EXHIBIT 13
Management Discussion and Analysis of Financial Condition
and Results of Operations
(All share and per share data reflect the three-for-two share splits in August
1998, June 1997 and June 1996)
The terms "Company" and "ServiceMaster" refer to the operations of ServiceMaster
Limited Partnership and The ServiceMaster Company, its successor corporation.
1998 Compared with 1997
Revenues increased 19 percent to $4.7 billion through a combination of
acquisitions and solid growth from base operations. Approximately eight percent
of the revenue increase resulted from internal growth and small tuck-in
acquisitions in existing service lines, primarily lawn care and pest control,
with another six percent coming from platform acquisitions primarily in plumbing
and landscaping. The remaining five percent of the revenue growth represented
the acquisition of a professional employer organization in August 1997. The
professional employer organization has a significant impact on revenues and
margins, because the entire employee payroll of the customer 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 margins. Operating income
increased 15 percent to $396 million, while margins decreased to 8.4 percent of
revenue from 8.7 percent in 1997. Operating margins excluding the professional
employer organization improved 10 basis points over last year, reflecting the
continued strong growth of higher margin businesses, productivity improvements
and the successful integration of acquisitions at Consumer Services.
Pro forma information is presented for 1997 and 1996 to compare the continuing
results of operations as if the Company had been a taxable corporation in all
years. On this basis, net income grew 16 percent to $190 million. Basic and
diluted earnings per share increased 16 percent to $.66 and $.64, respectively.
The Consumer Services business unit achieved a 23 percent increase in revenue,
reflecting strong growth from both internal sources and acquisitions, including
the Rescue Rooter plumbing business and commercial landscaping companies. Net
income increased 27 percent, reflecting solid double-digit profit increases at
all of the companies. TruGreen-ChemLawn reported strong growth in revenues and
profits, reflecting base business growth and the entry into the commercial
landscape market through the acquisition of several companies. The successful
integration of acquisitions and other cost initiatives helped offset the effects
of severe summer weather conditions in many regions of the country. Terminix
achieved strong double-digit growth in revenues and profits, resulting from
excellent increases in termite completions and renewals and improved margins.
Higher customer retention levels and efficiency improvements contributed to the
increased margins. American Home Shield continued to experience exceptional
momentum with very strong double-digit increases in warranty contracts written
due to excellent growth in real estate and direct-to-consumer sales, as well as
strong renewal growth. This volume increase was partially affected by increased
service orders relating to expensive air conditioning repairs due to the extreme
heat experienced in many parts of the country. The franchise operations,
ServiceMaster Residential/Commercial and Merry Maids, achieved solid revenue
increases and higher margins, reflecting improvements in company-owned
operations and cost controls. The Rescue Rooter operations reported very good
results, reflecting improved marketing efforts, productivity improvements and
effective cost controls.
The traditional Management Services business, achieved a seven percent revenue
increase as a result of acquisitions and modest growth in the base business.
Profits increased significantly due to a $38 million pretax gain relating to the
formation of a strategic venture between ServiceMaster and Texas Utilities
Company. The new venture has acquired all the assets of ServiceMaster Energy
Management and will be owned 85 percent by Texas Utilities and 15 percent by
ServiceMaster. This new business combination will provide the Company with an
expanded ability to provide comprehensive energy solutions to customers.
Excluding this gain, profits were one percent below the prior year level as
increases
25
in the Business & Industry and Education markets were offset by reduced
profitability in the Healthcare market. The traditional Healthcare market
reported a slight decline in revenues with lower profits than last year as a
result of continued industry pressures and additional investments in the
business compared with the prior year. The Company achieved significant revenue
and profit increases in the Business & Industry market, reflecting the
successful integration of acquisitions and increased sales in the base business.
The Education market reported strong growth in profits due to better customer
retention and the favorable effect of eliminating costs incurred last year
related to unwinding a large contract.
Other operations include primarily Diversified Health Services, which provides
services and products to the long term care market and Employer Services, the
professional employer organization. Revenues increased significantly as the 1998
results include a full year of the professional employer organization that was
acquired in August 1997. Operating income was down significantly from the prior
year, reflecting a large charge related primarily to the home health care
operations and operational losses. In late 1998, the Company completed a
strategic review of its home health care business and concluded that, without
significant investment to make home health care one of its core businesses, it
could not profitably provide high quality service in the future and continue to
satisfy all the changes and the requirements of new governmental reimbursement
programs. The Company plans to sell its direct operations of home health care
agencies and certain support operations. In addition, the Company is
discontinuing its outsourced management contracts of home health care agencies,
but will continue to provide consulting services to hospitals and other
providers of home health care. The Company incurred and established reserves of
approximately $32 million (pre-tax) relating to home health care, which included
a write-down for the impairment of assets and costs relating to exiting customer
arrangements. An additional $6 million pretax charge was recorded that was
specifically designated for other Diversified Health Services reserve needs. In
addition to these charges and losses in home health care, the decrease in
operating income reflects margin reductions in other Diversified Health Services
operations and the non-recurrence of transaction gains recognized in the prior
year.
On a consolidated basis, cost of services rendered and products sold increased
20 percent and increased as a percentage of revenue to 77.9 percent in 1998 from
77.2 percent in 1997. The addition of Employer Services had an impact on the
overall increase in costs as this business line carries a lower gross margin
level than the rest of the enterprise. Excluding Employer Services, cost of
services rendered and products sold decreased 10 basis points as a percentage of
revenue. This reflects the changing mix of the enterprise as Consumer Services
increased in size relative to the overall business of the Company. The Consumer
Services unit operates at a higher gross profit margin than the Management
Services business unit, but incurs relatively higher levels of selling and
administrative costs.
Consolidated selling and administrative expenses increased 16 percent over the
prior year, and as a percentage of revenue, decreased from 14.1 percent in 1997
to 13.7 percent in 1998.
Interest expense increased over the prior year, reflecting increased debt levels
in the first quarter associated with the 1997 repurchase of shares previously
held by Waste Management, Inc. The impact of larger seasonal borrowings,
primarily due to acquisitions and higher interest rates associated with the
refinancing of floating-rate bank debt with longer term, fixed-rate debt, was
partially offset by proceeds from the May 1998 equity offering.
Interest and investment income increased over the prior year levels due to
growth in the investment portfolio at American Home Shield, as well as gains
realized on sales of marketable securities.
Minority interest expense decreased as the General Partners' interests in the
parent entities were eliminated upon reincorporation.
1997 Compared with 1996
Revenues increased 15 percent to $4 billion, reflecting the effect of
acquisitions and growth from base operations. Operating income increased 17
percent to $344 million, while margins increased to 8.7 percent of revenue from
8.5 percent in 1996, reflecting the continued strong growth of higher margin
businesses, productivity improvements, and the integration of the acquired
Barefoot operations. These improvements were offset in part by the impact of the
acquired professional employer organization, which has significantly lower
margins than the rest of the Company's businesses. Operating income margins
would have improved 50 basis points excluding this acquisition.
26
Pro forma information is presented which compares the continuing results of
operations as if the Company had been a taxable corporation in 1997 and 1996. On
this basis, net income grew nine percent to $163 million. Basic earnings per
share increased 21 percent to $.57 and diluted earnings per share were up 20
percent to $.55. Earnings per share grew at a higher rate than net income due to
the transaction with Waste Management, Inc. (WMX) in which the Company
repurchased WMX's 19 percent ownership interest in ServiceMaster (61.1 million
shares) for $626 million on April 1, 1997. This transaction increased interest
expense significantly and reduced shares outstanding.
Historical partnership net income, which did not include a provision for
corporate taxes, was $329 million, including a one-time tax gain of $65 million
realized upon reincorporation. The resulting historical basic and diluted
earnings per share were $1.15 and $1.10, respectively. This gain represented the
difference between the tax and book basis of the enterprise's assets and
liabilities, which was recognized as a result of the reincorporation.
Partnership net income excluding this gain increased eight percent to $264
million. On this basis, basic and diluted earnings per share were $.92 and $.89,
reflecting increases of 19 percent.
The Consumer Services business unit achieved a 14 percent increase in revenue
and a 21 percent increase in pro forma net income, reflecting the successful
integration of the Barefoot business (which was acquired in February 1997),
combined with good growth from base operations and other acquisitions. The
TruGreen-ChemLawn operations achieved strong double-digit growth in revenues and
profits, reflecting the Barefoot acquisition, increases in the customer base,
improved branch efficiencies, strong sales of ancillary products and favorable
weather conditions throughout most of the year. Terminix achieved solid growth
in revenue and profits for the year. Strong growth in renewals and productivity
improvements offset the effects of adverse weather conditions on termite
operations and increased termite remediation costs. American Home Shield
achieved very strong double-digit increases in both revenues and profits, with
excellent increases in contract renewals and direct-to-consumer sales. This is
consistent with an overall strategy to expand channels of distribution in this
business, which have historically been concentrated in the residential resale
market. ServiceMaster Residential/Commercial and Merry Maids reported modest
profit growth and solid revenue growth for the year, reflecting the conversion
of certain franchises and distributors to company-owned operations.
The traditional Management Services business segment achieved five percent
growth in revenue, reflecting the Premier Manufacturing Support Services
(Premier) acquisition completed in 1996 and, to a lesser degree, growth in the
base business. The base business growth resulted from improvements in Healthcare
and Business & Industry, offset by reductions in Education. Pro forma net income
was up three percent compared with the prior year. Despite continuing
competitive pressures and industry consolidation in the acute care market, the
Company achieved solid revenue increases and improved customer retention in the
Healthcare market. Reported profits in this market were comparable to the prior
year. Within the acute care sector, good growth was realized from sales of the
IntegratedService product, which provides comprehensive service solutions to
clients. The Company achieved significant revenue and profit increases in the
Business & Industry market, largely as a result of the successful integration of
the Premier acquisition and modest growth in the base business. In the Education
market, revenues and profits declined due to the discontinuation of certain
large accounts and margin pressures in certain accounts.
Revenues in other operations increased significantly, reflecting the August 1997
acquisition of Certified Systems, Inc. (CSI) which added approximately $155
million in revenue and minimal profits after acquisition-related costs. CSI is a
professional employer organization that provides clients with administrative
processing of payroll, workers' compensation insurance, health insurance,
unemployment insurance, and other employee benefit plans. Other operations
primarily include CSI and Diversified Health Services. Pro forma net income
reflects the additional interest expense incurred at the parent level relating
to the WMX share repurchase.
On a consolidated basis, cost of services rendered and products sold increased
14 percent and decreased slightly as a percentage of revenue to 77.2 percent in
1997 from 77.5 percent in 1996. This reflects the changing mix of the enterprise
as Consumer Services increased in size relative to the overall business of the
Company. The Consumer Services unit operates at a higher gross profit margin
than the Management Services business unit, but incurs relatively higher levels
of selling and administrative costs. However, much of this reduction in cost of
goods sold was offset by the acquisition of CSI, which operates at significantly
lower gross margins than the Company's other businesses. Without CSI, cost of
goods sold would have been 76.5 percent of revenue in 1997.
27
Consolidated selling and administrative expenses increased 16 percent over the
prior year, and as a percentage of revenue, increased from 13.9 percent in 1996
to 14.1 percent in 1997, reflecting the changing business mix of the Company
described above.
Interest expense increased over the prior year primarily due to increased debt
levels associated with the repurchase of shares previously held by WMX and
acquisitions.
Interest and investment income increased over the prior
year due to growth in, and strong returns from, the investment portfolio at
American Home Shield, as well as a gain associated with the sale of an interest
in an international joint venture.
Minority interest expense decreased due to the repurchase of minority ownership
interests in subsidiary entities.
1998 Financial Position
The Company reported a nine percent increase in cash flows from operations to
$406 million and a two percent increase in free operating cash flows (defined as
cash flows from operations less net property additions) to $337 million. Cash
flows grew at a lower rate than net income, primarily due to the acceleration of
customer prepayments at TruGreen-ChemLawn into 1997, the full year funding of
preseason investments for Barefoot, and the timing of interest payments. Free
operating cash flow represents the cash available for enhancing shareholder
value (e.g., acquisitions, dividends and share repurchases) after financing the
growth of existing business units. The Company's free operating cash flows have
consistently exceeded recurring net income as a result of relatively low working
capital and fixed asset requirements, combined with the effects of noncash
charges for depreciation and amortization.
In the first year following reincorporation, the Company was able to defer the
payment of its federal taxes until March 1999. At that time the Company will pay
its 1998 obligation and will begin making estimated payments for its 1999
liability. Reported cash from operations reflects the deferral of this 1998 tax
payment which is approximately $83 million. Since the Company is able to defer
its 1998 tax payment, the cash flow is fairly comparable to last year when the
Company was in partnership form and paid no federal taxes. As a result of the
reincorporation, the Company also recognized a step-up in the tax basis of its
assets, which is being amortized against taxable income. The step-up resulted in
a reduction of the Company's cash tax payments in excess of $25 million per
annum for the current year and for the ensuing 14 years.
Cash and marketable securities totaled approximately $120 million at December
31, 1998. Debt levels decreased, reflecting the use of proceeds from the May
1998 equity offering to pay down debt, as well as strong cash from operations
partially offset by acquisitions, capital spending and distributions. The
Company is a party to a number of long-term debt agreements which require it to
comply 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 addition,
the Company had $700 million of unused commitment on its revolving bank facility
at December 31, 1998. Management believes that funds generated from operations
and other existing financial resources will continue to be adequate to satisfy
the ongoing operating needs of the Company.
During the year, the Company filed a Form S-3 registration statement and 21.2
million Company shares were sold at $19.17 per share. This included
approximately 11.4 million of newly-issued shares from the Company and 9.8
million shares sold by existing shareholders. The net proceeds to the Company
after the underwriting discount and offering expenses were approximately $209
million and were used to reduce outstanding debt under existing bank credit
facilities, thereby reducing interest expense and increasing the Company's
financial flexibility.
ServiceMaster also filed a Form S-1 shelf registration statement to issue up to
5.3 million shares of common stock in connection with future unidentified
acquisitions. As of December 31, 1998, approximately 3.5 million shares had been
issued with 1.8 million shares remaining available for future acquisitions.
28
In February 1998, the Company also completed a $300 million senior unsecured
dual-tranche debt offering. The offering consisted of $150 million at 7.10
percent due March 1, 2018 and $150 million at 7.25 percent due March 1, 2038.
The net proceeds were used to refinance borrowings under bank credit facilities,
reducing the Company's exposure to short-term interest rate fluctuations.
The Company completed a number of acquisitions in 1998, which included primarily
lawn care, commercial landscape and pest control companies. Three of the largest
transactions were Rescue Industries, Inc., National Britannia and Ruppert
Landscape Company. Rescue Industries, Inc., which operates under the trade name
Rescue Rooter, was acquired in January 1998 and is one of the largest companies
in America specializing in plumbing and drain cleaning services. The October
1998 acquisition of National Britannia, the third largest pest control company
in the United Kingdom, further strengthens the company's ability to grow its
Terminix business in Europe and continues the strategy of the enterprise to
expand internationally. Ruppert Landscape Company was purchased in August 1998
and represents one of the Mid-Atlantic's largest commercial landscape companies.
In March 1999, the Company is expected to complete the acquisition of LandCare
USA, Inc. (LandCare) in a stock-for-stock merger. The acquisition of LandCare,
one of the nation's leading commercial landscape companies, will significantly
broaden the Company's landscape initiative and will provide TruGreen-ChemLawn
the opportunity to fully integrate its traditional fertilizer and weed control
services with landscape maintenance and installation.
Accounts receivable increased, reflecting general business growth and
acquisitions. Property and equipment increased primarily due to investments in
computer systems and technology upgrades throughout the enterprise as well as
general business growth. The Company does not have any material capital
commitments at this time. The increase in intangible assets reflects the above
mentioned acquisitions as well as various commercial landscape companies and
other smaller companies.
Accounts payable and other accrued liabilities increased due to general business
growth and the effects of acquisitions. As previously discussed, there is a
significant current liability relating to the income taxes payable on 1998
earnings. Deferred revenues increased primarily as a result of strong growth in
warranty contracts written at American Home Shield.
Total shareholders' equity increased to $956 million in 1998 from $524 million
at December 31, 1997, reflecting the May 1998 equity offering, strong growth in
earnings and shares issued for acquisitions, partially offset by shareholder
distributions. 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.
At year end, the aggregate market value of the Company's outstanding shares
exceeded $6.5 billion. ServiceMaster shareholders have experienced compounded
total returns exceeding 20 percent annually over the last three-, 10- and
20-year periods.
Cash distributions paid directly to shareholders totaled $96 million, or $.33
per share, a six percent per share increase over the prior year. The total
amount of cash distributions, including payments made to the shareholders' trust
described below, decreased 52 percent from the prior year, reflecting a
substantial reduction in payments to the shareholders' trust, partially offset
by the six percent increase in direct shareholder distributions.
The shareholders' trust was established for the benefit of Partnership
shareholders. Each year, the trust was allocated a portion of the Partnership's
taxable income and received cash payments in amounts sufficient to pay its
income tax obligations resulting from this income allocation. Cash distributions
made to the trust in 1997 totaled $65 million. The trust was terminated upon
reincorporation and had no residual resources. In 1998, it received
approximately $20 million in tax refunds relating to its final 1997 tax return.
Several years ago, the Company adopted a pattern of annual increases in
dividends to shareholders for the remaining term of the Partnership. In
corporate form, the Company has increased, and expects to continue to increase,
its dividend payment each year. The timing and amount of future dividend
increases will be at the discretion of the Board of Directors and will depend
on, among other things, the Company's corporate finance objectives and cash
requirements. The Company has announced its intended cash dividends for 1999 of
$.36 per share.
29
Earnings before interest, taxes, depreciation and amortization (EBITDA) is a
commonly-used supplemental measurement of a company's ability to generate cash
flow and is used by many of the Company's investors and lenders. Management
believes that EBITDA is another measure which demonstrates the exceptional
cash-generating abilities of the Company's businesses. EBITDA in 1998 of $516
million has grown 16 percent, comparable to the growth in net income. EBITDA
should not be considered an alternative to net income in measuring the Company's
performance, or be used as an exclusive measure of cash flow because it does not
consider the impact of working capital growth, capital expenditures, debt
principal reductions or other sources and uses of cash which are disclosed in
the Consolidated Statements of Cash Flows.
Year 2000 Status
Year 2000 Compliance. Certain computer programs use two digits rather than four
to define the applicable year, and consequently may not function properly beyond
the year 1999 unless they are remediated. In addition, some computer programs
are unable to recognize the year 2000 as a leap year. These problems may also
exist in chips embedded in various types of equipment. The Company has long been
aware of this Year 2000 (Y2K) problem. The Company is dealing with the Y2K
problem in part through system upgrades, which were planned to occur in the
normal course of business. In other cases, the Company has put programs into
place which the Company believes will result in the completion of necessary
remediation efforts prior to the year 2000.
State of Readiness. The Company has initiated a program (the "Y2K program") to
address Y2K issues as they affect the Company's information technology (IT)
systems, electronic data interfaces and its non-IT hardware. The Y2K program was
set up to use the following steps as appropriate: inventory, assessment,
planning, renovation, testing and implementation. In addition, the program calls
for inquiries of the Company's major suppliers of goods and services to
determine their Y2K status and a review of the Company's relationships with its
customers to determine if the Company has any responsibility for the status of
the customers' IT and/or non-IT systems and hardware.
In 1998, the Company began to monitor its progress on the Y2K program on a
consolidated basis and completed an inventory which covered both IT and non-IT
items for all operating companies and administrative units within the
ServiceMaster enterprise. All items in the inventory were placed in one of four
categories: mission critical, critical, important and ordinary within the
context of the operating company or administrative unit involved. (A "mission
critical" or "critical" designation for an item within an operating company or
administrative unit does not necessarily hold the same level of criticality from
the perspective of the entire ServiceMaster enterprise).
Remediation plans have been developed for the mission critical and critical
matters, with milestones established for each plan which enable management to
measure the progress made in respect of a plan against the work schedule
established for that plan. Although these plans encompass many separately
identifiable items, from a ServiceMaster enterprise standpoint, there are nine
projects (the "Key Projects") which management has identified as either mission
critical or critical and which will require a measurable amount of attention to
remediate. Although all of the Key Projects are scheduled for completion before
the end of the year 1999, most of the Key Projects are scheduled for completion
by June 30, 1999. As of February 28, 1999, work on each of the Key Projects was
on schedule and the Company believes that all Key Projects will be completed in
accordance with their scheduled completion dates.
The Company has utilized the services of an outside consultant for the Y2K
program to help identify Y2K issues and to develop a system to closely monitor
remediation work. In early 1998, the Company established a Y2K committee in the
parent unit with responsibility for monitoring the Y2K program in each of the
Company's operating units and for providing status reports to the Board of
Directors.
Year 2000 Costs. Several of the Key Projects are upgrades of systems which the
Company would have undertaken irrespective of the Y2K problem. In some cases,
including a new accounting and financial reporting system for the parent company
and its Management Services subsidiary, work on these systems has been
accelerated in view of Y2K issues. Other upgrades or new systems were already
scheduled for completion prior to the year 2000, such as a new support system
for the Company's American Home Shield subsidiary and a new accounting and
billing system for the recently- developed commercial landscape business within
the Company's TruGreen-ChemLawn subsidiary. References to "Year 2000 costs" in
this report do not include the costs of projects for which no acceleration is
occurring due to Y2K issues.
30
The Company's Year 2000 costs to date are not material to the Company's results
of operations or financial position and the Company does not expect its future
Year 2000 costs to be material to the Company's results of operations or
financial position. All Year 2000 costs (as well as the costs of installing the
system upgrades referred to above) have been, and are expected to continue to
be, funded with cash from operations.
Year 2000 Risks. The Company believes that its greatest Year 2000 compliance
risk, in terms of magnitude of risk, is that key third party suppliers of goods
or services may fail to complete their own remediation efforts in a timely
manner and thereby provoke an interruption in the ability of one or more of the
operating segments of the Company to provide uninterrupted services to their
customers. Utility services (electrical, water and gas), telephone service,
banking services and, to a much lesser degree, the delivery of chemical products
are the critical items in this regard. Based on the Company's inquiries to its
providers of goods and services and on the basis of the Company's general
knowledge of the state of readiness of the utility companies and banks with
which it does business, the Company does not expect to suffer any material
interruption in the services on which the Company depends.
The Company has reviewed its agreements with its customers, including
particularly the customers of its Management Services units for whom such units
provide facility management services. The Company is satisfied that it is not
responsible, contractually or otherwise, for the Y2K readiness of the customers'
IT and non-IT systems and hardware, and the Company is in the process of
notifying all of its customers to this effect where, in the Company's judgment,
the nature of the customers' business or facility warranted such notices.
Where the Company uses its own software in the course of providing management
services, the Company is responsible to make such software Y2K compliant. The
Company is confident that such software is already, or soon will be, Y2K
compliant. For those units of the Company which sell franchises and which
provide software to the franchisees, such software is already, or soon will be,
fully Y2K compliant or, alternatively, provision has been made for making
available to franchisees software from third-party developers from whom
appropriate Y2K compliance assurances have been or will be received.
Contingency Plans. At this time, the Company fully expects all of its internal
key IT and non-IT systems to be Y2K compliant well in advance of the end of the
year 1999. If it appears that timely delivery of any Key Projects becomes
questionable, the Company will immediately develop appropriate contingency
plans.
The Company presently expects that its significant providers of goods and
services are or will be Y2K compliant by the end of the year 1999. The Company
will continue to make inquiries of its key suppliers for the purpose of testing
this expectation. Insofar as the Company is exposed to risks originating in Y2K
problems at key suppliers, the Company will utilize short-term solutions, but no
practical long-term contingency plans for these external Y2K problems are
possible.
Although the Company believes that critical remediation efforts will be
completed prior to the Year 2000, the untimely completion of these efforts
could, in certain circumstances, have a material adverse effect on the
operations of the Company.
IN ACCORDANCE WITH THE PRIVATE SECURITIES LITIGATION REFORM ACT OF 1995, THE
COMPANY NOTES THAT STATEMENTS THAT LOOK FORWARD IN TIME, WHICH INCLUDE
EVERYTHING OTHER THAN HISTORICAL INFORMATION, INVOLVE RISKS AND UNCERTAINTIES
THAT MAY AFFECT THE COMPANY'S ACTUAL RESULTS OF OPERATIONS. FACTORS WHICH COULD
CAUSE ACTUAL RESULTS TO DIFFER MATERIALLY INCLUDE THE FOLLOWING (AMONG OTHERS):
WEATHER CONDITIONS ADVERSE TO CERTAIN OF THE COMPANY'S CONSUMER SERVICES
BUSINESSES, LABOR SHORTAGES, THE ENTRY OF ADDITIONAL COMPETITORS IN ANY OF THE
MARKETS SERVED BY THE COMPANY, CONSOLIDATION OF HOSPITALS IN THE HEALTHCARE
MARKET, THE CONDITION OF THE U.S. ECONOMY, THE INABILITY OF KEY SUPPLIERS TO
ACHIEVE TIMELY Y2K COMPLIANCE IN THEIR DELIVERY SYSTEMS OR THE INABILITY OF THE
COMPANY TO MAKE ITS OWN SYSTEMS Y2K COMPLIANT, AND OTHER FACTORS LISTED FROM
TIME TO TIME IN THE COMPANY'S FILINGS WITH THE SECURITIES AND EXCHANGE
COMMISSION.
31
Eleven Year Financial Summary
(In thousands, except per share and percentage data)
All share and per share data reflect the three-for-two share splits in
1998, 1997, 1996, 1993 and 1992.
1998 1997 1996
Operating Results:
Operating revenue . . . . $4,724,119 $3,961,502 $3,458,328
Cost of services rendered
and products sold . . 3,679,612 3,058,160 2,681,008
Selling and administrative
expenses . . . . . . 648,085 559,409 482,102
Operating income(2) . . . 396,422 343,933 295,218
Percentage of operating
revenue . . . . . . . 8.4% 8.7% 8.5%
Non-operating expense . . 77,644 69,654 42,821
Provision for income
taxes(1) . . . . . . 128,786 110,809 101,968
Net income (pro forma
prior to 1998)(1),(2) $189,992 $163,470 $150,429
Percentage of operating
revenue . . . . . . . 4.0% 4.1% 4.3%
Earnings per share (pro
forma prior to 1998):(1),(2)
Basic . . . . . . . . $0.66 $0.57 $0.47
Diluted . . . . . . . $0.64 $0.55 $0.46
Shares used to compute
basic net income
per share . . . . . . 289,315 285,944 317,381
Shares used to compute
diluted net income
per share . . . . . . 298,887 299,640 330,429
Cash distributions per
share . . . . . . . . $0.33 $0.31 $0.29
Share price range:
High price . . . . . . $25.50 $19.67 $11.83
Low price . . . . . . . $16.00 $10.92 $8.61
Financial Position (at year end):
Current assets . . . . . $670,202 $594,084 $499,334
Current liabilities . . 753,697 558,177 425,552
Working capital . . . . (83,495) 35,907 73,782
Current ratio . . . . . .9-1 1.1-1 1.2-1
Total assets . . . . . . $2,914,851 $2,475,224 $1,846,841
Non-current liabilities. 1,204,668 1,392,609 607,614
Minority interest/
Deferred gain . . . --- --- 16,908
Shareholders' equity . . 956,486 524,438 796,767
Percentage return on
weighted-average
shareholders' equity 25% 26% 19%
Shares outstanding, net
of treasury shares . 298,030 279,944 320,396
(1) The Company converted from partnership to corporate form in a tax-free
exchange for shareholders on December 26, 1997. Prior to the conversion, the
Partnership was not subject to federal income taxes as its taxable income was
allocated to the Company's shareholders. As a result of the conversion, the
Company is a taxable entity and is responsible for such payments. The results
shown above for the years ended December 31, 1997 and before have been restated
to adjust the actual historical partnership information to a pro forma basis
that assumes that reincorporation had occurred as of the beginning of that year.
The pro forma provision for income taxes has been calculated assuming that the
Corporation's effective tax rate had been approximately 40 percent of pretax
earnings. Actual historical net income per share as a partnership for the four
prior periods was as follows:
1997 (a) 1996 1995 1994
Net Income $264,076 $245,140 $172,019 $139,883
EPS: Basic $.92 $.77 $.66 $.55
Diluted $.89 $.75 $.64 $.53
(a) Including the one-time tax gain related to reincorporation, net income was
$329,076 and basic and diluted earnings per share were $1.15 and $1.10
respectively.
32
1995 1994 1993 1992 1991 1990 1989 1988
$3,202,504 $2,985,207 $2,758,859 $2,488,854 $2,109,941 $1,825,750 $1,609,267 $1,531,276
2,499,700 2,356,435 2,192,684 2,021,010 1,762,700 1,545,527 1,387,448 1,327,128
450,937 414,746 393,131 326,477 225,814 177,941 129,035 118,275
251,867 214,026 173,044 141,367 121,427 102,282 92,784 85,873
7.9% 7.2% 6.3% 5.7% 5.8% 5.6% 5.8% 5.6%
74,260 71,388 55,151 45,740 39,860 30,397 24,016 21,247
71,753 57,626 47,629 38,633 32,953 29,042 27,782 26,109
$105,854 $85,012 $70,264 $56,994 $48,614 $42,843 $40,986 $38,517
3.3% 2.8% 2.5% 2.3% 2.3% 2.3% 2.5% 2.5%
$0.41 $0.33 $0.28 $0.23 $0.20 $0.18 $0.17 $0.16
$0.39 $0.32 $0.27 $0.22 $0.20 $0.18 $0.17 $0.16
260,382 255,650 253,919 249,828 240,276 239,730 245,058 240,290
273,203 266,892 266,231 262,941 252,579 243,038 249,219 245,658
$0.28 $0.27 $0.26 $0.26 $0.25 $0.24 $0.23 $0.22
$9.00 $8.41 $9.19 $5.90 $5.13 $3.13 $3.19 $3.71
$6.37 $6.37 $5.22 $4.35 $2.89 $2.60 $2.78 $2.93
$393,239 $331,045 $291,325 $257,542 $217,517 $237,262 $219,661 $203,925
372,930 304,395 244,552 206,755 157,458 158,046 135,375 76,908
20,309 26,650 46,773 50,787 60,059 79,216 84,286 127,017
1.1-1 1.1-1 1.2-1 1.2-1 1.4-1 1.5-1 1.6-1 2.7-1
$1,649,890 $1,230,839 $1,122,461 $1,005,531 $843,660 $796,935 $593,693 $485,492
517,603 483,906 471,177 511,211 376,638 372,052 410,056 346,970
12,697 135,272 117,513 77,906 187,583 170,831 9,174 10,186
746,660 307,266 289,219 209,659 121,981 96,006 39,088 51,428
24% 28% 28% 33% 45% 80% 84% 81%
321,341 256,419 257,901 255,386 243,527 242,939 230,396 236,966
(2) In the above presentation, the operating results in the years from 1990
through 1993 have been stated to exclude gains on issuance of subsidiary shares,
restructuring and unusual charges and the change in accounting for
postretirement benefits. The results, on a basis which includes these items, are
as follows:
1993 1992 1991 1990
Operating income $173,044 $62,432 $121,427 $95,782
Pro forma corporate net income $88,263 $73,486 $52,095 $50,889
EPS: Basic $0.35 $0.29 $0.22 $0.21
Diluted $0.34 $0.28 $0.21 $0.21
33
Notes to the Consolidated Financial Statements
Summary of Significant Accounting Policies
BASIS OF CONSOLIDATION: 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 in consolidation. Investments in
unconsolidated subsidiaries representing ownership of at least 20 percent, but
less than 50 percent, are accounted for under the equity method. Certain
immaterial 1997 and 1996 amounts have been reclassified to conform with the 1998
presentation. The preparation of the consolidated financial statements requires
management to make certain estimates and assumptions required under generally
accepted accounting principles which may differ from the actual results.
REVENUES: Revenues from lawn care, termite, pest control, and plumbing services
are recognized as the services are provided. Revenues from franchised services
(which in aggregate represent less than 10 percent of consolidated totals)
consist of initial franchise fees received from the sales of licenses, sales of
products to franchisees, and continuing monthly fees based upon franchise
revenue.
Home warranty contract fees are recognized as revenues ratably over the life of
the contract while the contract costs are expensed as incurred.
Revenues from management services are recognized as services are rendered and
consist of contract fees which reflect the total price of such services. Where
the Company principally manages people who are employees of the facility, the
payroll costs for such employees are recognized by the Company and included in
"Cost of services rendered and products sold" in the Consolidated Statements of
Income. Receivables from the facilities are reflected in the Consolidated
Statements of Financial Position at the net amount due, after deducting from the
contract price all amounts chargeable to the Company. Revenues from the
professional employer organization (PEO) are recognized as the services are
rendered. Consistent with PEO industry practice, revenues include the gross
amount billed to clients, which includes payroll and other direct costs.
INVENTORY VALUATION: Inventories are valued at the lower of cost (first-in,
first-out basis) or market. Inventory costs include material, labor, and factory
overhead and related handling costs. Raw materials represent less than three
percent of the inventory value at December 31, 1998. 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. Intangible
assets consist primarily of trade names ($177 million) and goodwill ($1.7
billion). These assets are amortized on a straight-line basis over their
estimated useful lives, which are predominately 40 years. Long-lived assets,
including fixed assets and intangible assets, are periodically reviewed to
determine recoverability by comparing their carrying values to the undiscounted
future cash flows expected to be realized from their use. No recovery problems,
other than that noted in the discontinued Home Health Care operations, have been
indicated by these comparisons. Based on the reviews, if the undiscounted future
cash flows 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.
INCOME TAXES: The Company accounts for income taxes under the Statement of
Financial Accounting Standards No. 109, "Accounting for Income Taxes." This
statement utilizes an asset and liability approach that requires the recognition
of deferred tax assets and liabilities for the expected future tax 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. Shares potentially issuable
under options have been considered outstanding for purposes of the diluted
earnings per share calculation.
NEWLY-ISSUED ACCOUNTING STATEMENTS AND POSITIONS: 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. The Company intends to
adopt these policies beginning in 1999 as required by the Statements. The
Company does not expect the adoption of these Statements to have a material
impact on the financial statements. Also in 1998, the Financial Accounting
Standards Board issued Statement of Financial Accounting Standards No. 133,
"Accounting for Derivative Instruments and Hedging Activities." The Company
intends to adopt this Statement in January 2000 as required by the Statement.
Adoption of this Statement is not expected to have a material impact on the
Company's financial statements.
34
Report of Independent Public Accountants
TO THE SHAREHOLDERS OF
THE SERVICEMASTER COMPANY
We have audited the accompanying consolidated statements of financial position
of THE SERVICEMASTER COMPANY (organized under the laws of the State of Delaware,
formerly ServiceMaster Limited Partnership) AND SUBSIDIARIES, as of December 31,
1998 and 1997, and the related consolidated statements of income, shareholders'
equity, and cash flows for each of the three years in the period ended December
31, 1998. 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
generally accepted auditing standards. 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, the consolidated financial statements referred to above present
fairly, in all material respects, the financial position of The ServiceMaster
Company and Subsidiaries as of December 31, 1998 and 1997, and the consolidated
results of operations and cash flows for each of the three years in the period
ended December 31, 1998, in conformity with generally accepted accounting
principles.
ARTHUR ANDERSEN LLP
Chicago, Illinois
January 25, 1999
35
Statements of Income
Years Ended December 31,
(In thousands, except per share data)
1998 1997 1996
Operating Revenue . . . . . $4,724,119 $3,961,502 $3,458,328
Operating Costs and Expenses:
Cost of services rendered
and products sold . . . 3,679,612 3,058,160 2,681,008
Selling and administrative
expenses . . . . . . . 648,085 559,409 482,102
Total operating costs and
expenses . . . . . . . 4,327,697 3,617,569 3,163,110
Operating Income . . . . . 396,422 343,933 295,218
Non-operating Expense (Income):
Interest expense . . . . . 92,945 76,447 38,298
Interest and investment
income . . . . . . . . (15,301) (14,304) (10,183)
Minority interest . . . . . --- 7,511 14,706
Income before Income
Taxes . . . . . . . . . 318,778 274,279 252,397
Provision for income taxes
(pro forma corporate
form in 1997 and 1996)(1) . 128,786 110,809 101,968
Net Income (pro forma
corporate form in 1997
and 1996)(1) . . . . . $189,992 $163,470 $150,429
Per Share (pro forma
corporate form in 1997
and 1996):(1), (2)
Basic . . . . . . . . . . $0.66 $0.57 $0.47
Diluted . . . . . . . . . $0.64 $0.55 $0.46
(1) The Company converted from partnership to corporate form in a tax-free
exchange for shareholders on December 26, 1997. Prior to the conversion, the
Partnership was not subject to federal income taxes as its taxable income was
allocated to the Company's shareholders. As a result of the conversion, the
Company is a taxable entity and is responsible for such payments. The results
shown above for the years ended December 31, 1997 and 1996 have been restated
to adjust the actual historical partnership information to a pro forma basis
that assumes that reincorporation had occurred as of the beginning of the
year. Upon reincorporation, the Company recognized a significant increase in
the tax basis of certain assets and recorded a $65 million tax gain related
to reincorporation, which represented the difference between the tax basis
and book value of its assets. The Company's historical net income and net
income per share as a partnership were as follows:
Before One-Time
--------------------
Tax Benefit Actual
-------------------- --------------------
Partnership Information as Recorded: 1997 1996 Earnings Per 1997 1996 1997 1996
Share:
----------- ----------- --------- --------- --------- ---------
Income before income $ 274,279 $252,397 Basic $.92 $.77 $1.15 $.77
taxes..........................
Partnership tax 10,203 7,257 Diluted $.89 $.75 $1.10 $.75
provision......................
Tax benefit relating to change in tax
status 65,000 -
=========== ===========
Net $ 329,076 $245,140
income.........................
=========== ===========
(2) Basic earnings per share are calculated based on 289,315 shares in
1998, 285,944 shares in 1997, and 317,381 shares in 1996, while diluted
earnings per share are calculated based on 298,887 shares in 1998, 299,640
shares in 1997, and 330,429 shares in 1996. All share and per share data
reflect the three-for-two share splits in August 1998, June 1997 and June
1996.
See accompanying Summary of Significant Accounting Policies and Notes
to the Consolidated Financial Statements.
36
Statements of Financial Position
As of December 31,
(In thousands)
1998 1997
Assets:
Current Assets:
Cash and cash equivalents . . . . . $ 66,400 $ 64,876
Marketable securities . . . . . . . 54,022 59,248
Receivables, less allowances of
$38,988 in 1998 and $32,22
in 1997 . . . . . . . . . . . . 372,375 299,138
Inventories . . . . . . . . . . . . 49,770 48,157
Prepaid expenses and other assets . 127,635 122,665
Total current assets . . . . . . . 670,202 594,084
Property, Plant, and Equipment, at Cost:
Land and buildings . . . . . . . . 53,068 46,632
Equipment . . . . . . . . . . . . . 388,141 316,021
441,209 362,653
Less: accumulated depreciation . . 229,049 204,383
Net property, plant, and equipment. 212,160 158,270
Other Assets:
Intangible assets, primarily trade names and goodwill, less accumulated
amortization of $272,254 in 1998 and $218,293
in 1997 . . . . . . . . . . . 1,884,002 1,563,309
Notes receivable, long-term
securities, and other assets . 148,487 159,561
Total Assets . . . . . . . . . . . $ 2,914,851 $2,475,224
Liabilities and Shareholders' Equity:
Current Liabilities:
Accounts payable . . . . . . . . . $ 110,523 $ 84,673
Accrued liabilities:
Payroll and related expenses . . 96,199 85,315
Insurance and related expenses . 56,748 55,909
Income taxes payable . . . . . . 84,165 8,423
Other . . . . . . . . . . . . . . 149,477 121,020
Deferred revenues . . . . . . . . . 204,969 181,298
Current portion of long-term debt . 51,616 21,539
Total current liabilities . . . . . 753,697 558,177
Long-Term Debt . . . . . . . . . . 1,076,167 1,247,845
Other Long-Term Obligations . . . . 128,501 144,764
Commitments and Contingencies (see Notes)
Shareholders' Equity:
Common stock $0.01 par value, authorized 1 billion shares; issued and
outstanding of 298,030 shares in 1998 and
279,944 shares in 1997 . . . . . 2,980 2,799
Additional paid-in capital . . . . . 788,124 513,148
Retained earnings . . . . . . . . . 179,840 65,000
Accumulated other comprehensive
income . . . . . . . . . . . . . 3,911 5,343
Restricted stock . . . . . . . . . . (3,383) (4,270)
Treasury stock . . . . . . . . . . . (14,986) (57,582)
Total shareholders' equity . . . . . 956,486 524,438
Total Liabilities and Shareholders'
Equity . . . . . . . . . . . . . $ 2,914,851 $2,475,224
See accompanying Summary of Significant Accounting Policies and Notes
to the Consolidated Financial Statements.
37
Statements of Cash Flows
Years Ended December 31,
(In thousands)
1998 1997 1996
Cash and Cash Equivalents
at January 1 . . . . . . $64,876 $72,009 $23,113
Cash Flows from Operations:
Net Income . . . . . . . . . 189,992 329,076 245,140
Adjustments to reconcile net income to net cash provided from
operations:
Depreciation . . . . . . 50,644 45,392 41,658
Amortization . . . . . . 53,961 47,670 37,348
Tax asset recorded upon
reincorporation . . --- (65,000) ---
Change in working capital,
net of acquisitions:
Receivables . . . . . . (46,205) (6,853) (19,084)
Inventories and other
current assets . . (2,360) (14,210) (12,666)
Accounts payable . . . . 18,475 5,603 10,302
Deferred revenues . . . 22,033 30,012 17,602
Deferred 1998 tax
payment . . . . . 83,000 --- ---
Deferred income tax
expense . . . . . . 36,400 --- ---
Accrued liabilities . . (2,028) (82) 13,140
Other, net . . . . . . . . 1,627 281 7,946
Net Cash Provided from
Operations . . . . . . . 405,539 371,889 341,386
Cash Flows from Investing Activities:
Property additions . . . . (75,297) (46,232) (42,952)
Sale of equipment and
other assets . . . . . . 6,941 4,134 2,664
Business acquisitions, net
of cash acquired . . . . (222,452) (233,689) (58,473)
Proceeds from sale of
businesses . . . . . . . 45,893 --- 4,526
Net purchases of investment
securities . . . . . . . (11,011) (16,753) (20,075)
Notes receivable and
financial investments . (10,645) (3,593) 3,304
Payments to sellers of
acquired businesses . . (10,271) (4,723) (3,742)
Net Cash Used for Investing
Activities . . . . . . . (276,842) (300,856) (114,748)
Cash Flows from Financing Activities:
Borrowings, net . . . . . 310,190 888,528 123,732
Payment of borrowings and
other obligations . . . (564,448) (160,155) (82,857)
Proceeds from stock
offering . . . . . . . . 208,561 --- ---
Distributions to
shareholders and
shareholders' trust . . (75,152) (155,883) (146,520)
Purchase of ServiceMaster
stock . . . . . . . . . (18,310) (657,191) (76,556)
Proceeds from employee
share plans . . . . . . 12,638 6,526 6,835
Distributions to holders
of minority interests . --- (542) (3,074)
Other . . . . . . . . . . (652) 551 698
Net Cash Used for Financing
Activities . . . . . . . (127,173) (78,166) (177,742)
Cash Increase (Decrease)
During the Year . . . . 1,524 (7,133) 48,896
Cash and Cash Equivalents at
December 31 . . . . . . $66,400 $64,876 $72,009
See accompanying Summary of Significant Accounting Policies and Notes
to the Consolidated Financial Statements.
38
Statements of Shareholders' Equity
Corporate Equity
-----------------------------
Additional Limited Accumulated
Common Paid-in Retained Partners' Comprehensive Treasury Restricted Total
(In thousands) Stock Capital Earnings Equity Income Stock Stock Equity
- ------------------------------------ -------- --------- -------- -------- ---------- -------- --------- -------
Balance, December 31, 1995 . . $ --- $ --- $ --- $761,710 $5,904 $(13,405) $(7,549) $746,660
Net income 1996 . . . . . . . 245,140 245,140
Other comprehensive income,
net of tax:
Unrealized gains on
securities, net of
reclassification
adjustment . . . . . . . . 1,452 1,452
Foreign currency translation
($678 tax expense) . . . . (999) (999)
Total comprehensive income . . 245,140 453 245,593
Shareholder distributions . . (146,520) (146,520)
Shares issued under option,
subscription, grant plans
and other (3,667 shares) . (7,166) 2,506 1,691 (2,969)
Treasury shares purchased and
related costs (7,825
shares) . . . . . . . . . (76,556) (76,556)
Shares issued for acquisitions
(3,213 shares) . . . . . . 3,104 27,455 30,559
Balance, December 31, 1996 . . $ --- $ --- $ --- $856,268 $6,357 $(60,000) $(5,858) $796,767
Net income 1997 . . . . . . . 65,000 264,076 329,076
Other comprehensive income,
net of tax: Unrealized
gains on securities, net
of reclassification
adjustment . . . . . . . . 4,269 4,269
Foreign currency translation ($3,580 tax expense) (5,283) (5,283)
Total comprehensive income . . 65,000 264,076 (1,014) 328,062
Shareholder distributions . . (155,883) (155,883)
Shares issued under option,
debentures, grant plans
and other (6,552 shares) . 21,165 3,511 1,588 26,264
Treasury shares repurchased from WMX
(61,112 shares) . . . . . (625,978) (625,978)
Treasury shares purchased
and related costs
(2,051 shares) . . . . . . (31,213) (31,213)
Shares issued for the
acquisition of Barefoot
Inc. and other
acquisitions (16,161 shares) 156,299 30,120 186,419
Conversion to corporate form . 2,799 513,148 (515,947)
Balance, December 31, 1997 . . $2,799 $513,148 $65,000 $ --- $5,343 $(57,582) $(4,270) $524,438
Net income 1998 . . . . . . . 189,992 189,992
Other comprehensive income,
net of tax: Unrealized
gains on securities, net
of reclassification
adjustment . . . . . . . . (485) (485)
Foreign currency translation
($640 tax expense) (947) (947)
Total comprehensive income . . 189,992 (1,432) 188,560
Shareholder distributions . . (75,152) (75,152)
Shares issued in public
offering (11,400 shares) . 114 208,447 208,561
Shares issued under option,
debentures, grant plans
and other (2,514 shares) . 25 9,403 13,507 887 23,822
Treasury shares purchased and
related costs (888 shares) (9) (18,301) (18,310)
Shares issued for acquisitions
(5,059 shares) 51 57,126 47,390 104,567
Balance, December 31, 1998 . . $2,980 $788,124 $179,840 $ --- $3,911 $(14,986) $(3,383) $956,486
All share data reflect the three-for-two share splits in August 1998, June
1997 and June 1996.
Disclosure of reclassification amounts (net of tax) relating to
comprehensive income:
1998 1997 1996
Unrealized holding gains
arising in period . . . $ 3,295 $ 5,904 $ 2,795
Less: gains realized . . . (3,780) (1,635) (1,343)
Net unrealized gains on
securities . . . . . . $ (485) $ 4,269 $ 1,452
See accompanying Summary of Significant Accounting Policies and Notes
to the Consolidated Financial Statements.
39
Notes to the Consolidated Financial Statements
Business Unit Reporting
The business of the Company is primarily conducted through the ServiceMaster
Consumer Services and ServiceMaster Management Services operating units. In
accordance with Statement of Financial Accounting Standards No. 131, the
Company's reportable segments are strategic business segments that offer
different services. They are managed separately because each business requires
different technology and marketing strategies. The Consumer Services unit
provides a variety of specialty services to residential and commercial
customers. The Management Services unit provides a variety of supportive
management services to health care, education and commercial accounts. The
Company derives substantially all of its revenues from customers in the United
States with less than five percent generated in foreign markets.
The other operations group includes primarily ServiceMaster Employer Services, a
professional employer organization that provides clients with administrative
processing of payroll, workers' compensation insurance, health insurance,
unemployment insurance and other employee benefit plans, and Diversified Health
Services, which provides services and products to the long-term care industry.
In the previous year, Diversified Health Services was reflected in the
Management Services operating unit. It is now reflected in the other operations
group for all years. The Company has reclassified Diversified Health Services
into the other operations segment due to the unique nature of the services it
provides and the industry factors which affect its performance. It also operates
in a highly regulated industry and is managed separately from the other service
lines.
Information regarding the accounting policies used by the Company is described
in the Summary of Significant Accounting Policies. Operating expenses of the
business units consist primarily of direct costs and a royalty payable to Parent
based on the revenues or profits of the business unit.
Identifiable assets are those used in carrying out the operations of the
business unit and include intangible assets directly related to its operations.
The Company's headquarters facility and other investments are included in the
identifiable assets of other operations.
The following information prior to 1998 is presented on a pro forma basis as if
the Company had been a taxable corporation in all years and corporate taxes had
been allocated to the segments.
(In thousands)
Consumer Management Other
Services Services Operations Consolidated
------------ ------------- ----------- ------------
1998
Operating revenue . . . . . . . $2,048,185 $2,040,948 $634,986 $4,724,119
Operating income . . . . . . . 305,408 112,919 (21,905) 396,422
Net interest expense (income) . 42,259 (1,882) 37,267 77,644
Income before income taxes . . 263,149 114,801 (59,172) 318,778
Provision for income taxes . . 106,309 46,380 (23,903) 128,786
Net income . . . . . . . . . . $156,840 $68,421 $(35,269) $189,992
Net income, excluding unusual
items (Note) . . . . . . . $156,840 $45,774 $(12,622) $189,992
Identifiable assets . . . . . . $2,244,652 $237,924 $432,275 $2,914,851
Depreciation and amortization
expense . . . . . . . . . $71,369 $22,023 $11,213 $104,605
Capital expenditures . . . . . $36,206 $29,757 $9,334 $75,297
1997
Operating revenue . . . . . . . $1,662,519 $1,905,291 $393,692 $3,961,502
Operating income . . . . . . . 235,064 76,224 32,645 343,933
Net interest and non-operating
expense (income) . . . . . 27,740 (1,264) 43,178 69,654
Income before income taxes . . 207,324 77,488 (10,533) 274,279
Corporate provision for
income taxes . . . . . . . 83,759 31,304 (4,254) 110,809
Net income (pro forma
corporate form) . . . . . $123,565 $46,184 $(6,279) $163,470
Identifiable assets . . . . . . $1,783,186 $212,727 $479,311 $2,475,224
Depreciation and amortization
expense . . . . . . . . . $63,010 $21,315 $8,737 $93,062
Capital expenditures . . . . . $16,778 $21,232 $8,222 $46,232
1996
Operating revenue . . . . . . . $1,461,696 $1,816,953 $179,679 $3,458,328
Operating income . . . . . . . 185,895 75,577 33,746 295,218
Net interest and non-operating
expense . . . . . . . . . 14,233 276 28,312 42,821
Income before income taxes . . 171,662 75,301 5,434 252,397
Corporate provision for
income taxes . . . . . . . 69,352 30,422 2,194 101,968
Net income (pro forma
corporate form) . . . . . $102,310 $44,879 $3,240 $150,429
Identifiable assets . . . . . . $1,394,177 $236,038 $216,626 $1,846,841
Depreciation and amortization
expense. . . . . . . . . . $52,446 $21,304 $5,256 $79,006
Capital expenditures . . . . . $19,915 $17,852 $5,185 $42,952
Note: This line excludes the $38 million pretax gain in the Management Services
segment related to the formation of a strategic venture which acquired the
assets of ServiceMaster Energy Management and the pretax charges totaling $38
million in the Other Operations segment related primarily to the home health
care operations, which included a write-down for the impairment of assets and
costs relating to exiting customer arrangements.
40
Reincorporation
Most operations of ServiceMaster and its subsidiary partnerships were conducted
from 1986 through 1997 in partnership form, free of federal corporate income
tax. Had ServiceMaster remained a partnership, the Internal Revenue Code would
have imposed federal corporate tax on ServiceMaster operations beginning in
1998. In January 1992, in anticipation of this change, the Partnership's
shareholders approved a tax-free plan of reorganization to return to corporate
form.
The ServiceMaster Company was created as part of this plan. The reorganization
became effective December 26, 1997, and was structured as a merger in which The
ServiceMaster Company became the successor entity through which the public now
invests in ServiceMaster. (The terms "the Company" and "ServiceMaster" are used
to collectively refer to the Partnership and its successor corporation, The
ServiceMaster Company.) At the time of reincorporation, each outstanding limited
partnership share was converted into one share of $0.01 par value common stock.
No federal income taxes were imposed on the shareholders of the Partnership as a
result of the reincorporation.
Pro forma information has been presented in the accompanying financial
statements in order to compare the continuing results of operations as if the
Company had been a taxable entity in 1997 and 1996. The pro forma tax provision
has been calculated assuming that the Company's effective tax rate had been
approximately 40 percent of pretax earnings.
Prior to December 26, 1997, The ServiceMaster Limited Partnership held as its
only asset a 99 percent interest in the profits, losses and distributions of The
ServiceMaster Company Limited Partnership, which through subsidiaries owned and
operated the ServiceMaster business. The Managing General Partner was
ServiceMaster Management Corporation, which held a one percent interest in the
income of both Partnerships. As a result of the reorganization, The
ServiceMaster Company owns all of the general and limited partnership interests
in the Partnership. No payment or equity issuance was made to the Managing
General Partner in connection with the reorganization except for the payout of
any income allocated to its capital account prior to reincorporation.
Income Taxes
Prior to reincorporation at the end of 1997, most operations conducted by the
Company and its subsidiary partnerships were exempt from federal corporate
income tax since 1986. As a result of the reincorporation, the Company
recognized a step-up in the tax basis of its assets, which is being amortized
against taxable income. The step-up resulted in a reduction of the Company's
cash tax payments in excess of $25 million per annum for the current year and
for the ensuing 14 years.
The reconciliation of income tax for 1998 computed at the U.S. federal statutory
tax rate to the Company's effective income tax rate is as follows:
Tax at U.S. federal statutory rate . . . . . . . . . . . . . . . 35.0%
State and local income taxes,
net of U.S. federal benefit . . . . . . . . . . . . . . . . . 4.4%
Other . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1.0%
Effective rate . . . . . . . . . . . . . . . . . . . . . . . . . 40.4%
Income tax expense for 1998 consists of:
(In thousands) Current Deferred Total
- ----------------------- ------- -------- -------
U.S. federal. . . . . $76,646 $30,200 $106,846
State and local. . . . 15,740 6,200 21,940
------- -------- --------
$92,386 $36,400 $128,786
Deferred income tax expense of $36.4 million for the year ended December 31,
1998 results from timing differences in the recognition of income and expense
for income tax and financial reporting purposes.
Deferred income taxes reflect the net tax effects of temporary differences
between the carrying amounts of assets and liabilities for financial reporting
purposes and the amounts for income tax purposes. Management believes that,
based upon its lengthy and consistent history of profitable operations, it is
probable that the net deferred tax assets will be realized on future tax
returns, primarily from the generation of future taxable income. Significant
components of the Company's deferred tax assets are as follows:
(In thousands) 1998 1997
- ------------------------------ -------------- ---------------
Deferred tax assets (liabilities):
Current:
Prepaid expenses and other . . . . $(23,400) $(11,500)
Accounts receivable allowance . . . 7,400 12,000
Accrued insurance and
related expenses . . . . . . . . 24,100 18,000
Other accrued expenses . . . . . . 16,700 18,100
Long-Term:
Long-term assets . . . . . . . . . (500) 13,000
Insurance expenses . . . . . . . . 32,500 32,000
Other long-term obligations . . . . (11,600) ---
-------- --------
Net deferred tax assets . . . . . . $ 45,200 $ 81,600
There were no federal taxes paid in 1998 and approximately $5 million of state
tax payments were made in the year. In the first year of corporate form, the
Company was able to defer the remaining 1998 tax payments into 1999.
Acquisitions
Current Year -
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 market values as of the acquisition dates.
In 1998, the Company completed a number of acquisitions, including Rescue
Industries, Inc. (Rescue), Ruppert Landscape Company (Ruppert), National
Britannia and other lawn care, landscape and pest control businesses. Rescue,
which operates under the Rescue Rooter trade name, is one of the largest
plumbing and drain cleaning companies in America. Ruppert is one of the
Mid-Atlantic's largest commercial landscape companies. National Britannia, the
third largest pest control company in the United Kingdom, significantly
increases the international presence of Terminix. The aggregate fair market
value of the assets acquired less liabilities assumed for these acquisitions was
$139 million, which consisted almost entirely of intangible assets, primarily
goodwill. During the year, the
41
Company acquired a number of smaller companies primarily in the lawn care,
landscaping and pest control businesses. The aggregate fair market value of the
assets acquired less seller financed notes and liabilities assumed for these
purchases was $194 million, including approximately $249 million of goodwill.
On November 1, 1998, the Company entered into an agreement to acquire LandCare
USA, Inc., one of the leading commercial landscape companies in the country. The
transaction is expected to be consummated in March 1999.
Prior Years -
On February 24, 1997, the Company acquired Barefoot Inc., (Barefoot) the second
largest professional residential lawn care services company in the United
States. The Company paid approximately $237 million by issuing 12.9 million
shares and paying $91 million in cash in exchange for all of the Barefoot stock.
The excess of the consideration paid over the fair value of the Barefoot
business of $254 million was recorded as goodwill, which is being amortized on a
straight-line basis over 40 years.
During 1997, the Company made several smaller acquisitions which included
Certified Systems, Inc. one of the nation's largest professional employer
organizations, Orkin's lawn care and plantscaping division and a number of other
lawn care and pest control businesses. The Company also purchased the minority
interests of Management Services and Diversified Health Services for a
combination of cash and Company shares, totaling approximately $25 million. The
aggregate fair market value of the assets acquired less liabilities assumed for
these smaller acquisitions was $196 million, including approximately $267
million of intangible assets, primarily goodwill.
During 1996, the Company acquired Premier Manufacturing Support Services, a
provider of management services to the automotive industry, and several other
smaller companies, predominately pest control, lawn care and pharmacy management
businesses. The aggregate fair value of assets acquired less liabilities assumed
was $91 million, including approximately $96 million of intangible assets which
are being amortized on a straight-line basis over 40 years.
Supplemental cash flow information regarding the Company's acquisitions is as
follows:
(In thousands)
1998 1997 1996
-------- -------- --------
Fair value of assets acquired . . . . . . $465,380 $590,600 $134,377
Less liabilities assumed . . . . . . . . . (132,381) (157,741) (43,781)
-------- -------- --------
Net assets acquired . . . . . . . . . . . 332,999 432,859 90,596
Less shares issued . . . . . . . . . . . . (104,567) (186,419) (30,559)
Less cash acquired . . . . . . . . . . . . (5,980) (12,751) (1,564)
-------- ------- --------
Business acquisitions,
net of cash acquired . . . . . . . . . $222,452 $233,689 $58,473
Other Events
The Company formed a strategic venture with Texas Utilities Company for the
ownership and operation of the ServiceMaster Energy Management business. The new
venture acquired all of the assets of ServiceMaster Energy Management and is
owned 85 percent by Texas Utilities and 15 percent by ServiceMaster. This
transaction resulted in a pretax gain of $38 million.
In late 1998, the Company completed a strategic review of its Home Health Care
operations and concluded that, without significant investment, it could not
profitably provide high quality service in the future and continue to satisfy
all the changes and the requirements of new governmental reimbursement programs.
The Company has decided to sell its direct operations and is discontinuing its
outsourced management operation of home health care agencies. The Company will
continue to provide consulting services to hospitals and other providers of home
health care.
During the course of the Company's strategic review of its Home Health Care
operations, the Company assessed the recoverability of the carrying value of the
intangible assets and fixed assets which resulted in pretax impairment losses of
$13 million and $3 million, respectively. In accordance with Statement of
Financial Accounting Standards No. 121, these losses reflect the amounts by
which the carrying values of these assets exceed their estimated fair values
determined by their future discounted cash flows. In addition, the Company has
recorded a pretax charge of $8 million related to the costs associated with
exiting customer arrangements in the Home Health Care business. In response to
the impact that changes in governmental reimbursement programs have begun to
have on the financial condition of certain customers of the Home Health Care and
Diversified Health Services businesses, the Company increased its reserves for
accounts receivable by $8 million and $6 million, respectively.
Employee Benefit Plans
Contributions to qualified profit sharing plans were made in the amount of $9.9
million in 1998, $8.2 million in 1997, and $6.9 million in 1996. Under the
Employee Share Purchase Plan, the Company contributed $1.2 million in 1998, $1.1
million in 1997, and $1.0 million in 1996. These funds defrayed part of the cost
of the shares purchased by employees.
42
Long-Term Debt
Long-term debt includes the following:
(In thousands, except per share data)
1998 1997
---------- ----------
Notes Payable:
10.57%, maturing in 1999-2000 . . $18,000 $27,000
8.38%, maturing in 1999-2001 . . 30,000 40,000
10.81%, maturing in 2000-2002 . . 55,000 55,000
6.65%, maturing in 2002-2004 . . 70,000 70,000
7.40%, maturing in 2006 . . . . 125,000 125,000
6.95%, maturing in 2007 . . . . 100,000 100,000
7.10%, maturing in 2018 . . . . 150,000 ---
7.45%, maturing in 2027 . . . . 200,000 200,000
7.25%, maturing in 2038 . . . . 150,000 ---
6.00%, subordinated, convertible
at $5.53 per share . . . --- 3,581
Revolving credit facilities . . . . 50,000 550,000
International borrowings . . . . . 48,272 29,856
Other . . . . . . . . . . . . . . . 131,511 68,947
Less current portion . . . . . . . (51,616) (21,539)
Total long-term debt . . . . . . . $1,076,167 $1,247,845
The Company is party to a number of long-term debt agreements which require it
to comply with certain financial covenants, including limitations on
indebtedness, restricted payments, fixed charge coverage ratios and net worth.
The Company has been and currently is in compliance with the covenants related
to these debt agreements.
ServiceMaster filed a shelf registration statement with the Securities and
Exchange Commission for the sale of up to $950 million in unsecured senior debt
securities or equity interests in June 1997. As of year end, the Company had
$350 million of securities available for issuance under this shelf registration
statement. The first debt issuance from the shelf occurred in August 1997. It
included two tranches of debt totaling $300 million. The Company completed a
second $300 million dual-tranche offering of unsecured senior notes in February
1998, that consisted 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 of these
offerings reduced borrowings under bank credit facilities and thereby reduced
exposure to short-term interest rate fluctuations.
In May 1998, the Company filed a Form S-3 registration statement under which
11.4 million newly-issued shares were sold at $19.17 per share. The net proceeds
to the Company were approximately $209 million and were used to reduce
outstanding debt under existing bank credit facilities.
The Company has a committed revolving credit facility for up to $750 million
maturing in April 2002. The facility can be used for general Company purposes.
The revolving credit facility had $700 million of unused commitment as of
December 31, 1998.
The Company is exposed to interest rate fluctuations on its floating rate debt.
As of year end, the Company had approximately $100 million in 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 year end, the Company was not a party to any
interest rate swaps.
Cash interest payments were $88 million in 1998, $63 million in 1997, and $34
million in 1996. Average rates paid on the revolving credit facility were 5.9
percent in 1998, 6.0 percent in 1997 and 5.6 percent in 1996. Future scheduled
long-term debt payments are $51.6 million in 1999 (average rate of 4.2 percent),
$67.7 million in 2000 (average rate of 6.0 percent), $44.3 million in 2001
(average rate of 6.7 percent), $45.9 million in 2002 (average rate of 6.6
percent), and $34.8 million in 2003 (average rate of 5.4 percent). Notes payable
of $19 million due in 1999 are intended to be refinanced by the long term
revolving credit facility in 1999 and therefore are not included in the $51.6
million of current liabilities. The $50 million revolving credit facility
balance as of year end has not been included in the scheduled payments above as
the Company expects to extend the revolving credit facility beyond 2003.
Based upon the borrowing rates currently available to the Company for long-term
borrowings with similar terms and maturities, the fair value of long-term debt
is approximately $1.1 billion.
Future long-term noncancelable operating lease payments are $33.4 million in
1999, $25.5 million in 2000, $17.9 million in 2001, $11.3 million in 2002, $6.6
million in 2003, and $7.4 million thereafter. Rental expense for 1998, 1997, and
1996 was $103.8 million, $83.9 million, and $74.8 million, respectively.
The Company maintains an $80 million operating lease facility with a bank which
provides 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 lease up to 82 percent of the fair market value at the commencement of the
lease. The Company does not expect to be required to make residual value
payments and therefore, no amounts have been included in the future payments
above. At December 31, 1998, approximately $38 million was funded under this
facility.
Cash and Marketable Securities
Marketable securities held at December 31, 1998 and 1997, with a maturity 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. Marketable
securities available for current operations are classified as current assets
while securities held for noncurrent uses are classified as long-term. The
Company's investments consist primarily of publicly-traded debt and common
equity securities. As of December 31, 1998, the aggregate market value of the
Company's short- and long-term investments in debt and equity securities was $97
million and the aggregate cost basis was $84 million. In 1998, the Company
entered into a hedging arrangement in a notional amount of $40 million expiring
November 1999, designed to protect its equity portfolio against a decline in the
equity market. This arrangement, which is
43
linked to the Standard & Poor's 500 Index, provides protection for a market
decline of up to 15 percent, while it caps the potential appreciation at 15
percent. At year end, the fair market value of this arrangement was an
immaterial net liability to the Company. There was no participation in the
trading of derivative securities in 1998 or 1997.
Interest and dividend income received on cash and marketable securities was $8.9
million, $8.3 million and $8.0 million, in 1998, 1997 and 1996, 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.
Comprehensive Income
The Company adopted Statement of Financial Accounting Standards No. 130,
"Reporting Comprehensive Income," which requires the reporting of all changes in
equity during a period, except those resulting from investment by owners and
distribution to owners. The Company has chosen to disclose Comprehensive Income,
which encompasses net income, unrealized gains on marketable securities, and the
effect of foreign currency translation, in the Statement of Shareholders'
Equity.
1998 1997 1996
--------- -------- --------
Unrealized holding gains
arising in period . . . . . . . . . $5,529 $9,908 $4,690
Tax expense . . . . . . . . . . . . . 2,234 4,004 1,895
Net of tax amount . . . . . . . . . . $3,295 $5,904 $2,795
Gains realized . . . . . . . . . . . $6,342 $2,743 $2,254
Tax expense . . . . . . . . . . . . . 2,562 1,108 911
Net of tax amount . . . . . . . . . . $3,780 $1,635 $1,343
Accumulated comprehensive income included the following components as of
December 31:
1998 1997 1996
--------- -------- --------
Unrealized gain on securities $7,753 $8,238 $3,969
Foreign currency translation (3,842) (2,895) 2,388
Total . . . . . . . . . . . . $3,911 $5,343 $6,357
Shareholders' Equity
The Company has authorized one billion shares of common stock with a par value
of $.01 and 11 million shares of preferred stock. There were no shares of
preferred stock issued or outstanding. In December 1997, ServiceMaster converted
from a publicly traded limited partnership to a corporation. At the time of
reincorporation, each outstanding limited partnership share was converted into
one share of common stock on a tax-free basis to the shareholders. Upon
reincorporation, all Limited Partners' equity was transferred to common stock
and additional paid-in capital. The shares underlying the obligations and rights
relating to the employee option plans were also converted from partnership
shares to corporate stock on a one-for-one basis.
In 1997, the Company filed a $950 million shelf registration statement with the
Securities and Exchange Commission for the sale of unsecured senior debt
securities and equity interests. On May 15, 1998, the Company filed a Form S-3
registration statement, and 21.2 million Company shares were sold at $19.17 per
share. This included approximately 11.4 million of newly-issued shares from the
Company and 9.8 million shares sold by existing shareholders. The net proceeds
to the Company, after the underwriting discount and offering expenses, were
approximately $209 million and were used to reduce outstanding debt under
existing bank credit facilities.
On July 23, 1998, the Company filed a Form S-1 shelf registration statement to
issue up to 5.3 million shares of common stock in connection with future,
unidentified acquisitions. The S-1 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 roll-up acquisitions
and small strategic acquisitions. There were approximately 3.5 million shares
issued at year end.
On April 1, 1997, the Company bought Waste Management, Inc.'s (WMX) entire
ownership interest in ServiceMaster for approximately $626 million. This
transaction resulted in the Company acquiring the 61.1 million Company shares
held by WMX and canceling WMX's option to purchase an additional 4.2 million
Company shares.
As of December 31, 1998, there were 18.1 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 vesting period and are restricted as to the sale or
transfer of the shares.
The Company accounts for employee share options under Accounting Principles
Board Opinion 25, as permitted under generally accepted accounting principles.
Accordingly, no compensation cost has been recognized in the accompanying
financial statements related to these options. Had compensation cost for these
plans been determined consistent with Statement of Financial Accounting
Standards No. 123 (SFAS 123), which is an accounting alternative that is
permitted, but not required, pro forma net income and net income per share would
reflect the following:
(In thousands, except per share data)
1998 1997 1996
-------- -------- --------
Net Income:
As reported(1) . . . . . . . $189,992 $163,470 $150,429
SFAS 123 pro forma. . . . . . $185,555 $160,966 $149,480
Net Income Per Share:
Basic: As reported(1) $.66 $.57 $.47
SFAS 123 pro forma $.64 $.56 $.47
Diluted: As reported(1) $.64 $.55 $.46
SFAS 123 pro forma $.62 $.54 $.45
(1) Pro forma corporate form prior to 1998.
The SFAS 123 pro forma net income reflects options granted in 1998, 1997 and
1996. Since SFAS 123 does not apply to options granted prior to 1995, the pro
forma disclosure is not likely to be indicative of pro forma results which may
be expected in future years. This primarily relates to the fact that options
vest over several years and pro forma compensation cost is recognized as the
options vest. In addition, awards may have been granted in earlier years, which
would have resulted in pro forma compensation cost in 1998.
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 1998, 1997 and 1996: risk-free interest rates of 5.6 percent, 6.3
percent and 5.6 percent, respectively; volatility rates of 22 percent, 21
percent and 27 percent, respectively; distribution yields of 1.9 percent, 3.2
percent and 3.2 percent, respectively; and average expected lives of seven
years. The options granted to employees in 1998, 1997 and 1996 have
weighted-average fair values of $5.17, $2.81 and $2.40, 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.
44
A summary of option and grant transactions during the last three years is
summarized below:
Share Price Weighted-Avg. Share Price
Options Range Exercise Price Grants Range
------- ------------- -------------- ---------- -------------
Total exercisable, December 31, 1995 . . . . 14,033,661 $0.73 - 7.63 $ 5.46 --- ---
Total outstanding December 31, 1995 . . . . 18,252,411 $0.73 - 9.78 $6.46 2,205,738 $2.86 - 7.96
Transactions during 1996
Granted to employees . . . . . . . . . . . 4,154,625 $ 9.26 - 10.78 $9.40 --- ---
Exercised, paid, or vested . . . . . . . . (5,470,646) $ 0.73 - 7.63 $5.56 (398,997) $2.86 - 7.96
Terminated or resigned . . . . . . . . . . (360,274) $ 2.79 - 7.63 $3.89 --- ---
Total exercisable, December 31, 1996 . . . . 8,202,741 $ 0.73 - 7.63 $ 5.49 --- ---
Total outstanding, December 31, 1996 . . . . 16,576,116 $ 0.73 - 10.78 $ 7.56 1,806,741 $2.86 - 7.96
Transactions during 1997
Granted to employees . . . . . . . . . . . 5,295,785 $11.23 - 18.42 $11.62 --- ---
Exercised, paid, or vested . . . . . . . . (1,892,034) $ 2.17 - 9.26 $5.17 (430,460) $2.86 - 7.96
Cancelled, related to WMX . . . . . . . . (4,218,750) $ 9.78 $9.78 --- ---
Terminated or resigned . . . . . . . . . . (440,960) $ 1.97 - 11.22 $7.11 (120,175) $2.86 - 7.96
Total exercisable, December 31, 1997 . . . . 6,919,718 $0.73 - 10.78 $ 6.05 --- ---
Total outstanding, December 31, 1997 . . . . 15,320,157 $0.73 - 18.42 $ 8.65 1,256,106 $2.86 - 7.96
Transactions during 1998
Granted to employees . . . . . . . . . . . 3,574,376 $15.74 - 22.77 $18.29 --- ---
Exercised, paid, or vested . . . . . . . . (1,604,784) $ 2.25 - 11.22 $6.29 (293,376) $2.86 - 7.96
Terminated or resigned . . . . . . . . . . (377,023) $ 0.73 - 18.26 $8.57 --- ---
Total exercisable, December 31, 1998 . . . . 7,269,279 $0.73 - 22.33 $ 7.51 --- ---
Total outstanding, December 31, 1998 . . . . 16,912,726 $0.73 - 22.77 $10.89 962,730 $2.86 - 7.96
Options outstanding at December 31, 1998:
Range of Number Outstanding Remaining Weighted-Average Number Exercisable Weighted-Average
Exercise Prices at 12/31/98 Life Exercise Price at 12/31/98 Exercise Price
- --------------- ------------------ --------- ---------------- ------------------ ----------------
$0.73 - 5.14 1,896,782 3.0 years $3.74 1,896,782 $ 3.74
6.44 - 9.33 6,040,722 6.5 years 8.27 4,048,253 7.78
10.78 - 22.77 8,975,222 8.5 years 14.17 1,428,808 12.50
$0.73 - 22.77 16,912,726 7.0 years $10.89 7,373,843 $7.65
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. 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 the denominator of the
diluted earnings per share computation.
For year ended 1998 For year ended 1997 For year ended 1996
(In thousands, except per share data) Income Shares EPS Income Shares EPS Income Shares EPS
--------- ---------- ----- --------- ---------- ----- --------- ---------- -----
Basic EPS
(pro forma corporate form in
1997 and 1996). . . . . . . . . $189,992 289,315 $0.66 $163,470 285,944 $0.57 $150,429 317,381 $0.47
Effect of Dilutive Securities,
net of tax
Options . . . . . . . . . . . . 9,391 8,333 7,607
Convertible debentures . . . . 32 181 1,114 5,363 1,115 5,441
Diluted EPS
(pro forma corporate form in
1997 and 1996). . . . . . . . . $190,024 298,887 $0.64 $164,584 299,640 $0.55 $151,544 330,429 $0.46
45
Quarterly Operating Results
Quarterly operating results and related growth for the last three years in
revenues, gross profit, net income, and basic and diluted net income per share
are shown in the table below. Net income and earnings per share amounts for 1997
and 1996 have been restated to a basis that assumes reincorporation had occurred
as of the beginning of each year. 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. Full
year results are not affected.
Certain amounts from prior periods have been reclassified to conform with the
current presentation.
Percent Incr. Percent Incr.
(Unaudited, in thousands, except per share data) 1998 '98-'97 1997 '97-'96 1996
-------- ------------- -------- ------------- --------
Operating Revenue:
First Quarter . . . . . . . . . . . . . $981,788 20% $817,136 10% $740,299
Second Quarter . . . . . . . . . . . . 1,244,627 23 1,010,794 10 916,931
Third Quarter . . . . . . . . . . . . . 1,273,093 17 1,090,114 18 927,227
Fourth Quarter . . . . . . . . . . . . 1,224,611 17 1,043,458 19 873,871
$4,724,119 19% $3,961,502 15% $3,458,328
Gross Profit:
First Quarter . . . . . . . . . . . . . $186,991 17% $159,991 13% $142,116
Second Quarter . . . . . . . . . . . . 293,261 14 257,260 16 221,505
Third Quarter . . . . . . . . . . . . . 316,718 23 257,449 17 219,127
Fourth Quarter . . . . . . . . . . . . 247,537 8 228,642 18 194,572
$1,044,507 16% $903,342 16% $777,320
Net Income:
(pro forma in 1997 and 1996):
First Quarter . . . . . . . . . . . . . $29,270 1% $28,982 15% $25,188
Second Quarter . . . . . . . . . . . . 56,404 21 46,707 8 43,326
Third Quarter . . . . . . . . . . . . . 56,352 20 46,793 11 42,262
Fourth Quarter . . . . . . . . . . . . 47,966 17 40,988 3 39,653
$189,992 16% $163,470 9% $150,429
Basic Net Income Per Share:
(pro forma in 1997 and 1996):
First Quarter . . . . . . . . . . . . . $0.11 22% $0.09 13% $0.08
Second Quarter . . . . . . . . . . . . 0.20 18 0.17 21 0.14
Third Quarter . . . . . . . . . . . . . 0.19 12 0.17 31 0.13
Fourth Quarter . . . . . . . . . . . . 0.16 7 0.15 25 0.12
$0.66 16% $0.57 21% $0.47
Diluted Net Income Per Share:
(pro forma in 1997 and 1996):
First Quarter . . . . . . . . . . . . . $0.10 11% $0.09 13% $0.08
Second Quarter . . . . . . . . . . . . 0.19 19 0.16 23 0.13
Third Quarter . . . . . . . . . . . . . 0.19 19 0.16 23 0.13
Fourth Quarter . . . . . . . . . . . . 0.16 14 0.14 17 0.12
$0.64 16% $0.55 20% $0.46
Cash Distributions Per Share:
First Quarter . . . . . . . . . . . . . $0.08 7% $0.07 1\2 5% $0.07 1\8
Second Quarter . . . . . . . . . . . . 0.08 7 0.07 1\2 5 0.07 1\8
Third Quarter . . . . . . . . . . . . . 0.08 --- 0.08 7 0.07 1\2
Fourth Quarter . . . . . . . . . . . . 0.09 13 0.08 7 0.07 1\2
$0.33 6% $0.31 6% $0.29 1\4
Price Per Share:
First Quarter . . . . . . . . . . . . . $19.63 - 16.50 $12.33 - 10.92 $ 9.93 - 8.61
Second Quarter . . . . . . . . . . . . 25.50 - 17.92 15.92 - 12.09 10.45 - 9.17
Third Quarter . . . . . . . . . . . . . 24.75 - 19.75 19.67 - 15.17 11.00 - 9.55
Fourth Quarter . . . . . . . . . . . . 23.81 - 16.00 19.50 - 14.00 11.83 - 10.55
All share and per share data reflect the three-for-two share splits in
August 1998, June 1997 and June 1996.
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