UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
X QUARTERLY REPORT UNDER SECTION 13 OR 15(d) OF
-------
THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended June 30, 2003
TRANSITION REPORT PURSUANT TO SECTION 13 OR
---------
15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the transition period from to
Commission file number 1-14762
THE SERVICEMASTER COMPANY
(Exact name of registrant as specified in its charter)
Delaware 36-3858106
(State or other jurisdiction of (IRS Employer Identification No.)
incorporation or organization)
3250 Lacey Road, Ste. 600, Downers Grove, Illinois 60515-1700
(Address of principal executive offices) (Zip Code)
630-663-2000
(Registrant's telephone number, including area code)
Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the registrant was
required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days. Yes X No .
Indicate by check mark whether the Registrant is an accelerated filer (as
defined in Exchange Act Rule 12b-2). Yes X No .
Indicate the number of shares outstanding of each of the issuer's classes of
common stock: 295,035,000 shares of common stock on August 5, 2003.
TABLE OF CONTENTS
Page
NO.
THE SERVICEMASTER COMPANY (Registrant) -
PART I. FINANCIAL INFORMATION
Item 1: Financial Statements
Condensed Consolidated Statements of Income for the three and six
months ended June 30, 2003 and June 30, 2002 3
Condensed Consolidated Statements of Financial Position
as of June 30, 2003 and December 31, 2002 4
Condensed Consolidated Statements of Cash Flows for the six months
ended June 30, 2003 and June 30, 2002 5
Notes to Condensed Consolidated Financial Statements 6
Item 2: Management Discussion and Analysis of Financial
Condition and Results of Operations 12
Item 3: Quantitative and Qualitative Disclosures About Market Risk 19
Item 4: Controls and Procedures 20
PART II. OTHER INFORMATION
Item 4: Submission of Matters to a Vote of Security Holders 21
Item 6: Exhibits and Reports on Form 8-K 21
Signature 23
PART I. FINANCIAL INFORMATION
THE SERVICEMASTER COMPANY
CONDENSED CONSOLIDATED STATEMENTS OF INCOME (UNAUDITED)
(IN THOUSANDS, EXCEPT PER SHARE DATA)
Three Months Ended Six Months Ended
June 30, June 30,
2003 2002 2003 2002
------------- ------------- ------------- -------------
OPERATING REVENUE ............................................. $ 1,052,629 $ 1,034,937 $ 1,786,294 $ 1,769,200
OPERATING COSTS AND EXPENSES:
Cost of services rendered and products sold ................... 679,241 680,381 1,217,160 1,211,192
Selling and administrative expenses ........................... 247,086 217,728 416,331 379,330
Amortization expense .......................................... 1,722 2,152 3,362 4,306
----------- ----------- ----------- -----------
Total operating costs and expenses ............................ 928,049 900,261 1,636,853 1,594,828
----------- ----------- ----------- -----------
OPERATING INCOME .............................................. 124,580 134,676 149,441 174,372
NON-OPERATING EXPENSE (INCOME):
Interest expense .............................................. 16,655 37,107 32,938 59,648
Interest and investment income................................. (3,125) (1,966) (4,344) (4,898)
Minority interest and other expense, net....................... 2,046 2,014 4,118 3,584
----------- ----------- ----------- -----------
INCOME FROM CONTINUING OPERATIONS BEFORE INCOME TAXES ......... 109,004 97,521 116,729 116,038
Provision for income taxes .................................... 42,817 35,313 45,867 41,972
----------- ----------- ----------- -----------
INCOME FROM CONTINUING OPERATIONS ............................. 66,187 62,208 70,862 74,066
Income (loss) from discontinued operations, net of income taxes (637) 295 (637) 78
----------- ----------- ----------- -----------
NET INCOME .................................................... $ 65,550 $ 62,503 $ 70,225 $ 74,144
=========== =========== =========== ===========
PER SHARE:
BASIC EARNINGS PER SHARE:
Income from continuing operations.............................. $0.22 $0.21 $0.24 $0.25
Discontinued operations, net ................................. - - - -
----------- ----------- ----------- -----------
$0.22 $0.21 $0.24 $0.25
=========== =========== =========== ===========
SHARES 296,819 301,092 297,307 300,653
DILUTED EARNINGS PER SHARE:
Income from continuing operations.............................. $0.22 $0.20 $0.24 $0.24
Discontinued operations, net ................................. - - - -
----------- ----------- ----------- -----------
$0.22 $0.20 $0.23 $0.24
=========== =========== =========== ===========
SHARES 308,947 316,474 301,188 307,700
Dividends per share............................................ $0.105 $0.10 $0.21 $0.20
=========== =========== =========== ===========
SEE NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
3
THE SERVICEMASTER COMPANY
CONDENSED CONSOLIDATED STATEMENTS OF FINANCIAL POSITION (UNAUDITED)
(IN THOUSANDS)
As of June 30, As of Dec 31,
ASSETS 2003 2002
-------------- --------------
CURRENT ASSETS:
Cash and cash equivalents ....................................... $ 101,553 $ 227,409
Marketable securities ........................................... 95,893 75,194
Receivables, less allowance of $31,122 and $27,616, respectively 397,643 332,186
Inventories ..................................................... 82,520 67,748
Prepaid expenses and other assets ............................... 57,568 39,464
Deferred customer acquisition costs ............................. 66,434 48,419
Deferred taxes and income taxes receivable ...................... 114,996 123,100
Assets of discontinued operations ............................... 1,342 5,654
----------- -----------
Total Current Assets ..................................... 917,949 919,174
----------- -----------
PROPERTY AND EQUIPMENT:
At cost ......................................................... 413,464 413,939
Less: accumulated depreciation .................................. (228,331) (219,062)
----------- -----------
Net property and equipment .................................... 185,133 194,877
----------- -----------
OTHER ASSETS:
Goodwill ........................................................ 1,945,205 1,919,780
Intangible assets, primarily trade names ........................ 252,090 257,781
Notes receivable ................................................ 56,451 55,770
Long-term securities and other assets ........................... 79,784 67,556
----------- -----------
Total Assets ............................................. $ 3,436,612 $ 3,414,938
=========== ===========
LIABILITIES AND SHAREHOLDERS' EQUITY
CURRENT LIABILITIES:
Accounts payable ................................................ $ 91,997 $ 92,121
Accrued liabilities:
Payroll and related expenses ................................. 79,878 99,504
Self-insured claims and related expenses ..................... 85,556 84,521
Other ........................................................ 108,483 102,380
Deferred revenues ............................................... 433,785 397,290
Liabilities of discontinued operations .......................... 15,976 32,113
Current portion of long-term debt ............................... 30,213 31,135
----------- -----------
Total Current Liabilities ................................ 845,888 839,064
----------- -----------
LONG-TERM DEBT .................................................. 796,627 804,340
LONG-TERM LIABILITIES:
Deferred taxes .................................................. 345,087 312,500
Liabilities of discontinued operations .......................... 28,800 28,800
Other long-term obligations ..................................... 125,799 111,225
----------- -----------
Total Long-Term Liabilities .................................. 499,686 452,525
----------- -----------
MINORITY INTEREST ............................................... 100,309 100,309
COMMITMENTS AND CONTINGENCIES
SHAREHOLDERS' EQUITY:
Common stock $0.01 par value, authorized 1 billion shares; issued
316,399 and 316,024 shares, respectively ................... 3,164 3,160
Additional paid-in capital ...................................... 1,052,879 1,054,272
Retained earnings ............................................... 363,303 355,893
Accumulated other comprehensive income (loss) ................... 4,267 (849)
Restricted stock ................................................ (4,682) (1,988)
Treasury stock .................................................. (224,829) (191,788)
----------- -----------
Total Shareholders' Equity ............................... 1,194,102 1,218,700
----------- -----------
Total Liabilities and Shareholders' Equity ............... $ 3,436,612 $ 3,414,938
=========== ===========
SEE NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
4
THE SERVICEMASTER COMPANY
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED)
(IN THOUSANDS)
Six Months Ended
June 30,
2003 2002
--------- ---------
CASH AND CASH EQUIVALENTS AT JANUARY 1 .................................... $ 227,409 $ 402,644
CASH FLOWS FROM OPERATIONS:
NET INCOME ................................................................ 70,225 74,144
Adjustments to reconcile net income to net cash flows from operations:
(Income) loss from discontinued operations ........................ 637 (78)
Depreciation expense .............................................. 25,336 24,291
Amortization expense .............................................. 3,362 4,306
Deferred income tax expense ....................................... 39,738 39,758
Change in working capital, net of acquisitions:
Receivables ................................................... (67,727) (59,876)
Inventories and other current assets .......................... (47,739) (62,160)
Accounts payable .............................................. (2,223) 4,590
Deferred revenues ............................................. 38,154 84,625
Accrued liabilities ........................................... (3,282) 22,179
Other, net .................................................... 1,554 11,394
--------- ---------
NET CASH PROVIDED FROM OPERATIONS ......................................... 58,035 143,173
--------- ---------
CASH FLOWS FROM INVESTING ACTIVITIES:
Property additions .................................................. (21,399) (29,387)
Sale of equipment and other assets .................................. 7,794 1,140
Business acquisitions, net of cash acquired ......................... (16,630) (6,849)
Notes receivable, financial investments and securities .............. (20,173) (4,228)
--------- ---------
NET CASH USED FOR INVESTING ACTIVITIES .................................... (50,408) (39,324)
--------- ---------
CASH FLOWS FROM FINANCING ACTIVITIES:
Net payments of debt ................................................ (15,256) (295,570)
Purchase of ServiceMaster stock ..................................... (48,975) --
Shareholders' dividends ............................................. (62,815) (59,598)
Other, net .......................................................... 6,399 12,825
--------- ---------
NET CASH USED FOR FINANCING ACTIVITIES .................................... (120,647) (342,343)
--------- ---------
CASH USED FOR DISCONTINUED OPERATIONS ..................................... (12,836) (31,406)
--------- ---------
CASH DECREASE DURING THE PERIOD ........................................... (125,856) (269,900)
--------- ---------
CASH AND CASH EQUIVALENTS AT JUNE 30 ...................................... $ 101,553 $ 132,744
========= =========
SEE NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
5
THE SERVICEMASTER COMPANY
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
NOTE 1: The condensed consolidated financial statements include the accounts of
ServiceMaster and its subsidiaries, collectively referred to as "the Company".
Intercompany transactions and balances have been eliminated in consolidation.
NOTE 2: The condensed consolidated financial statements have been prepared by
the Company in accordance with accounting principles generally accepted in the
United States (GAAP) and pursuant to the rules and regulations of the Securities
and Exchange Commission. The Company suggests that the quarterly condensed
consolidated financial statements be read in conjunction with the consolidated
financial statements and the notes thereto included in the Company's 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, 2002. The
condensed consolidated financial statements reflect all adjustments, which are,
in the opinion of management, necessary for the fair presentation of the
financial position, results of operations and cash flows for the interim
periods. The results of operations for any interim period are not necessarily
indicative of the results which might be achieved for a full year.
NOTE 3: The Company has identified the most important accounting policies with
respect to its financial position and results of operations. These relate
primarily to revenue recognition and the deferral of customer acquisition costs.
The following revenue recognition policies have not changed since year-end.
Revenues from lawn care, pest control, liquid and fumigation termite
applications, as well as heating/air conditioning and plumbing services are
recognized as the services are provided. Revenues from landscaping services are
recognized as they are earned based upon agreed monthly contract arrangements or
when services are performed for non-contractual arrangements. Revenues from the
Company's commercial installation contracts, primarily relating to heating,
ventilation and air conditioning (HVAC), are recognized on the percentage of
completion method in the ratio that total incurred costs bear to total estimated
costs. The Company eradicates termites through the use of baiting stations, as
well as through non-baiting methods (e.g., fumigation or liquid treatment).
Termite services using baiting stations as well as home warranty services
typically are sold through annual contracts for a one-time, upfront payment.
Direct costs of these contracts (ongoing service costs for termite completions
and claim costs for warranty contracts) are expensed as incurred. The Company
recognizes revenue over the life of these contracts in proportion to the
expected direct costs. Revenue from trade name licensing arrangements is
recognized when earned. Franchised revenues (which in the aggregate represent
approximately three percent of consolidated revenue) consist principally of
continuing monthly fees based upon the franchisee revenue. Monthly fee revenue
is recognized when the related franchise revenue is reported from the franchisee
and collectibility is assured and all material services or conditions relating
to the sale have been substantially performed. Total franchise fee income
(excluding trade name licensing) represented 8.8 percent and 7.3 percent of
consolidated operating income for the three months ended June 30, 2003 and 2002,
respectively and 13.2 percent and 10.5 percent for the six months ended June 30,
2003 and 2002, respectively. The portion of total franchise fee income related
to initial fees received from the sale of a franchise were immaterial to the
Company's consolidated financial statements for all periods.
Customer acquisition costs, which are incremental and direct costs of obtaining
the customer, are deferred and amortized over the life of the contract in
proportion to revenue recognized. These costs include sales commissions and
direct selling costs which can be shown to have resulted in a successful sale.
TruGreen ChemLawn has significant seasonality to its business. In the winter and
early spring, this business sells a series of lawn applications to customers
which are rendered primarily in March through October. The Company incurs and
defers incremental selling expenses at the beginning of the year that directly
relate to successful sales for which the revenues will be recognized in later
quarters. This business also defers, on an interim basis, pre-season advertising
costs and annual repairs and maintenance procedures that are performed in the
first quarter. These costs are deferred and recognized approximately in
proportion to the contract revenue over the production season, and are not
deferred beyond the calendar year-end.
6
As noted above, TruGreen's pre-season advertising costs are deferred and
recognized approximately in proportion to the contract revenue over the year.
Terminix also defers its advertising costs in the first quarter and recognizes
the expense over the year. These costs are not deferred beyond the calendar
year-end. The cost of direct-response advertising at Terminix is capitalized and
amortized over its expected period of future benefits. This direct-response
advertising consists primarily of direct-mail promotions, for which the cost is
capitalized and amortized over the one-year customer contract life.
The preparation of the financial statements requires management to make certain
estimates and assumptions required under GAAP which may differ materially from
the actual results. Disclosures in the 2002 Annual Report presented the
significant areas that require the use of management's estimates and discussed
how management formed its judgment. The areas discussed included the allowance
for receivables, accruals for self-insured retention limits related to medical,
workers compensation, auto and general liability insurance, the possible outcome
of litigation and the useful lives for depreciation and amortization expense and
the valuation of tangible and intangible assets. In 2003, there have been no
changes in the significant areas that require estimates or in the methodologies.
NOTE 4: The Company carries insurance policies on insurable risks which it
believes to be appropriate. The Company generally has self-insured retention
limits and has obtained fully insured layers of coverage above such self-insured
retention limits. Accruals for self-insurance losses are made based on the
Company's claims experience and actuarial assumptions. The Company has certain
liabilities with respect to existing or potential claims, lawsuits, and other
proceedings. The Company accrues for these liabilities when it is probable that
future costs will be incurred and such costs can be reasonably estimated.
NOTE 5: In accordance with Statement of Financial Accounting Standards (SFAS)
142, "Goodwill and Other Intangible Assets," the Company's goodwill and
indefinite lived intangible assets are not being amortized. Goodwill and
intangible assets that are not amortized are subject to at least an annual
assessment for impairment by applying a fair-value based test. In the first
quarter, the Company reviewed its intangible balances and removed the fully
amortized assets as well as the related accumulated amortized balance on the
financial statements. During this process certain reclassifications between
categories were made. The following table summarizes the goodwill and intangible
asset balances:
(IN THOUSANDS) As of As of
June 30, December 31,
2003 2002
--------------- --------------
Goodwill (1) $1,945,205 $1,919,780
Trade names (1) 238,550 238,550
Other intangible assets 43,458 78,284
Accumulated amortization (2) (29,918) (59,053)
--------------- --------------
Net other intangibles 13,540 19,231
--------------- --------------
Total $2,197,295 $2,177,561
=============== ==============
(1) Not subject to amortization.
(2) Annual amortization expense of approximately $7 million in 2003 is expected
to decline over the next five years.
The table below presents, by segment, the goodwill that is not subject to
amortization:
(IN THOUSANDS) June 30, December 31,
2003 2002
------------------ ------------------
TruGreen $803,548 $780,043
Terminix 619,300 618,055
American Home Shield 72,085 72,085
ARS/AMS 337,491 337,491
Other Operations 112,781 112,106
------------------ ------------------
Total $1,945,205 $1,919,780
================== ==================
7
NOTE 6: Basic earnings per share is 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 in the diluted
earnings per share calculations if their impact is dilutive. 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. Shares potentially issuable under convertible securities have
not been included in the diluted earnings per share calculation for the six
months ended June 30, 2003 and 2002, respectively, as their effect would have
been anti-dilutive.
The following table reconciles both the numerator and the denominator of the
basic earnings per share from continuing operations computation to the numerator
and the denominator of the diluted earnings per share from continuing operations
computation.
(IN THOUSANDS, EXCEPT PER SHARE DATA) Three Months Three Months
Ended June 30, 2003 Ended June 30, 2002
-------------------------------- ------------------------------
CONTINUING OPERATIONS: INCOME SHARES EPS INCOME SHARES EPS
- ---------------------- -------- -------- ------ -------- -------- ----
Basic earnings per share $66,187 296,819 $0.22 $62,208 301,092 $0.21
====== =====
Effect of dilutive securities, net of tax:
Options 3,928 7,182
Convertible securities 1,195 8,200 1,195 8,200
---------- --------- ---------- ---------
Diluted earnings per share $67,382 308,947 $0.22 $63,403 316,474 $0.20
========== ========= ====== ========== ========= =====
Six Months Six Months
Ended June 30, 2003 Ended June 30, 2002
-------------------------------- ------------------------------
CONTINUING OPERATIONS: INCOME SHARES EPS INCOME SHARES EPS
- ---------------------- -------- -------- ------ -------- -------- ------
Basic earnings per share $70,862 297,307 $0.24 $74,066 300,653 $0.25
===== =====
Effect of dilutive securities - options 3,881 7,047
-------- -------- -------- --------
Diluted earnings per share $70,862 301,188 $0.24 $74,066 307,700 $0.24
========== ========= ====== ======== ======== =====
NOTE 7: In 2003, the Company adopted SFAS 145, "Rescission of FASB Statements
No. 4, 44 and 64, Amendment of FASB Statement No. 13, and Technical
Corrections". The primary impact to the Company of SFAS 145 is that it rescinds
SFAS 4 which required all material gains and losses from the extinguishment of
debt to be classified as extraordinary items. SFAS 145 requires that the more
restrictive criteria of Accounting Principles Board Opinion No. 30 be used to
determine whether such gains or losses are extraordinary. In the second quarter
of 2002, the Company recorded an extraordinary loss of $.03 per diluted share
($15 million pretax, $9 million after-tax) from the early extinguishment of
debt. As a result of the Company's adoption of SFAS 145 in 2003, this loss has
been reclassified into interest expense, thereby reducing the previously
reported 2002 diluted earnings per share from continuing operations by the same
amount.
Beginning in 2003, the Company is accounting for employee stock options as
compensation expense in accordance with SFAS 123, "Accounting for Stock-Based
Compensation." SFAS 148 "Accounting for Stock-Based Compensation - Transition
and Disclosure, an amendment of FASB Statement No. 123", provides alternative
methods of transitioning to the fair value based method of accounting for
employee stock options as compensation expense. The Company is using the
"prospective method" of SFAS 148 and is expensing the fair value of new employee
option grants awarded subsequent to 2002. If the Company continues its
historical pattern of option granting, the impact is expected to be
approximately $.005 per share in 2003, growing to approximately $.03 per share
over five years.
Prior to 2003, the Company accounted for employee share options under the
intrinsic method of Accounting Principles Board Opinion No. 25, as permitted
under GAAP. Had compensation expense for employee options been determined under
the fair value based method of SFAS 123, proforma reported net income and net
earnings per share would reflect the following:
8
Three Months Ended Six Months Ended
June 30, June 30,
(IN THOUSANDS, EXCEPT PER SHARE DATA) 2003 2002 2003 2002
----------------------------------- -------------------------------
Net income as reported $65,550 $62,503 $70,225 $74,144
Add back: Stock-based compensation
expense included in reported net income,
net of related tax effects 313 - 477 -
Deduct: Total stock-based compensation
expense determined under fair value
method, net of related tax effects (1,884) (1,894) (3,761) (3,788)
--------------- ------------ -------------- -----------
Proforma net income $63,979 $60,609 $66,941 $70,356
=============== ============ ============== ===========
Basic Earnings Per Share:
As reported $0.22 $0.21 $0.24 $0.25
Proforma $0.22 $0.20 $0.23 $0.23
Diluted Earnings Per Share:
As reported $0.22 $0.20 $0.23 $0.24
Proforma $0.21 $0.20 $0.22 $0.23
NOTE 8: In May 2003, the FASB issued SFAS No. 150, "Accounting for Certain
Instruments with Characteristics of both Liabilities and Equity". This Statement
establishes standards for how an issuer classifies and measures certain
financial instruments with characteristics of both liabilities and equity. SFAS
150 is effective for financial instruments entered into or modified after May
31, 2003, and otherwise is effective at the beginning of the first interim
period beginning after June 15, 2003. The Company does not believe adoption of
this Statement will have a material impact on its Consolidated Financial
Statements.
In April 2003, the FASB issued SFAS No. 149, "Amendment of Statement 133 on
Derivative Instruments and Hedging Activities", which amends and clarifies
financial accounting and reporting for derivative instruments, including certain
derivative instruments embedded in other contracts, and for hedging activities
under SFAS 133. SFAS 149 is effective for contracts entered into or modified
after June 30, 2003, and for hedging relationships designated after June 30,
2003. The provisions of SFAS 149 are not expected to have a material impact on
the Company's Consolidated Financial Statements.
In January 2003, the FASB issued FASB Interpretation No. 46, "Consolidation of
Variable Interest Entities" (FIN 46). Under this Interpretation, certain
entities known as "Variable Interest Entities" (VIE) must be consolidated by the
"primary beneficiary" of the entity. The primary beneficiary is generally
defined as having the majority of the risks and rewards arising from the VIE.
For VIE's in which a significant (but not majority) variable interest is held,
certain disclosures are required. The Company is required to apply the
requirements of FIN 46 starting with its third quarter 2003 financial
statements. The Company is presently assessing the impact of this
Interpretation; however, it is not expected to have a material impact on the
Consolidated Financial Statements. Based on information as of June 30, 2003,
adoption of this Interpretation in 2003 could result in approximately $5 million
to $60 million of real estate operating leases being included on the balance
sheet as assets with associated debt.
NOTE 9: In the Condensed Consolidated Statements of Cash Flows, the caption Cash
and Cash Equivalents includes investments in short-term, highly-liquid
securities having a maturity of three months or less. Supplemental information
relating to the Condensed Consolidated Statements of Cash Flows for the six
months ended June 30, 2003 and 2002 is presented in the following table:
(IN THOUSANDS)
2003 2002
---------- ----------
CASH PAID OR (RECEIVED) FOR:
Interest expense....................... $ 30,799 $ 60,338
Interest and dividend income........... $ (4,353) $ (6,108)
Income taxes........................... $ 3,409 $ 31,294
The 2002 interest paid includes $15 million related to the early extinguishment
of debt. The remaining decrease in interest paid reflects reduced debt levels in
2003. The tax payment in 2002 resulted from the gain on the sale of the
Management Services business.
9
NOTE 10: Total comprehensive income was $71.9 million and $57.7 million for the
three months ended June 30, 2003 and 2002, respectively and $75.3 million and
$70.9 million for the six months ended June 30, 2003 and 2002, respectively.
Total comprehensive income includes primarily net income, changes in unrealized
gains and losses on marketable securities and foreign currency translation
balances.
NOTE 11: The Company has an agreement which provides for the ongoing revolving
sale of a designated pool of accounts receivable of TruGreen ChemLawn and
Terminix to a wholly-owned, bankruptcy-remote subsidiary, ServiceMaster Funding
LLC. ServiceMaster Funding LLC has entered into an agreement to transfer, on a
revolving basis, an undivided percentage ownership interest in a pool of
accounts receivable to unrelated third party purchasers. ServiceMaster Funding
LLC retains an undivided percentage interest in the pool of accounts receivable
and bad debt losses for the entire pool are allocated first to this retained
interest. At June 30, 2003 and 2002, there were no receivables sold to third
parties under this agreement. However, the Company may sell its receivables in
the future which would provide an additional funding source. 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 receivables to these purchasers in the future
and therefore has immediate access to cash proceeds from these sales. The amount
of the eligible receivables varies during the year based on seasonality of the
business and will at times limit the amount available to the Company.
NOTE 12: In October 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. As part of this
portfolio review, the Company sold or exited certain non-strategic or
under-performing businesses in the fourth quarter of 2001 and third quarter of
2002. The results of these discontinued business units have been separately
classified as "Discontinued Operations" in the accompanying financial
statements.
The Company continues to carry certain assets on its financial statements
relating to these operations. Management's intent is to sell the remaining
equipment and collect the outstanding receivables. The Company believes that the
remaining assets are presented at their net realizable value. In addition,
reserves and accrual balances remain on the financial statements relating to
these operations. Cash payments in the first six months of 2003 include an
adjustment to the sales price of a prior year disposition which was expensed in
2002. The remaining balances are outlined in the table below.
In the fourth quarter of 2001, the Company recorded a charge for asset
impairments and other items which included accruals for residual value
guarantees on leased properties, severance for former executives and terminated
employees, and other costs.
The table below summarizes the activity during the six months ended June 30,
2003 for the remaining liabilities from the discontinued operations and the
reserves for items recorded in the fourth quarter of 2001. The Company believes
that the remaining reserves continue to be adequate and reasonable.
(IN THOUSANDS) Balance at Cash Balance at
December 31, Payments Income/ June 30,
2002 or Other (Expense) 2003
--------------- ----------- ------------ --------------
Remaining liabilities from
discontinued operations
LandCare Construction $14,000 $4,400 $ - $9,600
Certified Systems, Inc. 13,600 1,200 - 12,400
Management Services 1,600 1,200 - 400
International businesses 21,400 9,900 (1,000) 12,500
Other 10,400 500 - 9,900
Reserves related to strategic
actions in the fourth
quarter of 2001 $15,500 $2,300 $ - $13,200
NOTE 13: The business of the Company is conducted through five operating
segments: TruGreen, Terminix, American Home Shield, ARS/AMS and Other
Operations. In accordance with Statement of Financial Accounting Standards No.
131, the Company's reportable segments are strategic business units that offer
different services. The TruGreen segment provides residential and commercial
lawn care and landscaping services through the TruGreen ChemLawn and TruGreen
LandCare companies. The Terminix segment provides termite and pest control
services to residential and commercial customers. The American Home Shield
segment provides home warranties to consumers that cover HVAC, plumbing and
other home systems and appliances. This segment also includes home inspection
services provided by
10
AmeriSpec. The ARS/AMS segment provides HVAC and plumbing installation and
repair services provided under the ARS Service Express, American Mechanical
Services and Rescue Rooter brand names. The Other Operations segment includes
the franchise operations of ServiceMaster Clean and Merry Maids, which provide
disaster restoration and cleaning services as well as the Company's headquarters
operations which provides various technology, marketing, finance and other
support services to the business units. Segment information is presented below.
(IN THOUSANDS) Three Months Three Months Six Months Six Months
Ended June 30, Ended June 30, Ended June 30, Ended June 30,
2003 2002 2003 2002
- ----------------------------------------------------------------------------------------------------------------------
Operating Revenue:
TruGreen $455,449 $434,279 $681,318 $663,422
Terminix 260,588 256,652 486,494 476,925
American Home Shield 126,149 116,440 220,373 202,356
ARS/AMS 172,977 192,079 324,410 357,170
Other Operations 37,466 35,487 73,699 69,327
- ----------------------------------------------------------------------------------------------------------------------
Total Operating Revenue $1,052,629 $1,034,937 $1,786,294 $1,769,200
======================================================================================================================
Operating Income:
TruGreen $67,723 $67,920 $58,893 $74,444
Terminix 41,897 44,289 75,425 82,225
American Home Shield 23,162 17,834 31,321 21,189
ARS/AMS 3,838 10,191 2,668 7,305
Other Operations (12,040) (5,558) (18,866) (10,791)
- ----------------------------------------------------------------------------------------------------------------------
Total Operating Income $124,580 $134,676 $149,441 $174,372
======================================================================================================================
As of As of
June 30, 2003 Dec. 31, 2002
- -------------------------------------------------------------------------------------------------------------
Identifiable Assets:
TruGreen $1,179,097 $1,070,031
Terminix 833,006 841,437
American Home Shield 397,118 376,059
ARS/AMS 480,685 489,366
Other Operations (and discontinued businesses) 546,706 638,045
- -------------------------------------------------------------------------------------------------------------
Total Identifiable Assets $3,436,612 $3,414,938
=============================================================================================================
11
MANAGEMENT DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF
OPERATIONS
RESULTS OF OPERATIONS
SECOND QUARTER 2003 COMPARED TO SECOND QUARTER 2002
CONSOLIDATED REVIEW
Revenue for the second quarter of 2003 was $1.05 billion, two percent above
2002. Second quarter 2003 diluted earnings per share was $.22 compared with $.20
in 2002. In 2002, the Company adopted Statement of Financial Accounting
Standards (SFAS) 145, "Rescission of FASB Statements No. 4, 44 and 64, Amendment
of FASB Statement No. 13, and Technical Corrections". SFAS 145 rescinds SFAS 4
that required all material gains and losses from the extinguishment of debt to
be classified as extraordinary items. In the second quarter of 2002, the Company
recorded an extraordinary loss of $.03 per diluted share ($15 million pretax, $9
million after-tax) from the early extinguishment of debt. As a result of the
Company's adoption of SFAS 145 in 2003, this loss was reclassified into interest
expense, thereby reducing the previously reported 2002 diluted earnings per
share from continuing operations by $.03.
Operating income for the second quarter was $125 million, compared to $135
million in 2002. The decrease in operating income reflects continued strong
results at American Home Shield and increased lawn care production at TruGreen,
offset by reduced service volume in the ARS/AMS segment, the impacts of
unfavorable weather and economic conditions in the Terminix operations and
reduced profitability in the TruGreen LandCare operations.
Cost of services rendered and products sold for the quarter was consistent with
the level in 2002 and decreased as a percentage of revenue to 64.5 percent in
2003 from 65.7 percent in 2002. This decrease reflects a change in the mix of
the business as American Home Shield, TruGreen ChemLawn and Terminix increased
in size in relationship to the overall business of the Company. These businesses
generally operate at higher gross margin levels than the rest of the business,
but incur somewhat higher selling and administrative expenses as a percentage of
revenue. Selling and administrative expenses increased 13 percent and increased
as a percentage of revenue to 23.5 percent for the quarter in 2003 from 21.0
percent in 2002. The increase in selling and administrative expenses primarily
reflects the change in business mix described above, as well as increased
expenditures on sales and marketing.
Net interest expense decreased $22 million from 2002, reflecting the
aforementioned reclassification of the $15 million extraordinary loss in 2002 as
well as lower interest expense resulting from reduced debt levels and higher
interest income. The tax provision in 2003 reflects a higher effective tax rate
than the prior year as the 2002 rate included the one-time benefit from
utilizing the prior year net operating losses of the ServiceMaster Home Service
Center operations.
OUTLOOK
In spite of difficult conditions, the Company continues to target 2003 earnings
in the range of $.56 per share, reflecting increased costs of approximately $.04
to $.05 per share from higher healthcare and insurance costs and $.03 per share
from a higher tax rate, partially offset by $.04 to $.05 per share in savings
generated by the Company's Six Sigma and strategic sourcing initiatives. The
Company is instituting additional cost and wage controls to keep it on track to
meet its expectations for the year. The Company's ability to hit its earnings
target depends on disciplined selling and field execution and a moderate upturn
in the economy during the second half. While working to deliver short-term
performance, the Company is simultaneously working to improve top-line growth by
building compelling brand positions, deepening geographic penetration and
expanding its access to customers through multiple channels.
12
SEGMENT REVIEW
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. The TruGreen segment reported second quarter
revenue of $455 million in 2003, a five percent increase over 2002. The
segment's operating income of $68 million was consistent with the prior year,
reflecting solid growth in the lawn care operations offset by declines in the
landscape maintenance and utility line clearing operations. Revenue in the lawn
care operations increased eight percent for the second quarter, reflecting
substantially increased production levels resulting from the recapture of some
of the revenue that was delayed in the first quarter. First quarter production
was delayed due to late spring snowfalls and cool weather conditions in the
central, mid-Atlantic and eastern regions of the country. In the landscape
maintenance business, revenue decreased one percent during the second quarter of
2003 compared with 2002, reflecting a reduced level of enhancement sales (higher
priced discretionary services such as seasonal flower plantings), which have
been impacted by the weak economy. In the lawn care operations, operating income
grew reflecting the increased production, however, margins declined primarily
due to higher direct costs from the increased level of production and increased
insurance and fuel costs. Overall sales and marketing costs have risen
reflecting the efforts in non-telemarketing channels. Restrictions on
telemarketing, TruGreen ChemLawn's primary sales channel, continue to increase
and the Company has implemented changes in its marketing, operations and service
to address these restrictions. The Company has reallocated marketing spending to
direct mail, television and community-based affiliations. In addition, in late
2001, the Company implemented quality of service initiatives to improve the
retention of existing customers. Operating income margins in the landscaping
business declined reflecting substantially lower profitability in the utility
line clearing operations and increased sales costs. Capital employed in the
TruGreen segment increased two percent to $1.08 billion at June 30, 2003
compared with $1.06 billion at June 30, 2002, primarily reflecting tuck-in
acquisitions. Capital employed is defined as the segment's total assets less
liabilities, exclusive of debt balances. The Company believes these figures are
useful to investors in helping them compute return on capital measures and
therefore better understand the performance of the Company's business segments.
The Terminix segment, which includes termite and pest control services, reported
a two percent increase in second quarter revenue to $261 million from $257
million in 2002 and operating income of $42 million compared to $44 million in
2002. Revenue growth was supported by an increase in renewals of higher priced
termite bait contracts and stronger growth in the commercial pest control
customer base. This growth, however, was partially offset by fewer sales of new
termite contracts which the Company attributes to the abnormally cool weather
conditions. The cool conditions impeded the termite swarm which generates most
of the lead flow in the second quarter. The Company is less reliant on swarming
activity in later months of the year. Operating income margins declined from
2002 and were impacted by a reduction in the volume of new termite customers, as
well as the incremental costs associated with Terminix's new information system.
This decline was partially offset by a decrease in damage claims expense of $5.6
million relating to the acquired Sears damage claim liability. Capital employed
at June 30, 2003 was $578 million, consistent with $581 million at June 30,
2002.
The American Home Shield (AHS) segment, which provides home warranties to
consumers that cover HVAC, plumbing and other home systems and appliances,
reported an eight percent increase in revenue to $126 million from $116 million
in 2002 and 30 percent growth in operating income to $23 million compared with
$18 million in 2002. The increase in revenue was driven by strong growth in
renewal contracts, partially offset by a lower level of sales in the real estate
channel which was impacted by a decline in the number of listings in AHS's
markets. Operating margins improved significantly reflecting a lower claims rate
and favorable trending of prior year claims. AHS has benefited from the weather
patterns that negatively affected Terminix and the ARS/AMS segment. Capital
employed increased 34 percent to $119 million at June 30, 2003 compared to $89
million at June 30, 2002, reflecting volume growth in the business as well as a
higher level of cash investments. The calculation of capital employed for the
AHS segment includes approximately $149 million and $116 million of cash, cash
equivalents and marketable securities at June 30, 2003 and 2002, respectively.
The interest and gains/losses on these investments are reported below operating
income as non-operating income/expense.
The ARS/AMS segment provides direct HVAC and plumbing installation and repair
services under the ARS Service Express, Rescue Rooter, and American Mechanical
Services (for large commercial accounts)
13
brand names. Second quarter revenue totaled $173 million in 2003, a decrease of
10 percent from $192 million in 2002. Economic conditions and cooler weather
have affected this business along with the entire HVAC and plumbing industries.
The decline in revenue reflects a reduced level of HVAC construction revenue in
both the residential and commercial sectors, as well as decreases in the
plumbing and HVAC service lines, partially offset by modest improvement in HVAC
add-on/replacement activity. The increased add-on/replacement activity and
strong increases in the backlog of its commercial business are encouraging
factors. Second quarter operating margins declined compared with 2002,
reflecting the decrease in revenue and an increase in sales and marketing
expenditures. Capital employed decreased seven percent to $387 million at June
30, 2003 compared with $417 million at June 30, 2002, as working capital and
equipment have been managed down to reflect the size of the business. In the
third quarter, management will conduct a review of certain branches in order to
determine their profit potential. Based on this review, under-performing
branches may be closed or certain activities exited. The outcome of this review
may lead management to complete an assessment of its goodwill in the third
quarter in accordance with SFAS 142.
The Other Operations segment includes the Company's ServiceMaster Clean, Merry
Maids, and international operations as well as its headquarters functions.
Segment revenue of $37 million in 2003 compared with $35 million in 2002,
primarily reflecting the impact of acquisitions at Merry Maids and growth in the
ServiceMaster Clean business, primarily in disaster restoration services. This
segment reported an operating loss of $12 million in 2003 compared with a loss
of $6 million in 2002, reflecting continued strong growth in the combined
franchise operations offset by increased expenditures related to marketing,
technology, and regulatory/compliance initiatives. Capital employed in this
segment decreased significantly, primarily reflecting an increase in deferred
tax liabilities and a reduction in cash balances.
RESULTS OF OPERATIONS
SIX MONTHS ENDED JUNE 30, 2003 COMPARED TO JUNE 30, 2002
CONSOLIDATED REVIEW
Revenue for the six months in 2003 increased one percent to $1.79 billion.
Diluted earnings per share from continuing operations were $.24 for both
periods. As discussed in the three-month comparison, the Company's adoption of
SFAS 145 in 2003 has resulted in the reclassification into interest expense of
the $.03 per diluted share extraordinary loss recorded in 2002, thereby reducing
the previously reported 2002 diluted earnings per share from continuing
operations to $.24 for the six months.
Operating income was $149 million in 2003, compared to $174 million in 2002. The
decline in profitability reflects strong growth at American Home Shield, offset
by decreases in TruGreen's landscaping operations from lower enhancement
activity and reduced profitability in the utility line clearing operations,
higher sales costs as well as labor-related costs in TruGreen's lawn care
operations resulting from weather-related delays earlier in the year, and
reduced lead flow at Terminix as cooler temperatures significantly reduced
termite swarms and pest activity.
Cost of services rendered and products sold increased slightly for the six
months and decreased as a percentage of revenue to 68.1 percent in 2003 from
68.5 percent in 2002 reflecting the business mix shift described in the second
quarter discussion. Selling and administrative expenses increased 10 percent and
increased as a percentage of revenue to 23.3 percent in 2003 from 21.4 percent
in 2002 as a result of the change in the mix of the business and increased
expenditures relating to sales and marketing, enterprise-wide technology, and
regulatory/compliance initiatives.
Net interest expense for the six months decreased $26 million from 2002,
reflecting the reclassification of the $15 million extraordinary loss in 2002
into interest expense as well as lower interest expense resulting from reduced
debt levels. The tax provision in 2003 reflects a higher effective tax rate than
the prior year as the 2002 rate included the one-time benefit from utilizing the
prior year net operating losses of the ServiceMaster Home Service Center
operations.
14
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 June 30,
2003 2002
--------- ----------
TRUGREEN -
Growth in Full Program Contracts 2% 1%
Customer Retention Rate 64.1% 64.5%
TERMINIX -
Growth in Pest Control Customers 1% 12%
Pest Control Customer Retention Rate 75.8% 77.5%
Growth in Termite Customers -2% 8%
Termite Customer Retention Rate 88.6% 90.1%
AMERICAN HOME SHIELD -
Growth in Warranty Contracts 9% 15%
Customer Retention Rate 53.2% 53.2%
SEGMENT REVIEW
For the six months, the TruGreen segment reported revenue of $681 million in
2003, an increase of three percent over 2002. Operating income totaled $59
million compared with $74 million in 2002. In the lawn care operations, revenue
increased three percent over 2002 reflecting growth in the number of customers,
which has been supported by tuck-in acquisitions. Restrictions on telemarketing
activities continue to increase and TruGreen ChemLawn has broadened its
marketing approach through increased expenditures on direct mail and television
advertising. Sales through non-telemarketing channels doubled this year compared
with the prior year. The rolling twelve-month retention rate has declined,
however, with the increased level of moisture experienced this year, the Company
believes there is a good chance to show improving retention over the next two
quarters relative to 2002 when dry conditions in selected regions increased
cancellations. Revenue in the landscape maintenance business increased two
percent for the six months, reflecting a significant increase in first quarter
snow removal revenue, partially offset by a decline in the level of enhancement
sales. Operating income margins in the lawn care operations declined in 2003
compared with 2002, reflecting higher sales and marketing costs as well as
higher labor related costs resulting from the underutilization of labor in the
first quarter due to weather-related delays in production, as well as increased
insurance costs. Operating income margins in the landscaping operations declined
in 2003 reflecting substantially lower margins in the utility line clearing
operations, as well as increased insurance costs and higher sales expenditures.
The Terminix segment reported a two percent increase in revenue for the six
months to $486 million from $477 million in 2002 and operating income of $75
million compared to $82 million in 2002. The growth in revenue reflects an
increase in higher priced bait contracts in the renewal base. Adverse cooler
temperatures that impacted many southern regions of the country significantly
impeded the development of the termite swarm and other pest activity. As a
result, termite and pest control sales leads declined significantly during the
six months. In addition, the weather conditions and the weak economy are
reflected in the decline in customer retention rates. Operating income margins
have decreased reflecting the reduction of new termite sales activity as well as
incremental costs associated with the unit's new information system.
The American Home Shield segment reported a nine percent increase in revenue to
$220 million from $202 million in 2002 and operating income of $31 million
compared to $21 million in 2002. The increase in revenue reflects strong
double-digit growth in renewal contracts, partially offset by a reduced level of
sales through the real estate and direct to consumer sales channels. The
retention rate is consistent with 2002, as
15
mortgage refinancings have resulted in an increase in cancellations in channels
where the customer's warranty payment is included in the mortgage statement.
Operating margins improved as the segment benefited from a decrease in the
incidence of claims and favorable trending of prior year claims.
The ARS/AMS segment reported revenue for the six months of $324 million in 2003,
a decrease of nine percent from $357 million in 2002. The decrease in revenue
primarily reflects a significant reduction in HVAC construction activity as well
as lower plumbing and HVAC repair volume, partially offset by an increase in
add-on/replacement HVAC activity. The add-on/replacement increase is important
as the transaction includes the sale of a piece of equipment which carries with
it a higher price point and total margin. For the six months, operating margins
declined reflecting the decrease in revenue and increased expenditures in sales
and marketing. As discussed in the second quarter comparison, management will
conduct a review of certain branches in the third quarter in order to determine
their profit potential. Based on this review, under-performing branches may be
closed or certain activities exited. The outcome of this review may lead
management to complete an assessment of its goodwill in the third quarter in
accordance with SFAS 142.
The Other Operations segment reported segment revenue of $74 million in 2003
compared with $69 million in 2002, reflecting increases in both the
ServiceMaster Clean and Merry Maids businesses. For the six months, this segment
reported an operating loss of $19 million in 2003 compared with a loss of $11
million in 2002, reflecting continued growth in profits of the combined
franchise operations, offset by higher costs related to marketing, technology,
and compliance initiatives incurred at the headquarters level.
FINANCIAL POSITION
Net cash flow provided from operations for the first six months was $58 million,
compared with $143 million in the previous year. The majority of the reduction
was experienced in the first quarter and is largely attributed to a higher level
of working capital usage. Several items impact the year over year comparison of
the cash flows from operations, with the largest component being approximately
$46 million in lower deferred revenue, primarily associated with customer
prepayments in TruGreen ChemLawn (approximately $22 million). TruGreen ChemLawn
typically receives prepayments from certain customers for the full season in the
fourth and first quarters. In preparation for the 2003 season, prepayment
programs were launched earlier than the prior year resulting in an acceleration
of prepayments (and cash flow) from the first quarter to the fourth quarter,
relative to the prior year. The Company has also lowered the prepayment discount
it offers customers which resulted in fewer customers prepaying. The Company
believes the margin benefit from a lower discount outweighed the benefit from
receiving payments earlier. In addition, deferred revenue growth at Terminix
decreased reflecting reduced sales growth. Although many businesses continued to
show improvements in receivables management in 2003, there was not the same
level of incremental improvement that was experienced in 2002 when both TruGreen
LandCare and ARS made substantial improvements in their receivable levels. The
cash flow comparison was also impacted by the timing of insurance, bonus and
vendor payments, with an increased level of payments in 2003 compared to 2002.
Consistent with historical patterns, the second half of the year is expected to
experience higher cash flow and the Company still anticipates its cash from
operations for the year to be significantly in excess of its net income.
Management expects 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 $197 million at June 30,
2003, approximately $105 million below the level at the beginning of the year.
The Company believes the cash balance will build significantly through the end
of the year due to the seasonally high levels of cash flow in the third and
fourth quarters. During 2002, the Company completed its debt reduction program
announced in October 2001. As a result of strong cash flows and the net proceeds
received from the Company's 2001 dispositions, total debt has been reduced by
approximately $1.0 billion over the last two and one-half years and represents
the Company's lowest debt levels in six years. The debt reduction program
enabled the Company to lengthen its maturity profile by focusing debt reductions
on shorter maturities. Approximately 68 percent of the Company's debt now
matures beyond five years and 42 percent beyond fifteen years. The Company's
next significant debt maturity is not until 2005.
16
The Company maintains a three-year revolving credit facility for $490 million,
which will expire in December 2004. As of June 30, 2003 the Company had no
borrowings outstanding, but had issued approximately $153 million of letters of
credit under the facility and, therefore, had unused commitments of
approximately $337 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 arrangement
enabling it to sell, on a revolving basis, certain receivables to unrelated
third party purchasers. At June 30, 2003, 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 lease facilities with banks totaling $95 million that provide for the
acquisition and development of properties to be leased by the Company. There are
residual value guarantees of these properties up to 82 percent of the fair
market value of the properties. At June 30, 2003, there was approximately $73
million funded under these facilities. Of the $95 million in facilities, $80
million expires in October 2004 and $15 million expires in January 2008.
Approximately $15 million of these leases that involve constructed properties
have been included on the balance sheet as assets with related debt as of June
30, 2003 and December 31, 2002, and the balance of the leases are operating
leases. The majority of the Company's vehicle fleet is leased through operating
leases. The lease terms are non-cancelable for the first twelve-month term, and
then are month-to-month leases, cancelable at the Company's option. There are
residual value guarantees (ranging from 70 percent to 87 percent depending on
the agreement) on these vehicles, which historically have not resulted in
significant net payments to the lessors. At June 30, 2003, there was
approximately $264 million of residual value relating to the Company's fleet.
The following table presents the Company's obligations and commitments:
2004 and 2006 and 2008 and
(IN MILLIONS) TOTAL 2003 2005 2007 later years
- --------------------------------------------------------------------------------------------------
Debt balances $827 $15 $176 $71 $565
Non-cancelable operating leases (1) 285 36 114 76 59
- --------------------------------------------------------------------------------------------------
Total amount $1,112 $51 $290 $147 $624
(1) Includes lease payments and residual value guarantees on leased properties.
There have been no material changes in the terms of the Company's financing
agreements since December 31, 2002. As described in the Company's latest Annual
Report to Shareholders, the Company is party to a number of debt agreements that
require it to maintain certain financial and other covenants, including
limitations on indebtedness and interest coverage ratio. In addition, under
certain circumstances, the agreements may limit the Company's ability to pay
dividends and repurchase shares of common stock. These limitations are not
expected to be a factor in the Company's future dividend and share repurchase
plans. Failure by the Company to maintain these covenants could result in the
acceleration of the maturity of the debt. At June 30, 2003, the Company was in
compliance with the covenants related to these debt agreements and based on its
operating outlook for the remainder of 2003, expects to be able to maintain
compliance in the future.
The assets and liabilities relating to the discontinued operations have been
classified in separate captions on the Condensed Consolidated Statements of
Financial Position. Assets of the discontinued operations have declined
reflecting cash collections on receivables and the sale of fixed assets. The
liabilities from discontinued operations have declined as a result of a cash
adjustment to the selling price of the 2001 disposition of the Company's
European pest control and property services operations as well as certain other
payments.
Receivables and inventories increased from year-end levels, reflecting general
business growth and increased seasonal activity. Prepaid expenses and other
assets increased from year-end primarily reflecting pre-season advertising costs
and annual repairs and maintenance procedures that are performed in the first
quarter at TruGreen ChemLawn. These costs are deferred and recognized in
proportion to the contract revenue over the production season, and are not
deferred beyond the calendar year-end. Deferred customer acquisition costs
increased reflecting the seasonality in the lawn care operations. In the winter
and early
17
spring, this business sells a series of lawn applications to customers that are
rendered primarily in March through October. The lawn care operations incur and
defer incremental selling expenses at the beginning of the year that directly
relate to successful sales in which the revenues will be recognized in later
quarters. These costs are deferred and recognized in proportion to the contract
revenue over the production season, and are not deferred beyond the calendar
year-end. Deferred revenues grew from year-end reflecting increased volume in
termite baiting contracts and increased customer prepayments for lawn care
services.
Capital expenditures, which include recurring capital needs and information
technology projects, are below prior year levels. In the prior year, there was a
significant payment relating to the residual value guarantees for leases on
assisted living facilities that were subsequently sold. The Company has no
material capital commitments at this time. Tuck-in acquisitions for the six
months ended June 30, 2003 and 2002 were $21.5 and $9.3 million, respectively.
The consideration consisted of cash payments and seller financed notes. The 2003
acquisitions occurred primarily at TruGreen ChemLawn.
Total shareholders' equity was $1.19 billion at June 30, 2003 and $1.22 billion
at December 31, 2002. The change reflects earnings in the first half of the
year, which was offset by cash dividends and share repurchases. Cash dividends
paid directly to shareholders totaled $63 million or $.21 per share for the six
months ended June 30, 2003. In July 2003, the Company paid a third quarter cash
dividend of $.105 per share and declared a fourth quarter cash dividend of $.105
per share payable on October 31, 2003. This quarterly dividend payment provides
for an annual payment for 2003 of $.42 per share, a 2.4% increase over 2002. 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 the first six months of 2003, the Company
has repurchased $49 million of its shares and anticipates purchasing $25 to $50
million of additional shares in the second half of 2003. Decisions relating to
any future share repurchases will take various factors into consideration such
as the Company's desire to maintain investment grade ratings, general business
conditions, and other strategic investment opportunities.
FORWARD LOOKING STATEMENTS
THE COMPANY'S FORM 10-Q FILING CONTAINS STATEMENTS CONCERNING FUTURE RESULTS AND
OTHER MATTERS THAT MAY BE DEEMED TO BE "FORWARD-LOOKING STATEMENTS" WITHIN THE
MEANING OF THE PRIVATE SECURITIES LITIGATION REFORM ACT OF 1995. THE COMPANY
INTENDS THAT THESE FORWARD-LOOKING STATEMENTS, WHICH LOOK FORWARD IN TIME AND
INCLUDE EVERYTHING OTHER THAN HISTORICAL INFORMATION, BE SUBJECT TO THE SAFE
HARBORS CREATED BY SUCH LEGISLATION. THE COMPANY NOTES THAT THESE
FORWARD-LOOKING STATEMENTS INVOLVE RISKS AND UNCERTAINTIES THAT COULD AFFECT ITS
RESULTS OF OPERATIONS, FINANCIAL CONDITION OR CASH FLOWS. FACTORS THAT COULD
CAUSE ACTUAL RESULTS TO DIFFER MATERIALLY FROM THOSE EXPRESSED OR IMPLIED IN A
FORWARD-LOOKING STATEMENT INCLUDE THE FOLLOWING (AMONG OTHERS): EXTREME WEATHER
CONDITIONS THAT AFFECT THE DEMAND FOR THE COMPANY'S SERVICES; COMPETITION IN THE
MARKETS SERVED BY THE COMPANY; LABOR SHORTAGES OR INCREASES IN WAGE RATES;
UNEXPECTED INCREASES IN OPERATING COSTS, SUCH AS HIGHER INSURANCE, HEALTH CARE
OR FUEL PRICES; INCREASED GOVERNMENTAL REGULATION OF TELEMARKETING; GENERAL
ECONOMIC CONDITIONS IN THE UNITED STATES, ESPECIALLY AS THEY MAY AFFECT HOME
SALES OR CONSUMER SPENDING LEVELS; TIME AND EXPENSES ASSOCIATED WITH INTEGRATING
AND WINDING DOWN BUSINESSES; AND OTHER FACTORS DESCRIBED FROM TIME TO TIME IN
DOCUMENTS FILED BY THE COMPANY WITH THE SECURITIES AND EXCHANGE COMMISSION.
18
QUANTITATIVE AND QUALITATIVE DISCLOSURES
ABOUT MARKET RISK
The economy and its impact on discretionary consumer spending, labor wages, fuel
costs, insurance costs and medical inflation rates could be significant to
future operating earnings.
The Company does not hold or issue financial instruments for trading or
speculative purposes. The Company has entered into specific financial
arrangements in the normal course of business to manage certain market risks,
with a policy of matching positions and limiting the terms of contracts to
relatively short durations. The effect of financial instrument transactions is
not material to the Company's financial statements.
The Company generally maintains the majority of its debt at fixed rates (over
95% of total debt at December 31, 2002 and June 30, 2003) and, therefore, its
exposure to interest rate fluctuations is not significant to the Company's
results of operations. The payments on the approximately $73 million of funding
outstanding under the Company's real estate operating lease facilities as well
as its cancelable vehicle fleet and equipment operating leases are tied to
floating interest rates. However, the Company does not expect interest rate
fluctuations to be significant to the Company's results of operations.
The Company has several debt and lease agreements where the interest rate or
rent payable under the agreements automatically adjust based on changes in the
Company's credit ratings. While the Company is not currently expecting a change
in its credit ratings, based on amounts outstanding at June 30, 2003, a one
rating category improvement in the Company's credit ratings would reduce expense
on an annualized basis by approximately $0.8 million. A one rating category
reduction in the Company's credit ratings would increase expense on an
annualized basis by approximately $1.4 million.
The following table summarizes information about the Company's fixed rate debt
instruments as of December 31, 2002 and presents the principal cash flows and
related weighted-average interest rates by expected maturity dates. The fair
value of the Company's fixed rate debt was approximately $880 million at
December 31, 2002.
Expected Maturity Date
---------------------------
There-
(In millions) 2003 2004 2005 2006 2007 after Total
-------------------------------------------------------------------------------
Fixed rate debt $31 $24 $151 $11 $59 $559 $835
Avg. Rate 4.2% 4.8% 8.2% 6.0% 6.7% 7.5% 7.2%
===============================================================================
19
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 as of the end of the period covered
by 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 with or submits to
the Commission is recorded, processed, summarized and reported within the time
periods specified in the Commission's rules and forms.
There were no changes in the Company's internal control over financial reporting
that occurred during the Company's most recent fiscal quarter that have
materially affected, or are reasonably likely to materially affect, the
Company's internal control over financial reporting.
20
PART II. OTHER INFORMATION
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
(a) The Company's 2003 Annual Meeting ("Annual Meeting") of Shareholders was
held on May 21, 2003 in Chicago, Illinois.
(b) The following persons were elected as Class of 2006 directors:
NAME VOTES FOR VOTES WITHHELD BROKER NON-VOTES
- ------------------ ----------- -------------- ----------------
Herbert P. Hess 223,603,503 13,512,624 N/A
Dallen W. Peterson 223,599,871 13,516,256 N/A
David K. Wessner 224,123,795 12,992,332 N/A
No votes were cast for any other nominee for directors. The Class of 2004
continuing in office are: Brian Griffiths, Sidney E. Harris, James D. McLennan
and Donald G. Soderquist. The Class of 2005 continuing in office are: Paul W.
Berezny, Jr., Roberto R. Herencia, Betty Jane Scheihing and Jonathan P. Ward.
Subsequent to the Annual Meeting, the Board of Directors elected John Carl to
the Class of 2006.
(c) The shareholders also voted on four proposals at the Annual Meeting. The
following table shows the vote tabulation for the shares represented at the
meeting:
Votes Votes Votes Broker
Proposal For Against Withheld Non-Votes
- --------------------------------------------- --------------- -------------- ------------- --------------
Ratification of Deloitte & Touche's
selection as independent auditor 229,729,226 6,567,661 819,240 N/A
Approval of the ServiceMaster 2003
Equity Incentive Plan 200,426,299 34,925,497 1,764,330 N/A
Approval of the ServiceMaster
Annual Bonus Plan 164,846,308 19,561,496 2,353,105 50,355,217
Shareholder proposal relating to
Poison Pills 91,067,197 89,311,340 6,363,159 50,374,431
ITEM 6(A): EXHIBITS
EXHIBIT NO. DESCRIPTION OF EXHIBIT
- ----------- -------------------------
31.1 Certification of Chief Executive Officer Pursuant to Rule 13a -
14(a) or 15d - 14(a), as Adopted Pursuant to Section 302 of the
Sarbanes-Oxley Act of 2002
31.2 Certification of Chief Financial Officer Pursuant to Rule 13a -
14(a) or 15d - 14(a), as Adopted Pursuant to Section 302 of the
Sarbanes-Oxley Act of 2002
32.1 Certification of Chief Executive Officer Pursuant to Section 1350
of Chapter 63 of Title 18 of the United States Code, as Adopted
Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002
32.2 Certification of Chief Financial Officer Pursuant to Section 1350
of Chapter 63 of Title 18 of the United States Code, as Adopted
Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002
21
ITEM 6(B): REPORTS ON FORM 8-K
A report on Form 8-K was filed on August 5, 2003. The purpose of the report was
to provide under Item 12, the press release issued by the Company on August 5,
2003 announcing the preliminary financial results for the second quarter of
2003.
22
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: August 14, 2003
THE SERVICEMASTER COMPANY
(Registrant)
By: /S/STEVEN C. PRESTON
------------------------------------------------------
Steven C. Preston
Executive Vice President and Chief Financial Officer
23