UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q/A
X QUARTERLY REPORT UNDER SECTION 13 OR 15(d) OF
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THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended June 30, 2002
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TRANSITION REPORT PURSUANT TO SECTION 13 OR
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15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the transition period from to
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Commission file number 1-14762
THE SERVICEMASTER COMPANY
(Exact name of registrant as specified in its charter)
Delaware 36-3858106
(State or other jurisdiction of (IRS Employer Identification No.)
incorporation or organization)
3250 Lacey Road, Downers Grove, Illinois 60515-1700
(Address of principal executive offices) (Zip Code)
630-663-2000
(Registrant's telephone number, including area code)
Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the registrant was
required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days. Yes X No .
Indicate the number of shares outstanding of each of the issuer's classes of
common stock: 302,368,000 shares of common stock on August 7, 2002.
Explanatory Note:
This amendment is being filed to reflect the restatement of the Company's
unaudited condensed consolidated financial statements, as discussed in Note 2
thereto, and other information related to such restated financial statements.
TABLE OF CONTENTS
Page
No.
THE SERVICEMASTER COMPANY (Registrant) -
Part I. Financial Information
Item 1 : Financial Statements
Condensed Consolidated Statements of Income for the three and six
months ended June 30, 2002 (Restated) and June 30, 2001 (Restated) 2
Condensed Consolidated Statements of Financial Position
as of June 30, 2002 (Restated) and December 31, 2001 (Restated) 4
Condensed Consolidated Statements of Cash Flows for the six months
ended June 30, 2002 (Restated) and June 30, 2001 (Restated) 5
Notes to Condensed Consolidated Financial Statements (Restated) 6
Item 2: Management Discussion and Analysis of Financial
Condition and Results of Operations 17
Item 3: Quantitative and Qualitative Disclosures About
Market Risk 24
Part II. Other Information
Item 4: Submission of Matters to a Vote of Security Holders 25
Item 6: Exhibits and Reports on Form 8-K 25
Signature 26
Exhibit 99.1: Certification of Chief Executive Officer Pursuant
to Section 1350 of Chapter 63 of Title 18 of the
United States Code 29
Exhibit 99.2: Certification of Chief Financial Officer Pursuant
to Section 1350 of Chapter 63 of Title 18 of the
United States Code 30
1
PART I. FINANCIAL INFORMATION
THE SERVICEMASTER COMPANY
CONDENSED CONSOLIDATED STATEMENTS OF INCOME (UNAUDITED)
(In thousands, except per share data)
Three Months Ended Six Months Ended
June 30, June 30,
2002 2001 2002 2001
(Restated 4) (Restated 4) (Restated 4) (Restated 4)
------------- ------------- -------------- -------------
OPERATING REVENUE .................................................. $ 1,034,937 $ 1,020,034 $ 1,769,200 $ 1,742,895
OPERATING COSTS AND EXPENSES:
Cost of services rendered and products sold......................... 680,381 681,006 1,211,192 1,211,487
Selling and administrative expenses................................. 217,728 205,026 379,330 345,795
Goodwill, trade name and other intangible amortization (1).......... 2,152 18,071 4,306 35,353
----------- ----------- ----------- -----------
Total operating costs and expenses.................................. 900,261 904,103 1,594,828 1,592,635
----------- ----------- ----------- -----------
OPERATING INCOME ................................................... 134,676 115,931 174,372 150,260
NON-OPERATING EXPENSE (INCOME):
Interest expense ................................................... 21,725 31,825 44,266 66,399
Interest and investment income...................................... (1,966) (4,324) (4,898) (5,573)
Minority interest and other expense, net............................ 2,014 2,838 3,584 1,064
------------ ------------ ------------ ------------
INCOME FROM CONTINUING OPERATIONS BEFORE INCOME TAXES .............. 112,903 85,592 131,420 88,370
Provision for income taxes.......................................... 41,466 35,857 48,125 37,901
------------ ------------ ------------ ------------
INCOME FROM CONTINUING OPERATIONS BEFORE EXTRAORDINARY
ITEMS ......................................................... 71,437 49,735 83,295 50,469
Income from discontinued operations, net of income taxes (2) ....... 295 4,225 78 9,483
Extraordinary gain (loss), net of income taxes (3) ................. (9,229) - (9,229) 6,003
------------ ------------ ------------ ------------
NET INCOME ......................................................... $ 62,503 $ 53,960 $ 74,144 $ 65,955
=========== =========== =========== ===========
PER SHARE:
Basic Earnings Per Share:
Income from continuing operations before extraordinary items ....... $ 0.24 $ 0.17 $ 0.28 $ 0.17
Discontinued operations, net (2) ................................... - 0.01 - 0.03
Extraordinary gain (loss) (3) ...................................... (0.03) - (0.03) 0.02
------------ ------------ ------------ ------------
$ 0.21 $ 0.18 $ 0.25 $ 0.22
============ ============ ============ ============
Shares ............................................................. 301,092 298,547 300,653 298,170
Diluted Earnings Per Share:
Income from continuing operations before extraordinary items ....... $ 0.23 $ 0.16 $ 0.27 $ 0.17
Discontinued operations, net (2) ................................... - 0.01 - 0.03
Extraordinary gain (loss) (3) ...................................... (0.03) - (0.03) 0.02
----------- ----------- ----------- -----------
$ 0.20 $ 0.18 $ 0.24 $ 0.22
=========== =========== =========== ===========
Shares ............................................................. 316,474 310,764 307,700 302,143
Dividends per share ................................................ $ 0.10 $ 0.10 $ 0.20 $ 0.20
=========== =========== =========== ===========
2
(1) The Company adopted Statement of Financial Accounting Standards (SFAS) No.
142, "Goodwill and Other Intangible Assets", which eliminates the amortization
of goodwill and intangible assets with indefinite lives beginning in 2002. Had
the provisions of SFAS 142 been applied to 2001, amortization expense would have
been reduced by $15.6 million ($10.6 million, after-tax) and $30.5 million
($20.7 million, after-tax) for the three and six month periods ended June 30,
2001, respectively.
(2) In the fourth quarter of 2001, the Company's Board of Directors approved a
series of actions related to the strategic review of its portfolio of businesses
that commenced earlier in 2001. These actions included the sale in November 2001
of the Company's Management Services business as well as the decision to exit
certain non-strategic and under-performing businesses including TruGreen
LandCareConstruction and Certified Systems, Inc., as well as certain Terminix
operations in Europe. During the third quarter of 2002, the Company sold its
remaining European Terminix operations. These operations are classified in
"Discontinued operations" for all periods presented.
(3) The Company purchased a portion of its public debt securities in the second
quarter of 2002 and in the first quarter of 2001. The Company has recorded an
extraordinary gain (loss) from the early extinguishment of debt related to these
repurchases. The Company intends to adopt SFAS 145 beginning in fiscal 2003.
Adoption of SFAS 145 in 2003 will result in the reclassification of the
extraordinary gain/loss into income from continuing operations.
(4) See Note 2 in the Notes to the Condensed Consolidated Financial Statements
for the basis of the restatement and the financial statement impact.
See Notes to Condensed Consolidated Financial Statements
3
THE SERVICEMASTER COMPANY
CONDENSED CONSOLIDATED STATEMENTS OF FINANCIAL POSITION (UNAUDITED)
(In thousands) As of Jun. 30, As of Dec. 31,
ASSETS 2002 (Restated 1) 2001 (Restated 1)
----------- -----------
CURRENT ASSETS:
Cash and cash equivalents ....................................... $ 132,744 $ 402,644
Marketable securities ........................................... 72,340 72,429
Receivables, less allowance of $33,919 and $28,397, respectively 401,733 340,935
Inventories ..................................................... 77,957 68,036
Prepaid expenses, deferred costs and other assets ............... 130,156 80,738
Deferred taxes and income taxes receivable ...................... 117,852 90,200
Assets of discontinued operations ............................... 44,237 64,068
----------- -----------
Total Current Assets ..................................... 977,019 1,119,050
----------- -----------
PROPERTY AND EQUIPMENT:
At cost ...................................................... 473,782 469,140
Less: accumulated depreciation ............................... (281,445) (272,930)
----------- -----------
Net property and equipment ................................. 192,337 196,210
----------- -----------
OTHER ASSETS:
Goodwill ........................................................ 1,909,792 1,904,178
Intangible assets, primarily trade names ........................ 259,096 261,136
Notes receivable ................................................ 59,352 59,204
Long-term securities and other assets ........................... 73,789 81,467
----------- -----------
Total Assets ............................................. $ 3,471,385 $ 3,621,245
=========== ===========
LIABILITIES AND SHAREHOLDERS' EQUITY
CURRENT LIABILITIES:
Accounts payable ................................................ $ 100,832 $ 97,251
Accrued liabilities:
Payroll and related expenses ................................. 79,270 83,182
Self-insured claims and related expenses ..................... 79,838 63,819
Income taxes payable ......................................... 11,258 --
Other ........................................................ 109,864 131,780
Deferred revenues ............................................... 428,572 343,873
Liabilities of discontinued operations .......................... 55,160 50,449
Current portion of long-term debt ............................... 44,496 34,944
----------- -----------
Total Current Liabilities ................................ 909,290 805,298
----------- -----------
LONG-TERM DEBT .................................................. 831,873 1,120,249
LONG-TERM LIABILITIES:
Deferred taxes ............................................. 257,146 233,000
Liabilities of discontinued operations ..................... 21,632 50,600
Other long-term obligations ................................ 112,323 102,234
----------- -----------
Total Long-Term Liabilities ............................. 391,101 385,834
----------- -----------
MINORITY INTEREST ............................................... 102,200 102,677
COMMITMENTS AND CONTINGENCIES
SHAREHOLDERS' EQUITY:
Common stock $0.01 par value, authorized 1 billion shares; issued
315,503 and 314,538 shares, respectively ................... 3,155 3,145
Additional paid-in capital ...................................... 1,049,452 1,039,228
Retained earnings ............................................... 336,649 322,103
Accumulated other comprehensive loss ............................ (5,783) (2,496)
Restricted stock ................................................ (491) (581)
Treasury stock .................................................. (146,061) (154,212)
----------- -----------
Total Shareholders' Equity ............................... 1,236,921 1,207,187
----------- -----------
Total Liabilities and Shareholders' Equity ............... $ 3,471,385 $ 3,621,245
=========== ===========
(1) See Note 2 in the Notes to the Condensed Consolidated Financial Statements
for the basis of the restatement and the financial statement impact.
See Notes to Condensed Consolidated Financial Statements
4
THE SERVICEMASTER COMPANY
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED)
(In thousands)
Six Months Ended
June 30,
2002 2001
(Restated 1) (Restated 1)
---------- ----------
CASH AND CASH EQUIVALENTS AT JANUARY 1 .................................... $ 402,644 $ 42,669
CASH FLOWS FROM OPERATIONS:
NET INCOME ................................................................ 74,144 65,955
Adjustments to reconcile net income to net cash flows from operations:
Income from discontinued operations ............................... (78) (9,483)
Extraordinary (gain) loss ......................................... 9,229 (6,003)
Depreciation expense .............................................. 24,291 24,547
Amortization expense .............................................. 4,306 35,353
Deferred income tax expense ....................................... 39,758 43,357
Change in working capital, net of acquisitions:
Receivables ................................................... (59,876) (76,176)
Sale of receivables ........................................... -- 100,000
Inventories and other current assets .......................... (62,160) (66,895)
Accounts payable .............................................. 4,590 (406)
Deferred revenues ............................................. 84,625 79,500
Accrued liabilities ........................................... 22,179 12,037
Tax refund from prior years payments .......................... -- 21,000
Other, net .................................................... 2,165 3,235
--------- ---------
NET CASH PROVIDED FROM OPERATIONS ......................................... 143,173 226,021
--------- ---------
CASH FLOWS FROM INVESTING ACTIVITIES:
Property additions .................................................. (29,387) (20,583)
Sale of equipment and other assets .................................. 1,140 7,702
Business acquisitions, net of cash acquired ......................... (6,849) (21,065)
Proceeds from business sales and minority interests ................. -- 4,925
Notes receivable, financial investments and securities .............. (4,228) (21,562)
--------- ---------
NET CASH USED FOR INVESTING ACTIVITIES .................................... (39,324) (50,583)
--------- ---------
CASH FLOWS FROM FINANCING ACTIVITIES:
Net payments of debt ................................................ (295,570) (141,310)
Purchase of ServiceMaster stock ..................................... -- (1,308)
Shareholders' dividends ............................................. (59,598) (59,792)
Other, net .......................................................... 12,825 5,125
--------- ---------
NET CASH USED FOR FINANCING ACTIVITIES .................................... (342,343) (197,283)
--------- ---------
--------- ---------
CASH USED FOR DISCONTINUED OPERATIONS ..................................... (31,406) (3,744)
--------- ---------
CASH DECREASE DURING THE PERIOD ........................................... (269,900) (25,591)
--------- ---------
CASH AND CASH EQUIVALENTS AT JUNE 30 ...................................... $ 132,744 $ 17,080
========= =========
(1) See Note 2 in the Notes to the Condensed Consolidated Financial Statements
for the basis of the restatement and the financial statement impact.
See Notes to Condensed Consolidated Financial Statements
5
THE SERVICEMASTER COMPANY
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
Note 1: The condensed consolidated financial statements include the accounts of
ServiceMaster and its subsidiaries, collectively referred to as "the Company".
Intercompany transactions and balances have been eliminated in consolidation.
Note 2: The condensed consolidated financial statements have been prepared by
the Company in accordance with generally accepted accounting principles and
pursuant to the rules and regulations of the Securities and Exchange Commission.
The Company suggests that the quarterly condensed consolidated financial
statements be read in conjunction with the consolidated financial statements and
the notes thereto included in the Company's most recent Annual Report to
Shareholders and the Annual Report to the Securities and Exchange Commission on
Form 10-K. The condensed consolidated financial statements reflect all
adjustments, which are in the opinion of management, necessary for the fair
presentation of the financial position, results of operations and cash flows for
the interim periods. The results of operations for any interim period are not
necessarily indicative of the results which might be obtained for a full year.
RESTATEMENT
The Company has restated its consolidated financial statements for the year
ended December 31, 2001 as well as the previously reported quarterly results for
2002 and 2001. Subsequent to the original issuance of these condensed
consolidated financial statements, management determined that the historical
accounting treatment relating to the items below required revision. The table
below presents the net income impacts from the restatements.
Three Months Three Months Six Months Six Months
Ended Ended Ended Ended
(In millions, except per share data) June 30, 2002 June 30, 2001 June 30, 2002 June 30, 2001
-------------------------------------------------------------------------------------------------------
Continuing Operations:
AHS deferred acquisition costs $ - $(0.5) $ - $ (4.7)
Trade name license fee (1.3) - (2.5) -
Interim accounting (TruGreen) 7.8 5.6 (4.0) (9.3)
Other, net 2.9 (0.2) 2.7 2.8
Tax adjustment from reincorporation - (0.2) - (0.4)
-------------------------------------------------------------------------------------------------------
Income Impact $ 9.4 $ 4.7 $ (3.8) $(11.6)
Diluted EPS Impact $0.03 $0.02 $(0.01) $(0.04)
Discontinued Operations:
Income Impact $ 0.1 $(1.4) $ (0.1) $ (2.4)
Diluted EPS Impact $ - $ - $ - $(0.01)
Cumulative effect of accounting
change:
Income Impact $ - $ - $ 44.6 $ -
Diluted EPS Impact $ - $ - $ 0.15 $ -
A summary of the significant effects of the restatement is as follows:
Three Months Ended Three Months Ended
June 30, 2002 June 30, 2001
----------------------------------------------------------------
As Previously As Previously
(in thousands, except per share data) Reported (1) As Restated Reported (1) As Restated
--------------------------------------------------------------------------------------------------------------
Operating revenue $1,032,807 $1,034,937 $1,015,687 $1,020,034
Operating income 118,158 134,676 108,386 115,931
Income from continuing operations before
income taxes 97,305 112,903 77,468 85,592
Income from continuing operations 62,024 71,437 45,019 49,735
Discontinued operations, net 200 295 5,694 4,225
Extraordinary loss, net (9,229) (9,229) - -
==============================================================================================================
Net income $52,995 $62,503 $50,713 $53,960
==============================================================================================================
Diluted earnings per share:
Income from continuing operations $0.20 $0.23 $0.15 $0.16
Discontinued operations, net - - 0.02 0.01
Extraordinary loss, net (0.03) (0.03) - -
==============================================================================================================
Diluted earnings per share $0.17 $0.20 $0.17 $0.18
==============================================================================================================
6
As of As of
June 30, 2002 December 31, 2001
------------------------------- -- ------------------------------
As Previously As Previously
Reported (1) As Restated Reported (1) As Restated
--------------- --------------- -- --------------- --------------
Current assets $949,102 $977,019 $1,131,824 $1,119,050
Net property, plant, and equipment 177,605 192,337 180,937 196,210
Other long-term assets 2,357,518 2,302,029 2,361,978 2,305,985
--------------------------------------------------------------------------------------------------------------
Total assets $3,484,225 $3,471,385 $3,674,739 $3,621,245
==============================================================================================================
Current liabilities $898,091 $909,290 $796,113 $805,298
Long-term debt 817,141 831,873 1,105,518 1,120,249
Long-term liabilities 458,198 391,101 449,470 385,834
Minority interest 102,200 102,200 102,677 102,677
Total shareholders' equity 1,208,595 1,236,921 1,220,961 1,207,187
--------------------------------------------------------------------------------------------------------------
Total liabilities and shareholders' equity $3,484,225 $3,471,385 $3,674,739 $3,621,245
==============================================================================================================
Six Months Ended Six Months Ended
June 30, 2002 June 30, 2001
-----------------------------------------------------------------
As Previously As Previously
(in thousands, except per share data) Reported (1) As Restated Reported (1) As Restated
---------------------------------------------------------------------------------------------------------------
Operating revenue $1,766,192 $1,769,200 $1,735,278 $1,742,895
Operating income 178,920 174,372 166,583 150,260
Income from continuing operations before
income taxes 137,603 131,420 106,383 88,370
Income from continuing operations before
extraordinary items and cumulative effect
of accounting change 87,051 83,295 62,025 50,469
Discontinued operations, net 157 78 11,912 9,483
Extraordinary gain (loss), net (9,229) (9,229) 6,003 6,003
Cumulative effect of accounting change, net (44,577) - - -
--------------------------------------------------------------------------------------------------------------
Net income $33,402 $74,144 $79,940 $65,955
==============================================================================================================
Diluted earnings per share:
Income from continuing operations before
extraordinary items and cumulative effect
of accounting change $0.28 $0.27 $0.21 $0.17
Discontinued operations, net - - 0.04 0.03
Extraordinary gain (loss), net (0.03) (0.03) 0.02 0.02
Cumulative effect of accounting change, net (0.15) - - -
--------------------------------------------------------------------------------------------------------------
Diluted earnings per share $0.11 $0.24 $0.26 $0.22
==============================================================================================================
1) During the third quarter of 2002, the Company sold its Terminix operations
in the United Kingdom. The financial results from these operations have
been reclassified from "Continuing Operations" to "Discontinued Operations"
for all periods presented. Amounts as restated include this
reclassification. The amount for 2002 reflects the cumulative effect of the
change in accounting principle at American Home Shield.
AMERICAN HOME SHIELD DEFERRED ACQUISITION COSTS
In July 2002, the Company changed its method of accounting for deferred customer
acquisition costs in its American Home Shield business from SFAS No. 60,
"Accounting and Reporting by Insurance Enterprises," pursuant to which the
Company believed it was appropriate to amortize deferred acquisition costs over
the expected customer life to FASB Technical Bulletin No. 90-1, "Accounting for
Separately Priced Extended Warranty and Product Maintenance Contracts," pursuant
to which deferred acquisition costs are amortized over the initial contract
life.
The new method of accounting reduced after-tax earnings by $.03 per diluted
share in 2002, but had no material impact on cash flow in current or future
years. In the second quarter of 2002, the Company retroactively recorded to the
first quarter of 2002 a cumulative charge of $45 million ($.15 per diluted
share) to effect this change.
Following discussions with the Staff of the Securities and Exchange Commission,
the Company has restated prior years to account for deferred acquisition costs
in accordance with FASB Technical Bulletin No. 90-1. The effect of this
restatement is to eliminate the cumulative charge for the accounting change and
reduce full year income from continuing operations by $8.5 million or $.03 per
diluted share in 2001, and $6.1 million or
7
$.02 per diluted share in 2000. In addition, this change results in a reduction
of retained earnings of $30 million at January 1, 2000. This restatement reduced
income from continuing operations by $.5 million for the second quarter of 2001
and $4.7 million for the six months ended June 30, 2001.
TRADE NAME LICENSE FEE
In connection with the sale of its Management Services business in the fourth
quarter of 2001, the Company entered into a three-year licensing arrangement
with ARAMARK Corporation for the use of the ServiceMaster trade name. This
agreement was valued at $15 million and accordingly, a like amount was allocated
from the purchase price. The Company intended to recognize this amount over the
three-year contractual period, and as such, recognized $2 million related
thereto in each of the first and second quarters of 2002. In November 2002, the
Company announced that it had determined that it was appropriate to recognize
the entire $15 million licensing fee in the fourth quarter of 2001. The effect
of this correction is to increase full year income from continuing operations by
$9 million and diluted earnings per share by $.03 in 2001, and to reduce income
from continuing operations by $2.5 million and diluted earnings per share by
$.01 in the first half of 2002. For the second quarter 2002, this restatement
reduced income from continuing operations by $1.3 million.
INSURANCE (TRUGREEN)
In January 2002, the Company reported that it had recognized a $9 million pretax
expense in 2001 relating to a revised estimate of the 2000 insurance reserve
requirements. Net income has been restated for this item which results in an
increase to full year income from continuing operations of $3.7 million (or
$.01) in 2001 and a decrease to income from continuing operations of the same
amount in 2000. The remaining adjustment results in a decrease to full year
income from discontinued operations of $1.1 million in 2000. This restatement
impacted the fourth quarter of 2001.
REINCORPORATION TAX
Prior to 1997, the Company was in partnership form and therefore was not a
federal taxpayer. Consequently, the Company did not record deferred tax balances
reflecting the differences between the book and tax basis of its assets and
liabilities. When the Company converted to corporate form in 1997, it realized a
significant step-up in the tax basis of its assets, which was largely reflected
as an increase in the basis of the tax intangibles and provided for significant
tax deductions over the next 15 years. In accounting for this event in 1997, the
Company recorded the net deferred tax asset associated with differences between
the book and tax basis of its tangible assets and liabilities. As it related to
intangible assets, the Company made a determination that the tax basis of
intangibles equaled the overall book balance of intangible assets on an
enterprise basis. Subsequently it was determined that intangible assets needed
to be considered at the individual business unit level which resulted in a
situation where tax basis exceeded book basis in certain units. This difference
created an additional deferred tax asset. The Company restated the financial
statements to reflect the deferred tax asset as if it had been recorded in 1997.
This change results in an increase to retained earnings as of January 1, 2000 of
$92.6 million, and an increase to the full year tax provision for continuing
operations of $.8 million in both 2001 and 2000 and an increase to the full year
tax provision for discontinued operations of $.8 million and $1.2 million in
2001 and 2000, respectively. This restatement also results in an increase to the
tax provision relating to the gain on certain businesses sold in the fourth
quarter of 2001 of $45.8 million. The net impact of these items was to increase
deferred tax assets by $33.4 million and equity by $43.2 million as of December
31, 2001. This restatement increased the tax provision for continuing operations
by $.2 million and $.4 million for the second quarter and six months ended June
30, 2001, respectively. In addition, the tax provision for discontinued
operations increased by $.3 million and $.6 million for the second quarter and
six months ended June 30, 2001, respectively.
OTHER, NET
Other items primarily relate to adjustments in accruals, timing of revenue and
expense items and other miscellaneous items. The Company also determined it was
appropriate to expense the costs associated with telephone directory placements
when the directory is published rather than expensing the cost over the contract
period. In addition, certain operating leases of constructed properties have
been included in the balance sheet as assets with associated debt. The financial
statements have been restated from the amounts previously reported for these
items. The restatement related to these items resulted in income from continuing
operations increasing $2.9 million and decreasing $.2 million for the second
quarter 2002 and 2001, respectively. Income
8
from continuing operations increased by $2.7 million and $2.8 million for the
six months ended June 30, 2002 and 2001, respectively. Income from discontinued
operations increased by $.1 million and decreased by $1.1 million for the second
quarter 2002 and 2001, respectively. For the six months ended June 30, 2002 and
2001, income from discontinued operations decreased by $.1 million and $1.8
million, respectively.
INTERIM ACCOUNTING
TruGreen ChemLawn incurs pre-season advertising costs and annual repair and
maintenance procedures in the first quarter. These costs are deferred and
recognized as expense in proportion to the related revenues. Full-year results
are not affected. The quarterly information for 2002 and 2001 has been restated
to treat certain costs that were previously deferred, as current period costs.
There was no impact on full-year results for 2002 and 2001 as a result of this
change. This restatement resulted in income from continuing operations
increasing by $7.8 million and $5.6 million for the second quarter of 2002 and
2001, respectively, and decreasing by $4.0 million and $9.3 million for the six
months ended June 30, 2002 and 2001, respectively.
Note 3: The Company has identified the most important accounting policies in
order to portray its financial condition and results of operations. These relate
primarily to revenue recognition and the deferral of customer acquisition costs.
The following revenue recognition policies have not changed since year-end.
Revenues from lawn care, non-baiting termite, pest control, heating/air
conditioning and plumbing services are recognized as the services are provided.
Revenues from landscaping services are recognized based upon agreed monthly
contract payments or when services are performed for non-contractual
arrangements. Revenues from the Company's commercial installation contracts,
primarily relating to HVAC, are recognized on the percentage of completion
method in the ratio that total incurred costs bear to total estimated costs.
Fees from home warranty and termite baiting contracts are recognized as revenues
over the life of the contract in proportion to the direct costs (service or
claim), which are expensed as incurred. Franchised revenues (which in aggregate
represents approximately three percent of consolidated totals) consist of
initial franchise fees and continuing monthly fees based upon the franchisee
revenue. Revenue is recognized when reported from the franchisee and
collectibility is assured.
Customer acquisition costs, which are incremental and direct costs of obtaining
the customer, relating to several of the Company's contracts are deferred and
amortized over the life of the contract, in proportion to revenue recognized.
These costs include sales commissions and direct selling costs which can be
shown to have resulted in a successful sale.
TruGreen ChemLawn has significant seasonality to its business. In the winter and
early spring, this business sells a series of lawn applications to customers
which are rendered primarily in March through October. The Company incurs
incremental selling expenses at the beginning of the year that directly relate
to successful sales in which the revenues will be recognized in later quarters.
This business also defers, on an interim basis, pre-season advertising costs and
annual repairs and maintenance procedures that are performed in the first
quarter. These costs are deferred and recognized approximately in proportion to
the contract revenue over the production season, and are not deferred beyond the
calendar year-end.
As noted above, TruGreen's pre-season advertising costs are deferred and
recognized approximately in proportion to the contract revenue over the year.
These costs are not deferred beyond the calendar year-end. Beginning in 2002,
the cost of direct-response advertising at Terminix is capitalized and amortized
over its expected period of future benefits. This direct-response advertising
consists primarily of direct-mail promotions, for which the cost is capitalized
and amortized over the one-year customer contract life.
The preparation of the financial statements requires management to make certain
estimates and assumptions required under generally accepted accounting
principles which may differ materially from the actual results. Disclosures in
the 2001 Annual Report presented the significant areas that require the use of
management's estimates and discussed how management formed its judgment. The
areas discussed included the allowance for receivables, accruals for
self-insured retention limits related to medical, workers compensation, auto and
general liability insurance, the possible outcome of litigation and the useful
lives for depreciation and amortization expense and the valuation of tangible
and intangible assets. There have been no changes in these areas or
methodologies in 2002.
9
Note 4: The Company carries insurance policies on insurable risks which it
believes to be appropriate. The Company generally has self-insured retention
limits and has obtained fully insured layers of coverage above such self-insured
retention limits. Accruals for self-insurance losses are made based on the
Company's claims experience and actuarial assumptions. The Company has certain
liabilities with respect to existing or potential claims, lawsuits, and other
proceedings. The Company accrues for these liabilities when it is probable that
future costs will be incurred and such costs can be reasonably estimated.
The Company believes that other legal proceedings and currently pending
litigation arising in the ordinary course of business will not have a material
effect on the consolidated financial statements.
Note 5: In June 2001, the Financial Accounting Standards Board (FASB) issued
Statement of Financial Accounting Standards (SFAS) 142, "Goodwill and Other
Intangible Assets". SFAS 142 requires that after December 31, 2001, existing
goodwill will no longer be amortized and intangible assets with indefinite
useful lives will not be amortized until their useful lives are determined to be
no longer indefinite. In accordance with SFAS 142, the Company discontinued the
amortization of goodwill and indefinite lived intangible assets effective
January 1, 2002. Goodwill and intangible assets that are not amortized are
subject to at least an annual assessment for impairment by applying a
fair-value-based test. The Company completed its initial assessment of goodwill
impairment in the second quarter of 2002 and the testing concluded that there
were no impairment issues. Estimated fair value was determined for each
reporting unit by utilizing the expected present value of the future cash flows
of the units. In all instances, the estimated fair value of the reporting units
exceeded their book values. In accordance with SFAS 142, the following table
provides summarized transitional information for the periods ended June 30, 2002
and 2001, with the 2001 information presented on an adjusted basis to reflect
the elimination of amortization expense required under SFAS 142:
Three Months Ended Six Months Ended
June 30, June 30,
----------------------------- ------------------------------
(in thousands, except per share data) 2002 2001 2002 2001
------------ ------------- ------------ --------------
Reported operating income $134,676 $115,931 $174,372 $150,260
Add back: Goodwill and trade name
amortization - 15,621 - 30,450
------------ ------------- ------------ --------------
Operating income as adjusted under
SFAS 142 $134,676 $131,552 $174,372 $180,710
============ ============= ============ ==============
Reported income from continuing
operations before extraordinary
gain/(loss) $71,437 $49,735 $83,295 $50,469
Add back: Goodwill and trade name
amortization, net of tax - 10,550 - 20,695
------------ ------------- ------------ --------------
Income from continuing operations
before extraordinary gain/loss as
adjusted under SFAS 142 71,437 60,285 83,295 71,164
Discontinued operations, net of taxes 295 4,225 78 9,483
Extraordinary gain/(loss), net of taxes (9,229) - (9,229) 6,003
------------ ------------- ------------ --------------
Net income as adjusted under SFAS 142 $62,503 $64,510 $74,144 $86,650
============ ============= ============ ==============
Reported basic earnings per share from
continuing operations before
extraordinary gain/(loss) $0.24 $0.17 $0.28 $0.17
Add back: Goodwill and trade name
amortization, net of tax - 0.04 - 0.07
------------ ------------- ------------ --------------
Basic earnings per share from continuing
operations before extraordinary gain/(loss)
as adjusted under SFAS 142 0.24 0.20 0.28 0.24
Discontinued operations, net - 0.01 - 0.03
Extraordinary gain/(loss), net (0.03) - (0.03) 0.02
------------ ------------- ------------ --------------
Basic earnings per share as adjusted
under SFAS 142 $0.21 $0.22 $0.25 $0.29
============ ============= ============ ==============
10
Three Months Ended Six Months Ended
(in thousands, except per share data) June 30, June 30,
----------------------------- ------------------------------
Reported diluted earnings per share
from continuing operations before
extraordinary gain/(loss) $0.23 $0.16 $0.27 $0.17
Add back: Goodwill and trade name
amortization, net of tax - 0.03 - 0.07
------------ ------------- ------------ --------------
Diluted earnings per share from continuing
operations before extraordinary gain/(loss)
as adjusted under SFAS 142 0.23 0.20 0.27 0.24
Discontinued operations, net - 0.01 - 0.03
Extraordinary gain/(loss), net (0.03) - (0.03) 0.02
------------ ------------- ------------ --------------
Diluted earnings per share as adjusted
under SFAS 142 $0.20 $0.21 $0.24 $0.29
============ ============= ============ ==============
The following table summarizes goodwill and intangible assets.
(in thousands) As of As of
June 30, December 31,
2002 2001
--------------- --------------
Goodwill (1) $1,909,792 $1,904,178
Trade names (1) 238,550 238,550
Other intangible assets 76,478 74,197
Accumulated amortization (2) (55,932) (51,611)
--------------- --------------
Net other intangibles 20,546 22,586
--------------- --------------
Total $2,168,888 $2,165,314
=============== ==============
(1) Not subject to amortization
(2) Annual amortization expense of approximately $6 - $8 million is expected
over the next five years.
Note 6: The Company has announced that, beginning in 2003, it will begin
accounting for employee stock options as compensation expense in accordance with
SFAS 123, "Accounting for Stock Based Compensation." If the Company continues
its historical pattern of option granting, the impact would be approximately
$.005 per diluted share in 2003, growing to approximately $.03 per diluted share
over five years.
In April 2002, the FASB issued SFAS 145, "Rescission of FASB Statements No. 4,
44, and 64, Amendment of FASB Statement No. 13, and Technical Corrections". The
primary impact to the Company of SFAS 145 is that it rescinds SFAS 4 which
required all material gains and losses from the extinguishment of debt to be
classified as extraordinary items. SFAS 145 requires that the more restrictive
criteria of APB Opinion No. 30 will be used to determine whether such gains or
losses are extraordinary. The Company intends to adopt SFAS 145 in its fiscal
year 2003, as required by SFAS 145. Adoption of SFAS 145 will result in the
reclassification of the extraordinary gains/losses into income from continuing
operations included in the accompanying Condensed Consolidated Statements of
Income.
In June 2002, the FASB issued SFAS 146, "Accounting for Costs Associated with
Exit or Disposal Activities". SFAS 146 requires recording costs associated with
exit or disposal activities at their fair values when a liability has been
incurred. Under previous guidance, certain exit costs were accrued upon
management's commitment to an exit plan, which is generally before an actual
liability has been incurred. The provisions of SFAS 146 are effective for exit
or disposal activities that are initiated after December 31, 2002.
Note 7: On October 3, 2001 the Company's Board of Directors approved a series of
strategic actions which were the culmination of an extensive portfolio review
process that was initiated in the first quarter of 2001. The goal of the
portfolio review was to increase shareholder value by creating a focused and
aligned company that provides the greatest return and growth potential. The
Company determined it could best achieve these goals with a portfolio of
businesses which support the business strategy to become America's Home Service
Company and have attractive cash flow and return characteristics. As part of
this determination, in the fourth quarter of 2001, the Company sold its
Management Services business to ARAMARK Corporation for
11
approximately $800 million. Also in the fourth quarter of 2001, the Company's
Board of Directors approved the exit of non-strategic and under-performing
businesses including TruGreen LandCare Construction, Certified Systems Inc.
(CSI), and certain other small operations. The Company sold its TruGreen
LandCare Construction operations to Environmental Industries, Inc. (EII) in
certain markets and entered into an agreement with EII to manage the wind-down
of commercial landscaping construction contracts in the remaining markets. In
addition, the Company sold all of its customer contracts relating to the exit of
CSI (the Company's professional employer organization), to AMS Staff Leasing,
N.A., Inc. The Company also completed, in the fourth quarter of 2001, the sale
of certain subsidiaries of its European pest control and property services
operations. The results of these discontinued business units have been separated
and classified as Discontinued Operations in the accompanying financial
statements.
The Company continues to carry certain assets on its financial statements
relating to these operations. Management is actively selling the remaining
equipment and collecting the outstanding receivables. The Company believes that
the remaining assets are presented at their net realizable value. In addition,
reserves and accrual balances remain on the financial statements relating to
these operations. Cash payments incurred for the wind-down of LandCare
construction contracts, lease termination costs, workers compensation and health
claims as well as professional service fees have been made in the first six
months of 2002. The remaining balances are outlined in the table below.
In the fourth quarter of 2001, the Company recorded a charge for asset
impairments and other items which included accruals for residual value
guarantees on leased properties, severance for former executives and terminated
employees, and other costs. During the second quarter of 2002, the Company
completed the sale of its ownership interest in five assisted living facilities.
These properties were financed through a synthetic lease arrangement, whereby,
the Company guaranteed the residual value of the properties. At year-end, a
$13.5 million reserve was established representing the amount by which the
residual value guarantees exceeded the value of bids to purchase the facilities
at that time. The final sales price was significantly greater than these bid
levels and the Company realized a gain of $3.6 million from the sale on the
assisted living properties.
The table below summarizes the activity during the six months ended June 30,
2002 for the remaining liabilities from the discontinued operation and the
reserves for items recorded in the fourth quarter of 2001. The Company believes
that the remaining reserves continue to be adequate and reasonable.
(in thousands) Balance at Cash Balance at
December 31, Payments Income/ June 30,
2001 or Other (Expense) 2002
--------------- ----------- ---------- --------------
Remaining liabilities from
discontinued operations
LandCare Construction $34,100 $12,000 $(100) $22,200
Certified Systems, Inc. 23,800 5,500 - 18,300
Management Services 7,400 900 - 6,500
International businesses 19,600 (400) (1) - 20,000
Other 16,100 6,300 - 9,800
Reserves related to strategic
actions in the fourth
quarter of 2001 $36,000 $10,600 $3,600 $21,800
(1) The liabilities of this business were assumed by the buyer of the sold
operations. No cash payments were required.
The Company recorded a $3.2 million charge in the second quarter of 2002
relating to the severance and termination agreement of a key executive. This
severance will be paid out over three years.
Note 8: Basic earnings per share are computed by dividing income available to
common stockholders by the weighted-average number of shares outstanding for the
period. The weighted average common shares for the diluted earnings per share
calculation includes the incremental effect related to outstanding options whose
market price is in excess of the exercise price. Shares potentially issuable
under convertible securities have been considered outstanding for purposes of
the diluted earnings per share calculations. In computing diluted earnings per
share, the after-tax interest expense related to convertible debentures is added
back to net income in the numerator, while the diluted shares in the denominator
include the shares issuable upon conversion of the debentures. The effects of
outstanding stock options whose market price is in excess of the exercise price
12
and shares potentially issuable under convertible securities have not been
included for the six months ended June 30, 2002 and 2001, respectively, as their
effect would have been anti-dilutive.
The following table reconciles both the numerator and the denominator of the
basic earnings per share from continuing operations computation to the numerator
and the denominator of the diluted earnings per share from continuing operations
computation.
(in thousands, except per share data) Three Months Three Months
Ended June 30, 2002 Ended June 30, 2001
-------------------------------- ------------------------------
Continuing Operations: Income Shares EPS Income Shares EPS
---------------------- -------- -------- ------ -------- -------- ------
Basic earnings per share $71,437 301,092 $0.24 $49,735 298,547 $0.17
====== ======
Effect of dilutive securities, net of tax:
Options 7,182 4,060
Convertible securities 1,195 8,200 1,191 8,157
---------- --------- -------- --------
Diluted earnings per share $72,632 316,474 $0.23 $50,926 310,764 $0.16
======== ======== ====== ======== ======== ======
Six Months Six Months
Ended June 30, 2002 Ended June 30, 2001
-------------------------------- ------------------------------
Continuing Operations: Income Shares EPS Income Shares EPS
---------------------- -------- -------- ------ -------- -------- -----
Basic earnings per share $83,295 300,653 $0.28 $50,469 298,170 $0.17
====== ======
Effect of dilutive securities, net of tax:
Options 7,047 3,973
-------- -------- -------- --------
Diluted earnings per share $83,295 307,700 $0.27 $50,469 302,143 $0.17
======== ======== ====== ======== ======== ======
Note 9: In the Condensed Consolidated Statements of Cash Flows, the caption Cash
and Cash Equivalents includes investments in short-term, highly-liquid
securities having a maturity of three months or less. Supplemental information
relating to the Condensed Consolidated Statements of Cash Flows for the six
months ended June 30, 2002 and 2001 is presented in the following table:
(in thousands)
2002 2001
---------- ------------
Cash paid or (received) for:
Interest expense............................. $ 44,956 $ 64,845
Interest and dividend income................. $ (6,108) $ (4,366)
Income taxes................................. $ 31,294 $ (12,277)
The decrease in interest paid in 2002 is primarily due to reduced debt levels
reflecting debt retirements utilizing the proceeds from the sale of Management
Services. The increase in interest income received is also due to the proceeds
received from the Management Services sale as the Company maintained significant
cash levels throughout the year. The tax payment in 2002 resulted from the gain
on the sale of the Management Services business which compared to the prior year
tax refund of $21 million related to prior year over-payments.
Note 10: Total comprehensive income was $57.7 million and $51.8 million for the
three months ended June 30, 2002 and 2001, respectively, and $70.9 million and
$52.2 million for the six months ended June 30, 2002 and 2001, respectively.
Total comprehensive income includes primarily net income, changes in unrealized
gains and losses on marketable securities and translation balances.
Note 11: On March 23, 2001, the Company entered into an agreement which provides
for the ongoing revolving sale of a designated pool of accounts receivable of
TruGreen and Terminix. At June 30, 2002, there were no outstanding receivables
sold to third parties under this agreement. However, the Company may sell its
receivables in the future which would provide an alternative funding source.
Note 12: In the second quarter of 2002, the Company recorded an extraordinary
loss on early debt extinguishment of $9.2 million after-tax or $.03 per diluted
share resulting from the repurchase of approximately $218 million in
ServiceMaster corporate bonds pursuant to a tender offer. In the first quarter
of 2001, the Company repurchased approximately $35 million of its public debt
securities and recorded an extraordinary gain of $6.0 million after-tax or $.02
per diluted share. The Company intends to adopt SFAS
13
145 beginning in fiscal 2003. Adoption of SFAS 145 will result in the
reclassification of the extraordinary gain/loss into income from continuing
operations.
Note 13: The Company maintains minority investors in the combined ARS/AMS entity
as well as in Terminix. Members of management acquired, at fair market value,
equity interests in ARS. The Company and the equity investors have respective
options to acquire or sell the minority interests in the future at a price based
on fair market value. The future acquisition of this minority interest will be
recorded as additional purchase cost at the time of payment. At Terminix, the
minority ownership reflects an interest issued to the prior owners of the Allied
Bruce Terminix Companies in connection with that acquisition. This equity
security is exchangeable into eight million ServiceMaster common shares. The
ServiceMaster shares are included in the shares used for the calculation of
diluted earnings per share.
In January 2001, Jonathan P. Ward, President and Chief Executive Officer of
ServiceMaster, purchased from ServiceMaster a 5.50% convertible debenture due
January 9, 2011, with a face value of $1.1 million. ServiceMaster financed the
purchase of the debenture with a 5.50% full recourse loan due January 9, 2011.
In May 2001, Mr. Ward purchased a second 5.50% convertible debenture due May 10,
2011, with a face value of $1.1 million. ServiceMaster financed 50% of the
purchase price of this second debenture with a 5.50% full recourse loan due May
10, 2011. Each debenture becomes convertible into 20,000 shares of ServiceMaster
common stock on December 31 on each of the years 2001 through 2005.
Note 14: The business of the Company is conducted through five operating
segments: TruGreen, Terminix, American Home Shield, ARS/AMS and Other
Operations. Due to the Company's sale of its Management Services business unit
and its exit from other businesses in 2001, certain operations have become more
significant for segment reporting purposes. As a result, the Company has
expanded its business segment reporting which will allow for better ongoing
visibility into the components of the business. The companies that previously
were reported in the Home Maintenance & Improvement segment have been further
broken out into American Home Shield and the combination of ARS/AMS. The
franchise operations, ServiceMaster Clean and Merry Maids, formerly in the Home
Maintenance & Improvement segment, are reported in the Other Operations segment.
In accordance with Statement of Financial Accounting Standards No. 131, the
Company's reportable segments are strategic business units that offer different
services. The TruGreen segment provides residential and commercial lawn care and
landscaping services through the TruGreen ChemLawn and TruGreen LandCare
companies. As a result of the decision in the fourth quarter of 2001 to exit the
LandCare Construction business, the results of the construction operations are
now included in discontinued operations for all periods. The Terminix segment
provides termite and pest control services to residential and commercial U.S.
customers. The American Home Shield segment provides home warranties to
consumers that cover heating, ventilation, air conditioning (HVAC), plumbing and
certain appliances. This segment also includes home inspection services provided
by AmeriSpec. The American Residential Services, (ARS) and American Mechanical
Services (AMS) segment provides HVAC and plumbing services provided under the
ARS, AMS and Rescue Rooter brand names. The Other Operations segment includes
the franchise operations of ServiceMaster Clean and Merry Maids, which provide
disaster restoration and cleaning services as well as the Company's headquarters
operations which provides various technology, marketing, finance and other
support services to the business units.
Segment information is presented below. As discussed in Note 2 in the Notes to
the Condensed Consolidated Financial Statements, the information for 2002 and
2001 has been restated.
SFAS 142, "Goodwill and Other Intangible Assets", eliminates the amortization of
goodwill and intangible assets with indefinite lives beginning in 2002. The
table below also presents "Proforma" information for 2001 which eliminates
amortization expense related to goodwill and intangible assets with indefinite
lives, so that these periods are presented on a comparable basis to the 2002
information.
14
(In thousands) Three Months Three Months Three Months
Ended June 30, Ended June 30, Ended June 30,
2002 2001 2001
Reported Reported Proforma
----------------------------------------------------------------------------------------------------------------------
Operating Revenue:
TruGreen $434,279 $430,065
Terminix 256,652 231,633
American Home Shield 116,440 100,027
ARS/AMS 192,079 224,173
Other Operations 35,487 34,136
-------------------------------------------------------------------------------------------------
Total Operating Revenue $1,034,937 $1,020,034
=================================================================================================
Operating Income:
TruGreen $67,920 $61,912 $68,507
Terminix 44,289 33,279 38,715
American Home Shield 17,834 10,949 11,559
ARS/AMS 10,191 13,352 15,672
Other Operations (5,558) (3,561) (2,901)
----------------------------------------------------------------------------------------------------------------------
Total Operating Income $134,676 $115,931 $131,552
======================================================================================================================
As of As of
June 30, 2002 Dec. 31, 2001
----------------------------------------------------------------------------------------------------------------------
Identifiable Assets:
TruGreen $1,148,644 $1,082,135
Terminix 846,789 823,333
American Home Shield 356,344 323,229
ARS/AMS 505,736 519,026
Other Operations (and discontinued businesses) 613,872 873,522
-------------------------------------------------------------------------------------------------
Total Identifiable Assets $3,471,385 $3,621,245
=================================================================================================
Six Months Six Months Six Months
Ended June 30, Ended June 30, Ended June 30,
2002 2001 2001
Reported Reported Proforma
----------------------------------------------------------------------------------------------------------------------
Operating Revenue:
TruGreen $663,422 $659,820
Terminix 476,925 428,421
American Home Shield 202,356 173,189
ARS/AMS 357,170 415,345
Other Operations 69,327 66,120
-------------------------------------------------------------------------------------------------
Total Operating Revenue $1,769,200 $1,742,895
=================================================================================================
Operating Income:
TruGreen $74,444 $61,454 $74,644
Terminix 82,225 63,204 73,022
American Home Shield 21,189 12,076 13,295
ARS/AMS 7,305 18,621 23,160
Other Operations (10,791) (5,095) (3,411)
----------------------------------------------------------------------------------------------------------------------
Total Operating Income $174,372 $150,260 $180,710
======================================================================================================================
15
The following table summarizes the previously amortized goodwill and trade names
by segment that, beginning on January 1, 2002 are no longer amortized.
June 30, December 31,
2002 2001
------------------ ------------------
TruGreen $911,183 $910,573
Terminix 708,722 705,608
American Home Shield 72,085 72,085
ARS/AMS 347,967 347,863
Other Operations 108,385 106,599
------------------ ------------------
Total $2,148,342 $2,142,728
================== ==================
16
MANAGEMENT DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
RESULTS OF OPERATIONS
SECOND QUARTER 2002 COMPARED TO SECOND QUARTER 2001
CONSOLIDATED REVIEW
The Company has restated its financial statements for 2001 as well as the
previously reported 2002 quarterly results. See Note 2 of the Notes to the
Condensed Consolidated Financial Statements for the description of the
restatement and the financial statement impact. This Management Discussion and
Analysis reflects the impacts of the restatement.
Revenue for the second quarter was $1.03 billion, one percent above 2001, and
operating income was $135 million. The Company reported income from continuing
operations in 2002 of $71 million, income from discontinued operations of $.3
million, and a $9 million extraordinary loss from the early extinguishment of
debt. Net income was $63 million in 2002 and $54 million in 2001 and diluted
earnings per share were $.20 in 2002 and $.18 in 2001.
Diluted earnings per share from continuing operations were $.23 in 2002 compared
with $.16 in 2001. As discussed further in Note 4 of the Notes to the Condensed
Consolidated Financial Statements, Statement of Financial Accounting Standards
(SFAS) No. 142, "Goodwill and Other Intangible Assets", requires that beginning
in 2002, goodwill and trade names no longer be amortized. SFAS 142 does not
permit the restatement of the 2001 financial information to reflect the impact
of SFAS 142. The diluted earnings per share equivalent of reduced amortization
expense under SFAS 142 is $.03 ($16 million pretax) for the second quarter of
2001.
Second quarter operating income in 2002 was $135 million compared to $116
million in 2001. The 2001 figure includes $16 million of amortization expense
that has been eliminated under SFAS 142. Operating margins after adjusting for
the amortization expense eliminated under SFAS 142 increased to 13.0 percent of
revenue in 2002 from 12.9 percent in 2001. The increase in operating income
reflects continued strong performance at American Home Shield, solid performance
from Terminix and the TruGreen lawn care operations, partially offset by lower
volume in the heating, ventilation and air conditioning (HVAC) and plumbing
businesses of ARS and AMS, increased workers compensation claims at TruGreen
LandCare, as well as increased expenditures related to Company-wide operational
initiatives and overhead support.
Cost of services rendered and products sold decreased slightly for the quarter
and decreased as a percentage of revenue to 65.7 percent in 2002 from 66.8
percent in 2001. This decrease reflects a change in mix of the business as
TruGreen ChemLawn, Terminix, and American Home Shield increased in size in
relationship to the overall business of the Company. These businesses generally
operate at higher gross margin levels than the rest of the business, but also
incur somewhat higher selling and administrative expenses as a percentage of
revenue. Selling and administrative expenses increased six percent and increased
as a percentage of revenue to 21.0 percent from 20.1 percent in 2001. The
increase in selling and administrative expenses reflects the change in business
mix discussed above, as well as enterprise-wide initiatives to measure customer
and employee satisfaction, improved marketing techniques and expenditures on the
Six Sigma programs.
In the second quarter of 2002, the Company completed two non-recurring
transactions. The ownership interest in five assisted living facilities was sold
during the quarter, and a gain of $3.6 million was realized. In addition, a key
executive signed a termination and severance agreement in the quarter. The
Company recorded a $3.2 million charge relating to this agreement. Cash payments
will be made over a three-year period.
Interest expense decreased from the prior year, primarily due to reduced debt
levels as a portion of the proceeds received from sales of the Management
Services and certain European pest control businesses were used to pay down
debt. Interest and investment income decreased primarily reflecting a reduced
17
level of investment gains realized on the American Home Shield investment
portfolio. Minority interest and other expense decreased primarily due to losses
incurred in 2001 relating to the sale of accounts receivables under the
Company's securitization program.
The tax provision in 2002 reflects a lower effective tax rate than 2001 based on
benefits received through the consolidation for tax purposes of the
ServiceMaster Home Service Center. As a result of the Company's acquisition of
the minority interest, it was able to reorganize the subsidiary in 2002 and
utilize prior year net operating losses of this subsidiary operation.
OTHER DEVELOPMENTS
New distribution channels for the Company's services continue to be explored. In
July 2002, the Company announced that it had entered into an agreement to
provide Yahoo! consumers the ability to schedule and purchase ServiceMaster home
services through the newly created Home Service Center on Yahoo! Real Estate.
Also in August, the Home Service Center (a subsidiary of the Company) partnered
with Sears, Roebuck and Company to allow customers to tap into the network of
Sears parts and repair services.
In July 2002, the Company and the Home Depot announced that they had concluded
their joint home services pilot program. The two companies will, however,
continue to explore ways to expand existing relationships for installation and
other services on a local basis.
SEGMENT REVIEW
SEGMENT RESULTS FOR 2002 REFLECT THE ELIMINATION OF GOODWILL AND TRADE NAME
AMORTIZATION REQUIRED UNDER SFAS 142. THEREFORE, FOR COMPARATIVE PURPOSES, 2001
RESULTS HAVE BEEN PRESENTED ON A PROFORMA BASIS AS IF SFAS 142 HAD BEEN IN
EFFECT FOR 2001 THEREBY EXCLUDING THE AMORTIZATION EXPENSE AFFECTED BY THE NEW
ACCOUNTING STANDARD. (SEE THE BUSINESS SEGMENT REPORTING IN NOTE 14 IN THE NOTES
TO THE CONDENSED CONSOLIDATED FINANCIAL STATEMENTS). MANAGEMENTS DISCUSSION AND
ANALYSIS FOCUSES ON THE 2002 REPORTED AND THE 2001 PROFORMA AMOUNTS.
The TruGreen segment includes lawn care operations performed under the TruGreen
ChemLawn brand name and landscape maintenance services provided under the
TruGreen LandCare brand name. This segment's results for both 2002 and 2001
exclude the discontinued TruGreen LandCare Construction business. The TruGreen
segment reported revenue of $434 million, one percent above 2001. Operating
income decreased one percent to $68 million from $69 million (proforma) in 2001,
primarily reflecting solid growth in the lawn care operations, offset by
increased workers compensation claims (approximately $5 million) in the
landscape operations. Revenue in the lawn care business improved two percent
over 2001, reflecting growth in customer counts from increased sales and
improved retention rates. The sales growth has been supported by the deployment
of more sophisticated marketing tools and by reaching customers more effectively
through broader distribution channels. The higher level of full program
customers has also increased the sale of ancillary services in the quarter.
Operating income margins in the lawn care operations improved as a result of
revenue growth and increased leverage of fixed costs. The landscape maintenance
operations experienced a decline in revenue for the quarter. Although volume was
down, the base of business consists of more profitable contracts with a stronger
customer base and improved pricing. Operating income margins in the landscaping
operations declined primarily reflecting increased workers compensation claims,
partially offset by lower material costs. This business is focusing on specific
operating initiatives including hiring a senior sales leader, expanding and
developing its sales force, continuing to focus on labor efficiency programs,
and improving the results of the bottom quartile of its branches.
The Terminix segment, which includes the domestic termite and pest control
services, reported an 11 percent increase in revenue to $257 million from $232
million in 2001 and operating income growth of 14 percent to $44 million from
$39 million (proforma) in 2001. Revenue growth was supported by the 2001
acquisition of Sears Termite & Pest Control as well as new sales and improved
customer retention in both the termite and pest control business. Operating
income margins improved over the prior year reflecting the beneficial impact of
acquisitions and improved labor efficiency, offset in part by costs for quality
improvement initiatives and direct marketing expenditures. The segment has
produced steady
18
improvement in customer retention rates which reflects the increased emphasis on
training and customer service processes in the branches.
The American Home Shield segment, which provides home warranties to consumers
that cover HVAC, plumbing and other appliances, reported a 16 percent increase
in revenue to $116 million from $100 million in 2001. This increase in revenue
reflected strong growth in the real estate and third party channels as well as
improved customer renewal rates. Operating income increased 54 percent to $18
million from $12 million (proforma) in 2001. Operating income margins improved
reflecting both lower service costs per claim and a decrease in the incidence of
claims.
The ARS/AMS segment provides direct HVAC and plumbing services under the
American Residential Services (ARS), Rescue Rooter, and American Mechanical
Services (AMS) (for commercial accounts) brand names. The segment reported
revenue of $192 million, a decrease of 14% from $224 million in 2001. Operating
income decreased to $10 million from $16 million (proforma) in 2001. A decline
in call volume for air conditioning and plumbing repairs and reduced
construction activity continued to affect the industry and resulted in the
decline in revenue and profit. A comprehensive rebuilding of marketing and sales
strategies is underway to counteract the impact of the decrease in demand, and
in the second quarter, the Company hired a chief marketing officer for the ARS
operations.
The Other Operations segment includes the Company's ServiceMaster Clean, Merry
Maids, and international operations as well as its headquarters functions.
Reported segment revenue of $35 million in 2002 compared with $34 million in
2001, primarily reflecting growth in the ServiceMaster Clean and Merry Maids
businesses. The operations achieved revenue and profit growth, primarily driven
by a strong growth in disaster restoration and increased franchise sales at
ServiceMaster Clean and the beneficial impact of acquisitions at Merry Maids.
This segment reported an operating loss of $6 million in 2002 compared with a
loss of $3 million (proforma) in 2001, reflecting increased expenditures in the
headquarters organization for Six Sigma and other enterprise-wide initiatives to
support purchasing efficiencies, marketing programs and technology projects.
RESULTS OF OPERATIONS
SIX MONTHS ENDED JUNE 30, 2002 AS COMPARED TO JUNE 30, 2001
CONSOLIDATED REVIEW
Revenue for the six months in 2002 increased two percent to $1.8 billion and
operating income was $174 million. The Company reported income from continuing
operations in 2002 of $83 million and a $9 million extraordinary loss from the
early extinguishment of debt. Net income was $74 million in 2002 and $66 million
in 2001 and diluted earnings per share were $.24 in 2002 and $.22 in 2001.
Diluted earnings per share from continuing operations were $.27 in 2002 compared
with $.17 in 2001. As discussed in the three-month comparison, the diluted
earnings per share equivalent of reduced amortization expense under SFAS 142 are
$.07 ($30 million pretax) for the six months of 2001.
Six month operating income in 2002 was $174 million compared to $150 million in
2001. The 2001 figure includes $30 million of amortization expense that has been
eliminated under SFAS 142. Operating margins after adjusting for the
amortization expense eliminated under SFAS 142 decreased to 9.9 percent of
revenue in 2002 from 10.4 percent in 2001. The decline in operating income
reflects strong increases at American Home Shield and Terminix offset by reduced
volume in the HVAC and plumbing businesses of ARS and AMS and increased
expenditures related to Company-wide operational initiatives.
Cost of services rendered and products sold decreased slightly for the six
months and decreased as a percentage of revenue to 68.5 percent in 2002 from
69.5 percent in 2001. Selling and administrative expenses increased 10 percent
and increased as a percentage of revenue to 21.4 percent in 2002 from 19.8
percent in 2001 The increase in selling and administrative expenses reflects
strong growth in operations that have higher gross margin levels than the rest
of the business, but also incur somewhat higher selling and administrative
expenses as a percentage of revenue, as well as increase expenditures on
initiatives to
19
measure customer and employee satisfaction, improved marketing techniques and
expenditures in Six Sigma.
Interest expense decreased from the prior year, primarily due to reduced debt
levels as a portion of the proceeds received from the sales of the Management
Services and certain European pest control businesses were used to pay down
debt. Interest and investment income decreased primarily reflecting a reduced
level of investment gains realized on the American Home Shield investment
portfolio. Minority interest and other expense increased from the prior year
primarily due to the elimination of minority interest income related to the
ServiceMaster Home Service Center initiative that was recorded in 2001. In the
first quarter of 2001 and until May 2001, the operating losses totaling $6.1
million of ServiceMaster Home Service Center had been offset through minority
interest income (below the operating income line) because of investments in the
venture made by Kleiner Perkins Caufield & Byers. In December 2001, the Company
acquired the minority interest in the ServiceMaster Home Service Center held by
Kleiner Perkins and management. The operating losses incurred in the first six
months of 2002 from ServiceMaster Home Service Center have been included in the
accompanying financial statements without an offset at minority interest income
in the consolidated statements of income.
The tax provision in 2002 reflects a lower effective tax rate than 2001 based on
benefits received through the consolidation for tax purposes of the
ServiceMaster Home Service Center. As a result of the Company's acquisition of
the minority interest, it was able to reorganize the subsidiary in 2002 and
utilize prior year net operating losses of this subsidiary operation.
KEY PERFORMANCE INDICATORS
The table below presents selected metrics related to customer counts and
customer retention for the three stet businesses of the Company. These measures
are presented on a rolling, twelve month basis in order to avoid seasonal
anomalies.
KEY PERFORMANCE INDICATORS
As of June 30,
2002 2001
------------ -------------
TRUGREEN -
Growth in Full Program Contracts 1% -3%
Customer Retention Rate 64.5% 62.4%
TERMINIX -
Growth in Pest Control Customers 12% 14%
Pest Control Customer Retention Rate 77.5% 76.2%
Growth in Termite Customers 8% 20%
Termite Customer Retention Rate 90.1% 88.8%
AMERICAN HOME SHIELD -
Growth in Warranty Contracts 15% 11%
Customer Retention Rate 53.2% 51.1%
SEGMENT REVIEW
SEGMENT RESULTS FOR 2002 REFLECT THE ELIMINATION OF GOODWILL AND TRADE NAME
AMORTIZATION REQUIRED UNDER SFAS 142. THEREFORE, FOR COMPARATIVE PURPOSES, 2001
RESULTS HAVE BEEN PRESENTED ON A PROFORMA BASIS AS IF SFAS 142 HAD BEEN IN
EFFECT FOR 2001 THEREBY EXCLUDING THE AMORTIZATION EXPENSE AFFECTED BY THE NEW
ACCOUNTING STANDARD. (SEE THE BUSINESS SEGMENT REPORTING IN NOTE 14 IN THE NOTES
TO THE CONDENSED CONSOLIDATED FINANCIAL STATEMENTS). MANAGEMENTS DISCUSSION AND
ANALYSIS FOCUSES ON THE 2002 REPORTED AND THE 2001 PROFORMA AMOUNTS.
The TruGreen segment reported revenue of $663 million, slightly above the prior
year. Operating income of $74 million in 2002 was comparable to the 2001
proforma amount. Revenue in the lawn care business improved two percent over
2001. Customer contracts have increased one percent over the prior twelve
20
months compared with a three percent decline in the prior year period,
reflecting the benefit of new marketing strategies as well as the impact of
improved customer retention. In addition to telemarketing, which is the primary
channel used by TruGreen ChemLawn to sell its services, the business has
expanded expenditures in direct mail and television advertising leading to
higher sales of new customers. Quality and other satisfaction initiatives have
resulted in improving retention of existing customers. The customer retention
rate improved 210 basis points to 64.5 percent compared to the same period last
year. The retention rate continued to increase in the second quarter. Operating
income margins in the lawn care operations increased reflecting improved labor
productivity. Revenue in the landscaping operations declined reflecting a
decrease in snow removal services due to mild winter weather and a slight
decrease in its core maintenance business. Despite the decline in the
maintenance business, the base of contracts is more profitable reflecting a
stronger customer base and improved pricing. Operating income margins in the
landscaping operations declined primarily reflecting the decreased volume of
higher margin snow removal business and increased workers compensation claims.
Management is highly focused on mid-season sales of enhanced services to support
second half of the year growth expectations.
The Terminix segment reported an 11 percent increase in revenue to $477 million
from $428 million in 2001 and operating income growth of 13 percent to $82
million from $73 million (proforma) in 2001. Revenue growth was driven by the
acquisition in 2001 of Sears Termite & Pest Control as well as solid internal
growth. One area where the Company has begun to see challenges is from the
decrease in profitable pest control customers from the Sears name in certain
markets. New sales in these markets have not kept pace with cancellations. As a
result, the Company expects to see a reduction in revenue growth in the fourth
quarter. Terminix has continued to show favorable comparisons in both termite
and pest control customer retention, reflecting increased focus on quality,
training, and customer service processes in the branches. Operating income
margins improved over 2001 reflecting the impact of the acquisitions, continuing
migration to higher margin products, improved labor efficiencies and lower
material costs. Terminix is in the process of rolling out a new operating system
to support its field operations. This system is expected to be in all branches
by 2004.
The American Home Shield segment reported a 17 percent increase in revenue to
$202 million from $173 million in 2001 and operating income growth of 59 percent
to $21 million compared to $13 million (proforma) in 2001. Revenue growth
reflected increases in all sales channels, complemented by improved customer
retention. Operating income margins improved as the segment benefited from
strong volume growth, lower service costs per claim and a decrease in the
incidence of claims.
The ARS/AMS segment reported a 14 percent decrease in revenue to $357 million
from $415 million in 2001 and operating income of $7 million compared to $23
million (proforma) in 2001. A soft economic environment combined with mild
weather led to lower demand for heating, air conditioning and plumbing repairs
and replacement service. These operations also experienced lower construction
activity in both the residential and commercial sectors. With new leadership in
place, this business continues to focus on cost containment initiatives and is
implementing significant changes to its sales and marketing programs.
Other Operations revenue increased to $69 million from $66 million in 2001,
primarily reflecting growth in the ServiceMaster Clean and Merry Maids
businesses. These businesses achieved solid revenue and profit growth, supported
by strong demand for disaster restoration services at ServiceMaster Clean and
acquisitions at Merry Maids. This segment reported an operating loss of $11
million compared with a loss of $3 million (proforma) in 2001, reflecting
increased expenditures on enterprise-wide initiatives including procurement,
marketing, and technology.
FINANCIAL CONDITION
Net cash provided from operations of $143 million was $38 million higher than
the first six months of 2001 before the impact of the Company's accounts
receivable securitization program and tax refunds in 2001. Net cash provided
from operations is 72 percent higher than earnings for the six months and
represents a 36 percent increase over the $105 million that was reported last
year. This increase was driven, in part, by a significant reduction in the use
of working capital, primarily at TruGreen ChemLawn and American Home Shield as a
result of better receivables, payables and inventory management. Management
believes that funds generated from operations and other existing resources will
continue to be adequate to satisfy ongoing working capital needs of the Company.
21
Cash and marketable securities totaled approximately $205 million at June 30,
2002. During the second quarter of 2002, the Company completed the last major
phase of the debt reduction program announced in October 2001, when through a
tender offer, the Company repurchased $218 million of its publicly traded debt.
As a result the Company reduced its total outstanding debt level in the quarter
to approximately $876 million. This represents a reduction in debt outstanding
of approximately $1.1 billion over the last two years and the Company's lowest
level since the first quarter of 1997. The debt repurchase allowed the Company
the opportunity to strengthen its credit profile by focusing the majority of the
repurchase on debt with shorter maturities. Approximately 60% of the Company's
debt now matures beyond seven years and 40% beyond fifteen years. The Company's
first public bond maturity is not due until 2005.
The Company maintains a three-year revolving credit facility for $490 million,
which will expire in December 2004. As of June 30, 2002 the Company had issued
approximately $130 million of letters of credit under the facility and had
unused commitments of approximately $360 million. The Company also has $550
million of senior unsecured debt and equity securities available for issuance
under an effective shelf registration statement. In addition, the Company has an
agreement to ultimately sell, on a revolving basis, certain receivables to
unrelated third party purchasers. At June 30, 2002, there were no receivables
outstanding that had been sold to third parties. The agreement is a 364-day
facility that is renewable at the option of the purchasers. The Company may sell
up to $65 million of its eligible receivables to these purchasers in the future
and therefore has immediate access to cash proceeds from these sales. The amount
of eligible receivables varies during the year based on seasonality of the
business and will at times limit the amount available to the Company. The
Company also maintains operating lease facilities with banks totaling $95
million that provide for the acquisition and development of properties to be
leased by the Company. There are residual value guarantees of these properties
up to 82 percent of the fair market value of the properties. At June 30, 2002,
there was approximately $72 million funded under these facilities. Of the $95
million in facilities, $80 million expires in October 2004 and $15 million
expires in January 2008. Approximately $15 million of these leases that involve
constructed properties have been included on the balance sheet as assets with
related debt as of June 30, 2002 and December 31, 2001. The majority of the
Company's vehicle fleet is leased through operating leases. The lease terms are
non-cancelable for the first twelve month term, then are month-to-month leases,
cancelable at the Company's option. There are residual value guarantees (ranging
from 70 percent to 87 percent depending on the agreement) on these vehicles,
which historically have not resulted in significant net payments to the lessors.
At June 30, 2002, there was approximately $265 million of residual value
relating to the Company's fleet.
The following table presents the Company's obligations and commitments:
2003 and 2005 and 2007 and
(In millions) Total 2002 2004 2006 later years
-------------------------------------------------------------------------------------------
Debt balances $ 876 $ 21 $ 73 $ 169 $ 613
Non-cancelable operating leases (1) 253 30 93 62 68
------ ------- ------- ------- -------
Total amount $1,129 $ 51 $ 166 $ 231 $ 681
(1) Includes lease payments and residual value guarantees on leased properties.
There have been no material changes in the terms of the Company's financing
agreements since December 31, 2001. As described in the Company's latest Annual
Report to Shareholders, the Company is party to a number of debt agreements
which require it to maintain certain financial and other covenants, including
limitations on indebtedness and interest coverage ratio. In addition, under
certain circumstances, the agreements may limit the Company's ability to pay
dividends and repurchase shares of common stock. These limitations are not
expected to be a factor in the Company's future dividend and share repurchase
plans. Failure by the Company to maintain these covenants could result in the
acceleration of the maturity of the debt. At June 30, 2002 the Company was in
compliance with the covenants related to these debt agreements and based on its
operating outlook for the remainder of 2002, expects to be able to maintain
compliance in the future.
The assets and liabilities relating to the discontinued companies have been
classified in separate captions on the Condensed Consolidated Statements of
Financial Position. In the first quarter, the Company made
22
approximately $70 million in tax payments relating to the sale of Management
Services. There were other cash payments relating to the wind-down of the
discontinued operations which were offset by cash collected on assets remaining
from these operations. Assets of the discontinued operations have declined
reflecting cash collections on receivables and the sale of fixed assets. The
liabilities from discontinued operations have decreased reflecting cash outflows
related to the wind-down of contracts, lease termination costs, workers'
compensation payments and legal costs.
Receivables and inventories increased from year-end levels, reflecting general
business growth and increased seasonal activity. Prepaid expenses, deferred
costs and other assets increased from year-end levels, reflecting the
seasonality in the lawn care operations and increased volume of contracts
written at Terminix and American Home Shield. The lawn care operations incur
incremental selling expenses at the beginning of the year that directly relate
to successful sales in which the revenues will be recognized in later quarters.
This business also defers, on an interim basis, pre-season advertising costs and
annual repairs and maintenance procedures that are performed in the first
quarter. These costs are deferred and recognized in proportion to the contract
revenue over the production season, and are not deferred beyond the calendar
year-end. The Company also capitalizes sales commissions and other direct
contract acquisition costs relating to termite and pest control contracts as
well as home warranty contracts. Deferred revenue grew significantly reflecting
increases in customer prepayments for lawn care services and strong growth in
warranty contracts written at American Home Shield.
Capital expenditures which include recurring capital needs and information
technology projects are higher than prior year levels reflecting the payments of
the residual value guarantees relating to leases for the five assisted living
facilities sold in the quarter. See Note 7 for additional details. The Company
has no material capital commitments at this time.
Total shareholders' equity was $1.2 billion at June 30, 2002 and December 31,
2001, reflecting earnings which were offset by cash dividends. Cash dividends
paid directly to shareholders totaled $60 million or $.20 per share for the six
months ended June 30, 2002. In July 2002, the Company paid a third quarter cash
dividend of $.105 per share and declared a fourth quarter cash dividend of $.105
per share payable on October 31, 2002. This quarterly dividend payment provides
for an annual payment for 2002 of $.41 per share, a 2.5% increase over 2001. The
Company approves its actual dividend payment on a quarterly basis and
continually reviews its dividend policy, share repurchase program and other
capital structure objectives. The Company has not undertaken material share
repurchases during the first six months of 2002 or for the year ended 2001.
Decisions relating to any future share repurchases will take various factors
into consideration such as the Company's commitment to maintain investment grade
credit ratings, general business conditions, and other strategic investment
opportunities.
FORWARD LOOKING STATEMENTS
THE COMPANY'S FORM 10-Q/A FILING CONTAINS STATEMENTS CONCERNING FUTURE RESULTS
AND OTHER MATTERS THAT MAY BE DEEMED TO BE "FORWARD-LOOKING STATEMENTS" WITHIN
THE MEANING OF THE PRIVATE SECURITIES LITIGATION REFORM ACT OF 1995. THE COMPANY
INTENDS THAT THESE FORWARD-LOOKING STATEMENTS, WHICH LOOK FORWARD IN TIME AND
INCLUDE EVERYTHING OTHER THAN HISTORICAL INFORMATION, BE SUBJECT TO THE SAFE
HARBORS CREATED BY SUCH LEGISLATION. THE COMPANY NOTES THAT THESE
FORWARD-LOOKING STATEMENTS INVOLVE RISKS AND UNCERTAINTIES THAT COULD AFFECT ITS
RESULTS OF OPERATIONS, FINANCIAL CONDITION OR CASH FLOWS. FACTORS THAT COULD
CAUSE ACTUAL RESULTS TO DIFFER MATERIALLY FROM THOSE EXPRESSED OR IMPLIED IN A
FORWARD-LOOKING STATEMENT INCLUDE THE FOLLOWING (AMONG OTHERS): EXTREME WEATHER
CONDITIONS THAT AFFECT THE DEMAND FOR THE COMPANY'S SERVICES; COMPETITION IN THE
MARKETS SERVED BY THE COMPANY; LABOR SHORTAGES OR INCREASES IN WAGE RATES;
UNEXPECTED INCREASES IN OPERATING COSTS, SUCH AS HIGHER INSURANCE, HEALTH CARE
OR FUEL PRICES; INCREASED GOVERNMENTAL REGULATION OF TELEMARKETING; GENERAL
ECONOMIC CONDITIONS IN THE UNITED STATES, ESPECIALLY AS THEY MAY AFFECT HOME
SALES OR CONSUMER SPENDING LEVELS; TIME AND EXPENSES ASSOCIATED WITH INTEGRATING
AND WINDING DOWN BUSINESSES; AND OTHER FACTORS DESCRIBED FROM TIME TO TIME IN
DOCUMENTS FILED BY THE COMPANY WITH THE SECURITIES AND EXCHANGE COMMISSION.
23
QUANTITATIVE AND QUALITATIVE DISCLOSURES
ABOUT MARKET RISK
The economy and its impact on discretionary consumer spending, labor wages, fuel
costs, insurance costs and medical inflation rates could be significant to
future operating earnings.
The Company does not hold or issue financial instruments for trading or
speculative purposes. The Company has entered into specific financial
arrangements in the normal course of business to manage certain market risks,
with a policy of matching positions and limiting the terms of contracts to
relatively short durations. The effect of financial instrument transactions is
not material to the Company's financial statements.
The Company generally maintains the majority of its debt at fixed rates (over
95% of total debt at December 31, 2001 and June 30, 2002) and, therefore, its
exposure to interest rate fluctuations is not significant to the Company's
results of operations. The payments on the approximately $72 million of funding
outstanding under the Company's real estate operating lease facilities as well
as its cancelable vehicle fleet and equipment operating leases are tied to
floating interest rates. However, the Company does not expect interest rate
fluctuations to be significant to the Company's results of operations.
The following table summarizes information about the Company's fixed rate debt
instruments as of December 31, 2002 and presents the principal cash flows and
related weighted-average interest rates by expected maturity dates. The fair
value of the Company's fixed rate debt was approximately $880 million at
December 31, 2002.
Expected Maturity Date
----------------------------------------
There-
(In millions) 2003 2004 2005 2006 2007 After Total
---------------------- -------- ------- ------- ------- ------- ------ -----
Fixed rate debt $31 $24 $151 $11 $59 $559 $835
Avg. Rate 4.2% 4.8% 8.2% 6.0% 6.7% 7.5% 7.2%
---------------------- -------- ------- ------- ------- ------- ------ -----
24
PART II. OTHER INFORMATION
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
(a) The 2002 Annual Meeting of Shareholders was held on April 26, 2002.
(b) The following persons were elected as Class of 2005 directors:
Name Votes For Votes Withheld Broker Non-Votes
------------------- ----------- -------------- ----------------
Paul W. Berezny, Jr. 247,162,142 7,248,494 N/A
Carlos H. Cantu 248,659,562 5,751,074 N/A
Vincent C. Nelson 246,594,910 7,815,726 N/A
Charles W. Stair 248,226,619 6,184,017 N/A
Jonathan P. Ward 250,546,178 3,864,458 N/A
No votes were cast for any other nominee for directors. The Class of 2003
continuing in office are: Herbert P. Hess, Michele M. Hunt, Dallen W. Peterson,
and David K. Wessner. The Class of 2004 continuing in office are: Brian
Griffiths, Sidney E. Harris, James D. McLennan, C. William Pollard and Donald G.
Soderquist.
No other matters were submitted to shareholders.
ITEM 6(A): EXHIBITS
Exhibit 18.1 Letter Re: Change in Accounting Principles
Exhibit 99.1 Certification of Chief Executive Officer Pursuant to Section 1350 of Chapter 63
of Title 18 of the United States Code
Exhibit 99.2 Certification of Chief Financial Officer Pursuant to Section 1350 of Chapter 63
of Title 18 of the United States Code
ITEM 6(B): REPORTS ON FORM 8-K
A report on Form 8-K was filed on May 22, 2002 reporting under "Item 4. Changes
in Registrant's Certifying Accountant." In this filing, the Company reported
that on May 20, 2002 it had dismissed ArthurAndersen LLP as its independent
accountants and, effective May 22, 2002, the Company engaged Deloitte & Touche
LLP as its new independent accountants.
A report on Form 8-K/A was filed on May 24, 2002 for the purpose of including a
revised Exhibit 16.1 to the Form 8-K filed on May 22, 2002.
A report on Form 8-K was filed on June 20, 2002 reporting under "Item 5. Other
Events". The purpose of the report was to provide updated Key Performance
Indicators that were included in the Company's first quarter earnings release.
The Company discussed these metrics in an investors conference on June 20, 2002.
25
SIGNATURE
Pursuant to the requirements of the Securities Exchange Act of 1934, the
Registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
Date: May 14, 2003
THE SERVICEMASTER COMPANY
(Registrant)
By: /s/Steven C. Preston
---------------------------------------------------
Steven C. Preston
Executive Vice President and Chief Financial Officer
26
CERTIFICATION OF CHIEF EXECUTIVE OFFICER
I, Jonathan P. Ward, certify that:
1. I have reviewed this quarterly report on Form 10-Q/A of The ServiceMaster
Company;
2. Based on my knowledge, this quarterly report does not contain any untrue
statement of a material fact or omit to state a material fact necessary to
make the statements made, in light of the circumstances under which such
statements were made, not misleading with respect to the period covered by
this quarterly report; and
3. Based on my knowledge, the financial statements, and other financial
information included in this quarterly report, fairly present in all
material respects the financial condition, results of operations and cash
flows of the registrant as of, and for, the periods presented in this
quarterly report.
Date: May 13, 2003
/s/ Jonathan P. Ward
---------------------
Jonathan P. Ward
Chairman and Chief Executive Officer
27
CERTIFICATION OF CHIEF FINANCIAL OFFICER
I, Steven C. Preston, certify that:
1. I have reviewed this quarterly report on Form 10-Q/A of The ServiceMaster
Company;
2. Based on my knowledge, this quarterly report does not contain any untrue
statement of a material fact or omit to state a material fact necessary to
make the statements made, in light of the circumstances under which such
statements were made, not misleading with respect to the period covered by
this quarterly report; and
3. Based on my knowledge, the financial statements, and other financial
information included in this quarterly report, fairly present in all
material respects the financial condition, results of operations and cash
flows of the registrant as of, and for, the periods presented in this
quarterly report.
Date: May 13, 2003
/s/ Steven C. Preston
----------------------
Steven C. Preston
Executive Vice President and Chief Financial Officer
28