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 September 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
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: 301,344,000 shares of common stock on November 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 nine months ended
September 30, 2002 (Restated) and
September 30, 2001 (Restated) 2
Condensed Consolidated Statements of Financial Position as of
September 30, 2002 (Restated) and December 31, 2001 (Restated) 4
Condensed Consolidated Statements of Cash Flows for the nine months ended
September 30, 2002 (Restated) and
September 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
Item 4: Controls and Procedures 25
PART II. OTHER INFORMATION
Item 6: Exhibits and Reports on Form 8-K 26
Signature 28
Exhibit 99.1: Certification of Chief Executive Officer Pursuant
to Section 1350 of Chapter 63 of Title 18 of the
United States Code 31
Exhibit 99.2: Certification of Chief Financial Officer Pursuant
to Section 1350 of Chapter 63 of Title 18 of the
United States Code 32
1
PART I. FINANCIAL INFORMATION
THE SERVICEMASTER COMPANY
CONDENSED CONSOLIDATED STATEMENTS OF INCOME (UNAUDITED)
(IN THOUSANDS, EXCEPT PER SHARE DATA)
Three Months Ended Nine Months Ended
September 30, September 30,
2002 2001 2002 2001
(Restated 4) (Restated 4) (Restated 4) (Restated 4)
------------- ------------ ------------ -------------
OPERATING REVENUE .................................................. $ 1,010,661 $ 981,284 $ 2,779,861 $ 2,724,179
OPERATING COSTS AND EXPENSES:
Cost of services rendered and products sold ........................ 685,893 671,961 1,897,085 1,883,448
Selling and administrative expenses ................................ 197,647 184,947 576,977 530,742
Goodwill, trade name and other intangible amortization (1) ......... 2,126 17,872 6,432 53,225
----------- ----------- ----------- -----------
Total operating costs and expenses ................................. 885,666 874,780 2,480,494 2,467,415
----------- ----------- ----------- -----------
OPERATING INCOME ................................................... 124,995 106,504 299,367 256,764
NON-OPERATING EXPENSE (INCOME):
Interest expense ................................................... 17,030 30,948 61,296 97,347
Interest and investment income ..................................... (405) (5,461) (5,303) (11,034)
Minority interest and other expense, net ........................... 1,905 2,248 5,489 3,312
----------- ----------- ----------- -----------
INCOME FROM CONTINUING OPERATIONS BEFORE INCOME TAXES .............. 106,465 78,769 237,885 167,139
Provision for income taxes ......................................... 39,477 33,727 87,602 71,628
----------- ----------- ----------- -----------
INCOME FROM CONTINUING OPERATIONS BEFORE EXTRAORDINARY
ITEMS ......................................................... 66,988 45,042 150,283 95,511
Income from discontinued operations, net of income taxes (2) ....... 1,095 7,490 1,173 16,973
Extraordinary gain (loss), net of income taxes (3) ................. - - (9,229) 6,003
----------- ----------- ----------- -----------
NET INCOME ......................................................... $ 68,083 $ 52,532 $ 142,227 $ 118,487
=========== =========== =========== ===========
PER SHARE:
BASIC EARNINGS PER SHARE:
Income from continuing operations before extraordinary items ....... $ 0.22 $ 0.15 $ 0.50 $ 0.32
Discontinued operations, net (2) ................................... - 0.03 - 0.06
Extraordinary gain (loss) (3) ...................................... - - (0.03) 0.02
----------- ----------- ----------- -----------
$ 0.23 $ 0.18 $ 0.47 $ 0.40
=========== =========== =========== ===========
SHARES ............................................................. 301,093 298,925 300,805 298,425
DILUTED EARNINGS PER SHARE:
Income from continuing operations before extraordinary items ........ $ 0.22 $ 0.15 $ 0.49 $ 0.32
Discontinued operations, net (2) .................................... - 0.02 - 0.06
Extraordinary gain (loss) (3) ....................................... - - (0.03) 0.02
------------ ----------- ------------ -----------
$ 0.22 $ 0.17 $ 0.46 $ 0.39
============ =========== ============ ===========
SHARES .............................................................. 313,649 312,524 315,155 302,844
Dividends per share ................................................. $ 0.105 $ 0.10 $ 0.305 $ 0.30
============ =========== ============ ===========
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 $15.4 million ($10.4 million, after-tax) and $45.9 million
($31.1 million, after-tax) for the three and nine month periods ended September
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 Sept.30, As of Dec. 31,
ASSETS 2002 (Restated 1) 2001 (Restated 1)
------------- --------------
CURRENT ASSETS:
Cash and cash equivalents .................................................... $ 170,178 $ 402,644
Marketable securities ........................................................ 71,789 72,429
Receivables, less allowance of $31,003 and $28,397, respectively ............. 397,164 340,935
Inventories .................................................................. 73,634 68,036
Prepaid expenses, deferred costs and other assets ............................ 104,092 80,738
Deferred taxes and income taxes receivable ................................... 118,558 90,200
Assets of discontinued operations ............................................ 8,604 64,068
----------- -----------
Total Current Assets .................................................. 944,019 1,119,050
----------- -----------
PROPERTY AND EQUIPMENT:
At cost ................................................................... 480,480 469,140
Less: accumulated depreciation ............................................ (289,122) (272,930)
----------- -----------
Net property and equipment .............................................. 191,358 196,210
----------- -----------
OTHER ASSETS:
Goodwill ..................................................................... 1,912,605 1,904,178
Intangible assets, primarily trade names ..................................... 258,826 261,136
Notes receivable ............................................................. 57,953 59,204
Long-term securities and other assets ........................................ 64,883 81,467
----------- -----------
Total Assets .......................................................... $ 3,429,644 $ 3,621,245
=========== ===========
LIABILITIES AND SHAREHOLDERS' EQUITY
CURRENT LIABILITIES:
Accounts payable ............................................................. $ 94,993 $ 97,251
Accrued liabilities:
Payroll and related expenses .............................................. 92,067 83,182
Self-insured claims and related expenses .................................. 81,050 63,819
Income taxes payable ...................................................... 41,771 --
Other ..................................................................... 92,435 131,780
Deferred revenues ............................................................ 378,346 343,873
Liabilities of discontinued operations ....................................... 31,675 50,449
Current portion of long-term debt ............................................ 31,404 34,944
----------- -----------
Total Current Liabilities ............................................. 843,741 805,298
----------- -----------
LONG-TERM DEBT ............................................................... 810,719 1,120,249
LONG-TERM LIABILITIES:
Deferred taxes .......................................................... 259,780 233,000
Liabilities of discontinued operations .................................. 28,500 50,600
Other long-term obligations ............................................. 120,568 102,234
----------- -----------
Total Long-Term Liabilities .......................................... 408,848 385,834
----------- -----------
MINORITY INTEREST ............................................................ 101,851 102,677
COMMITMENTS AND CONTINGENCIES
SHAREHOLDERS' EQUITY:
Common stock $0.01 par value, authorized 1 billion shares; issued
315,753 and 314,538 shares, respectively ................................ 3,158 3,145
Additional paid-in capital ................................................... 1,050,467 1,039,228
Retained earnings ............................................................ 372,956 322,103
Accumulated other comprehensive loss ......................................... (3,024) (2,496)
Restricted stock ............................................................. (446) (581)
Treasury stock ............................................................... (158,626) (154,212)
----------- -----------
Total Shareholders' Equity ............................................ 1,264,485 1,207,187
----------- -----------
Total Liabilities and Shareholders' Equity ............................ $ 3,429,644 $ 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)
Nine Months Ended
September 30,
2002 2001
(Restated 1) (Restated 1)
----------- -----------
CASH AND CASH EQUIVALENTS AT JANUARY 1 .................................... $ 402,644 $ 42,669
CASH FLOWS FROM OPERATIONS:
NET INCOME ................................................................ 142,227 118,487
Adjustments to reconcile net income to net cash flows from operations:
Income from discontinued operations ............................... (1,173) (16,973)
Extraordinary (gain) loss ......................................... 9,229 (6,003)
Depreciation expense .............................................. 37,124 36,782
Amortization expense .............................................. 6,432 53,225
Deferred income tax expense ....................................... 69,990 77,667
Change in working capital, net of acquisitions:
Receivables ................................................... (53,594) (72,073)
Sale of receivables ........................................... -- 92,500
Inventories and other current assets .......................... (31,504) (32,522)
Accounts payable .............................................. (1,370) (12,697)
Deferred revenues ............................................. 34,222 43,390
Accrued liabilities ........................................... 29,702 6,514
Tax refund from prior years payments .......................... -- 21,000
Other, net .................................................... 3,259 3,007
--------- ---------
NET CASH PROVIDED FROM OPERATIONS ......................................... 244,544 312,304
--------- ---------
CASH FLOWS FROM INVESTING ACTIVITIES:
Property additions .................................................. (41,802) (32,231)
Sale of equipment and other assets .................................. 2,031 7,837
Business acquisitions, net of cash acquired ......................... (10,132) (23,298)
Proceeds from business sales and minority interests ................. -- 4,925
Notes receivable, financial investments and securities .............. (1,512) (18,417)
Proceeds from sale of European businesses ........................... 30,500 --
--------- ---------
NET CASH USED FOR INVESTING ACTIVITIES .................................... (20,915) (61,184)
--------- ---------
CASH FLOWS FROM FINANCING ACTIVITIES:
Net payments of debt ................................................ (338,129) (240,120)
Purchase of ServiceMaster stock ..................................... (14,529) (1,308)
Shareholders' dividends ............................................. (91,374) (88,921)
Other, net .......................................................... 15,386 9,009
--------- ---------
NET CASH USED FOR FINANCING ACTIVITIES .................................... (428,646) (321,340)
--------- ---------
--------- ---------
CASH PROVIDED FROM (USED FOR) DISCONTINUED OPERATIONS ..................... (27,449) 54,696
--------- ---------
CASH DECREASE DURING THE PERIOD ........................................... (232,466) (15,524)
--------- ---------
CASH AND CASH EQUIVALENTS AT SEPTEMBER 30 ................................. $ 170,178 $ 27,145
========= =========
(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 restatement.
Three Months Three Months Nine Months Nine Months
Ended Ended Ended Ended
(In millions, except per share data) Sept. 30, 2002 Sept. 30, 2001 Sept. 30, 2002 Sept. 30, 2001
--------------------------------------------------------------------------------------------------------------
Continuing Operations:
AHS deferred acquisition costs $ - $ (0.7) $ - $ (5.3)
Trade name license fee - - - -
Interim accounting (TruGreen) 7.6 8.7 3.6 (0.6)
Other, net 1.6 1.5 4.3 4.3
Tax adjustment from reincorporation - (0.2) - (0.6)
---------------------------------------------------------------------------------------------------------------
Income Impact $ 9.2 $ 9.3 $ 7.9 $ (2.2)
Diluted EPS Impact $ 0.03 $ 0.03 $ 0.03 $(0.01)
Discontinued Operations:
Income Impact $ 0.6 $ (2.9) $ 0.5 $ (5.3)
Diluted EPS Impact $ - $(0.01) $ - $(0.02)
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
September 30, 2002 September 30, 2001
--------------------------------------------------------------
As Previously As Previously
(in thousands, except per share data) Reported As Restated Reported As Restated
-------------------------------------------------------------------------------------------------------------
Operating revenue $1,013,484 $1,010,661 $981,552 $981,284
Operating income 108,752 124,995 88,594 106,504
Income from continuing operations before
income taxes 91,429 106,465 62,807 78,769
Income from continuing operations 57,810 66,988 35,730 45,042
Discontinued operations, net 527 1,095 10,393 7,490
-------------------------------------------------------------------------------------------------------------
Net income $58,337 $68,083 $46,123 $52,532
=============================================================================================================
Diluted earnings per share:
Income from continuing operations $0.19 $0.22 $0.12 $0.15
Discontinued operations, net - - 0.03 0.02
-------------------------------------------------------------------------------------------------------------
Diluted earnings per share $0.19 $0.22 $0.15 $0.17
=============================================================================================================
6
As of As of
September 30, 2002 December 31, 2001
---------------------------------------------------------------
As Previously As Previously
Reported As Restated Reported As Restated
---------------------------------------------------------------
Current assets $937,931 $944,019 $1,131,824 $1,119,050
Net property, plant, and equipment 173,686 191,358 180,937 196,210
Other long-term assets 2,306,172 2,294,267 2,361,978 2,305,985
-------------------------------------------------------------------------------------------------------------
Total assets $3,417,789 $3,429,644 $3,674,739 $3,621,245
=============================================================================================================
Current liabilities $840,668 $843,741 $796,113 $805,298
Long-term debt 795,987 810,719 1,105,518 1,120,249
Long-term liabilities 446,833 408,848 449,470 385,834
Minority interest 101,851 101,851 102,677 102,677
Total shareholders' equity 1,232,450 1,264,485 1,220,961 1,207,187
-------------------------------------------------------------------------------------------------------------
Total liabilities and shareholders' equity $3,417,789 $3,429,644 $3,674,739 $3,621,245
=============================================================================================================
Nine Months Ended Nine Months Ended
September 30, 2002 September 30, 2001
---------------------------------------------------------------
As Previously As Previously
(in thousands, except per share data) Reported (1) As Restated Reported As Restated
-------------------------------------------------------------------------------------------------------------
Operating revenue $2,779,676 $2,779,861 $2,716,830 $2,724,179
Operating income 283,672 299,367 255,177 256,764
Income from continuing operations before
income Taxes 225,032 237,885 169,190 167,139
Income from continuing operations before
extraordinary items 142,345 150,283 97,755 95,511
Discontinued operations, net 684 1,173 22,305 16,973
Extraordinary gain (loss), net (9,229) (9,229) 6,003 6,003
Cumulative effect of accounting change, net (44,577) - - -
--------------------------------------------------------------------------------------------------------------
Net income $89,223 $142,227 $126,063 $118,487
==============================================================================================================
Diluted earnings per share:
Income from continuing operations before
extraordinary items $0.46 $0.49 $0.32 $0.32
Discontinued operations, net - - 0.07 0.05
Extraordinary gain (loss), net (0.03) (0.03) 0.02 0.02
Cumulative effect of accounting change, net (0.15) - - -
--------------------------------------------------------------------------------------------------------------
Diluted earnings per share $0.29 $0.46 $0.42 $0.39
==============================================================================================================
(1) Includes 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 $.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 $.7 million for the third quarter of 2001 and $5.3 million for the nine
months ended September 30, 2001.
7
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. The impact of this restatement was reflected in
the Company's Form 10-Q filing of November 14, 2002. There is no restatement
reflected for this item in the amended Form 10-Q filing.
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 tax full year 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 $.6 million for the third quarter and nine months ended
September 30, 2001, respectively. In addition, the tax provision for
discontinued operations increased by $.3 million and $.8 million for the third
quarter and nine months ended September 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 $1.6 million and $1.5 million for the third quarter 2002
and 2001, respectively. For the nine months ended September 30, 2002 and 2001,
income from continuing operations increased by $4.3 million in both periods.
Income from discontinued operations increased by $.6 million and decreased by
$2.7 million for the
8
third quarter 2002 and 2001, respectively. For the nine months ended September
30, 2002 and 2001, income from discontinued operations increased by $.5 million
and decreased $4.5 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 $7.6 million and $8.7 million for the third quarter of 2002 and
2001, respectively, and increasing by $3.6 million and decreasing $.6 million
for the nine months ended September 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.
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
9
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. The Company will perform impairment testing on an
annual basis and may test for impairment on a more frequent basis if management
believes events have changed resulting in a reporting units fair value being
reduced below its book value. In accordance with SFAS 142, the following table
provides summarized transitional information for the periods ended September 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 Nine Months Ended
September 30, September 30,
--------------------------------- -------------------------------
(in thousands, except per share data) 2002 2001 2002 2001
--------------- -------------- ------------- -------------
Reported operating income $124,995 $106,504 $299,367 $256,764
Add back: Goodwill and trade name
amortization - 15,443 - 45,893
--------------- -------------- ------------- -------------
Operating income as adjusted under
SFAS 142 $124,995 $121,947 $299,367 $302,657
=============== ============== ============= =============
Reported income from continuing
operations before extraordinary
gain (loss) $66,988 $45,042 $150,283 $95,511
Add back: Goodwill and trade name
amortization, net of tax - 10,445 - 31,140
--------------- -------------- ------------- -------------
Income from continuing operations
before extraordinary gain/loss as
adjusted under SFAS 142 66,988 55,487 150,283 126,651
Discontinued operations, net of taxes 1,095 7,490 1,173 16,973
Extraordinary gain/(loss), net of taxes - - (9,229) 6,003
--------------- -------------- ------------- -------------
Net income as adjusted under SFAS 142 $68,083 $62,977 $142,227 $149,627
=============== ============== ============= =============
Reported basic earnings per share from
continuing operations before
extraordinary gain/(loss) $0.22 $0.15 $0.50 $0.32
Add back: Goodwill and trade name
amortization, net of tax - 0.03 - 0.10
--------------- -------------- ------------- -------------
Basic earnings per share from continuing
operations before extraordinary gain/(loss)
as adjusted under SFAS 142 0.22 0.19 0.50 0.42
Discontinued operations, net - 0.03 - 0.06
Extraordinary gain/(loss), net - - (0.03) 0.02
--------------- -------------- ------------- -------------
Basic earnings per share as adjusted
under SFAS 142 $0.23 $0.21 $0.47 $0.50
=============== ============== ============= =============
10
Three Months Ended Nine Months Ended
September 30, September 30,
--------------------------------- -------------------------------
(in thousands, except per share data) 2002 2001 2002 2001
--------------- -------------- ------------- -------------
Reported diluted earnings per share
from continuing operations before
extraordinary gain/(loss) $0.22 $0.15 $0.49 $0.32
Add back: Goodwill and trade name
amortization, net of tax - 0.03 - 0.10
--------------- -------------- ------------- -------------
Diluted earnings per share from continuing
operations before extraordinary gain/(loss)
as adjusted under SFAS 142 0.22 0.18 0.49 0.42
Discontinued operations, net - 0.02 - 0.06
Extraordinary gain/(loss), net - - (0.03) 0.02
--------------- -------------- ------------- -------------
Diluted earnings per share as adjusted
under SFAS 142 $0.22 $0.21 $0.46 $0.49
=============== ============== ============= =============
The following table summarizes goodwill and intangible assets.
(IN THOUSANDS) As of As of
September 30, December 31,
2002 2001
--------------- --------------
Goodwill (1) $1,912,605 $1,904,178
Trade names (1) 238,550 238,550
Other intangible assets 77,475 74,197
Accumulated amortization (2) (57,199) (51,611)
--------------- --------------
Net other intangibles 20,276 22,586
--------------- --------------
Total $2,171,431 $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
11
quarter of 2001, the Company sold its Management Services business to ARAMARK
Corporation for approximately $800 million. Also in the fourth quarter of 2001,
the Company's Board of Directors approved the exit of non-strategic and
under-performing businesses including TruGreen LandCare Construction, 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. During the third quarter of 2002, the Company sold its
Terminix operations in the United Kingdom and the financial results have been
reclassified from "Continuing Operations" to "Discontinued Operations" for all
periods presented.
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 nine
months of 2002.
As part of the overall strategic review, the Company recorded a charge for asset
impairments and other items in the fourth quarter of 2001 which included
accruals for residual value guarantees on leased properties, severance for
former executives and terminated employees, and other costs. At December 31,
2001, the accrual balance was $36 million. 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 in
the second quarter of 2002 from the sale on the assisted living properties.
The following table below summarizes the activity during the nine months ended
September 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/ September 30,
2001 or Other (Expense) 2002
------------ ----------- ------------ --------------
Remaining liabilities from
discontinued operations
LandCare Construction $34,100 $21,400 $(2,100) $14,800
Certified Systems, Inc. 23,800 7,500 (3,500) 19,800
Management Services 7,400 1,000 3,500 2,900
International businesses 19,600 19,600 (1) (12,900) 12,900
Other 16,100 6,300 - 9,800
Reserves related to strategic
actions in the fourth quarter
of 2001 $36,000 $13,700 $3,600 $18,700
(1) The liabilities of this business assumed by the buyer of the sold operations
totaled $19.6 million. During 2002, the Company recorded accruals in connection
with sold operations and a cash adjustment to the purchase price of the 2001
dispositions.....
The Company recorded a $3.2 million charge in the second quarter of 2002
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
12
been considered outstanding for purposes of the diluted earnings per share
calculations. In computing diluted earnings per share, the after-tax interest
expense related to convertible debentures is added back to net income in the
numerator, while the diluted shares in the denominator include the shares
issuable upon conversion of the debentures. The effects of outstanding stock
options whose market price is in excess of the exercise price and shares
potentially issuable under convertible securities have not been included for the
nine months ended September 30, 2001, 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 September 30, 2002 Ended September 30, 2001
-------------------------------- ------------------------------
CONTINUING OPERATIONS: INCOME SHARES EPS INCOME SHARES EPS
---------------------- -------- -------- ------ -------- -------- -----
Basic earnings per share $66,988 301,093 $0.22 $45,042 298,925 $0.15
====== =====
Effect of dilutive securities,net of tax:
Options 4,356 5,399
Convertible securities 1,195 8,200 1,195 8,200
---------- --------- -------- --------
Diluted earnings per share $68,183 313,649 $0.22 $46,237 312,524 $0.15
========== ========= ====== ========= ======== =====
Nine Months Nine Months
Ended September 30, 2002 Ended September 30, 2001
-------------------------------- ------------------------------
CONTINUING OPERATIONS: INCOME SHARES EPS INCOME SHARES EPS
---------------------- -------- -------- ------ -------- -------- -----
Basic earnings per share $150,283 300,805 $0.50 $95,511 298,425 $0.32
====== ======
Effect of dilutive securities, net of tax:
Options 6,150 4,419
Convertible securities 3,585 8,200 - -
-------- -------- -------- --------
Diluted earnings per share $153,868 315,155 $0.49 $95,511 302,844 $0.32
======== ======== ======= ======== ======== ======
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 nine
months ended September 30, 2002 and 2001 is presented in the following table:
(IN THOUSANDS)
2002 2001
----------- -----------
CASH PAID OR (RECEIVED) FOR:
Interest expense...................... $ 68,369 $ 106,645
Interest and dividend income.......... $ (8,195) $ (6,659)
Income taxes.......................... $ 36,629 $ (7,277)
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 $70.8 million and $48.8 million for the
three months ended September 30, 2002 and 2001, respectively, and $141.7 million
and $100.9 million for the nine months ended September 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 September 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.
13
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 145 beginning in fiscal
2003. Adoption of this Statement 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 Sept. 30, Ended Sept. 30, Ended Sept. 30,
2002 2001 2001
Reported Reported Proforma
--------------------------------------------------------------------------------------------------------------------------
Operating Revenue:
TruGreen $418,715 $414,279
Terminix 235,414 212,029
American Home Shield 121,639 104,297
ARS/AMS 192,721 215,123
Other Operations 42,172 35,556
-----------------------------------------------------------------------------------------------------
Total Operating Revenue $1,010,661 $981,284
=====================================================================================================
Operating Income:
TruGreen $76,204 $70,145 $76,744
Terminix 25,359 19,275 24,235
American Home Shield 19,715 8,726 9,374
ARS/AMS 7,736 13,717 16,057
Other Operations (4,019) (5,359) (4,463)
--------------------------------------------------------------------------------------------------------------------------
Total Operating Income $124,995 $106,504 $121,947
==========================================================================================================================
As of As of
Sept. 30, 2002 Dec. 31, 2001
-----------------------------------------------------------------------------------------------------
Identifiable Assets:
TruGreen $1,122,330 $1,082,135
Terminix 847,881 823,333
American Home Shield 367,064 323,229
ARS/AMS 495,329 519,026
Other Operations (and discontinued businesses) 597,040 873,522
-----------------------------------------------------------------------------------------------------
Total Identifiable Assets $3,429,644 $3,621,245
=====================================================================================================
Nine Months Nine Months Nine Months
Ended Sept. 30, Ended Sept. 30, Ended Sept. 30,
2002 2001 2001
Reported Reported Proforma
--------------------------------------------------------------------------------------------------------------------------
Operating Revenue:
TruGreen $1,082,137 $1,074,099
Terminix 712,339 640,450
American Home Shield 323,995 277,486
ARS/AMS 549,891 630,468
Other Operations 111,499 101,676
-----------------------------------------------------------------------------------------------------
Total Operating Revenue $2,779,861 $2,724,179
=====================================================================================================
Operating Income:
TruGreen $150,648 $131,599 $151,388
Terminix 107,584 82,479 97,257
American Home Shield 40,904 20,802 22,669
ARS/AMS 15,041 32,338 39,217
Other Operations (14,810) (10,454) (7,874)
--------------------------------------------------------------------------------------------------------------------------
Total Operating Income $299,367 $256,764 $302,657
==========================================================================================================================
15
The following table summarizes the previously amortized goodwill and trade names
by segment that, beginning on January 1, 2002 are no longer amortized.
September 30, December 31,
2002 2001
------------------ ------------------
TruGreen $913,987 $910,573
Terminix 708,408 705,608
American Home Shield 72,085 72,085
ARS/AMS 347,971 347,863
Other Operations 108,704 106,599
------------------ ------------------
Total $2,151,155 $2,142,728
================== ==================
16
MANAGEMENT DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
RESULTS OF OPERATIONS
THIRD QUARTER 2002 COMPARED TO THIRD 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 third quarter was $1.01 billion, three percent above 2001, and
operating income was $125 million. The Company reported income from continuing
operations in 2002 of $67 million and income from discontinued operations of
$1.1 million. Net income was $68 million in 2002 and $53 million in 2001 and
diluted earnings per share were $.22 in 2002 and $.17 in 2001.
Diluted earnings per share from continuing operations were $.22 in 2002 compared
with $.15 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 ($15 million pretax) for the third quarter of
2001.
Third quarter operating income in 2002 was $125 million compared to $107 million
in 2001. The 2001 figure includes $15 million of amortization expense that has
been eliminated under SFAS 142. Operating margins after adjusting for the
amortization expense eliminated under SFAS 142 was 12.4 percent of revenue in
2002, consistent with 2001. The increase in operating income reflects continued
strong performance at American Home Shield, solid performance from Terminix and
the TruGreen lawn care operations and $6 million of licensing fees received in
the sale of the Terminix United Kingdom operations. The increase in operating
income is partially offset by continuing challenges in the heating, ventilation
and air conditioning (HVAC) and plumbing businesses of ARS and AMS, as well as
increased expenditures related to Company-wide operational initiatives and
overhead support.
Cost of services rendered and products sold increased two percent for the
quarter and decreased as a percentage of revenue to 67.9 percent in 2002 from
68.5 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 seven percent and
increased as a percentage of revenue to 19.6 percent from 18.8 percent in 2001.
The increase in selling and administrative expenses reflects the change in
business mix discussed above, increased expenditures for marketing leadership
and sales initiatives, as well as enterprise-wide expenditures in procurement,
technology and initiatives to measure and improve customer and employee
satisfaction.
Interest expense decreased from the prior year, 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 one time
venture capital gains realized in 2001 and a reduced level of investment gains
realized on the American Home Shield investment portfolio. As of September 30,
2002, there was an unrealized loss of approximately $6 million on the American
Home Shield investment portfolio which has been reflected in other comprehensive
income. Minority interest and other expense reflected a lower level of expense
as 2001 included approximately $1 million of losses relating to the sale of
accounts receivables under the Company's securitization program.
17
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.
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 $419 million, one percent above 2001. Operating
income decreased one percent to $76 million from $77 million (proforma) in 2001,
reflecting solid improvement in the lawn care operations offset by increased
expenditures in the landscape operations related to sales and retention
initiatives. Revenue in the lawn care business improved two percent over 2001,
reflecting growth in customer counts from increased sales and improved retention
rates. Solid growth in the sale of ancillary services was supported by the
higher level of full program customers. Operating income margins in the lawn
care operations were comparable to 2001. Revenue in the landscape maintenance
operations declined one percent reflecting a volume decrease in the core
maintenance business, offset in part by solid growth in the utility line
clearing business. Despite the volume decline, the base of maintenance business
consists of more profitable contracts with stronger customers and improved
pricing. Margins in the landscaping operations declined primarily reflecting
lower labor and material costs offset by increased insurance costs and
investments to support sales and retention initiatives. This business has hired
a senior sales leader and is expanding and developing its sales force. In
addition, management continues 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 $235 million from $212
million in 2001 and operating income growth of five percent to $25 million from
$24 million (proforma) in 2001. Revenue growth reflects the impact of 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 declined reflecting the near-term expenses associated with the
rollout of Terminix's new branch information system, increased direct marketing
expenditures and investments in Six Sigma, offset in part by the prior year
acquisition and improved branch efficiencies related to labor and material
costs.
The American Home Shield segment, which provides home warranties to consumers
that cover HVAC, plumbing and other appliances, reported a 17 percent increase
in revenue to $122 million from $104 million in 2001. The increase in revenue
reflected strong growth in the real estate sales channel, significant growth in
direct sales to consumers and continued improvement in customer retention.
Operating income increased 110 percent to $20 million from $9 million (proforma)
in 2001. Operating income margins improved significantly reflecting various
initiatives to improve the cost structure and modest weather conditions in
several regions, which resulted in a reduced level 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 $193 million, a decrease of ten percent from $215 million in 2001.
Operating income decreased to $8 million compared to $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 segment's decline in revenue and profit. ARS has hired a senior operations
leader and is realigning its field operating structure to narrow the span of
control in troubled locations. Management is developing specific turnaround
plans for each location, including improving the quality and depth of management
through internal and external recruiting and creating a management
18
development program. ARS is continuing to rebuild its marketing and sales
strategies by centralizing its marketing planning and placement, improving the
lead and sales tracking system, and reducing reliance on yellow pages
advertising.
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 $42 million in 2002 compared with $36 million in
2001. The increase in revenue largely reflects the impact of a $6 million
licensing fee received in 2002. In the third quarter of 2002, the Company sold
its Terminix operations in the United Kingdom and entered into a two-year
licensing agreement with the buyer for the use of the Terminix trade name in the
United Kingdom. This agreement was valued at $6 million and accordingly a like
amount was allocated from the purchase price. This segment reported an operating
loss of $4 million in 2002. The reduced operating loss reflects continued growth
in profits in ServiceMaster Clean and Merry Maids and the impact of the trade
name license fee, partially offset by increased expenditures in 2002 related
technology and major operational initiatives to improve operating efficiency and
build greater customer and employee satisfaction.
RESULTS OF OPERATIONS
NINE MONTHS ENDED SEPTEMBER 30, 2002 AS COMPARED TO SEPTEMBER 30, 2001
CONSOLIDATED REVIEW
Revenue for the nine months in 2002 increased two percent to $2.8 billion and
operating income was $299 million. The Company reported income from continuing
operations in 2002 of $150 million, income from discontinued operations of $1
million, and a $9 million extraordinary loss from the early extinguishment of
debt. Net income was $142 million in 2002 and $118 million in 2001 and diluted
earnings per share were $.46 in 2002 and $.39 in 2001.
Diluted earnings per share from continuing operations were $.49 in 2002 compared
with $.32 in 2001. As discussed in the three-month comparison, the diluted
earnings per share equivalent of reduced amortization expense under SFAS 142 are
$.10 ($46 million pretax) for the nine months of 2001.
Nine month operating income in 2002 was $299 million compared to $257 million in
2001. The 2001 figure includes $46 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 10.8 percent of
revenue in 2002 from 11.1 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 and overhead
support.
Cost of services rendered and products sold increased one percent for the nine
months and decreased as a percentage of revenue to 68.2 percent in 2002 from
69.1 percent in 2001. Selling and administrative expenses increased nine percent
and increased as a percentage of revenue to 20.8 percent from 19.5 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 increased expenditures for initiatives to
measure and improve customer and employee satisfaction.
Interest expense decreased from the prior year, reflecting reduced debt levels
resulting from the pay down of debt with the proceeds received from the sales of
the Management Services and certain European pest control businesses as well as
strong cash flows from operations. The decrease in interest and investment
income reflects one-time venture capital gains realized in 2001 and a reduced
level of investment gains in the American Home Shield investment portfolio.
Minority interest and other expense increased from the prior year as 2001
included minority interest income related to the ServiceMaster Home Service
Center initiative. In the first quarter of 2001 and until May 2001, the
operating losses 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.
19
The tax provision in 2002 reflects a lower effective tax rate based on benefits
received through the consolidation for tax purposes of the ServiceMaster Home
Service Center. As a result of the Company's acquisition of the minority
interest, it was able to reorganize the subsidiary in 2002 and utilize prior
year net operating losses of this subsidiary operation.
In the second quarter of 2002, the Company repurchased a portion of its public
debt securities and recorded an extraordinary loss of $.03 per diluted share ($9
million after-tax) resulting from the early extinguishment of debt. In the first
quarter of 2001, the Company recorded a $.02 extraordinary gain ($6 million
after-tax) resulting from the repurchase of certain ServiceMaster corporate
debt.
KEY PERFORMANCE INDICATORS
The table below presents selected metrics related to customer counts and
customer retention for the three most profitable businesses of the Company.
These measures are presented on a rolling, twelve month basis in order to avoid
seasonal anomalies.
KEY PERFORMANCE INDICATORS
As of September 30,
2002 2001
------------ -----------
TRUGREEN CHEMLAWN -
Growth in Full Program Contracts 2% -4%
Customer Retention Rate 62.4% 60.1%
TERMINIX -
Growth in Pest Control Customers 11% 13%
Pest Control Customer Retention Rate 76.7% 76.6%
Growth in Termite Customers 8% 19%
Termite Customer Retention Rate 89.5% 89.1%
AMERICAN HOME SHIELD -
Growth in Warranty Contracts 16% 15%
Customer Retention Rate 53.0% 52.1%
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 $1.08 billion, an increase of one
percent over the prior year. Operating income was $151 million in 2002,
comparable to the 2001 proforma amount. Revenue in the lawn care operations
increased two percent over 2001. Customer contracts have increased two percent
over the prior twelve months compared with a four percent decline for the year
ended 2001, 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 230 basis points to 62.4 percent compared to the same period in
2001. Operating income margins in the lawn care operations increased as the
business is beginning to see margin leverage resulting from top-line growth and
the success of its quality of service and Six Sigma initiatives. Revenue in the
landscaping operations declined two percent reflecting a decrease in snow
removal services due to mild winter weather and a decrease in the core
maintenance business. Despite the decline in the maintenance business, the base
of contracts is more profitable reflecting lower job costs, improved pricing,
and a stronger base of customers. This business has strengthened and expanded
its
20
sales operations. Operating income margins in the landscaping business declined
primarily as a result of a decreased volume of higher margin snow removal
business, increased workers compensation claims, and increased expenditures for
field operations training. In the fourth quarter, sales of enhanced services
will be a priority along with the reduction of seasonal labor levels.
The Terminix segment reported an 11 percent increase in revenue to $712 million
from $640 million in 2001 and operating income growth of 11 percent to $108
million from $97 million (proforma) in 2001. Revenue growth was driven by the
acquisition in 2001 of Sears Termite & Pest Control as well as solid internal
growth. 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 declined slightly compared to 2001 reflecting increased expenditures for
marketing and health insurance, offset in part by the continuing migration to
higher margin products, improved labor efficiencies and lower material costs.
The fourth quarter will be the first time in which the year over year
comparisons include the Sears acquisition in both years. As expected by the
Company, there has been a substantial decrease in profitable pest control
customers from the Sears name in certain markets, as the Company has not been
able to replace terminations with new sales at the same rate in these markets.
As a result, the Company expects to see a reduction in revenue growth and
retention rates in the fourth quarter. In addition, operating income margins in
the fourth quarter will be impacted by the near-term expenses associated with
the rollout of Terminix's new branch information system. The rollout of this
system to the branches will continue through 2004, and the system will be an
important tool in the Company's efforts to improve sales productivity, customer
service, cost efficiency and regulatory compliance.
The American Home Shield segment reported a 17 percent increase in revenue to
$324 million from $277 million in 2001 and operating income growth of 80 percent
to $41 million compared to $23 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, improved management of service costs and reduced incidence
of claims resulting, in part, from less extreme weather trends.
The ARS /AMS segment reported a 13 percent decrease in revenue to $550 million
from $630 million in 2001 and 62 percent decrease in operating income to $15
million compared to $39 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. As
noted in the three-month comparison, this business continues to focus on new
sales and marketing strategies that place less reliance on yellow pages
advertising. ARS is also realigning its field operating structure and developing
specific turnaround plans for troubled locations.
Other Operations revenue increased to $111 million from $102 million in 2001,
reflecting the $6 million in licensing fees received in the sale of the Terminix
United Kingdom operations and solid growth in the franchise operations. The
combined franchise operations reported a three percent increase in revenue and
solid profit growth, supported by strong demand for disaster restoration
services at ServiceMaster Clean and acquisition growth at Merry Maids. This
segment reported an operating loss of $15 million compared with a loss of $8
million (proforma) in 2001, reflecting increased expenditures on enterprise-wide
initiatives including procurement, marketing, and technology.
FINANCIAL CONDITION
Net cash provided from operations for the first nine months was $245 million,
$102 million in excess of net income, and reflects an improvement of $46 million
over the previous year, before the impact of the Company's accounts receivable
securitization program and tax refunds in 2001. Net cash provided from
operations is 62 percent higher than earnings for the nine months and represents
a 23 percent increase over the $199 million that was reported last year. This
increase was driven, in part, by a $45 million reduction in the use of working
capital, primarily at TruGreen ChemLawn and American Home Shield as a result of
better receivables and payables 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 $242 million at September
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 of continued strong cash flows and the application of
the net proceeds received from the Company's 2001 dispositions, total debt was
reduced by $313 million during the nine month period. This represents a
reduction in debt outstanding of approximately $1.1 billion over the last two
years and the Company's lowest level in over five years. The debt repurchase
allowed the Company the opportunity to lengthen its maturity profile by focusing
the majority of the repurchase on debt with shorter maturities. Approximately
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 September 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 September 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 September 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 September 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 September 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 $842 $9 $58 $161 $614
NON-CANCELABLE OPERATING LEASES (1) 251 16 101 65 69
--------------------------------------------------------------------------------------------------------------------
Total amount $1,093 $25 $159 $226 $683
(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 September 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 reflecting increases in
customer prepayments for termite and pest control 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 second quarter. See Note 7 for additional details. The
Company has no material capital commitments at this time.
Total shareholders' equity increased to $1.3 billion at September 30, 2002
compared to $1.2 billion at December 31, 2001, reflecting earnings which were
offset by cash dividends. Cash dividends paid directly to shareholders totaled
$91 million or $.305 per share for the nine months ended September 30, 2002. In
October 2002, the Company paid a fourth quarter cash dividend of $.105 per share
and declared a first quarter 2003 cash dividend of $.105 per share payable on
January 31, 2003. 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. Through September 30, 2002, the Company has completed share
repurchases totaling $15 million, compared to $1 million last year. 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 September 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 Company has several debt and lease agreements where the interest rate or
rent payable under the agreements automatically adjust based on changes in the
Company's credit ratings. While the Company is not currently expecting a change
in its credit ratings, based on amounts outstanding at September 30, 2002, a one
rating category improvement in the Company's credit ratings would reduce expense
on an annualized basis by approximately $.7 million. A one rating category
reduction in the Company's credit ratings would increase expense on an
annualized basis by approximately $1.3 million.
The following table summarizes information about the Company's fixed rate debt
instruments as of December 31, 2002 and presents the principal cash flows and
related weighted-average interest rates by expected maturity dates. The fair
value of the Company's fixed rate debt was approximately $880 million at
December 31, 2002.
Expected Maturity Date
------------------------------------------
There-
(In millions) 2003 2004 2005 2006 2007 after Total
-------------------- ------- ------- -------- ------- --------- --------- ------
Fixed rate debt $31 $24 $151 $11 $59 $559 $835
Avg. Rate 4.2% 4.8% 8.2% 6.0% 6.7% 7.5% 7.2%
-------------------- ------- ------- -------- ------- --------- --------- ------
24
CONTROLS AND PROCEDURES
The Company's Chairman and Chief Executive Officer, Jonathan P. Ward, and the
Company's Chief Financial Officer, Steven C. Preston, have evaluated the
Company's disclosure controls and procedures within 90 days of the filing of
this report.
Messrs. Ward and Preston have concluded that the Company's disclosure controls
and procedures provide reasonable assurance that the Company can meet its
disclosure obligations. The Company's disclosure controls and procedures are
based upon a roll-up of financial and non-financial reporting that is
consolidated in the principal executive office of the Company in Downers Grove,
Illinois. The reporting process is designed to ensure that information required
to be disclosed by the Company in the reports that it files or submits with the
Commission is recorded, processed, summarized and reported within the time
periods specified in the Commission's rules and forms.
There have been no significant changes in the Company's internal controls or in
other factors that could significantly affect these controls subsequent to the
date of their evaluation.
25
PART II. OTHER INFORMATION
ITEM 6(A): EXHIBITS
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 August 14, 2002 reporting under "Item 9.
Regulation FD Disclosure". In this filing, the Company reported that on August
13, 2002 it had filed sworn statements of its Chief Executive Officer and Chief
Financial Officer (the "Sworn Statements") with the Securities and Exchange
Commission (the "Commission") pursuant to the Commission's Order of June 27,
2002. These Sworn Statements were included as exhibits to the Form 8-K.
26
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
27
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;
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;
4. The registrant's other certifying officers and I are responsible for
establishing and maintaining disclosure controls and procedures (as defined in
Exchange Act Rules 13a-14 and 15d-14) for the registrant and have:
a) designed such disclosure controls and procedures to ensure that material
information relating to the registrant, including its consolidated subsidiaries,
is made known to us by others within those entities, particularly during the
period in which this quarterly report is being prepared;
b) evaluated the effectiveness of the registrant's disclosure controls and
procedures as of a date within 90 days prior to the filing date of this
quarterly report (the "Evaluation Date"); and
c) presented in this quarterly report our conclusions about the effectiveness of
the disclosure controls and procedures based on our evaluation as of the
Evaluation Date;
5. The registrant's other certifying officers and I have disclosed, based on our
most recent evaluation, to the registrant's auditors and the audit committee of
registrant's board of directors (or persons performing the equivalent function):
a) all significant deficiencies in the design or operation of internal controls
which could adversely affect the registrant's ability to record, process,
summarize and report financial data and have identified for the registrant's
auditors any material weaknesses in internal controls; and
b) any fraud, whether or not material, that involves management or other
employees who have a significant role in the registrant's internal controls; and
6. The registrant's other certifying officers and I have indicated in this
quarterly report whether or not there were significant changes in internal
controls or in other factors that could significantly affect internal controls
subsequent to the date of our most recent evaluation, including any corrective
actions with regard to significant deficiencies and material weaknesses.
Date: May 13, 2003
/S/ JONATHAN P. WARD
---------------------
Jonathan P. Ward
Chairman and Chief Executive Officer
28
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;
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;
4. The registrant's other certifying officers and I are responsible for
establishing and maintaining disclosure controls and procedures (as defined in
Exchange Act Rules 13a-14 and 15d-14) for the registrant and have:
a) designed such disclosure controls and procedures to ensure that material
information relating to the registrant, including its consolidated subsidiaries,
is made known to us by others within those entities, particularly during the
period in which this quarterly report is being prepared;
b) evaluated the effectiveness of the registrant's disclosure controls and
procedures as of a date within 90 days prior to the filing date of this
quarterly report (the "Evaluation Date"); and
c) presented in this quarterly report our conclusions about the effectiveness of
the disclosure controls and procedures based on our evaluation as of the
Evaluation Date;
5. The registrant's other certifying officers and I have disclosed, based on our
most recent evaluation, to the registrant's auditors and the audit committee of
registrant's board of directors (or persons performing the equivalent function):
a) all significant deficiencies in the design or operation of internal controls
which could adversely affect the registrant's ability to record, process,
summarize and report financial data and have identified for the registrant's
auditors any material weaknesses in internal controls; and
b) any fraud, whether or not material, that involves management or other
employees who have a significant role in the registrant's internal controls; and
6. The registrant's other certifying officers and I have indicated in this
quarterly report whether or not there were significant changes in internal
controls or in other factors that could significantly affect internal controls
subsequent to the date of our most recent evaluation, including any corrective
actions with regard to significant deficiencies and material weaknesses.
Date: May 13, 2003
/S/ STEVEN C. PRESTON
----------------------
Steven C. Preston
Executive Vice President
and Chief Financial Officer
29