitions, and decreased as a percentage of revenue to 11.9% in
1998 from 12.4% in 1997. This decrease as a percentage of revenue is primarily
attributable to the addition of ServiceMaster Employer Services and efficiency
gains at Consumer Services, offset in part by the changing business mix of the
Company noted above.
Interest expense increased over the prior year primarily due to increased debt
levels associated with the repurchase of ServiceMaster shares from WMX and
acquisitions. Interest and investment income increased due to gains on sale of
marketable securities at American Home Shield in 1998.
FINANCIAL POSITION
- ------------------
Net cash provided from operations of $13 million was below the first quarter
level in 1997. The decrease primarily reflects the timing of interest payments
relating to the public debt issued in August of 1997, the acceleration of
prepayment collections at TruGreen-ChemLawn into the fourth quarter of 1997, and
the current year funding of seasonal investments for the acquired lawn care
operations. Due to the seasonality of the lawn care and pest control operating
cycles, the Company's working capital needs are the highest during the first
quarter. 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.
Federal taxes on the Company's earnings, while accrued in the consolidated
income statement, will not have to be paid until the first quarter of 1999. At
that time, the Company will be responsible for its 1998 obligation and will
begin making estimated payments for 1999 as well.
Accounts and notes receivable grew over year end levels reflecting general
business growth, increased seasonal activity in the Consumer Services segment,
8
and acquisitions. Inventories also increased over year end levels as a result of
normal seasonal build-ups in the pest control and lawn care businesses.
Prepaids and other assets have increased from year end because of seasonality in
the lawn care business. The lawn care operation defers certain marketing costs
that are incurred during the first quarter but are directly associated with
revenues realized in subsequent quarters of the current year. These costs are
then amortized over the balance of the current lawn care production season, as
the related revenues are recognized. Deferred revenues also grew significantly,
reflecting strong growth and increases in customer prepayments for lawn care
services as well as increased volume of warranty contracts written at American
Home Shield.
Property and equipment increased due to general business growth and
acquisitions. Capital expenditures grew primarily due to investments in
predictive dialers at TruGreen-ChemLawn and computer system upgrades throughout
the organization. The Company has no material capital commitments at this time.
Intangible assets increased from year end primarily reflecting the effect of the
acquisitions, which included Rescue Rooter (a plumbing business), commercial
landscape companies and other smaller Consumer Services companies.
Accrued liabilities increased from year end reflecting seasonal activity at
Consumer Services. Debt levels increased due to the seasonal nature of the
Company's operating cash flows, combined with the effects of acquisitions,
property additions and share repurchases. The Company is a party to a number of
long-term debt agreements which require it to maintain compliance with certain
financial covenants, including limitations on indebtedness, restricted payments,
fixed charge coverage ratios and net worth. The Company is in compliance with
the covenants related to these debt agreements.
In February, the Company completed a $300 million dual-tranche debt offering
consisting of $150 million, 7.10 percent notes due March 1, 2018 and $150
million, 7.25 percent notes due March 1, 2038. The net proceeds were used to
refinance borrowings under bank credit facilities, thereby reducing the
Company's exposure to short-term interest rate fluctuations.
Total shareholders' equity increased to $549 million in 1998 from $524 million
at December 31, 1997 reflecting earnings growth, as well as the shares issued
for acquisitions, partially offset by distributions and treasury share
repurchases. The Company continues to repurchase shares in the open market or in
privately negotiated transactions pursuant to the authorization previously
granted by the Board of Directors. Cash distributions paid directly to
shareholders totaled $22 million or $.12 per share. The 9 percent decrease from
the prior year primarily reflects the April 1997 repurchase of ServiceMaster
shares from WMX offset in part by a 6 percent increase in distributions per
share.
In April, the Company filed a Form S-3 registration statement with the
Securities and Exchange Commission to offer up to 10.6 million shares of common
stock which included approximately 7.6 million shares to be newly issued by the
Company and the remaining 3 million shares to be sold by existing shareholders.
Due to strong investor demand, the selling shareholders component of the
9
offering was increased from 3 million to 6.55 million shares, including the
exercise of the over-allotment option by the underwriters. On May 11, the public
offering of approximately 14.15 million shares was priced at $28.75 per share.
The net proceeds to the Company after the underwriting discount and offering
expenses are approximately $209 million and will be used to reduce outstanding
debt under existing bank credit facilities, thereby reducing interest expense
and increasing the Company's financial flexibility.
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SIGNATURE
Pursuant to the requirements of the Securities Exchange Act of 1934, the
Registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
Date: May 15, 1998
THE SERVICEMASTER COMPANY
(Registrant)
By: /s/Steven C. Preston
---------------------------------------------------
Steven C. Preston
Senior Vice President and Chief Financial Officer
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