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, 2005
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: 291,079,000 shares of common stock on May 2, 2005.
1
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, 2005 and March 31, 2004 3
Condensed Consolidated Statements of Financial Position
as of March 31, 2005 and December 31, 2004 4
Condensed Consolidated Statements of Cash Flows for the three months
ended March 31, 2005 and March 31, 2004 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: Unregistered Sales of Equity Securities and Use of Proceeds 21
Item 6: Exhibits 21
Signature 22
2
PART I. FINANCIAL INFORMATION
THE SERVICEMASTER COMPANY
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS (UNAUDITED)
(IN THOUSANDS, EXCEPT PER SHARE DATA)
Three Months Ended
March 31
2005 2004
----------- -----------
OPERATING REVENUE .................................... $ 782,309 $ 756,891
OPERATING COSTS AND EXPENSES:
Cost of services rendered and products sold .......... 556,323 545,056
Selling and administrative expenses .................. 198,984 179,310
Amortization expense ................................. 1,152 1,422
--------- ---------
Total operating costs and expenses ................... 756,459 725,788
--------- ---------
OPERATING INCOME ..................................... 25,850 31,103
NON-OPERATING EXPENSE (INCOME):
Interest expense ..................................... 15,579 14,931
Interest and investment income ....................... (9,374) (4,570)
Minority interest and other expense, net ............. 2,046 2,046
--------- ---------
INCOME FROM CONTINUING OPERATIONS BEFORE
INCOME TAXES .................................. 17,599 18,696
Provision for income taxes............................ 6,881 7,235
--------- ---------
INCOME FROM CONTINUING OPERATIONS .................... 10,718 11,461
Loss from discontinued operations, net of income taxes (146) (262)
--------- ---------
NET INCOME ........................................... $ 10,572 $ 11,199
========= =========
PER SHARE:
BASIC EARNINGS PER SHARE:
Income from continuing operations .................... $ 0.04 $ 0.04
Loss from discontinued operations .................... - -
--------- ---------
Basic earnings per share ............................. $ 0.04 $ 0.04
========= =========
SHARES ............................................... 291,117 291,799
DILUTED EARNINGS PER SHARE:
Income from continuing operations .................... $ 0.04 $ 0.04
Loss from discontinued operations .................... - -
--------- ---------
Diluted earnings per share ........................... $ 0.04 $ 0.04
========= =========
SHARES ............................................... 297,080 296,035
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 Mar. 31, As of Dec. 31,
ASSETS 2005 2004
------------- ------------
CURRENT ASSETS:
Cash and cash equivalents .......................................... $ 114,536 $ 256,626
Marketable securities .............................................. 106,443 103,681
Receivables, less allowance of $24,872 and $25,183, respectively ... 375,109 369,026
Inventories ........................................................ 78,744 66,657
Prepaid expenses and other assets .................................. 70,643 27,456
Deferred customer acquisition costs ................................ 76,917 41,574
Deferred taxes and income taxes receivable ......................... 106,320 108,780
Assets of discontinued operations .................................. 1,689 4,952
----------- -----------
Total Current Assets ........................................ 930,401 978,752
----------- -----------
PROPERTY AND EQUIPMENT:
At cost ......................................................... 415,637 405,655
Less: accumulated depreciation .................................. (229,002) (218,838)
----------- -----------
Net property and equipment .................................... 186,635 186,817
----------- -----------
OTHER ASSETS:
Goodwill ........................................................... 1,575,681 1,568,044
Intangible assets, primarily trade names ........................... 220,365 220,780
Notes receivable ................................................... 33,601 35,411
Long-term marketable securities .................................... 138,117 135,824
Other assets ....................................................... 12,659 14,574
----------- -----------
Total Assets ................................................ $3,097,459 $ 3,140,202
=========== ===========
LIABILITIES AND SHAREHOLDERS' EQUITY
CURRENT LIABILITIES:
Accounts payable ................................................... $ 89,714 $ 76,053
Accrued liabilities:
Payroll and related expenses .................................... 88,570 113,366
Self-insured claims and related expenses ........................ 80,378 86,554
Income taxes payable ............................................ 22,329 152,841
Other ........................................................... 109,745 111,092
Deferred revenues .................................................. 495,830 443,238
Liabilities of discontinued operations ............................. 19,526 21,536
Current portion of long-term debt .................................. 22,265 23,247
----------- -----------
Total Current Liabilities ................................... 928,357 1,027,927
----------- -----------
LONG-TERM DEBT ..................................................... 853,503 781,841
LONG-TERM LIABILITIES:
Deferred taxes ................................................ 90,217 88,100
Liabilities of discontinued operations ........................ 8,568 9,057
Other long-term obligations ................................... 148,285 141,742
----------- -----------
Total Long-Term Liabilities ................................ 247,070 238,899
----------- -----------
MINORITY INTEREST .................................................. 100,000 100,000
COMMITMENTS AND CONTINGENCIES
SHAREHOLDERS' EQUITY:
Common stock $0.01 par value, authorized 1,000,000 shares; issued
319,247 and 318,559 shares, respectively ...................... 3,192 3,186
Additional paid-in capital ......................................... 1,093,458 1,083,057
Retained earnings .................................................. 190,708 212,116
Accumulated other comprehensive income ............................. 8,902 10,804
Restricted stock ................................................... (17,898) (12,857)
Treasury stock ..................................................... (309,833) (304,771)
----------- -----------
Total Shareholders' Equity .................................. 968,529 991,535
----------- -----------
Total Liabilities and Shareholders' Equity .................. $3,097,459 $ 3,140,202
=========== ===========
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,
2005 2004
----------- -----------
CASH AND CASH EQUIVALENTS AT JANUARY 1 .................................. $ 256,626 $ 228,161
CASH FLOWS FROM OPERATING ACTIVITIES:
NET INCOME .............................................................. 10,572 11,199
Adjustments to reconcile net income to net cash flows from operating
activities:
Loss from discontinued operations ............................... 146 262
Depreciation expense ............................................ 12,545 12,175
Amortization expense ............................................ 1,152 1,422
Change in working capital, net of acquisitions:
Receivables ................................................. (6,302) (5,822)
Inventories and other current assets ........................ (84,346) (62,308)
Accounts payable ............................................ 14,548 7,490
Deferred revenues ........................................... 52,323 41,443
Accrued liabilities ......................................... (25,241) 3,027
Decrease in tax accounts:
Deferred income taxes ................................... 4,391 5,815
Resolution of income tax audits ......................... (130,568) -
Other, net ...................................................... 3,238 1,514
--------- ---------
NET CASH (USED FOR) PROVIDED FROM OPERATING ACTIVITIES .................. (147,542) 16,217
--------- ---------
CASH FLOWS FROM INVESTING ACTIVITIES:
Property additions ................................................ (12,283) (12,520)
Sale of equipment and other assets ................................ 393 488
Business acquisitions, net of cash acquired ....................... (5,662) (4,197)
Notes receivable, financial investments and securities ............ (10,790) 3,696
--------- ---------
NET CASH USED FOR INVESTING ACTIVITIES .................................. (28,342) (12,533)
--------- ---------
CASH FLOWS FROM FINANCING ACTIVITIES:
Net borrowings (payments) of debt ................................. 72,282 (9,962)
Purchase of ServiceMaster stock ................................... (15,401) (39,831)
Shareholders' dividends ........................................... (31,980) (30,792)
Other, net ........................................................ 8,652 (2,646)
--------- ---------
NET CASH PROVIDED FROM (USED FOR) FINANCING ACTIVITIES .................. 33,553 (83,231)
--------- ---------
NET CASH PROVIDED FROM (USED FOR) DISCONTINUED OPERATIONS ............... 241 (2,042)
--------- ---------
CASH DECREASE DURING THE PERIOD ......................................... (142,090) (81,589)
--------- ---------
CASH AND CASH EQUIVALENTS AT MARCH 31 ................................... 114,536 $ 146,572
========= =========
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 recommends 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 incorporated in the Form 10-K filed with the
Securities and Exchange Commission for the year ended December 31, 2004 (2004
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 systems, as well as through non-baiting methods (e.g., fumigation or
liquid treatments). Termite services using baiting systems as well as home
warranty services frequently 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. Franchised revenue (which in the aggregate represents
less than four percent of consolidated revenue) consists principally of monthly
fees based upon the franchisee's customer level revenue. Monthly fee revenue 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 profits
comprised 23 percent and 18 percent of consolidated operating income before
headquarter overheads for the three-month periods ended March 31, 2005 and 2004,
respectively, a much higher percentage than is expected for subsequent quarters
and the year as a whole. 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 $496 million and $443 million of deferred revenue at March 31,
2005 and December 31, 2004, respectively, which consist primarily of upfront
payments received for annual contracts relating to home warranty, termite
baiting, pest control and lawn care services. The revenue related to these
services is recognized over the contractual period as the direct costs occur,
such as when the services are performed or claims are incurred.
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.
6
TruGreen ChemLawn has significant seasonality in 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. This business incurs
incremental selling expenses at the beginning of the year that directly relate
to successful sales for which the revenues are recognized in later quarters.
TruGreen ChemLawn also defers, on an interim basis, pre-season advertising costs
and annual repairs and maintenance procedures that are performed in the first
quarter. These costs are deferred and recognized in proportion to the contract
revenue over the production season, and are not deferred beyond the calendar
year-end. Other business segments of the Company also defer, on an interim
basis, advertising costs incurred early in the year. These costs are deferred
and recognized approximately in proportion to revenue over the balance of the
year, and 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 2004 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 uncollectible receivables; accruals for self-insured retention limits
related to medical, workers' compensation, auto and general liability insurance
claims; accruals for home warranty claims, the possible outcome of outstanding
litigation, income tax liabilities and deferred tax accounts; useful lives for
depreciation and amortization expense, and the valuation of tangible and
intangible assets. In 2005, there have been no changes in these significant
areas that require estimates or in the underlying methodologies used in
determining the amounts of these associated 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.
Any resulting adjustments, which could be material, are recorded in the period
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 goodwill and intangible assets that were added in the first quarter this
year relate to tuck-in acquisitions completed by Terminix and TruGreen ChemLawn.
The table below summarizes the goodwill and intangible asset activity and
balances:
(In thousands) As of As of
Dec. 31, Mar. 31,
2004 Additions Amort. 2005
------------- ------------- ----------- -------------
Goodwill(1) $1,568,044 $7,637 $ - $1,575,681
Trade names(1) 204,793 - - 204,793
Other intangible assets 45,788 737 - 46,525
Accumulated amortization(2) (29,801) - (1,152) (30,953)
------------- ------------- ----------- -------------
Net other intangibles 15,987 737 (1,152) 15,572
------------- ------------- ----------- -------------
Total $1,788,824 $8,374 $(1,152) $1,796,046
============= ============= =========== =============
(1) Not subject to amortization.
(2) Annual amortization expense of approximately $7 million in 2005 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) Mar. 31, Dec. 31,
2005 2004
------------- --------------
TruGreen $686,829 $681,954
Terminix 646,355 643,567
American Home Shield 72,085 72,085
ARS/AMS 56,171 56,171
Other Operations 114,241 114,267
------------- --------------
Total $1,575,681 $1,568,044
============= ==============
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, 2005 and 2004, 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, 2005 and 2004, incremental shares attributable to the
assumed conversion of the debentures would have increased shares outstanding by
8.0 million shares for both periods 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, 2005 Ended March 31, 2004
-------------------------------- ---------------------------------
CONTINUING OPERATIONS: Income Shares EPS Income Shares EPS
- ---------------------- ---------- --------- -------- ---------- --------- ----------
Basic earnings per share $10,718 291,117 $0.04 $11,461 291,799 $0.04
======== ==========
Effect of dilutive securities, net of tax:
Options 5,963 4,236
---------- --------- ---------- ---------
Diluted earnings per share $10,718 297,080 $0.04 $11,461 296,035 $0.04
========== ========= ======== ========== ========= ==========
NOTE 7: Beginning in 2003, the Company has been accounting for employee stock
options in accordance with SFAS 123, "Accounting for Stock-Based Compensation."
SFAS 123 requires that stock option and share grant awards be recorded at fair
value and that this value be recognized as compensation expense over the vesting
period of the award. SFAS 148 "Accounting for Stock-Based Compensation -
Transition and Disclosure, an amendment of FASB Statement No. 123", provided
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 in 2003 and later.
Employee option grants awarded prior to 2003 continue to be accounted for under
the intrinsic method of Accounting Principles Board Opinion No. 25, as permitted
under GAAP. Compensation expense relating to the unvested portion of these
awards would have resulted in proforma reported net income and net earnings per
share as follows:
8
Three Months Ended
March 31,
(In thousands, except per share data) 2005 2004
--------------------------------
Net income as reported $10,572 $11,199
Add back: Stock-based compensation
expense included in reported net income,
net of related tax effects 466 249
Deduct: Stock-based compensation
expense determined under fair-value method,
net of related tax effects (1,606) (1,424)
--------------- ---------------
Proforma net income $9,432 $10,024
=============== ===============
Basic Earnings Per Share:
As reported $0.04 $0.04
Proforma $0.03 $0.03
Diluted Earnings Per Share:
As reported $0.04 $0.04
Proforma $0.03 $0.03
In December 2004, the FASB issued SFAS 123 (revised 2004), "Share-Based Payment"
(SFAS 123(R)). This Statement replaces SFAS 123, "Accounting for Stock-Based
Compensation", and supersedes APB Opinion No. 25, "Accounting for Stock Issued
to Employees". The Statement requires that compensation expense be recorded for
newly issued awards as well as the unvested portion of previously issued awards
that remain outstanding as of the effective date of this Statement. The
provisions of this Statement become effective beginning with the Company's first
quarter 2006 Consolidated Financial Statements. The Company currently estimates
that the adoption of this Statement would reduce annual earnings per share by
approximately $.01 to $.02. This Statement permits the restatement of periods
prior to its adoption. Upon adopting this Statement, the Company expects to
restate prior periods as if the Statement were in effect for all periods.
NOTE 8: 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, 2005 and 2004 is presented in the following table:
(IN THOUSANDS)
2005 2004
----------- ------------
CASH PAID FOR OR (RECEIVED FROM):
Interest expense....................... $ 22,409 $ 23,165
Interest and investment income......... $ (7,402) $ (4,836)
Income taxes........................... $ 132,947 $ 2,552
The increase in cash received from interest and investment income reflects a
higher level of gains realized on the investment portfolio at American Home
Shield. Cash paid for income taxes increased in 2005 as a result of the payment
in the first quarter this year of $131 million of taxes and interest to the IRS
and various states pursuant to the comprehensive agreement with the IRS
regarding its examination of the Company's federal income taxes through the year
2002.
NOTE 9: Total comprehensive income was $9 million and $11 million for the three
months ended March 31, 2005 and 2004, respectively. Total comprehensive income
includes primarily net income, changes in unrealized gains and losses on
marketable securities and foreign currency translation balances.
NOTE 10: The Company has an agreement to provide 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
9
interest. During the three months ended March 31, 2005 and 2004, 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 $70 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 11: Total debt was $876 million at March 31, 2005, approximately $71
million above the level at December 31, 2004, reflecting borrowings under the
Company's revolving credit facility primarily to fund tax payments made pursuant
to the resolution reached in January of the prior year audits. Approximately 50
percent of the Company's debt matures beyond five years and 40 percent beyond
fifteen years. In April 2005, approximately $137 million of the Company's public
debt matured. The Company funded this debt payment with long-term financing
under revolving credit facilities.
NOTE 12: In the past several years, the Company has sold or exited various
operations of the Company. The results of these business units have been
reclassified as "Discontinued Operations" in the accompanying financial
statements. The following table summarizes the activity during the three months
ended March 31, 2005 for the remaining liabilities from the discontinued
operations. The Company continues to believe that the remaining reserves are
adequate and reasonable.
(IN THOUSANDS) Balance at Cash Balance at
December 31, Payments Mar. 31,
2004 or Other 2005
--------------- ----------- --------------
Remaining liabilities from
discontinued operations $30,593 $2,499 $28,094
NOTE 13: In the ordinary course, the Company is subject to review by domestic
and foreign taxing authorities, including the IRS. In the second quarter of
2005, the IRS commenced the audits of the Company's 2003, 2004, and 2005 fiscal
years. 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. 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 provides HVAC, plumbing and electrical
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, legal and other support services to the business units. Segment
information is presented in the following table.
10
(IN THOUSANDS) Three Months Three Months
Ended Mar. 31, Ended Mar. 31,
2005 2004
- --------------------------------------------------------------------------
Operating Revenue:
TruGreen $222,982 $224,659
Terminix 247,745 236,796
American Home Shield 111,010 102,797
ARS/AMS 158,549 153,984
Other Operations 42,023 38,655
- --------------------------------------------------------------------------
Total Operating Revenue $782,309 $756,891
==========================================================================
Operating Income:
TruGreen $(7,608) $(2,898)
Terminix 30,765 36,254
American Home Shield 14,273 10,116
ARS/AMS (3,505) (3,648)
Other Operations (8,075) (8,721)
- --------------------------------------------------------------------------
Total Operating Income $25,850 $31,103
==========================================================================
(IN THOUSANDS) As of As of
Mar. 31, 2005 Dec. 31, 2004
- ----------------------------------------------------------------------------------------------
Identifiable Assets:
TruGreen $1,073,534 $957,683
Terminix 855,468 843,272
American Home Shield 466,098 474,326
ARS/AMS 191,463 191,618
Other Operations 510,896 673,303
- ----------------------------------------------------------------------------------------------
Total Identifiable Assets $3,097,459 $3,140,202
==============================================================================================
(IN THOUSANDS) As of As of
Mar. 31, 2005 Mar. 31, 2004
- ----------------------------------------------------------------------------------------------
Capital Employed: (1)
TruGreen $862,573 $850,163
Terminix 626,962 598,445
American Home Shield 167,813 135,435
ARS/AMS 90,871 94,805
Other Operations 196,078 6,717
- ----------------------------------------------------------------------------------------------
Total Capital Employed $1,944,297 $1,685,565
==============================================================================================
(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.
The combined franchise operations of ServiceMaster Clean and Merry Maids
comprised approximately five percent of the consolidated revenue for the three
months ended March 31, 2005 and 2004. Due to the seasonality of the TruGreen and
Terminix operations, these operations comprised approximately 24 percent and 21
percent of the consolidated operating income before headquarter overheads for
the three months ended March 31, 2005 and 2004, respectively, a much higher
percentage than is expected for subsequent quarters and the year as a whole.
11
MANAGEMENT DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS
RESULTS OF OPERATIONS
FIRST QUARTER 2005 COMPARED TO FIRST QUARTER 2004
ServiceMaster (the "Company") reported first quarter 2005 revenue of $782
million, a three percent increase compared to 2004. First quarter 2005 diluted
earnings per share were $.04, consistent with 2004. Operating income for the
first quarter was $26 million compared to $31 million in 2004. The Company is
committed to consistent, sustainable revenue growth and, as previously
disclosed, made incremental off-season investments in the first quarter that
should help it continue to achieve that objective in subsequent periods of the
year. The current quarter results include incremental investments in salespeople
and marketing programs, primarily at Terminix and American Home Shield. The
first quarter results were unfavorably impacted by later winter weather
conditions than last year, which resulted in delayed production of available
lawn care service applications at TruGreen ChemLawn and reduced termite swarm
activity at Terminix.
The Company has re-affirmed its outlook for the year and expects revenue growth
to be in the mid- to high-single digit range and that earnings per share will
grow somewhat faster than revenues. Earnings per share growth is anticipated at
a higher rate than revenue growth due to the Company's ability to leverage its
cost base on the incremental volume. The Company continues to remain focused on
revenue growth, increased customer retention, and improved price realization.
Throughout 2005, the Company expects to continue to overcome certain external
factors that it does not directly control (e.g., rapidly rising fuel and health
insurance costs and unfavorable weather). As demonstrated in 2004, the Company
believes these challenges can be mitigated and in some cases used to its
competitive advantage through a combination of focused cost controls, strategic
initiatives, improved customer retention, and effective execution by field
employees. In addition, the Company expects net cash provided from operating
activities for 2005 to continue to exceed net income similar to prior years.
However, the rate of growth in cash flows is expected to temporarily subside in
2005 primarily due to the previously disclosed and non-recurring payments to the
Internal Revenue Service and a higher level of incentive payments made in 2005
than in 2004.
Cost of services rendered and products sold increased two percent for the first
quarter and decreased as a percentage of revenue to 71.1 percent in 2005 from
72.0 percent in 2004. This decrease reflects a change in the mix of business as
Terminix and American Home Shield increased in size in relationship to the
overall business of the Company. These businesses generally operate at higher
gross margin levels than the rest of the business, but also incur relatively
higher selling and administrative expenses. Selling and administrative expenses
increased 11 percent for the quarter. As a percentage of revenue, these costs
increased to 25.4 percent for the quarter in 2005 from 23.7 percent in 2004. The
increase in selling and administrative expenses reflects investments associated
with an increase in the size of the sales forces and expanded marketing efforts
primarily at Terminix and American Home Shield and other strategic initiatives
which are expected to benefit future periods, as well as the change in business
mix described above.
The first quarter was impacted by two significant cost factors. The Company
annually consumes over 36 million gallons of fuel, and hedges two-thirds of the
estimated usage every year. The significant increase in fuel costs, net of the
impact of the hedge, have adversely impacted first quarter results by
approximately a half cent per share. The Company is currently piloting routing
and scheduling software and GPS technologies which, among other benefits, would
tighten routes and reduce drive time and fuel consumption in future years. On
the positive side, a cost that has been trending favorably relates to insurance
claims. The Company is beginning to experience tangible results from its efforts
to reduce safety related costs, which include workers compensation, auto and
general liability claims. Such costs total over $120 million annually, and had
been increasing at double-digit rates. The Company believes it is succeeding in
its efforts to create a safety culture throughout the enterprise, and is
experiencing a sharp decline in both the number and the severity of incidents.
In total, first quarter costs were relatively flat.
12
Net non-operating expenses for the quarter were $8 million compared with $12
million in the prior year. A modest increase in interest expense due to higher
interest rates and debt balances was more than offset by a $5 million increase
in income experienced on the American Home Shield investment portfolio. This
increase included a $2.5 million favorable correction in the accounting for a
specific investment at American Home Shield. It is important to note that
investment gains are an integral part of the business model at American Home
Shield, and there will always be some market-based variability in the amount of
gains realized from quarter to quarter.
KEY PERFORMANCE INDICATORS
The table below presents selected metrics related to customer counts and
customer retention for the three largest profit businesses in 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,
2005 2004
----------------- -----------------
TRUGREEN CHEMLAWN-
Growth in Full Program Contracts 6% (a) 2%
Customer Retention Rate 65.5% (a) 63.6%
TERMINIX -
Growth in Pest Control Customers 6% 4%
Pest Control Customer Retention Rate 77.2% 77.6%
Growth in Termite Customers 0% -2%
Termite Customer Retention Rate 87.8% 88.2%
AMERICAN HOME SHIELD -
Growth in Warranty Contracts 5% 6%
Customer Retention Rate 55.7% 54.7%
(a) Customer count growth in 2005, excluding the impact of the Canadian
acquisition completed in April 2004, was approximately two percent. The
customer retention rate improvement in 2005, excluding the impact of the
Canadian acquisition added to the customer base, was approximately 90 basis
points.
SEGMENT REVIEW
The TruGreen segment includes lawn care services performed under the TruGreen
ChemLawn brand name and landscape maintenance services provided under the
TruGreen LandCare brand name. The TruGreen segment reported first quarter
revenue of $223 million, one percent below the prior year. The segment reported
an operating loss for the quarter of ($8) million compared to ($3) million in
2004.
Revenue in the lawn care operations decreased two percent to $123 million from
$125 million in 2004. The decrease in revenue reflects the impact of less
favorable weather conditions, primarily in six operating regions in the
northeast and midwest, which delayed TruGreen ChemLawn's ability to begin
servicing residential contracts that had already been sold. On average,
production in these regions was more than five days below both last year and six
year historical averages, resulting in delayed revenues of over $9 million. The
Company expects that this revenue will be recovered over the second and third
quarters, with only modest incremental costs. Customer counts, excluding the
impact of the Canadian acquisition, increased two percent reflecting continued
improved customer retention, partially offset by a modest decline in new sales.
Expansion of the Company's neighborhood selling campaign and direct mail efforts
have helped substantially offset an anticipated decrease in telemarketing sales,
which resulted from growth in the number of households signed up to the National
Do Not Call Registry. Overall, the Company's neighborhood selling efforts are
over three times as extensive as its initial efforts last year, and now involve
over three quarters of its branches. Total sales from this new channel have
tripled during the first quarter, consistent with the Company's expectations. As
the Company continues to develop these alternative sales and marketing channels,
the timing of customer sales will trend more heavily toward the earlier part of
13
the second quarter, versus the first quarter where telemarketing has
historically been more heavily concentrated. The migration away from the
telemarketing channel continues consistent with the Company's expectations and,
for the year, telemarketing is expected to comprise less than 50 percent of
total sales compared to over 90 percent three years ago. Operating results for
the quarter were approximately $9 million below prior year levels, reflecting
the impact of the weather-related delays in production as well as the first time
inclusion of $3 million of seasonal losses in the Canadian operations that were
acquired in April 2004.
First quarter revenue in the landscape maintenance operations was $100 million,
comparable to 2004, as continued solid growth in enhancement revenue (e.g.,
add-on services such as seasonal flower plantings, mulching etc.) and a modest
increase in base contract maintenance revenue, was partially offset by branch
consolidations and closures that were completed in early 2004. Excluding the
impact of branch consolidations and closures, revenue increased three percent
for the quarter. Customer retention decreased slightly from last year's level,
and continues to be an area requiring improvement. Management is placing strong
focus on better communications and service-level consistency at each branches'
top 25 customer locations. These operations achieved a $5 million reduction in
operating losses for the quarter compared to prior year levels. The improvement
reflected higher volume and gross margins, as well as a favorable $2 million
impact from branches closed in 2004.
Capital employed in the TruGreen segment increased one percent primarily
reflecting the impact of the 2004 Canadian acquisition, offset in part by
improved working capital management. 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 $248 million, compared to
$237 million in 2004. Operating income decreased 15 percent to $31 million
compared to $36 million in 2004. Revenues from sales of initial termite
treatments, ("termite completions") increased modestly, reflecting a strong,
nine percent increase in renewable unit sales, offset by a shift in mix to lower
priced services. The unit sales growth was supported by the expanded sales
force; partially offset by reduced termite swarm activity from cooler seasonal
temperatures. In March, the Company introduced a new bait option which utilizes
an active ingredient from day one and provides meaningful cost and marketing
advantages. Since introduction, the Company has seen bait sales as a percentage
of total sales rebound back toward prior year levels. Termite renewal revenue
increased modestly, reflecting improved pricing, partially offset by a slight
decrease in customer retention. Management has taken actions to address the
decline in retention through improving customer communication and problem
resolution. Total termite customer counts remained relatively flat, reflecting
the growth in unit sales, offset by the decline in the rate of retention. Pest
control operations experienced solid growth in customers, reflecting a 15
percent increase in unit sales, partially offset by a decline in customer
retention. The overall operating income comparisons for the segment were
unfavorably impacted by incremental investments which included a 15 percent
increase in the sales force headcount and costs to re-organize the field
operations. The Company also recorded a $3 million unfavorable correction of
reserve levels relating to prior year termite damage claims. Capital employed in
the Terminix segment increased five percent, reflecting the impact of
acquisitions.
The American Home Shield segment, which provides home warranties to consumers
that cover heating, ventilation and air conditioning (HVAC), plumbing and other
home systems and appliances, reported an eight percent increase in revenue to
$111 million from $103 million in 2004 and operating income of $14 million
compared to $10 million in 2004. New warranty contracts written increased seven
percent, a sharp rebound from fourth quarter 2004 levels. Renewal sales, which
are American Home Shield's largest source of revenue, experienced strong growth,
reflecting a larger base of renewable customers and an overall improved customer
retention rate. The improvement in retention reflects a favorable mix in
customers renewing as well as a reduced level of non-renewed contracts due to
mortgage refinancings in the consumer sales channel. Real estate sales, which
are American Home Shield's second largest channel, were comparable to 2004
levels. Consumer sales, which are the smallest but fastest growing channel,
experienced double-digit growth, reflecting an increased level of targeted
direct mail solicitations. The substantial increase in operating income resulted
from continued favorable trending in costs per claim
14
coupled with a slightly lower incident rate of claims. The Company continued to
experience very strong control over costs per claim, which were down four
percent (or $2.3 million) in comparison to 2004 levels, and represented a
compound rate of increase over the past three years of under one percent. Mild
weather also resulted in a three percent decrease in the claim incidence rate
during the quarter, favorably impacting profits by approximately $1.7 million.
Partially offsetting these factors were continuing investments to increase
market penetration and customer retention. Capital employed increased 24 percent
reflecting volume growth in the business resulting in a higher level of cash and
marketable securities balances. The calculation of capital employed for the
American Home Shield segment includes approximately $249 million and $212
million of cash, cash equivalents and marketable securities at March 31, 2005
and 2004, respectively.
The ARS/AMS segment provides direct HVAC, plumbing and electrical installation
and repair services under the brand names of ARS Service Express and Rescue
Rooter (collectively "ARS Service Express"), as well as American Mechanical
Services (AMS) for large commercial accounts. Revenue for the first quarter
increased three percent to $159 million in 2005 from $154 million in 2004. This
segment's seasonal operating loss of ($4) million was comparable to 2004. The
revenue increase resulted from continued strong increases in commercial
installation revenue in the AMS operations and modest growth in residential
construction revenue. These increases were partially offset by declines in
plumbing and HVAC service revenue. Plumbing revenue decreased in the quarter as
continued declines in retail service calls more than offset increases from sewer
line repairs and light commercial services. Moderate winter weather adversely
impacted the HVAC operations, which experienced a decline in service revenue.
The segment achieved good growth in HVAC replacement sales revenue supported by
the Company's retail outlet initiative and its efforts to increase the sales mix
of higher priced and more energy efficient units. The segment's first quarter
operating loss in 2005 was comparable to 2004 as increased profits on commercial
projects were offset by the impact of volume decline in the plumbing and HVAC
service lines. Capital employed in this segment decreased four percent.
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 nine percent to $42 million compared to $39 million in 2004.
On a combined basis, the ServiceMaster Clean and Merry Maids franchise
operations reported revenue growth of nine percent and a strong increase in
operating income. ServiceMaster Clean experienced strong growth in disaster
restoration services and continued good momentum in new franchise sales. Merry
Maids continued to experience very strong internal revenue growth in both the
branch and franchise operations. The segment as a whole reported a smaller first
quarter operating loss in 2005, reflecting an increase in profits from the
combined franchise operations and lower insurance costs at the headquarters
level, offset in part by increases in certain strategic investments. Capital
employed in this segment increased primarily reflecting the deferred tax assets
recorded in the fourth quarter of 2004 at the conclusion of the IRS reviews of
the Company's federal income taxes through the year 2002.
FINANCIAL POSITION AND LIQUIDITY
CASH FLOWS FROM OPERATING ACTIVITIES
Net cash used for operating activities was $148 million in the first quarter,
compared to $16 million provided from operating activities in the prior year.
The decrease reflects $131 million in tax payments resulting from the previously
disclosed agreement with the IRS. The Company anticipates that, pursuant to the
agreement, this payment will be partially offset in the second half of 2005 by
an approximate $45 million reduction in estimated tax payments that would
otherwise have been paid in that period. First quarter cash flows also include
the impact of increased incentive payments made early in the year relating to
2004 performance.
Full year cash provided from operating activities is expected to remain strong,
reflecting a solid earnings base, businesses that need relatively little working
capital to fund growth in their operations, and significant annual deferred
taxes. However, the first quarter cash flows generally reflect seasonal
investments and working capital usage as many of the Company's businesses
prepare for the peak summer and fall production season.
15
The significant annual cash tax benefit primarily represents a large base of
amortizable intangible assets which exist for income tax reporting purposes, but
not for book purposes. A significant portion of these assets arose in connection
with the Company's 1997 conversion from a limited partnership to a corporation.
The amortization of the tax basis will result in approximately $57 million of
average annual cash tax benefits through 2012 for which no corresponding income
statement benefit is recorded.
In the ordinary course, the Company is subject to review by domestic and foreign
taxing authorities, including the IRS. In the second quarter of 2005, the IRS
commenced the audits of the Company's 2003, 2004, and 2005 fiscal years. As with
any review of this nature, the outcome of the IRS examination is not known at
this time.
CASH FLOWS FROM INVESTING ACTIVITIES
Capital expenditures, which include recurring capital needs and information
technology projects, were comparable to prior year levels. The Company
anticipates approximately $50 million of capital expenditures in 2005,
reflecting investments in information systems and productivity enhancing
operating systems. The Company has no material capital commitments at this time.
Tuck-in acquisitions in the first quarter of 2005 totaled $8 million, comparable
to prior year levels. Consideration consisted of cash payments, seller financed
notes and Company stock. In 2005, the Company expects to continue its tuck-in
acquisition program at both Terminix and TruGreen ChemLawn, with overall
acquisitions slightly higher than the 2004 level.
CASH FLOWS FROM FINANCING ACTIVITIES
Cash dividends paid to shareholders totaled $32 million or $.11 per share for
the three months ended March 31, 2005. In May 2005, the Company announced the
declaration of a cash dividend of $.11 per share payable on May 31, 2005 to
shareholders of record on May 16, 2005. 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. The Company completed approximately $16 million in share
repurchases in the first three months of 2005 at an average price of $13.64 per
share. There remains approximately $65 million available for repurchases under
the July 2000 authorization. The Company anticipates continuing its share
repurchase program in 2005 at a similar level to 2004. The actual level of
future share repurchases will depend on various factors such as the Company's
commitment to maintain investment grade credit rating and other strategic
investment opportunities.
LIQUIDITY
Cash and short and long-term marketable securities totaled approximately $359
million at March 31, 2005, compared with $496 million at December 31, 2004.
Approximately $300 million of the 2005 amount is effectively required to support
regulatory requirements at American Home Shield and for other purposes. Total
debt was $876 million at March 31, 2005, approximately $71 million higher than
the amount at December 31, 2004.
Approximately 50 percent of the Company's debt matures beyond five years and 40
percent beyond fifteen years. In April 2005, $137 million of the Company's
public debt matured. The Company funded this debt payment with long-term
financing under the existing revolving credit facilities.
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 maintains a five-year revolving credit
facility of $500 million. In May 2005, this agreement was amended to extend the
maturity date to May 2010. As of March 31, 2005, the Company had issued
approximately $140 million of letters of credit under this facility, had
outstanding borrowings of $80 million, and had unused commitments of
approximately $280 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. The agreement is a 364-day facility that is renewable at
the option of the purchasers. The Company may sell up to $70 million of its
receivables to these purchasers in the future and therefore would
16
have 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. During the three
month period ended March 31, 2005, there were no receivables sold to third
parties under this agreement.
There have been no material changes in the Company's financing agreements since
December 31, 2004. As described in the Company's 2004 Annual Report, 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 an
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 dividend and share repurchase plans in the near future. Failure by the
Company to maintain these covenants could result in the acceleration of the
maturity of the debt. At March 31, 2005, the Company was in compliance with the
covenants related to these debt agreements and, based on its operating outlook
for the remainder of 2005, expects to be able to maintain compliance in the
future. The Company does not have any debt agreements that contain put rights or
provide for acceleration of maturity as a result of a change in credit rating.
The Company maintains lease facilities with banks totaling $68 million which
provide for the acquisition and development of branch properties to be leased by
the Company. At March 31, 2005, there was approximately $68 million funded under
these facilities. Approximately $15 million of these leases have been included
on the balance sheet as assets with related debt as of March 31, 2005 and
December 31, 2004. The balance of the funded amount has been treated as
operating leases. Approximately $15 million of the available facility expires in
January 2008 and the remaining $53 million expires in September 2009. The
Company has guaranteed the residual value of the properties under the leases up
to 82 percent of the fair market value at the commencement of the lease. At
March 31, 2005, the Company's residual value guarantee related to the leased
assets totaled $56 million for which the Company has recorded the estimated fair
value of this guarantee (approximately $1.1 million) in the Consolidated
Statements of Financial Position.
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, 2005, there
was approximately $256 million of residual value relating to the Company's fleet
and equipment leases. The fair value guarantee of the assets under the leases is
expected to fully mitigate the Company's obligations under the agreements. The
fair value of this guarantee is not material to the Company's consolidated
financial statements.
The Company's 2004 Annual Report included disclosure of the Company's
contractual obligations and commitments as of December 31, 2004. The Company
continues to make the contractually required payments and therefore, the 2005
obligations and commitments as listed in the December 31, 2004 Annual Report
have been reduced by the required payments. In the first quarter of 2005, the
Company signed a product supply agreement with minimum purchases of $17 million
over the next 18 months.
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 at TruGreen ChemLawn and Terminix as well as annual
repairs and maintenance procedures that are performed in the first quarter at
TruGreen ChemLawn. 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. These direct and incremental selling expenses which relate to
successful sales are deferred and recognized over the production season and are
not deferred beyond the calendar year-end. The Company capitalizes
17
sales commissions and other direct contract acquisition costs relating to
termite baiting and pest contracts, as well as home warranty agreements. These
costs vary with and are directly related to a new sale.
Property and equipment was comparable to year-end levels. The Company does not
have any material capital commitments at this time.
Deferred revenue increased from year-end levels, reflecting the significant
amount of customer prepayments received in the first quarter (pre-season) at
TruGreen ChemLawn. Payroll and related expenses have decreased from year-end
levels reflecting payments related to 2004 performance that had been accrued at
year-end. The decrease in income taxes payable from year-end levels reflects the
February 2005 federal tax payment related to the IRS agreement.
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 $969 million at March 31, 2005 and $992 million
at December 31, 2004. The decrease reflects operating profits in the business
offset by cash dividend payments and share repurchases.
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 from year-end
levels representing collections on receivables. The remaining liabilities
primarily represent obligations related to long-term self-insurance claims and
certain contractual obligations related to international pest control
operations.
FORWARD-LOOKING STATEMENTS
THE COMPANY'S FORM 10-Q FILING 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; CHANGES IN COMPETITION IN THE MARKETS SERVED BY THE
COMPANY; LABOR SHORTAGES OR INCREASES IN WAGE RATES; UNEXPECTED INCREASES IN
OPERATING COSTS, SUCH AS HIGHER INSURANCE PREMIUMS, SELF INSURANCE AND HEALTH
CARE CLAIM COSTS; HIGHER FUEL PRICES; CHANGES IN THE TYPES OR MIX OF THE
COMPANY'S SERVICE OFFERINGS OR PRODUCTS; INCREASED GOVERNMENTAL REGULATION,
INCLUDING TELEMARKETING; GENERAL ECONOMIC CONDITIONS IN THE UNITED STATES,
ESPECIALLY AS THEY MAY AFFECT HOME SALES OR CONSUMER SPENDING LEVELS; 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 (7.0% average rate during
the first quarter).
The Company generally maintains the majority of its debt at fixed rates. After
the effect of the interest swap agreements, approximately 71 percent of total
debt at March 31, 2005 was at a fixed rate. With respect to other obligations,
the payments on the approximately $68 million of funding outstanding under the
Company's real estate operating lease facilities as well as its fleet and
equipment operating leases (approximately $256 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, 2005, a one
rating category improvement in the Company's credit ratings would reduce pre-tax
annual expense by approximately $0.7 million. A one rating category reduction in
the Company's credit ratings would increase pre-tax expense on an annualized
basis by approximately $0.9 million.
The following table summarizes information about the Company's fixed rate debt
as of December 31, 2004, 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 $673 million at December 31,
2004.
Expected Maturity Date
-------------------------------------
There-
(In millions) 2005 2006 2007 2008 2009 after Total
---------------------------------------------------------------------------
Fixed rate debt $160 $13 $62 $10 $21 $359 $625
Avg. rate 8.0% 6.4% 7.0% 5.8% 7.9% 7.5% 7.5%
===========================================================================
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: UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS
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, 2005 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 Share Plan Plan
- ---------------------------------------------------------------------------------------------------------------------
January 1, 2005 through
January 31, 2005 - $ - - $81,000,000
February 1, 2005 through
February 28, 2005 50,000 $13.37 50,000 $81,000,000
March 1, 2005 through
March 31, 2005 1,141,575 $13.65 1,141,575 $65,000,000
------------------------------------------------------------
Total 1,191,575 $13.64 1,191,575
============================================================
ITEM 6: EXHIBITS
EXHIBIT NO. DESCRIPTION OF EXHIBIT
3(i) Amended and Restated Certificate of Incorporation of
ServiceMaster, amended as of May 9, 2005, is incorporated by
reference to Exhibit 3(i) to ServiceMaster's Current Report on
Form 8-K dated May 9, 2005
3(ii) Bylaws of ServiceMaster, amended as of May 9, 2005, are
incorporated by reference to Exhibit 3(ii) to ServiceMaster's
Current Report on Form 8-K dated May 9, 2005
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
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, 2005
THE SERVICEMASTER COMPANY
(Registrant)
By: /S/ ERNEST J. MROZEK
----------------------------
Ernest J. Mrozek
President and Chief Financial Officer
22