UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
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
---------
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)
2300 Warrenville Road, Downers Grove, Illinois 60515-1700
(Address of principal executive offices) (Zip Code)
630-271-1300
(Registrant's telephone number, including area code)
Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the registrant was
required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days. Yes X No .
--- ---
Indicate the number of shares outstanding of each of the issuer's classes of
common stock: 301,344,000 shares of common stock on November 7, 2002.
TABLE OF CONTENTS
Page
NO.
THE SERVICEMASTER COMPANY (Registrant) -
PART I. FINANCIAL INFORMATION
- ------ ---------------------
Item 1 : Financial Statements
Consolidated Statements of Income for the three and nine
months ended September 30, 2002 and September 30, 2001 2
Consolidated Statements of Financial Position
as of September 30, 2002 and December 31, 2001 4
Consolidated Statements of Cash Flows for the nine months
ended September 30, 2002 and September 30, 2001 5
Notes to Consolidated Financial Statements 6
Item 2: Management Discussion and Analysis of Financial
Condition and Results of Operations 15
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 27
Certifications 28
Exhibit 99.1: Certification of Chief Executive Officer Pursuant
to Section 1350 of Chapter 63 of Title 18 of the
United States Code 30
Exhibit 99.2: Certification of Chief Financial Officer Pursuant
to Section 1350 of Chapter 63 of Title 18 of the
United States Code 31
1
PART I. FINANCIAL INFORMATION
THE SERVICEMASTER COMPANY
CONSOLIDATED STATEMENTS OF INCOME
(IN THOUSANDS, EXCEPT PER SHARE DATA)
Three Months Ended Nine Months Ended
September 30, September 30,
(Unaudited) (Unaudited)
2002 2001 2002 2001
------------ ------------ ---------- -----------
OPERATING REVENUE .................................................. $1,013,484 $ 981,552 $2,779,676 $2,716,830
OPERATING COSTS AND EXPENSES:
Cost of services rendered and products sold ........................ 690,028 675,489 1,907,035 1,884,266
Selling and administrative expenses ................................ 212,196 199,672 581,391 524,390
Goodwill, trade name and other intangible amortization (1) ........ 2,508 17,797 7,578 52,997
----------- ----------- ----------- -----------
Total operating costs and expenses ................................. 904,732 892,958 2,496,004 2,461,653
----------- ----------- ----------- -----------
OPERATING INCOME ................................................... 108,752 88,594 283,672 255,177
NON-OPERATING EXPENSE (INCOME):
Interest expense ................................................... 17,030 30,948 61,296 97,347
Interest and investment income ..................................... (1,612) (7,409) (8,145) (14,672)
Minority interest and other expense, net ........................... 1,905 2,248 5,489 3,312
----------- ----------- ----------- -----------
INCOME FROM CONTINUING OPERATIONS BEFORE INCOME TAXES 91,429 62,807 225,032 169,190
Provision for income taxes ......................................... 33,619 27,077 82,687 71,435
----------- ----------- ----------- -----------
INCOME FROM CONTINUING OPERATIONS BEFORE EXTRAORDINARY
ITEMS AND CUMULATIVE EFFECT OF ACCOUNTING CHANGE .............. 57,810 35,730 142,345 97,755
Income from discontinued operations, net of income taxes (2) ....... 527 10,393 684 22,305
Extraordinary gain (loss), net of income taxes (3) ................. - - (9,229) 6,003
Cumulative effect of accounting change (4) ......................... - - (44,577) -
----------- ----------- ----------- -----------
NET INCOME ......................................................... $ 58,337 $ 46,123 $ 89,223 $ 126,063
============ ============ ========== ===========
PER SHARE:
BASIC EARNINGS PER SHARE:
Income from continuing operations before extraordinary items
and cumulative effect of accounting change....................... $.19 $.12 $.47 $.33
Discontinued operations, net (2) ................................... - .03 .01 .07
Extraordinary gain (loss) (3)....................................... - - (.03) .02
Cumulative effect of accounting change (4).......................... - - (.15) -
------------ ------------ ---------- ---------
$.19 $.15 $.30 $.42
============ ============ ========== =========
SHARES 301,093 298,925 300,805 298,425
DILUTED EARNINGS PER SHARE:
Income from continuing operations before extraordinary items
and cumulative effect of accounting change....................... $.19 $.12 $.46 $.33
Discontinued operations, net (2) ................................... - .03 - .07
Extraordinary gain (loss) (3)....................................... - - (.03) .02
Cumulative effect of accounting change (4).......................... - - (.14) -
------------ ------------ ---------- -----------
$.19 $.15 $.29 $.42
============ ============ ========== ===========
SHARES 313,649 312,524 315,155 311,044
Dividends per share................................................. $.105 $.10 $.305 $.30
============ ============ ========== ===========
2
(1) The Company adopted SFAS 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 $45.7 million ($31.0 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
LandCare Construction, Certified Systems, Inc. and certain other operations.
These operations are included in "Discontinued Operations" in 2001. During the
third quarter of 2002, the Company sold its Terminix UK operations and
reclassified the financial results from "Continuing Operations" to "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.
(4) In the second quarter of 2002, the Company changed its accounting method for
customer acquisition costs in its American Home Shield business. In accordance
with Accounting Principles Board Opinion No. 20, "Accounting Changes", the
cumulative effect of this change in accounting policy has been recorded as of
the beginning of fiscal 2002. The impact of retroactively applying the change in
method of accounting to 2001 would have reduced pretax earnings by $1.1 million
($.7 million, after-tax) and $8.9 million ($5.8 million, after-tax) for the
three and nine month periods ended September 30, 2001.
SEE NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
3
THE SERVICEMASTER COMPANY
CONSOLIDATED STATEMENTS OF FINANCIAL POSITION
(IN THOUSANDS; UNAUDITED)
As of
December 31,
ASSETS September 30, 2001
2002 (Restated, Note 6)
----------- -----------
CURRENT ASSETS:
Cash and cash equivalents ........................................... $ 192,600 $ 420,469
Marketable securities ............................................... 60,440 61,561
Receivables, less allowance of $30,268 and $27,188, respectively .... 406,528 351,761
Inventories ......................................................... 72,656 69,518
Prepaid expenses, deferred costs and other assets ................... 116,848 167,915
Deferred taxes ...................................................... 88,859 60,600
----------- -----------
Total Current Assets ......................................... 937,931 1,131,824
----------- -----------
PROPERTY AND EQUIPMENT:
At cost ............................................................. 462,808 453,378
Less: accumulated depreciation ...................................... 289,122 272,441
----------- -----------
Net property and equipment ........................................ 173,686 180,937
----------- -----------
OTHER ASSETS:
Goodwill ............................................................ 1,913,222 1,902,934
Intangible assets, primarily trade names ............................ 261,237 264,789
Assets of discontinued operations ................................... 5,605 64,068
Notes receivable .................................................... 57,953 59,204
Long-term securities and other assets ............................... 68,155 70,983
----------- -----------
Total Assets ................................................. $ 3,417,789 $ 3,674,739
=========== ===========
LIABILITIES AND SHAREHOLDERS' EQUITY
CURRENT LIABILITIES:
Accounts payable .................................................... $ 130,331 $ 116,165
Accrued liabilities:
Payroll and related expenses ..................................... 91,488 82,340
Insurance and related expenses ................................... 48,585 40,019
Accrued income taxes ............................................. 60,958 25,237
Other ............................................................ 90,339 128,057
Deferred revenues ................................................... 387,563 355,129
Current portion of long-term debt ................................... 31,404 35,159
----------- -----------
Total Current Liabilities .................................... 840,668 782,106
----------- -----------
LONG-TERM DEBT ...................................................... 795,987 1,105,518
OTHER LONG-TERM LIABILITIES:
Deferred tax liability ......................................... 271,735 269,000
Liabilities of discontinued operations ......................... 51,132 93,769
Other long-term obligations .................................... 123,966 91,708
----------- -----------
Total Other Long-Term Liabilities ........................... 446,833 454,477
----------- -----------
MINORITY INTEREST ................................................... 101,851 102,677
Commitments and Contingencies
SHAREHOLDERS' EQUITY:
Common stock $0.01 par value, authorized 1 billion shares; issued
and outstanding 301,052 and 300,531 shares, respectively ....... 3,011 3,005
Additional paid-in capital .......................................... 1,050,465 1,037,969
Retained earnings ................................................... 344,081 346,232
Accumulated other comprehensive loss ................................ (5,477) (1,888)
Restricted stock .................................................... (1,151) (1,285)
Treasury stock ...................................................... (158,479) (154,072)
----------- -----------
Total Shareholders' Equity ................................... 1,232,450 1,229,961
----------- -----------
Total Liabilities and Shareholders' Equity ................... $ 3,417,789 $ 3,674,739
=========== ===========
SEE NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
4
THE SERVICEMASTER COMPANY
CONSOLIDATED STATEMENTS OF CASH FLOWS
(IN THOUSANDS)
Nine Months Ended
September 30,
(Unaudited)
2002 2001
------------- -------------
CASH AND CASH EQUIVALENTS AT JANUARY 1 ........................................ $ 420,469 $ 56,133
CASH FLOWS FROM OPERATIONS:
NET INCOME .................................................................... 89,223 126,063
Adjustments to reconcile net income to net cash flows from operations:
Income from discontinued operations ................................... (684) (22,305)
Extraordinary (gain) loss ............................................. 9,229 (6,003)
Cumulative effect of accounting change ................................ 44,577 -
Depreciation expense .................................................. 37,124 37,056
Amortization expense .................................................. 7,578 52,997
Tax refund from prior years payments ..................................... - 21,000
Deferred income tax expense .............................................. 64,986 75,796
Change in working capital, net of acquisitions:
Receivables ....................................................... (52,131) (70,552)
Sale of receivables ............................................... - 92,500
Inventories and other current assets .............................. (22,835) (37,611)
Accounts payable .................................................. 13,866 (16,917)
Deferred revenues ................................................. 32,184 49,530
Accrued liabilities ............................................... 19,692 8,586
Other, net ........................................................... 2,726 1,972
--------- ---------
NET CASH PROVIDED FROM OPERATIONS ............................................. 245,535 312,112
--------- ---------
MEMO: NET CASH PROVIDED FROM OPERATIONS
(EXCLUDING PRIOR YEAR SALE OF RECEIVABLES AND TAX REFUNDS) ............. 245,535 198,612
CASH FLOWS FROM INVESTING ACTIVITIES:
Property additions ...................................................... (38,861) (32,231)
Sale of equipment and other assets ...................................... 2,031 7,837
Business acquisitions, net of cash acquired ............................. (14,128) (26,689)
Proceeds from business sales and minority interests ..................... - 4,925
Notes receivable, financial investments and securities .................. (1,031) (18,449)
--------- ---------
NET CASH USED FOR INVESTING ACTIVITIES ........................................ (51,989) (64,607)
--------- ---------
CASH FLOWS FROM FINANCING ACTIVITIES:
Net payments of debt .................................................... (303,129) (240,120)
Purchase of ServiceMaster stock ......................................... (14,529) (1,308)
Shareholders' dividends ................................................. (91,374) (88,921)
Other, net .............................................................. 15,385 9,009
--------- ---------
NET CASH USED FOR FINANCING ACTIVITIES ........................................ (393,647) (321,340)
--------- ---------
--------- ---------
CASH PROVIDED FROM (USED FOR) DISCONTINUED OPERATIONS ......................... (27,768) 58,925
--------- ---------
CASH DECREASE DURING THE PERIOD ............................................... (227,869) (14,910)
--------- ---------
CASH AND CASH EQUIVALENTS AT SEPTEMBER 30 ..................................... $ 192,600 $ 41,223
========= =========
SEE NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
5
THE SERVICEMASTER COMPANY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
NOTE 1: The 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 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 consolidated financial statements be read in
conjunction with the consolidated financial statements and the notes thereto
included in the Company's latest Annual Report to Shareholders and the Annual
Report to the Securities and Exchange Commission on Form 10-K for the year ended
December 31, 2001. The 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.
As further discussed in Note 5, effective January 2002, the Company adopted
Statement of Financial Accounting Standards ("SFAS") No. 142, "Goodwill and
Other Intangible Assets". In addition, in the second quarter the Company changed
its accounting method for customer acquisition costs in its American Home Shield
business. In accordance with Accounting Principles Board Opinion No. 20,
"Accounting Changes", the cumulative effect of this change in accounting policy
(totaling a charge of $.14 per diluted share) has been recorded as of the
beginning of fiscal 2002. The Company has also announced that, beginning in
2003, it will begin accounting for employee stock options as compensation
expense in accordance with SFAS No. 123, "Accounting for Stock-Based
Compensation." As currently required by the Statement, the Company plans on
prospectively applying the provisions of this Statement to new option grants
awarded subsequent to 2002. If the Company continues its historical pattern of
option granting, the impact would be approximately $.005 per share in 2003,
growing to approximately $.03 per share over five years.
NOTE 3: The Company has identified the most significant accounting policies that
impact its financial statements. These relate primarily to revenue recognition
and the deferral of related costs. See Note 5 regarding a change of accounting
for costs associated with warranty contracts. No other change in accounting for
deferred costs has occurred since year-end 2001. 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. Termite and home warranty services
typically are sold through annual contracts for a one-time, up-front payment.
Direct costs of these contracts (service costs for termite contracts and claim
costs for warranty contracts) are expensed as incurred. The Company recognizes
revenue over the life of the contracts in proportion to the expected direct
costs. Franchised revenues (which in aggregate represents approximately three
percent of consolidated totals) consist of continuing monthly fees based upon
the franchisee revenue and initial franchise fees. Monthly fee revenue is
recognized when reported from the franchisee and collectibility is assured, and
initial fee revenue, which is fixed, is recognized at the time of sale and when
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. The Company
expenses the cost of advertising the first time the advertising takes place,
except for direct-response advertising at Terminix which is capitalized and
amortized over its expected period of future benefits. This direct-response
advertising consists primarily of direct-mail promotions, for which the cost is
capitalized and amortized over the one year customer contract life. At September
30, 2002,
6
approximately $2 million of advertising costs were deferred. TruGreen ChemLawn
incurs significant sales and other costs at the beginning of the fiscal year
that directly relate to supporting services to customers throughout the
production season (April through October). These costs are deferred and
recognized in proportion to the contract revenue over the year. These costs are
not deferred beyond the calendar year-end. The Company has $388 million of
deferred revenues at September 30, 2002, which consist of customer prepayments
for lawn care services and payments received for annual contracts relating to
home warranty and termite baiting services. The revenue related to these
services will be recognized as the service is performed or over the contractual
period.
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 uncollectible 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. 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 insured layers of coverage above such self-insured
retention limits. Accruals for self-insurance losses are made based on the
Company's claims experience and actuarial assumptions. The establishment of
appropriate reserves is an inherently uncertain process. Reserve estimates are
regularly reviewed and updated using the most current information available. Any
resulting adjustments, which could be material, are reflected in the period
identified.
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: The Company periodically reviews its accounting practices to ensure that
its adopted policies appropriately reflect current conditions in its businesses,
the industries it operates in, and the regulatory and business environments.
During the second quarter, the Company reviewed and compared its accounting
principles for its American Home Shield business with its direct competitors as
well as with companies operating in various aspects of the insurance industry.
Although there is some diversity of practice in these industries, the Company
determined to change its policy to the more prevalent and conservative method of
accounting for deferred acquisition costs from SFAS No. 60, "Accounting and
Reporting by Insurance Enterprises", where deferred acquisition costs were
amortized over the expected customer life to a more preferable method, FASB
Technical Bulletin No. 90-1, "Accounting for Separately Priced Extended Warranty
and Product Maintenance Contracts", where deferred acquisition costs are
amortized over the initial contract life. Such accounting principle is
consistent with the Company's understanding of the methods used by others in the
warranty industry. This new method of accounting is expected to result in a
reduction of $.03 per share in reported earnings in 2002, but will have no
impact on cash flow in the current or future years. In accordance with
Accounting Principles Board Opinion No. 20 "Accounting Changes", the cumulative
effect of this change in accounting policy (totaling a charge of $.14 per
diluted share) has been recorded as of the beginning of fiscal 2002.
In June 2001, the Financial Accounting Standards Board issued Statement of
Financial Accounting Standards No.142, "Goodwill and Other Intangible Assets"
(SFAS 142). 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. Goodwill and intangible assets that are not amortized will be
subject to at least an annual assessment for impairment by applying a
fair-value-based test. As of July 30, 2002, the Company's impairment testing was
completed and the testing concluded that there were no impairment issues.
Estimated fair value was determined for each reporting unit by utilizing the
7
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 occurred
or circumstances have changed resulting in a reporting unit's fair value being
reduced below its book value.
The following table provides summarized financial information for the three and
nine month 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 and the impact of retroactively applying the
change in method of accounting for customer acquisition costs at American Home
Shield.
Three Months Ended Nine Months Ended
September 30, September 30,
(IN THOUSANDS, EXCEPT PER SHARE DATA) 2002 2001 2002 2001
------------- -------- --------- -------------
OPERATING INCOME AND MARGINS:
- ----------------------------------------
Reported operating income .................................................... $ 108,752 $ 88,594 $ 283,672 $ 255,177
Add back: Goodwill and trade name amortization ............................... - 15,366 - 45,660
Subtract: Impact of retroactively applying the change in method of
accounting for customer acquisition costs at AHS .......................... - (1,152) - (8,922)
--------- --------- --------- ---------
Operating income as adjusted under SFAS 142 and for
retroactive application of accounting change .............................. $ 108,752 $ 102,808 $ 283,672 $ 291,915
========= ========= ========= =========
MARGIN PERCENTAGE (1) ................................................ 10.7% 10.5% 10.2% 10.7%
(1) The 2001 margin percentages are based on adjusted operating income amounts which are non-GAAP financial measures
NET INCOME:
Reported net income from continuing operations before
extraordinary gain (loss) and cumulative
effect of accounting change ............................................... $ 57,810 $ 35,730 $ 142,345 $ 97,755
Add back: Goodwill and trade name amortization, net of tax ................... - 10,400 - 31,000
Subtract: Impact of retroactively applying the change in method of
accounting for customer acquisition costs at AHS, net of tax ............... - (750) - (5,800)
--------- --------- --------- ---------
Net income from continuing operations before
extraordinary gain (loss) and cumulative effect
of accounting change as adjusted under SFAS 142 and
for retroactive application of accounting change .......................... $ 57,810 $ 45,380 $ 142,345 $ 122,955
========= ========= ========= =========
DILUTED EARNINGS PER SHARE:
Reported earnings per share from continuing operations before
extraordinary gain (loss) and cumulative
effect of accounting change ........................................... $ 0.19 $ 0.12 $ 0.46 $ 0.33
Add back: Goodwill and trade name amortization, net of tax ............... - 0.04 - 0.10
Subtract: Impact of retroactively applying the change in method of
accounting for customer acquisition costs at AHS, net of tax ........... - - - (0.02)
--------- --------- --------- ---------
Earnings per share from continuing operations before
extraordinary gain (loss) and cumulative effect
of accounting change as adjusted under SFAS 142 and
for retroactive application of accounting change ...................... $ 0.19 $ 0.16 $ 0.46 $ 0.41
========= ========= ========= =========
8
The following table summarizes goodwill and intangible assets.
As of As of
(IN THOUSANDS) September 30, 2002 December 31, 2001
------------- ------------
Covenants not to compete ..... 69,404 $ 67,667
Accumulated amortization (1) . (52,882) (47,640)
----------- -----------
Net covenants not to compete 16,522 20,027
Other intangibles ............ 8,071 6,639
Accumulated amortization (1) . (1,906) (427)
----------- -----------
Net other intangibles ...... 6,165 6,212
Trade names (2) .............. 238,550 238,550
Goodwill (2), (3) ............ 1,913,222 1,902,934
----------- -----------
Total ........................ $ 2,174,459 $ 2,167,723
=========== ===========
(1) Annual amortization expense of approximately $8 - $10 million is expected
for the next five years.
(2) Not subject to amortization.
(3) For the nine months ended September 30, 2002 approximately $11.1 million of
additional goodwill was recorded.
NOTE 6: On October 3, 2001 the Company's Board of Directors approved a series of
strategic actions which were the culmination of an extensive portfolio review
process that was initiated in the first quarter of 2001. The goal of the
portfolio review was to increase shareholder value by creating a focused and
aligned company that provides the greatest return and growth potential. The
Company determined it could best achieve these goals with a portfolio of
businesses which support the business strategy to become America's Home Service
Company and have attractive cash flow and return characteristics. As part of
this determination, in the fourth quarter of 2001, the Company sold its
Management Services business to ARAMARK Corporation for 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.
In the fourth quarter of 2001, the Company entered into a three-year licensing
arrangement with ARAMARK for use of the ServiceMaster trade name, valued at $15
million. 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. Subsequently, the Company determined
that it was appropriate to recognize the entire $15 million licensing fee in the
fourth quarter of 2001. The accompanying December 31, 2001 balance sheet has
been adjusted to eliminate the $15 million in deferred revenue related to this
arrangement. In addition, the accompanying nine-month financial statements have
been adjusted to eliminate the $4 million.
As discussed above, the 2001 financial statements will be restated for the $15
million license fee and the 2001 and 2000 financial statements will be
reclassified for the effects of the operations discontinued in the third quarter
of 2002. Because the prior auditor, Arthur Andersen, is unable to reissue
reports on these years, the Company has engaged Deloitte & Touche to re-audit
the 2001 and 2000 financial statements.
9
The December 31, 2001 Form 10-K and the 2002 first and second quarter Form 10-Qs
will be amended once the re-audit of the 2001 financial statements and the audit
of the 2002 financial statements are completed.
It is important to note that in the October 29, 2002 press release of the
Company's financial results, the Company recognized a $4 million expense in the
third quarter results to reverse the impact of the license fees in the first and
second quarters. Because of the Company's intention to restate the first and
second quarters, third quarter earnings as reflected herein, no longer include
the $4 million reversal.
NOTE 7: The Company continues to carry certain assets on its financial
statements relating to discontinued operations. Management is actively selling
remaining equipment and collecting 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 the year.
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 $33,700 $21,000 $(1,200) $13,900
Certified Systems, Inc. 23,800 7,500 (3,500) 19,800
Management Services 11,400 2,200 4,700 4,500
International businesses 18,600 18,600 (1) (12,900) 12,900
Other 6,300 6,300 - -
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 were assumed by the buyer of the sold
operations. No cash payments were required.
The Company recorded a $3.2 million charge in the second quarter of 2002
relating to the severance and termination agreement of a key executive. This
severance will be paid out over three years.
NOTE 8: Basic earnings per share are computed by dividing income available to
common stockholders by the weighted-average number of shares outstanding for the
period. The weighted average common shares for the diluted earnings per share
calculation includes the incremental effect related to outstanding options whose
market price is in excess of the exercise price. Shares potentially issuable
under convertible securities have been considered outstanding for purposes of
10
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 following chart reconciles both the numerator and the denominator of the
basic earnings per share computation to the numerator and the denominator of the
diluted earnings per share computation.
(IN THOUSANDS, EXCEPT PER SHARE DATA) Three Months Three Months
Ended September 30, 2002 Ended September 30, 2001
-------------------------------- ------------------------------
INCOME SHARES EPS INCOME SHARES EPS
-------- -------- ------ -------- -------- -----
Basic earnings per share $58,337 301,093 $0.19 $46,123 298,925 $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 $59,532 313,649 $0.19 $47,318 312,524 $0.15
========== ========= ======== ========== ========= =======
Nine Months Nine Months
Ended September 30, 2002 Ended September 30, 2001
-------------------------------- ------------------------------
INCOME SHARES EPS INCOME SHARES EPS
-------- -------- ------ -------- -------- -----
Basic earnings per share $89,223 300,805 $0.30 $126,063 298,425 $0.42
===== ======
Effect of dilutive securities, net of tax:
Options 6,150 4,419
Convertible securities 3,585 8,200 3,579 8,200
---------- --------- ---------- ---------
Diluted earnings per share $92,808 315,155 $0.29 $129,642 311,044 $0.42
========== ========= ======== ========== ========= ======
NOTE 9: In the Consolidated Statements of Cash Flows, the caption Cash and Cash
Equivalents includes investments in short-term, highly-liquid securities having
a maturity of three months or less. Supplemental information relating to the
Consolidated Statements of Cash Flows for the 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 $60.7 million and $41.1 million for the
three months ended September 30, 2002 and 2001, respectively, and $85.6 million
and $109.8 million for the nine months ended September 30, 2002 and 2001,
respectively. Comprehensive income for the nine months ended September 30, 2002
includes the cumulative adjustment of $45 million related to the change in
accounting method for customer acquisition costs at American Home Shield. 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.
11
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.
In April 2002, the Financial Accounting Standards Board ("FASB") issued
Statement of Financial Accounting Standard No. 145, "Recission of FASB
Statements No. 4, 44 and 64, Amendment of FASB Statement No.13, and Technical
Corrections" (SFAS 145). The primary impact to the Company of this Statement is
that it rescinds Statement No. 4 which required all material gains and losses
from extinguishment of debt to be classified as extraordinary items. SFAS 145
requires that the more restrictive criteria of APB Opinion No. 30 will be used
to determine whether such gains or losses are extraordinary. The Company intends
to adopt this Statement in its fiscal year 2003, as required by the Statement.
Adoption of this Statement will result in the reclassification of the
extraordinary gain (loss) included in the accompanying Consolidated Statements
of Income.
In June 2002, the FASB issued Statement of Financial Accounting Standard No.
146, "Accounting for Costs Associated with Exit or Disposal Activities". This
Statement requires recording costs associated with exit or disposal activities
at their fair values when a liability has been incurred. Under previous
guidance, certain exit costs were accrued upon management's commitment to an
exit plan, which is generally before an actual liability has been incurred. The
provisions of this statement are effective for exit or disposal activities that
are initiated after December 31, 2002.
NOTE 13: The Company continues to maintain 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 Company is in the process of repurchasing
the shares of ARS that were previously purchased by members of management. The
Company expects to repurchase such shares at fair market value at the time of
repurchase. 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 the Company a 5.50% convertible debenture due
January 9, 2011, with a face value of $1.1 million. The Company loaned Mr. Ward
the entire amount of the purchase price through a 5.50% 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. The Company
loaned 50% of the purchase price of this second debenture with a 5.50% full
recourse note 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 primarily conducted through three
operating segments: TruGreen, Terminix, and Home Maintenance and Improvement. In
accordance with Statement of Financial Accounting Standards No. 131 (SFAS 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 Home Maintenance and Improvement segment includes
American Residential Services, (ARS) and American Mechanical Services (AMS) that
provide heating, ventilation, air conditioning (HVAC) and plumbing services as
well as American Home Shield which provides home warranties to consumers that
cover HVAC, plumbing and other appliances. The segment also includes the two
franchise operations, ServiceMaster Clean and Merry Maids, which provide
disaster restoration and cleaning services.
12
The Other Operations segment consists primarily of overhead functions that
support the operations of the enterprise. This segment includes ServiceMaster
Home Service Center, an initiative that has developed valuable competencies and
has built an infrastructure that allows customers the ability to purchase all of
the Company's services through a single point of contact; and the Company's
headquarters operations which provides various technology, marketing, finance
and other support services to the business units.
Segment information as of and for the three months and nine months ended
September 30, 2002 and 2001 is presented below. The table below also presents an
"Adjusted" column of 2001 information which includes two adjustments made to the
reported amounts:
(1) SFAS 142, "Goodwill and Other Intangible Assets", eliminates the
amortization of goodwill and intangible assets with indefinite lives
beginning in 2002. The 2001 operating income information has been adjusted
to eliminate amortization expense related to goodwill and intangible assets
with indefinite lives.
(2) The change in method of accounting for deferred acquisition costs at
American Home Shield has been reflected as a cumulative adjustment as of
January 1, 2002. The 2001 operating income, capital employed, and
identifiable asset information has been adjusted to reflect the retroactive
application of the change in method of accounting.
(IN THOUSANDS) Three Months Three Months Three Months
Ended Sept. 30, Ended Sept. 30, Ended Sept. 30,
2002 2001 2001
Reported Reported Adjusted
- --------------------------------------------------- ------------------- ------------------- --------------------
Operating Revenue:
TruGreen $418,715 $414,279
Terminix 239,053 213,611
Home Maintenance and Improvement 345,900 350,238
Other Operations 9,816 3,424
- --------------------------------------------------- ------------------- -------------------
Total Operating Revenue $1,013,484 $981,552
=================================================== =================== ===================
Operating Income:
TruGreen $60,752 $51,732 $58,331
Terminix 28,826 21,413 26,373
Home Maintenance and Improvement 33,838 30,411 33,066
Other Operations (14,664) (14,962) (14,962)
- --------------------------------------------------- ------------------- ------------------- --------------------
Total Operating Income $108,752 $88,594 $102,808
=================================================== =================== =================== ====================
Capital Employed:
CAPITAL EMPLOYED REPRESENTS THE NET ASSETS OF THE SEGMENT; I.E., TOTAL ASSETS LESS LIABILITIES
(LIABILITIES DO NOT INCLUDE DEBT BALANCES)
TruGreen $1,070,834 $1,090,514 $1,090,514
Terminix 621,568 578,793 578,793
Home Maintenance and Improvement 630,337 668,048 626,546
Other Operations (and discontinued businesses) (161,047) 569,980 569,980
- ---------------------------------------------------------- ------------ ------------------- --------------------
Total Capital Employed $2,161,692 $2,907,335 $2,865,833
=================================================== =================== =================== ====================
Identifiable Assets:
TruGreen $1,117,188 $1,161,875 $1,161,875
Terminix 859,819 781,869 781,869
Home Maintenance and Improvement 1,006,280 1,041,620 1,000,118
Other Operations (and discontinued businesses) 434,502 1,033,056 1,033,056
- --------------------------------------------------- ------------------- ------------------- --------------------
Total Identifiable Assets $3,417,789 $4,018,420 $3,976,918
=================================================== =================== =================== ====================
13
Nine Months Nine Months Nine Months
Ended Sept. 30, Ended Sept. 30, Ended Sept. 30,
2002 2001 2001
Reported Reported Adjusted
- --------------------------------------------------- ------------------- ------------------- --------------------
Operating Revenue:
TruGreen $1,082,137 $1,074,099
Terminix 714,502 638,575
Home Maintenance and Improvement 966,415 994,471
Other Operations 16,622 9,685
- --------------------------------------------------- ------------------- -------------------
Total Operating Revenue $2,779,676 $2,716,830
=================================================== =================== ===================
Operating Income:
TruGreen $138,513 $125,588 $145,377
Terminix 110,448 81,939 96,717
Home Maintenance and Improvement 78,719 83,348 85,519
Other Operations (44,008) (35,698) (35,698)
- --------------------------------------------------- ------------------- ------------------- --------------------
Total Operating Income $283,672 $255,177 $291,915
=================================================== =================== =================== ====================
The following table summarizes by segment goodwill and trade names that are not
subject to amortization.
September 30, December 31,
2002 2001
------------------ ------------------
TruGreen $916,178 $912,808
Terminix 708,408 703,266
Home Maintenance and Improvement 507,186 505,410
Other Operations 20,000 20,000
------------------ ------------------
Total $2,151,772 $2,141,484
================== ==================
14
MANAGEMENT DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
RESULTS OF OPERATIONS
THIRD QUARTER 2002 COMPARED TO THIRD QUARTER 2001
- ----------------------------------------------------
CONSOLIDATED REVIEW
Revenue for the third quarter totaled $1.01 billion, three percent above the
prior year. Reported operating income was $109 million in 2002 compared with $89
million in 2001 and reported diluted earnings per share from continuing
operations was $.19 in 2002 compared with $.12 in 2001. On a comparable basis,
earnings per share was $.01 above the prior year. In order to compare the 2001
figures on a comparable basis, adjustments to reflect accounting changes and the
effect of debt repayments need to be made.
In order to assist in the comparison of earnings per share, the table below
presents diluted earnings per share on a comparable basis, assuming: (i) only
continuing operations existed, (ii) SFAS 142 was effective, (iii) the change in
method of accounting for customer acquisition costs at American Home Shield was
applied retroactively, and (iv) after-tax proceeds from the 2001 sales of
Management Services and certain European pest control operations were used to
repay debt prior to 2001. These adjustments in the aggregate provide a less
favorable comparison to the prior year than the reported results, however, they
allow for the review of the underlying base business performance on a comparable
basis.
Three months ended Nine months ended
September 30, September 30,
2002 2001 2002 2001
--------- ------- -------- -----------
Continuing operations before extraordinary items $0.19 $0.12 $0.46 $0.33
Earnings per share equivalent of reduced
amortization expense under new accounting rules - 0.04 - 0.10
Interest expense reduction - 0.02 - 0.06
Retroactive application of accounting change - - - (0.02)
--------- ------- -------- -----------
As adjusted earnings per share $0.19 $0.18 $0.46 $0.47
========= ======= ======== ===========
For comparative purposes, the Company has provided supplemental information in
Note 5 which presents certain 2001 information as adjusted to reflect the
elimination of goodwill and trade name amortization and the impact of
retroactively applying the change in method of accounting for American Home
Shield customer acquisition costs. Statement of Financial Accounting Standards
No. 142, "Goodwill and Other Intangible Assets" (SFAS 142), requires that
goodwill and trade names no longer be amortized. SFAS 142 does not permit the
restatement of 2001 financial information to reflect the impact of this
Statement. In the second quarter of 2002, the Company changed its accounting
method for customer acquisition costs in its American Home Shield business. In
accordance with Accounting Principles Board Opinion No. 20, "Accounting
Changes", prior period financial statements are not restated for the impact of
the new accounting method. This new policy is expected to result in a reduction
of $.03 per share in reported earnings in 2002, but will have no impact on cash
flow in the current or future years.
Third quarter operating income on this comparable basis increased six percent to
$109 million from $103 million, with operating margins increasing to 10.7
percent from 10.5 percent. The increase in operating income reflects continued
strong performance at American Home Shield and Terminix, solid performance from
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 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 68.1 percent in 2002 from
68.8 percent in 2001. Selling and
15
administrative expenses increased six percent and increased as a percentage of
revenue to 20.9 percent from 20.3 percent in 2001 (20.5 percent in 2001,
retroactively applying the prior year impact of the American Home Shield
accounting change). 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 enterprise-wide investments 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 the prior year and a reduced level of
investment gains realized on the American Home Shield investment portfolio. As
of September 30, 2002, there is an unrealized loss of approximately $10 million
on the American Home Shield investment portfolio which has been reflected in
other comprehensive income. Minority interest and other expense decreased
primarily due to prior year losses incurred relating to the sale of accounts
receivables under the Company's securitization program.
The tax provision in 2002 reflects an effective tax rate (approximately 37%),
which is lower than 2001 as it includes the 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.
OUTLOOK
In light of economic conditions and the persistent challenges in the HVAC and
plumbing businesses, the Company is lowering its previously stated guidance to
be in the range of $.55 to $.57 per share for 2002. However, the Company is
confident the fourth quarter will show its first year over year growth since the
second quarter of 2000. The Company expects to provide earnings guidance for
2003 when it reports its 2002 financial results. The Company expects mid to
high-single digit growth rates in 2003 driven primarily by new sales, increased
retention and a resumption of tuck-in acquisitions.
OTHER DEVELOPMENTS
In the fourth quarter of 2001, the Company entered into a three-year licensing
arrangement with ARAMARK for use of the ServiceMaster trade name, valued at $15
million. 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. Subsequently, the Company determined
that it was appropriate to recognize the entire $15 million licensing fee in the
fourth quarter of 2001. The accompanying December 31, 2001 balance sheet has
been adjusted to eliminate the $15 million in deferred revenue related to this
arrangement. In addition, the accompanying nine-month financial statements have
been adjusted to eliminate the $4 million.
As discussed above, the 2001 financial statements will be restated for the $15
million license fee and the 2001 and 2000 financial statements will be
reclassified for the effects of the discontinued operations in the third quarter
of 2002. Because the prior auditors, Arthur Andersen, is unable to reissue
reports on these years, the Company has engaged Deloitte & Touche to re-audit
the 2001 and 2000 financial statements.
The December 31, 2001 Form 10-K and the 2002 first and second quarter Form 10-Qs
will be amended once the re-audit of the 2001 financial statements and the audit
of the 2002 financial statements are completed.
It is important to note that in the October 29, 2002 press release of the
Company's financial results, the Company recognized a $4 million expense in the
third quarter results to reverse the impact of the license fees in the first and
second quarters. Because of the Company's intention to restate the
16
first and second quarters, third quarter earnings as reflected herein, no longer
include the $4 million reversal.
SEGMENT REVIEW
NOTE: 2002 RESULTS OF THE SEGMENTS REFLECT THE ELIMINATION OF GOODWILL AND TRADE
NAME AMORTIZATION REQUIRED UNDER SFAS NO. 142 AND THE CHANGE IN ACCOUNTING FOR
AMERICAN HOME SHIELD. THEREFORE, FOR COMPARATIVE PURPOSES, 2001 RESULTS HAVE
BEEN RESTATED TO REFLECT COMPARABLE ACCOUNTING POLICIES.
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 the prior year.
Operating income increased four percent to $61 million from $58 million last
year, reflecting solid improvement in the lawn care operations. Revenue in the
lawn care business improved two percent over the prior year, 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. 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. Revenues 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.
Capital employed decreased two percent, reflecting improved working capital
management in both the lawn care and landscape operations, partially offset by
the securitization of receivables in the prior year.
The Terminix segment, which includes the domestic termite and pest control
services, reported a 12 percent increase in revenue to $239 million from $214
million in 2001 and operating income growth of nine percent to $29 million from
$26 million last year. 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
margins declined reflecting initial investments in a new information and
operating system, increased direct marketing expenditures and investments in Six
Sigma, offset in part by the prior year acquisition and improved branch
efficiencies for labor and material costs. Capital employed increased seven
percent primarily reflecting acquisitions.
The Home Maintenance and Improvement segment includes heating, ventilation, air
conditioning (HVAC), and plumbing services provided under the American
Residential Services (ARS), Rescue Rooter, and American Mechanical Services
(AMS) (for commercial accounts) brand names; home systems and appliance warranty
contracts offered through American Home Shield; and the Company's primary
franchised operations, ServiceMaster Clean and Merry Maids. The segment reported
revenue of $346 million, a decrease of one percent from $350 million last year.
Operating income increased two percent to $34 million compared to $33 million
last year. Performance in the segment was supported by strong double-digit
revenue and profit growth at American Home Shield offset by a decline in volume
of air conditioning and plumbing services in the ARS and AMS businesses.
American Home Shield reported strong growth in the real estate sales channel,
significant growth in direct sales to consumers and continued improvement in
customer retention. Margins improved significantly reflecting various
initiatives to improve our cost structure and modest weather conditions in
several regions which resulted in a reduced level of claims. In the combined ARS
and AMS operations, a decline in call volume for air conditioning and plumbing
repairs and reduced construction activity continued to affect the industry and
resulted in a double-digit 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
17
developing specific turnaround plans for each location, including improving the
quality and depth of management through internal and external recruiting and
creating a management 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 combined franchise operations reported a one
percent increase in revenue and solid profit growth, primarily driven by a
strong growth in disaster restoration and increased franchise sales at
ServiceMaster Clean and growth from branch acquisitions in Merry Maids. Capital
employed decreased six percent reflecting the change in accounting for American
Home Shield deferred customer acquisition costs and improved working capital
management. Adjusting for the change in accounting, capital employed increased
one percent.
Other Operations includes ServiceMaster Home Service Center and the Company's
headquarters operations. Revenue for the quarter increased to $10 million from
$3 million in the prior year, primarily due to $6 million in licensing fees
received in the sale of the Terminix United Kingdom operations. This segment
shows a net operating expense, which decreased slightly from the prior year
reflecting higher provisions for workers compensation claims and investments for
initiatives at the enterprise level, offset by the $6 million of Terminix
licensing fees. Capital employed in this segment includes the discontinued
operations and therefore is significantly reduced from the prior year,
reflecting the prior year divestitures of businesses.
RESULTS OF OPERATIONS
NINE MONTHS ENDED SEPTEMBER 30, 2002 AS COMPARED TO SEPTEMBER 30, 2001
CONSOLIDATED REVIEW
Revenue for the nine months increased two percent to $2.8 billion. Reported
operating income was $284 million in 2002 compared with $255 million in 2001,
and reported diluted earnings per share from continuing operations was $.46 in
2002 compared with $.33 in 2001. The nine month results in 2002 include a $.14
charge related to the cumulative effect of the change in accounting method and a
$.03 extraordinary loss from early debt extinguishment. Including these items,
reported diluted earnings per share was $.29 for the nine months in 2002.
The Company has changed significantly since last year and in the third quarter
consolidated review section there is a table that presents the 2001 earnings per
share for the quarter and nine-month periods adjusted to be comparable to the
2002 figures. In order to assist in the comparison of earnings per share, the
table presents 2001 diluted earnings per share on a comparable basis, assuming:
(i) only continuing operations existed, (ii) SFAS 142 was effective, (iii) the
change in method of accounting for customer acquisition costs at American Home
Shield was applied retroactively, and (iv) after-tax proceeds from the 2001
sales of Management Services and certain European pest control operations were
used to repay debt prior to 2001. These adjustments in the aggregate provide for
a less favorable comparison to the prior year than the reported results,
however, they allow for the review of the underlying base business performance
on a comparable basis. Diluted earnings per share for the nine months on a
comparable basis was $.46 in 2002 compared to $.47 in 2001.
As presented in the supplemental information in Note 5, operating income on this
basis decreased three percent to $284 million in 2002 from $292 million in 2001,
with margins decreasing to 10.2 percent from 10.7 percent. The decline in
operating income reflects strong increases at Terminix and American Home Shield
offset by reduced volume in the HVAC and plumbing businesses of ARS and AMS, a
reduced deferral of seasonal costs compared to the prior year at TruGreen,
increased workers compensation claims at TruGreen LandCare, as well as increased
investments for Company-wide initiatives.
Cost of services rendered and products sold increased one percent for the nine
months and decreased as a percentage of revenue to 68.6 percent in 2002 from
69.4 percent in 2001. Selling and administrative expenses increased 11 percent
and increased as a percentage of revenue to 20.9 percent from 19.3 percent in
2001 (19.6 percent in 2001, retroactively applying the prior year
18
impact of the American Home Shield accounting change). 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 enterprise-wide investments 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 Company realized a reduced level of
investment gains on the American Home Shield investment portfolio this year
which is in the interest and investment income line on the Income Statement
along with prior year venture capital gains. 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 of ServiceMaster Home Service
Center had been offset through minority interest income (below the operating
income line) because of investments in the venture made by Kleiner, Perkins,
Caufield & Byers. In December 2001, the Company acquired the minority interest
in the ServiceMaster Home Service Center held by Kleiner Perkins.
The tax provision in 2002 reflects a lower effective tax rate based on benefits
received through the consolidation for tax purposes of the ServiceMaster Home
Service Center. As a result of the Company's acquisition of the minority
interest, it was able to reorganize the subsidiary in 2002 and utilize prior
year net operating losses of this subsidiary operation.
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
NOTE: 2002 RESULTS OF THE SEGMENTS REFLECT THE ELIMINATION OF GOODWILL AND TRADE
NAME AMORTIZATION REQUIRED UNDER SFAS NO. 142 AND THE CHANGE IN ACCOUNTING FOR
AMERICAN HOME SHIELD. THEREFORE, FOR COMPARATIVE PURPOSES, 2001 RESULTS HAVE
BEEN RESTATED TO REFLECT COMPARABLE ACCOUNTING POLICIES.
The TruGreen segment reported revenue of $1.08 billion, an increase of one
percent over the prior year. Operating income decreased to $139 million from
$145 million last year, primarily reflecting an increased level of seasonal
costs in the lawn care operations (approximately $5 million), increased workers
compensation claims in the landscaping operations (approximately $5 million)
19
and a lower volume of snow removal business (approximately $2.5 million) early
in the year. Revenue in the lawn care business increased two percent over the
prior year. Customer contracts have increased two percent over the prior twelve
months compared with a four percent decline in the prior year period, reflecting
the benefit of new marketing strategies as well as the impact of improved
customer retention. In addition to telemarketing, which is the primary channel
used by TruGreen ChemLawn to sell its services, the business has expanded
investments 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 last year. Margins
in the lawn care operations declined, reflecting improved labor productivity
offset by an increased level of seasonal costs. Year-to-date this year, the
Company has expensed more in seasonal costs than in the prior year due to a
higher expectation of revenue in the prior year that did not materialize.
Revenue in the landscaping business 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 stronger customers and improved
pricing. Margins in the landscaping services business declined primarily
reflecting the decreased volume of higher margin snow removal business and
increased workers compensation claims. In the fourth quarter, sales of enhanced
services will be a priority along with the reduction of seasonal labor levels.
The Terminix segment reported a 12 percent increase in revenue to $715 million
from $639 million in 2001 and operating income growth of 14 percent to $110
million from $97 million last year. 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 margins improved over the
prior year reflecting the impact of the acquisitions, 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 in the Sears 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 in the fourth quarter. In
addition, operating margins in the fourth quarter will be impacted by the
near-term expenses associated with the roll-out of Terminix's new branch
operating system. The roll-out of this new information system to the branches
will continue through 2003, and the system will be an important tool to
supporting improved sales productivity, customer satisfaction, cost efficiency
and regulatory compliance.
The Home Maintenance and Improvement segment reported revenue of $966 million, a
decrease of three percent from $994 million last year. Operating income
decreased eight percent to $79 million compared to $86 million last year.
American Home Shield reported double-digit growth in revenue and profit. Both
sales and retention rates continued to show improvements over prior year levels.
Margins improved benefiting from lower service costs and a decrease in the
incidence of claims. The combined ARS and AMS operations reported a 12 percent
decrease in revenue and profit $24 million below the prior year. 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. 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.
Other Operations revenue increased to $17 million from $10 million in the prior
year, primarily due to $6 million in licensing fees received in the sale of the
Terminix United Kingdom operations. This segment shows a net operating expense,
which increased from the prior year reflecting the increased investments in the
headquarters organization for Six Sigma and other initiatives including
purchasing, marketing, and technology.
20
FINANCIAL CONDITION
Net cash provided from operations for the first nine months was $246 million,
$103 million in excess of net income, and reflects an improvement of $47 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 72 percent higher than earnings for the nine months and represents
a 24 percent increase over the $199 million that was reported last year. This
increase was driven, in part, by a $58 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.
Cash and marketable securities totaled approximately $253 million at September
30, 2002, including approximately $138 million of required regulatory
investments at American Home Shield. During the second quarter of 2002, the
Company completed the last major phase of the debt reduction program announced
in October 2001 through the repurchase of $218 million in face value of its
corporate bonds. 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 bonds 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 is a residual value guarantee 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. The majority of the Company's vehicle fleet and some of
its equipment needs are leased through cancelable operating leases. There are
residual value guarantees (ranging from 70% to 87% depending on the agreement)
on these vehicles and equipment, 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 these leases.
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 $827 $9 $48 $161 $609
NON-CANCELABLE OPERATING LEASES (1) 253 16 102 65 70
- ---------------------------------------------------------------------------------------------------------------------
Total amount $1,080 $25 $150 $226 $679
(1) Includes lease payments and residual value guarantees on leased properties.
21
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 is
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 Consolidated Statements of Financial
Position. In the first quarter, the Company made 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.
Accounts receivable and inventories increased from year-end levels, reflecting
general business growth and increased seasonal activity. Deferred revenues grew
reflecting increases in customer prepayments for termite and pest control
services and strong growth in warranty contracts written at American Home
Shield. Prepaid expenses, deferred costs and other assets have decreased from
year-end primarily reflecting the impact of the change in accounting for
customer acquisition costs at American Home Shield, partially offset by an
increase in capitalized sales commissions and other direct contract acquisition
costs relating to more termite baiting and pest control contracts. As required
by APB No. 20 "Change in Accounting", the reduction in deferred customer
acquisition costs resulting from the change in accounting method has been
reflected as a cumulative adjustment as of January 1, 2002 and prior periods
have not been restated.
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 was $1.2 billion at September 30, 2002 and 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.
As disclosed in Note 3, the Company has identified the most significant
accounting policies that impacts its financial condition and results of
operations. These policies relate primarily to revenue recognition and the
deferral of customer acquisition costs. Except for the change in accounting
principle at American Home Shield, the policies are the same as discussed in the
2001 Annual Report. The critical estimates and assumptions required by
management in order to prepare the financial statements were also discussed in
the 2001 Annual Report and in Note 3 in this report. There have been no changes
in the assumptions or methodologies in 2002.
22
FORWARD LOOKING STATEMENT
The Company notes that statements that look forward in time, which include
everything other than historical information, involve risks and uncertainties
that affect the Company's results of operations. Factors which could cause
actual results to differ materially from those expressed or implied in a
forward-looking statement include the following (among others): weather
conditions adverse to certain of the Company's residential and commercial
services businesses; the entry of additional competitors in any of the markets
served by the Company; labor shortages; unexpected changes in operating costs;
the condition of the U.S. economy; the cost and length of time associated with
integrating or winding down businesses and other factors listed from time to
time in the Company's filings with the Securities and Exchange Commission.
23
QUANTITATIVE AND QUALITATIVE DISCLOSURES
ABOUT MARKET RISK
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 $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 that interest rate
fluctuations are likely 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 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.
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: November 14, 2002
THE SERVICEMASTER COMPANY
(Registrant)
By: /S/STEVEN C. PRESTON
------------------------------------------------------
Steven C. Preston
Executive Vice President and Chief Financial Officer
27
CERTIFICATION
I, Jonathan P. Ward, certify that:
1. I have reviewed this quarterly report on Form 10-Q 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 we 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: November 14, 2002
/S/ JONATHAN P. WARD
Jonathan P. Ward
Chairman and Chief
Executive Officer
CERTIFICATION
I, Steven C. Preston, certify that:
1. I have reviewed this quarterly report on Form 10-Q 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 we 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: November 14, 2002
/S/ STEVEN C. PRESTON
Steven C. Preston
Executive Vice President
and Chief Financial Officer