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 March 31, 2004
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: 290,467,000 shares of common stock on May 3, 2004.
TABLE OF CONTENTS
Page
NO.
THE SERVICEMASTER COMPANY (Registrant) -
PART I. FINANCIAL INFORMATION
Item 1: Financial Statements (Unaudited)
Condensed Consolidated Statements of Operations for the three
months ended March 31, 2004 and March 31, 2003 3
Condensed Consolidated Statements of Financial Position
as of March 31, 2004 and December 31, 2003 4
Condensed Consolidated Statements of Cash Flows for the three months
ended March 31, 2004 and March 31, 2003 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 2: Changes in Securities, Use of Proceeds and Issuer
Purchases of Equity Securities 21
Item 6: Exhibits and Reports on Form 8-K 21
Signature 23
PART I. FINANCIAL INFORMATION
THE SERVICEMASTER COMPANY
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS (UNAUDITED)
(IN THOUSANDS, EXCEPT PER SHARE DATA)
Three Months Ended
March 31,
2004 2003
---------- ----------
OPERATING REVENUE ........................................................ $ 756,891 $ 712,343
OPERATING COSTS AND EXPENSES:
Cost of services rendered and products sold .............................. 545,056 516,354
Selling and administrative expenses ...................................... 179,310 169,208
Amortization expense ..................................................... 1,422 1,640
Total operating costs and expenses ....................................... 725,788 687,202
--------- ---------
OPERATING INCOME ......................................................... 31,103 25,141
NON-OPERATING EXPENSE (INCOME):
Interest expense ......................................................... 14,931 16,283
Interest and investment income ........................................... (4,570) (1,219)
Minority interest and other expense, net ................................. 2,046 2,072
--------- ---------
INCOME FROM CONTINUING OPERATIONS BEFORE
INCOME TAXES ...................................................... 18,696 8,005
Provision for income taxes................................................ 7,235 3,162
--------- ---------
INCOME FROM CONTINUING OPERATIONS ........................................ 11,461 4,843
Loss from discontinued operations, net of income taxes ................... (262) (168)
--------- ---------
NET INCOME ............................................................... $ 11,199 $ 4,675
========= =========
PER SHARE:
BASIC EARNINGS PER SHARE:
Income from continuing operations ........................................ $ 0.04 $ 0.02
Discontinued operations, net ............................................. - -
--------- ---------
Basic earnings per share ................................................. $ 0.04 $ 0.02
========= =========
SHARES ................................................................... 291,799 297,801
DILUTED EARNINGS PER SHARE:
Income from continuing operations ........................................ $ 0.04 $ 0.02
Discontinued operations, net ............................................. - -
--------- ---------
Diluted earnings per share ............................................... $ 0.04 $ 0.02
========= =========
SHARES ................................................................... 296,035 301,635
SEE NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
3
THE SERVICEMASTER COMPANY
CONDENSED CONSOLIDATED STATEMENTS OF FINANCIAL POSITION (UNAUDITED)
(IN THOUSANDS, EXCEPT PER SHARE DATA)
As of March 31, As of Dec. 31,
ASSETS 2004 2003
----------- -----------
CURRENT ASSETS:
Cash and cash equivalents .................................................................... $ 146,572 $ 228,161
Marketable securities ........................................................................ 89,167 90,540
Receivables, less allowance of $26,406 and $26,220, respectively ............................. 336,008 333,834
Inventories .................................................................................. 72,563 70,163
Prepaid expenses and other assets ............................................................ 77,343 33,408
Deferred customer acquisition costs .......................................................... 68,776 41,806
Deferred taxes and income taxes receivable ................................................... 87,556 87,589
Assets of discontinued operations ............................................................ 4,948 5,273
----------- -----------
Total Current Assets .................................................................. 882,933 890,774
----------- -----------
PROPERTY AND EQUIPMENT:
At cost ................................................................................... 399,719 387,569
Less: accumulated depreciation ............................................................ (215,101) (208,054)
----------- -----------
Net property and equipment .............................................................. 184,618 179,515
----------- -----------
OTHER ASSETS:
Goodwill ..................................................................................... 1,523,818 1,516,206
Intangible assets, primarily trade names ..................................................... 215,787 216,453
Notes receivable ............................................................................. 45,425 46,441
Long-term marketable securities .............................................................. 93,118 92,562
Other assets ................................................................................. 14,198 14,475
----------- -----------
Total Assets .......................................................................... $ 2,959,897 $ 2,956,426
=========== ===========
LIABILITIES AND SHAREHOLDERS' EQUITY
CURRENT LIABILITIES:
Accounts payable ............................................................................. $ 94,417 $ 86,963
Accrued liabilities:
Payroll and related expenses .............................................................. 83,543 89,427
Self-insured claims and related expenses .................................................. 70,706 73,320
Other ..................................................................................... 105,944 100,454
Deferred revenues ............................................................................ 461,871 419,915
Liabilities of discontinued operations ....................................................... 12,955 14,380
Current portion of long-term debt ............................................................ 30,245 33,781
----------- -----------
Total Current Liabilities ............................................................. 859,681 818,240
----------- -----------
LONG-TERM DEBT ............................................................................... 792,837 785,490
LONG-TERM LIABILITIES:
Deferred taxes .......................................................................... 279,545 276,000
Liabilities of discontinued operations .................................................. 33,977 34,396
Other long-term obligations ............................................................. 131,374 125,474
----------- -----------
Total Long-Term Liabilities .......................................................... 444,896 435,870
----------- -----------
MINORITY INTEREST ............................................................................ 100,309 100,309
COMMITMENTS AND CONTINGENCIES
SHAREHOLDERS' EQUITY:
Common stock $0.01 par value, authorized 1,000,000 shares; issued
317,451 and 317,315 shares, respectively ................................................ 3,175 3,173
Additional paid-in capital ................................................................... 1,062,695 1,061,640
Retained earnings (accumulated deficit) ...................................................... (13,228) 6,365
Accumulated other comprehensive income ....................................................... 7,627 7,932
Restricted stock ............................................................................. (9,786) (4,368)
Treasury stock ............................................................................... (288,309) (258,225)
----------- -----------
Total Shareholders' Equity ............................................................ 762,174 816,517
----------- -----------
Total Liabilities and Shareholders' Equity ............................................ $ 2,959,897 $ 2,956,426
=========== ===========
SEE NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
4
THE SERVICEMASTER COMPANY
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED)
(IN THOUSANDS)
Three Months Ended
March 31,
2004 2003
--------- ----------
CASH AND CASH EQUIVALENTS AT JANUARY 1 ...................................... $228,161 $227,177
CASH FLOWS FROM OPERATING ACTIVITIES:
NET INCOME .................................................................. 11,199 4,675
Adjustments to reconcile net income to net cash flows from operating
activities:
Loss from discontinued operations ................................... 262 168
Depreciation expense ................................................ 12,175 12,397
Amortization expense ................................................ 1,422 1,640
Deferred income tax expense ......................................... 5,815 2,448
Change in working capital, net of acquisitions:
Receivables ..................................................... (5,822) (15,264)
Inventories and other current assets ............................ (62,308) (65,828)
Accounts payable ................................................ 7,490 (7,133)
Deferred revenues ............................................... 41,443 42,867
Accrued liabilities ............................................. 3,027 (12,795)
Other, net ...................................................... 1,514 3,782
--------- ---------
NET CASH PROVIDED FROM (USED FOR) OPERATING ACTIVITIES ...................... 16,217 (33,043)
--------- ---------
CASH FLOWS FROM INVESTING ACTIVITIES:
Property additions .................................................... (12,520) (10,527)
Sale of equipment and other assets .................................... 488 933
Business acquisitions, net of cash acquired ........................... (4,197) (13,070)
Notes receivable, financial investments and securities ................ 3,696 (14,016)
--------- ---------
NET CASH USED FOR INVESTING ACTIVITIES ...................................... (12,533) (36,680)
--------- ---------
CASH FLOWS FROM FINANCING ACTIVITIES:
Net payments of debt .................................................. (9,962) (10,549)
Purchase of ServiceMaster stock ....................................... (39,831) (1,901)
Shareholders' dividends ............................................... (30,792) (31,359)
Other, net ............................................................ (2,646) 2,273
--------- ---------
NET CASH USED FOR FINANCING ACTIVITIES ...................................... (83,231) (41,536)
--------- ---------
CASH USED FOR DISCONTINUED OPERATIONS ....................................... (2,042) (11,651)
--------- ---------
CASH DECREASE DURING THE PERIOD ............................................. (81,589) (122,910)
--------- ---------
CASH AND CASH EQUIVALENTS AT MARCH 31 ....................................... $ 146,572 $ 104,267
========= =========
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, 2003 (2003
Annual Report). 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), and electrical 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 (service costs for termite
contracts 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
monthly fee revenue, which is recognized when the related customer level revenue
is reported by the franchisee and collectibility is assured. Franchise revenue
also includes initial fees resulting from the sale of a franchise. These fees
are fixed and are recognized as revenue when collectibility is assured and all
material services or conditions relating to the sale have been substantially
performed. Due to the seasonality of the TruGreen and Terminix operations,
franchise fee income represented 30 percent and 35 percent of consolidated
operating income for the three months ended March 31, 2004 and 2003,
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.
The Company had $462 million and $420 million of deferred revenue at March 31,
2004 and 2003, respectively, which consist primarily of payments received for
annual contracts relating to home warranty, termite baiting and lawn care
services. The revenue related to these services is recognized as the services
are performed over the contractual period.
Customer acquisition costs, which are incremental and direct costs of obtaining
a customer, are deferred and amortized over the life of the related 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 the costs of annual repairs and maintenance procedures that are
performed in the first quarter. These costs are deferred and recognized
6
approximately in proportion to the contract revenue over the production season,
and are not deferred beyond the calendar year-end.
As noted above, TruGreen's pre-season advertising costs are deferred and
recognized approximately in proportion to the contract revenue over the
production season. Terminix and ARS also defer advertising costs in the first
quarter and recognizes the expense over the year approximately in proportion to
their revenue. 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 2003 Annual Report presented the
significant areas that require the use of management's estimates and discussed
how management formed its judgments. The areas discussed included the allowance
for receivables, accruals for self-insured retention limits related to medical,
workers compensation, auto and general liability insurance, accruals for home
warranty claims, the possible outcome of outstanding litigation, accruals for
income tax liabilities as well as deferred tax accounts, useful lives for
depreciation and amortization expense, and the valuation of tangible and
intangible assets. In 2004, there have been no changes in the significant areas
that require estimates or in the methodologies which underlie these estimates.
NOTE 4: The Company carries insurance policies on insurable risks at levels
which it believes to be appropriate, including workers' compensation, auto and
general liability risks. The Company has self-insured retention limits and
insured layers of excess insurance coverage above those limits. Accruals for
self-insurance losses and warranty claims in the American Home Shield business
are made based on the Company's claims experience and actuarial projections.
Current activity could differ causing a change in estimates. 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 records deferred income tax balances based on the net tax effects of
temporary differences between the carrying value of assets and liabilities for
financial reporting purposes and income tax purposes. There are significant
amortizable intangible assets for tax reporting purposes (not for financial
reporting purposes) which arose as a result of the Company's reincorporation
from partnership to corporate form in 1997. The Company records its deferred tax
items based on the estimated ultimate value of the tax basis. The Company's tax
estimates are adjusted when required to reflect changes based on factors such as
changes in tax laws, results of tax authority reviews and statutory limitations.
In the event that actual results differ from the estimates discussed in this
note, the Company would reflect those changes, which could be material, in the
period that the difference is identified.
NOTE 5: In accordance with Statement of Financial Accounting Standards (SFAS)
142, goodwill and intangible assets that are not amortized are subject to
assessment for impairment by applying a fair-value based test on an annual basis
or more frequently if circumstances indicate a potential impairment. Such
circumstances could include actual earnings being significantly below
management's estimates. The Company's annual assessment date is October 1.
The following table summarizes the goodwill and intangible asset activity and
balances:
(In thousands) As of As of
Dec. 31, March 31,
2003 Additions Amort. 2004
----------- ----------- ------------ -----------
Goodwill(1) ............... $ 1,516,206 $ 7,612 $ -- $ 1,523,818
Trade names(1) ............ 204,793 -- -- 204,793
Other intangible assets ... 35,432 756 -- 36,188
Accumulated amortization(2) (23,772) -- (1,422) (25,194)
----------- ----------- ----------- -----------
Net other intangibles ..... 11,660 756 (1,422) 10,994
----------- ----------- ----------- -----------
Total ..................... $ 1,732,659 $ 8,368 $ (1,422) $ 1,739,605
=========== =========== ============ ===========
(1) Not subject to amortization.
(2) Annual amortization expense of approximately $6 million in 2004 is expected
to decline over the next five years.
7
The table below presents, by segment, the goodwill that is not subject to
amortization:
(In thousands) March 31, Dec. 31,
2004 2003
------------- --------------
TruGreen $659,034 $652,534
Terminix 623,279 622,351
American Home Shield 72,085 72,085
ARS/AMS 56,171 56,171
Other Operations 113,249 113,065
------------- --------------
Total $1,523,818 $1,516,206
============= ==============
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 for purposes of
the diluted earnings per share calculations. In computing diluted earnings per
share, the after-tax interest expense related to convertible debentures is added
back to net income in the numerator, while the diluted shares in the denominator
include the shares issuable upon conversion of the debentures. Shares
potentially issuable under convertible securities have not been considered
outstanding for the three months ended March 31, 2004 and 2003, respectively, as
their inclusion results in a less dilutive computation. Had the inclusion of
convertible securities not resulted in a less dilutive computation for the three
months ended March 31, 2004 and 2003, incremental shares attributable to the
assumed conversion of the debentures would have increased shares outstanding by
8.0 million shares and 8.2 million shares, respectively, and the after-tax
interest expense related to the convertible debentures that would have been
added to net income in the numerator would have been $1.2 million for both
periods.
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 March 31, 2004 Ended March 31, 2003
-------------------------------- ------------------------------
CONTINUING OPERATIONS: Income Shares EPS Income Shares EPS
- ---------------------- ---------- --------- -------- ---------- --------- -------
Basic earnings per share $11,461 291,799 $0.04 $4,843 297,801 $0.02
===== =====
Effect of dilutive securities, net of tax:
Options 4,236 3,834
------- ------- ------ -------
Diluted earnings per share $11,461 296,035 $0.04 $4,843 301,635 $0.02
======= ========= ===== ====== ======= =====
NOTE 7: 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.
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 for all periods, proforma reported net
income and net earnings per share would reflect the following:
8
Three Months Ended
March 31,
(In thousands, except per share data) 2004 2003
--------------- ---------------
Net income as reported $11,199 $4,675
Add back: Stock-based compensation
expense included in reported net income,
net of related tax effects 249 164
Deduct: Stock-based compensation
expense determined under fair-value
method,
net of related tax effects (1,424) (1,877)
--------------- ---------------
Proforma net income $10,024 $2,962
=============== ===============
Basic Earnings Per Share:
As reported $0.04 $0.02
Proforma $0.03 $0.01
Diluted Earnings Per Share:
As reported $0.04 $0.02
Proforma $0.03 $0.01
In March 2004, the Financial Accounting Standards Board (FASB) issued an
Exposure Draft, "Share-Based Payment, an Amendment of FASB Statements No. 123
and 95". In its current form, this Exposure Draft would require companies to
record stock options and share grants at fair value and recognize this value as
compensation expense over their vesting period. The Exposure Draft would require
companies to record compensation expense for newly issued awards as well as the
unvested portion of previously issued awards that remain outstanding as of the
date of the adoption of the Exposure Draft. ServiceMaster has recorded
compensation expense relating to the vesting of awards granted subsequent to
2002. If adopted in its current form, the Exposure Draft would be effective for
fiscal years beginning after December 15, 2004. ServiceMaster is currently
assessing the potential impact of this Exposure Draft.
NOTE 8: 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. In December 2003, the FASB issued FASB Interpretation No.
46, Revised (FIN 46R), which revised the originally issued document. The
requirements of FIN 46 and FIN 46R have been adopted by the Company and their
adoption did not have a material impact on the Company's Consolidated Financial
Statements.
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 three
months ended March 31, 2004 and 2003 is presented in the following table:
(IN THOUSANDS)
2004 2003
CASH PAID OR (RECEIVED) FOR: --------- ---------
Interest expense........................... $ 22,509 $ 23,491
Interest and dividend income............... $ (1,988) $ (2,036)
Income taxes............................... $ 2,552 $ 618
Cash paid for income taxes increased in 2004 as a result of a higher level of
tax refunds received in the prior year.
NOTE 10: Total comprehensive income was $11 million and $3 million for the three
months ended March 31, 2004 and 2003, 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 and Terminix to a
wholly owned, bankruptcy-remote subsidiary,
9
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 March 31, 2004 and 2003, 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: During the third quarter of 2003, the Company sold substantially all of
the assets and related operational obligations of Trees, Inc., the utility line
clearing operations of TruGreen LandCare. The results of the utility line
clearing operations of Trees, Inc. have been reclassified as "Discontinued
Operations" and are not included in continuing operations.
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. 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.
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. At the end of 2003, there were approximately $10
million of reserves remaining, primarily relating to long term severance
agreements that extend over several years.
The table below summarizes the activity during the three months ended March 31,
2004 for the remaining liabilities from the discontinued operations. The Company
believes that the remaining reserves continue to be adequate and reasonable.
(IN THOUSANDS) Balance at Cash Balance at
December 31, Payments Mar. 31,
2003 or Other 2004
------------ ----------- -----------
Remaining liabilities from
discontinued operations
LandCare Construction $7,152 $746 $6,406
LandCare utility line
clearing business 9,011 625 8,386
Certified Systems, Inc. 11,024 403 10,621
Management Services 283 21 262
International businesses 12,017 49 11,968
Other 9,289 - 9,289
NOTE 13: In the ordinary course, the Company is subject to review by domestic
and foreign taxing authorities, including the Internal Revenue Service ("IRS").
From 1986 through 1997 most operations of the Company were conducted in
partnership form, free of federal corporate income tax. During that period, the
Company was not reviewed by the IRS. In 1997, the Company converted from
partnership to corporate form. In 2003, the IRS commenced an examination of the
Company's consolidated income tax returns for 2002, 2001 and 2000. The Company
expects the IRS' examination to be in its final stages in late 2004 and
completed in early 2005. As with any review of this nature, the outcome of the
IRS examination is not known at this time.
NOTE 14: The business of the Company is conducted through five operating
segments: TruGreen, Terminix, American Home Shield, ARS/AMS and Other
Operations. In accordance with 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. 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 AmeriSpec. The
ARS/AMS segment
10
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 and company-owned operations
of ServiceMaster Clean, Furniture Medic and Merry Maids, which provide disaster
restoration, cleaning, furniture repair and maid services. The segment also
includes the Company's headquarters operations, which provide various
technology, marketing, finance and other support services to the business units.
Segment information is presented below.
(IN THOUSANDS) Three Months Three Months
Ended Mar. 31, Ended Mar. 31,
2004 2003
- ----------------------------------------------------------------------------
Operating Revenue:
TruGreen $224,659 $204,547
Terminix 236,796 225,906
American Home Shield 102,797 94,224
ARS/AMS 153,984 151,433
Other Operations 38,655 36,233
- ----------------------------------------------------------------------------
Total Operating Revenue $756,891 $712,343
============================================================================
Operating Income:
TruGreen $(2,898) $(8,550)
Terminix 36,254 33,528
American Home Shield 10,116 8,159
ARS/AMS (3,648) (1,170)
Other Operations (8,721) (6,826)
- ----------------------------------------------------------------------------
Total Operating Income $31,103 $25,141
============================================================================
(IN THOUSANDS) As of As of
March 31, 2004 Dec. 31, 2003
- -----------------------------------------------------------------------------------------------------
Identifiable Assets:
TruGreen $1,037,548 $911,958
Terminix 822,003 822,407
American Home Shield 415,878 422,765
ARS/AMS 184,663 185,528
Other Operations (and discontinued businesses) 499,805 613,768
- -----------------------------------------------------------------------------------------------------
Total Identifiable Assets $2,959,897 $2,956,426
=====================================================================================================
(IN THOUSANDS) As of As of
March 31, 2004 March 31, 2003
- -----------------------------------------------------------------------------------------------------
Capital Employed: (1)
TruGreen $850,163 $1,000,406
Terminix 598,445 602,068
American Home Shield 135,435 101,725
ARS/AMS 94,805 394,483
Other Operations (and discontinued businesses) 6,717 27,608
- -----------------------------------------------------------------------------------------------------
Total Capital Employed $1,685,565 $2,126,290
=====================================================================================================
(1) Capital employed is a non-U.S. GAAP measure that is defined as the
segment's total assets less liabilities, exclusive of debt balances. The
Company believes this information is useful to investors in helping them
compute return on capital measures and therefore better understand the
performance of the Company's business segments.
11
MANAGEMENT DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
RESULTS OF OPERATIONS
FIRST QUARTER 2004 COMPARED TO FIRST QUARTER 2003
CONSOLIDATED OVERVIEW
ServiceMaster (the "Company") reported revenue of $757 million in the first
quarter of 2004, six percent above 2003 with substantially all of the growth
from internal sources. First quarter 2004 diluted earnings per share doubled to
$.04 from $.02 in 2003. Operating income for the first quarter increased 24
percent to $31 million compared to $25 million in 2003. All of the Company's
businesses experienced increases in revenue and many had meaningful improvements
in growth rate trends. Most units also reported solid increases in profits. As
discussed below, the Company's results benefited from a few favorable
comparisons, however, these were virtually offset by unfavorable factors of
nearly equal value. On the positive side, the lawn care operations of TruGreen
ChemLawn benefited from more normal weather conditions than last year, when late
season snow adversely impacted production. This business was able to return to
more typical production schedules, thereby offsetting the effects of reduced
snow removal revenue in the TruGreen LandCare operations. In addition, the
Company realized approximately $3 million more in investment gains this year on
its equity investment portfolio at American Home Shield. The level of gains
realized was reasonable given the substantially improved market conditions and
size of the investment portfolio. On the other hand, results were adversely
impacted by some unfavorable factors. More normal levels of variable
compensation throughout the enterprise increased costs by almost $7 million and
branch consolidations at TruGreen LandCare resulted in increased charges of
approximately $1.2 million. Finally, the cost controls and the focus on improved
efficiencies that were evident throughout the enterprise during the second half
of last year remained firmly in place, helping the Company to offset large
increases in certain key costs such as insurance and fuel.
The Company has re-affirmed its outlook for the year. The Company expects
revenue growth to be in the mid-single digit range in 2004 with earnings per
share growing somewhat faster. Earnings per share growth is typically faster
than revenue growth due to the Company's ability to leverage its cost base on
the incremental volume. The Company believes that positive factors such as an
improving economy, higher consumer confidence and increased home sales will help
it overcome higher insurance, fuel costs and a return to a more normal level of
incentive compensation. The Company continues to remain focused on top-line
sales growth, increased customer retention and price realization, as well as
improving performance in the ARS/AMS segment and at TruGreen LandCare.
Cost of services rendered and products sold increased six percent for the
quarter and decreased as a percentage of revenue to 72.0 percent in 2004 from
72.5 percent in 2003. 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 six percent for the quarter. As a
percentage of revenue, these costs decreased to 23.7 percent for the quarter in
2004 from 23.8 percent in 2003 driven by the substantial increase in lawn care
revenue in 2004.
Net non-operating expense decreased $5 million from 2003, reflecting higher
investment income from securities gains in the American Home Shield investment
portfolio, as well as the favorable impact from interest rate swap agreements
entered into at the end of 2003 and early 2004.
12
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 March 31,
2004 2003
----------------- -----------------
TRUGREEN CHEMLAWN-
Growth in Full Program Contracts 2% 2%
Customer Retention Rate 63.6% 63.5%
TERMINIX -
Growth in Pest Control Customers 4% 1%
Pest Control Customer Retention Rate 77.6% 75.2%
Growth in Termite Customers -2% -%
Termite Customer Retention Rate 88.2% 88.6%
AMERICAN HOME SHIELD -
Growth in Warranty Contracts 6% 12%
Customer Retention Rate 54.7% 55.1% *
* Restated to conform with the 2004 calculation.
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 a 10 percent
increase in first quarter revenue to $225 million compared to $205 million in
2003. The segment's operating loss for the quarter was $3 million compared with
an operating loss of $9 million in 2003.
Revenue in the lawn care operations increased 18 percent over 2003 and operating
income grew $11 million for the quarter. These strong results reflect
accelerated timing of production due to more favorable weather conditions, as
late season snow last year delayed the start of lawn care production in many
parts of the country. Customer counts increased two percent over last year,
which was slightly favorable to the Company's expectations. As the Company has
previously disclosed, it had expected an adverse first quarter impact on the
customer count comparison as a result of a change in the timing of its customer
acquisition efforts. The Company has diversified its sales channels and placed
less reliance on telemarketing, which has historically been heaviest in the
first quarter, while more emphasis has been placed on direct mail, door to door
and other efforts, which are more heavily concentrated in the second quarter. As
a result of the enactment of the National Do Not Call Registry last fall and the
Company's changes in its sales channels, telemarketing sales declined by 11
percent. However, on a year to date basis through April, the decline in
telemarketing sales was offset by a sharp improvement in customer retention and
strong growth in non-telemarketing sales. The customer retention rates included
in the Key Performance Indicators are presented on a rolling, twelve-month basis
and reflect a modest 10 basis point improvement in TruGreen ChemLawn's
retention. However, when measured more discretely for the first quarter,
retention has improved more dramatically, by 160 basis points. Improvements in
retention were pervasive with nearly every region and division of TruGreen
ChemLawn showing gains. This reflected the results of steady focus on improving
customer service and problem resolution, as well as more strategic pricing
policies for existing customers.
In April, the Company announced that TruGreen ChemLawn acquired the assets of
Greenspace Services Limited (Greenspace). Greenspace is Canada's largest
professional lawn care service company. As this transaction closed in April, it
had no impact on first quarter results.
13
Revenue in the landscape maintenance business was comparable to 2003. Modest
growth in base contract maintenance combined with stronger enhancement sales
volume was offset by last year's higher snow removal business. Good growth in
new maintenance contract sales was offset by lower customer retention. The
Company is encouraged by the sharp increase in enhancement revenue, which
reflects focused sales efforts and an improving economy. Operating income of the
landscape maintenance operations declined by $6 million primarily reflecting a
reduction in higher margin snow removal volume, higher insurance, fuel and
labor-related costs as well as $1.2 million of branch consolidation costs.
Management is dedicated to improving performance and has identified key areas of
focus which include strengthening the sales team and maintenance contract base,
continuing to increase enhancement revenue, further development of safety
programs, and improving consistency through better process disciplines.
Capital employed in the TruGreen segment decreased 15 percent reflecting
improved working capital management as well as the impact of the impairment
charge recorded in the third quarter of 2003. Capital employed is a non-U.S.
GAAP measure that is defined as the segment's total assets less liabilities,
exclusive of debt balances. The Company believes this information is 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 five percent increase in first quarter revenue to $237 million compared to
$226 million in 2003 and operating income growth of eight percent to $36 million
compared to $34 million in 2003. After a slow start in the quarter, the annual
termite swarm activity increased in March and Terminix achieved a solid increase
in termite completion volume. As previously disclosed, with the improved
efficacy of liquid termite treatments, the Company is providing consumers with
the choice of receiving termite services through baiting stations or liquid
treatments. With this enhanced termite offering, the Company is expecting, and
has experienced, a shift in the mix of its termite customer base from baiting
stations to liquid treatments. Because the liquid alternative is less expensive
than the bait alternative, the combined average unit price for the quarter
declined. When combined with the previously mentioned volume increase, the net
result was a modest increase in overall revenue dollars for termite completions.
By offering consumers a choice in treatments and by tightening controls over
price discounting, Terminix has been able to increase the average price realized
for each of the two treatment alternatives, thus partially offsetting the impact
on profits of the mix shift. As previously disclosed, liquid termite treatments
are generally less profitable than bait treatments during the first year, but
are more profitable in subsequent years, with approximately equal value over the
average life of a customer. In the first quarter, the effects of increased
volume and improved price realization virtually offset the impact of the shift
in mix.
In other parts of the business, Terminix benefited from increased pricing of
termite renewals and a solid improvement in pest control retention rates.
Overall, Terminix was able to more than offset increased costs in the quarter
associated with the roll-out of the its new branch operating system (which is
now nearly complete) and higher variable compensation expense, resulting in an
eight percent overall improvement in operating income. Capital employed in the
Terminix segment decreased one percent to $598 million.
The American Home Shield (AHS) segment, which provides home warranties to
consumers that cover HVAC, plumbing and other home systems and appliances,
reported a nine percent increase in revenue to $103 million from $94 million in
2003 and operating income growth of 24 percent, to $10 million compared to $8
million in 2003. The revenue increase reflected strong growth in the
direct-to-consumer channel resulting from continued expansion of marketing
efforts with premier mortgage lenders and financial institutions. AHS also
experienced a solid increase in renewal revenues, despite less favorable
retention rates. Sales in the real estate channel increased modestly. The
increase in operating income was driven by the growth in revenue as well as
continued effective management of costs per warranty claim. The Company expects
AHS' core momentum to remain strong, although operating income comparisons for
the second quarter will be adversely impacted by favorable claim adjustments
recorded last year, as well as certain strategic investments, both of which have
been previously considered in the Company's full year earnings outlook. Capital
employed increased 33 percent reflecting volume growth in the business requiring
a higher level of investment. The calculation of capital employed for the AHS
segment includes approximately $212 million and $165 million of cash, cash
equivalents and marketable securities at March 31, 2004 and 2003,
14
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) brand names. Revenues increased 2%
overall to $154 million in the quarter, which was a 6% growth excluding the
effects of discontinued branches. The segment reported an operating loss of $4
million compared to an operating loss of $1 million in 2003. The growth in
revenue reflected strong increases in residential new construction and
commercial project revenue, offset by declines in HVAC service revenue. Plumbing
revenue decreased by less than one percent for the quarter. Within ARS,
meaningful progress has been made on specific initiatives to improve brand
differentiation (through such measures as on-time arrival guarantee), expand
sewer line repair revenue, and increase the average sales ticket prices on
replacement HVAC sales. However, the impact from these initiatives has not yet
been enough to offset the effect of continued softness in the core service
revenues. At AMS, project bidding activity has shown sporadic signs of
improvement, although this has not yet resulted in firmer contract pricing. The
segment's operating loss for the quarter increased as a result of higher sales,
advertising and insurance related costs at ARS, as well as lower margins at AMS
due to cyclically depressed industry conditions in commercial real estate.
Capital employed decreased 76 percent reflecting the impact of the impairment
charge recorded in the third quarter of 2003.
The Other Operations segment includes the Company's ServiceMaster Clean and
Merry Maids operations as well as its headquarters functions. Revenue in this
segment increased seven percent to $39 million compared to $36 million in 2003.
The combined ServiceMaster Clean and Merry Maids franchise operations reported
revenue growth of nine percent and a solid increase in operating income.
ServiceMaster Clean continued to experience strong growth in disaster
restoration services, despite an industry-wide reduction in water damage claims
due to milder weather. ServiceMaster Clean's unique service capabilities and
geographic footprint have helped it establish significant relationships with
several national insurance carriers. At Merry Maids, a better economy and
improved sales processes have driven a steady increase in internal revenue
growth in both the branch and franchise operations. The segment reported an
increased operating loss, reflecting higher variable compensation expense at the
headquarters level. Capital employed in this segment decreased to $7 million at
March 31, 2004 compared to $28 million at March 31, 2003 reflecting the
wind-down of discontinued operations.
FINANCIAL POSITION AND LIQUIDITY
CASH FLOWS FROM OPERATING ACTIVITIES
Net cash provided by operating activities was a positive $16 million in the
quarter, compared to a negative $33 million in the prior year. The $49 million
overall improvement is a result of higher earnings and a decrease in the use of
working capital, reflecting strong management on both sides of the balance
sheet, as well as a $10 million temporary benefit from the timing of certain
payments. Consistent with earnings, nearly all the business units reported
improvements in cash flows from operating activities. Days sales outstanding
declined in several key businesses and on an overall basis. Inventory levels
declined slightly from a year ago. For the full year 2004, the Company expects
cash from operating activities to increase consistent with earnings and to
continue to substantially exceed net income.
The Company receives a significant annual cash benefit from deferred income
taxes. Much of this benefit is due to a large base of tax deductible intangible
assets which exist for income tax reporting purposes but not for book purposes,
a significant portion of which arose in connection with the Company's 1997
conversion from a limited partnership to a corporation. In the ordinary course,
the Company is subject to review by domestic and foreign taxing authorities,
including the Internal Revenue Service ("IRS"). From 1986 through 1997 most
operations of the Company were conducted in partnership form, free of federal
corporate income tax. During that period, the Company was not reviewed by the
IRS. In 1997 the Company converted from partnership to corporate form. In 2003,
the IRS commenced an examination of the Company's consolidated income tax
returns for 2002, 2001 and 2000. The Company expects the IRS' examination to be
in its final stages in late 2004 and completed in early 2005. As with any review
of this nature, the outcome of the IRS examination is not known at this time.
15
CASH FLOWS FROM INVESTING ACTIVITIES
Capital expenditures, which include recurring capital needs and information
technology projects, were above prior year levels. The Company anticipates
approximately $50 million of capital expenditures in 2004 reflecting systems
enhancements and other initiatives. The Company has no material capital
commitments at this time.
Tuck-in acquisitions in the first quarter of 2004 totaled $8 million, compared
with $17 million in 2003. Consideration consisted of cash payments and seller
financed notes. The decrease in acquisitions is a timing matter as the Company
believes that the level of tuck-in acquisitions for the year could double from
last year's level due to increased activity at Terminix.
CASH FLOWS FROM FINANCING ACTIVITIES
Cash dividends paid to shareholders totaled $31 million or $.105 per share for
the three months ended March 31, 2004. In April 2004, the Company paid a second
quarter cash dividend of $.105 per share and declared a third quarter cash
dividend of $.11 per share payable on July 30, 2004 to shareholders of record on
July 9, 2004. The announced dividend reflects a 4.8 percent increase in the
quarterly dividend amount compared to the $.105 per share paid in the second
quarter. The Company records its dividend liability on the record date. The
timing and amount of future dividend increases are at the discretion of the
Board of Directors and will depend on, among other things, the Company's capital
structure objectives and cash requirements.
In July 2000, the Board of Directors authorized $350 million for share
repurchases. For the three months ended March 31, 2004, the Company repurchased
approximately $40 million of its shares at an average price of $11.22. Future
share repurchases for the year will depend on operating trends and business
acquisition opportunities but currently the Company expects the full year amount
to be consistent with last year. There remains approximately $104 million
available for repurchases under the July 2000 authorization. Decisions relating
to any future share repurchases will depend on various factors such as the
Company's commitment to maintain investment grade credit ratings and other
strategic investment opportunities.
LIQUIDITY
Cash and short and long-term marketable securities totaled approximately $330
million at March 31, 2004, with approximately $250 million of that amount
required to support regulatory requirements at American Home Shield and for
other purposes. Total debt was $823 million at March 31, 2004 compared to $819
million at December 31, 2003. Approximately 65 percent of the Company's debt
matures beyond five years and 35 percent beyond fifteen years. The Company's
next public debt maturity is in 2005, and involves $138 million.
Management believes that funds generated from operating activities and other
existing resources will continue to be adequate to satisfy ongoing working
capital needs of the Company. The Company has had a committed revolving credit
facility for $490 million, which expires in December 2004. As of March 31, 2004,
the Company had issued approximately $161 million of letters of credit under
this facility and had unused commitments of approximately $329 million. The
Company expects to replace its existing credit facility with a new five-year
revolving credit facility for $500 million in May 2004. This new facility is
expected to expire in May 2009. 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 March 31, 2004, 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 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.
There have been no material changes in the Company's financing agreements since
December 31, 2003. 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 March
16
31, 2004, the Company was in compliance with the covenants related to these debt
agreements and based on its operating outlook for the remainder of 2004, expects
to be able to maintain compliance in the future.
The Company maintains operating lease facilities with banks totaling $95 million
which provide for the acquisition and development of branch properties to be
leased by the Company. There are residual value guarantees of these properties
for up to 82 percent of their fair market value. At March 31, 2004, there was
approximately $73 million funded under these facilities. Approximately $20
million of these leases have been included on the balance sheet as assets with
related debt as of March 31, 2004 and December 31, 2003. Of the $95 million
available, $80 million expires in October 2004 and $15 million expires in
January 2008. The Company intends to refinance the existing facility which
expires in October 2004. If the Company does not refinance the facility it may
be required to purchase the leased assets which total approximately $53 million.
The majority of the Company's fleet and some equipment are leased through
operating leases. The lease terms are non-cancelable for the first twelve month
term, and then are month-to-month, 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 and equipment, which historically have not
resulted in significant net payments to the lessors. At March 31, 2004, there
was approximately $242 million of residual value relating to the Company's fleet
and equipment leases.
The Company's 2003 Annual Report included disclosure of the Company's
contractual obligations and commitments as of December 31, 2003. There have been
no material changes to these obligations and commitments since December 31,
2003.
FINANCIAL POSITION - CONTINUING OPERATIONS
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 preseason advertising costs
and annual repairs and maintenance procedures that are performed in the first
quarter at TruGreen ChemLawn and advertising at Terminix. These costs are
deferred and recognized 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 spring,
this business sells a series of lawn applications to customers which are
rendered primarily in March through October. The lawn care operations incur
incremental selling expenses at the beginning of the year that directly relate
to successful sales in which the revenue will be recognized in later quarters.
These costs are deferred and recognized over the production season and are not
deferred beyond the calendar year-end. Property and equipment increased slightly
from year-end levels, reflecting general business growth. Deferred revenue
increased from year-end levels, reflecting strong growth in customer prepayments
at TruGreen ChemLawn. The Company does not have any material capital commitments
at this time.
The Company has minority investors in Terminix. This minority ownership reflects
an interest issued to Allied Bruce Terminix Companies in connection with the
acquisition of its business in 2001. This equity security is convertible into
eight million ServiceMaster common shares. The ServiceMaster shares are
considered in the shares used for the calculation of diluted earnings per share.
Total shareholders' equity was $762 million at March 31, 2004 and $817 million
at December 31, 2003. The decrease reflects earnings in the business offset by
cash dividend payments and share repurchases.
Dividends paid in 2003 on the Company's common stock were not taxable to
shareholders as dividend income for federal income tax purposes, but instead
were treated as a non-taxable return of capital. Under federal tax rules,
dividends are considered taxable only when paid out of current or accumulated
earnings and profits as defined under federal tax laws. As a result of its
December 1997 reincorporation, the Company only began generating corporate
earnings and profits for tax purposes in 1998. Since 1998, earnings and profits
for tax purposes have been reduced by dividend payments, amortization of
intangible assets for tax reporting, deductions relating to business closures
and the timing of certain other tax-related items. The Company currently expects
that approximately 70 percent of its 2004 dividends on common stock will be
taxable as dividend income for federal income tax purposes. The Company
currently expects that the taxable portion of its dividend income will grow to
be fully taxable by the year 2007.
17
FINANCIAL POSITION - DISCONTINUED OPERATIONS The assets and liabilities related
to discontinued businesses have been classified in separate captions on the
Consolidated Statements of Financial Position. Assets from the discontinued
operations have declined slightly from year-end levels representing collections
on receivables. The remaining liabilities primarily represent obligations
related to long-term self-insurance claims.
FORWARD-LOOKING STATEMENTS
THE COMPANY'S ANNUAL REPORT CONTAINS OR INCORPORATES BY REFERENCE 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): 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 AND SELF INSURANCE AND HEALTH CARE COSTS; HIGHER
FUEL PRICES; INCREASED GOVERNMENTAL REGULATION INCLUDING 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
prices, 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, primarily fuel hedges, 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 derivative financial
instrument transactions is not material to the Company's financial statements.
In December 2003 and January 2004, the Company entered into interest rate swap
agreements with a total notional amount of $165 million. Under the terms of
these agreements, the Company pays a floating rate of interest (based on a
specified spread over six-month LIBOR) on the notional amount and the Company
receives a fixed rate of interest at 7.88% on the notional amount. The impact of
these swap transactions was to convert $165 million of the Company's debt from a
fixed rate of 7.88% to a variable rate based on LIBOR.
The Company generally maintains the majority of its debt at fixed rates. After
the effect of the interest swap agreements, approximately 77 percent of total
debt at March 31, 2004 was at a fixed rate. The payments on the approximately
$73 million of funding outstanding under the Company's real estate operating
lease facilities as well as its fleet and equipment operating leases
(approximately $242 million in residual value) are tied to floating interest
rates. The Company's exposure to interest expense based on floating rates is
partially offset by floating rate investment income earned on cash and
marketable securities. The Company believes its overall exposure to interest
rate fluctuations is not material to its overall results of operations.
The Company has several debt and lease agreements where the interest rate or
rent payable under the agreements automatically adjusts 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 March 31, 2004, a one
rating category improvement in the Company's credit ratings would reduce annual
expense 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
as of December 31, 2003, including the principal cash payments and related
weighted-average interest rates by expected maturity dates. The fair-value of
the Company's fixed rate debt was approximately $862 million at December 31,
2003.
Expected Maturity Date
---------------------------------------
There-
(In millions) 2004 2005 2006 2007 2008 after Total
------------------------------------------------------------------------------
Fixed rate $28 $151 $12 $60 $8 $540 $799
debt
Avg. rate 4.8% 8.3% 6.0% 6.7% 6.1% 7.7% 7.6%
==============================================================================
As previously discussed, the Company has entered into interest rate swap
agreements, the impact of which was to convert $165 million of the Company's
2009 maturity debt from a fixed rate of 7.88% to a variable rate based on LIBOR.
19
CONTROLS AND PROCEDURES
The Company's Chairman and Chief Executive Officer, Jonathan P. Ward, and the
Company's President and Chief Financial Officer, Ernest J. Mrozek, have
evaluated the Company's disclosure controls and procedures as of the end of the
period covered by this report.
The Company's disclosure controls and procedures include 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 Securities and Exchange
Commission is recorded, processed, summarized and reported within the time
periods specified in the Securities and Exchange Commission's rules and forms.
Messrs. Ward and Mrozek have concluded that both the design and operation of the
Company's disclosure controls and procedures are effective.
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 2: CHANGES IN SECURITIES, USE OF PROCEEDS AND ISSUER PURCHASES OF
EQUITY SECURITIES
SHARE REPURCHASES:
In July 2000, the Board of Directors authorized $350 million for share
repurchases. The following table summarizes the Company's common stock share
repurchases for the three months ended March 31, 2004 under its share repurchase
authorization. Decisions relating to any future share repurchases will depend on
various factors such as the Company's commitment to maintain investment grade
credit ratings and other strategic investment opportunities.
Total Approximate
Number Dollar Value
of Shares of Shares that
Purchased as May Yet be
Total Number Average Price Part of Publicly Purchased
of Shares Paid per Announced Under the
Purchased (a) Share Plan Plan
- -------------------------------------------------------------------------------------------------------------------------
January 1, 2004 through
January 31, 2004 - $ - - $ 143,000,000
February 1, 2004 through
February 29, 2004 960,000 $ 10.92 960,000 $ 133,000,000
March 1, 2004 through
March 31, 2004 2,606,700 $ 11.33 2,606,700 $ 104,000,000
------------------------------------------------------------
Total 3,566,700 $ 11.22 3,566,700
============================================================
a) Does not include 14,000 shares acquired from employees in connection with
the settlement of income tax and related withholding obligations arising
from the exercise of stock options or vesting of restricted stock grants.
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
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ITEM 6(B): REPORTS ON FORM 8-K
A report on Form 8-K was furnished on February 18, 2004. The purpose of the
report was to provide under Item 9, the press release issued by the Company on
February 18, 2004 discussing information concerning the tax treatment of
dividend payments made by the Company during 2004, as well as dividend payments
made by the Company during 2000. The Company is continuing to review the proper
tax treatment of dividends paid to shareholders in 2001 and 2002 and expects to
provide additional information for those years by December, 2004.
A report on Form 8-K was furnished on February 12, 2004. The purpose of the
report was to provide under Item 12, the press release issued by the Company on
February 12, 2004 announcing the financial results for the fourth quarter of
2003.
A report on Form 8-K was furnished on January 14, 2004. The purpose of the
report was to provide under Item 9, the press release issued by the Company on
January 14, 2004 announcing that dividend payments made by the Company during
2003 will not be taxable as dividend income for federal income tax purposes, but
instead will be treated as a non-taxable return of capital.
A report on Form 8-K was furnished on January 12, 2004. The purpose of the
report was to provide under Item 9, the press release issued by the Company on
January 12, 2004 announcing that Ernest J. Mrozek, who previously served as
President and Chief Operating Officer of the Company was named President and
Chief Financial Officer.
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SIGNATURE
Pursuant to the requirements of the Securities Exchange Act of 1934, the
Registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
Date: May 10, 2004
THE SERVICEMASTER COMPANY
(Registrant)
By: /S/ ERNEST J. MROZEK
------------------------------------------------------
Ernest J. Mrozek
President and Chief Financial Officer
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