SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
X QUARTERLY REPORT UNDER SECTION 13 OR 15(d) OF
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THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended June 30, 2001
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TRANSITION REPORT PURSUANT TO SECTION 13 OR
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15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the transition period from to
Commission file number 1-14762
THE SERVICEMASTER COMPANY
(Exact name of registrant as specified in its charter)
Delaware 36-3858106
(State or other jurisdiction of (IRS Employer Identification No.)
incorporation or organization)
One ServiceMaster Way, Downers Grove, Illinois 60515-1700
(Address of principal executive offices) (Zip Code)
630-271-1300
(Registrant's telephone number, including area code)
Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the registrant was
required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days. Yes X No .
--- ----
Indicate the number of shares outstanding of each of the issuer's classes of
common stock: 299,797,000 shares of common stock on August 10, 2001.
TABLE OF CONTENTS
Page
No.
THE SERVICEMASTER COMPANY (Registrant) -
Part I. Financial Information
------- ---------------------
Consolidated Statements of Income for the three and six
months ended June 30, 2001 and June 30, 2000 2
Consolidated Statements of Financial Position
as of June 30, 2001 and December 31, 2000 3
Consolidated Statements of Cash Flows for the six months
ended June 30, 2001 and June 30, 2000 4
Notes to Consolidated Financial Statements 5
Management Discussion and Analysis of Financial Position
and Results of Operations 9
Part II. Other Information
-------- -----------------
Item 1: Legal Proceedings 15
Item 2: Changes in Securities and Use of Proceeds 15
Item 4: Submission of Matters to a Vote of Security Holders 16
Item 6: Exhibits and Reports on Form 8-K 17
Signature
1
PART I. FINANCIAL INFORMATION
THE SERVICEMASTER COMPANY
Consolidated Statements of Income
(In thousands, except per share data)
Three Months Ended Six Months Ended
June 30, June 30,
2001 2000 2001 2000
------------ ----------- ----------- -----------
Operating Revenue .............................................. $ 1,648,941 $ 1,614,695 $ 2,978,603 $ 2,955,579
Operating Costs and Expenses:
Cost of services rendered and products sold..................... 1,265,964 1,225,043 2,337,584 2,309,859
Selling and administrative expenses............................. 264,508 249,435 453,409 418,631
----------- ----------- ----------- -----------
Total operating costs and expenses ............................. 1,530,472 1,474,478 2,790,993 2,728,490
----------- ----------- ----------- -----------
Operating Income ............................................... 118,469 140,217 187,610 227,089
Non-operating Expense (Income):
Interest expense ............................................... 31,825 35,680 66,399 67,545
Interest and investment income.................................. (3,745) (6,756) (7,263) (10,649)
Minority interest and other expense (income), net............... 2,838 (3,422) 1,064 (6,362)
----------- ----------- ----------- -----------
Income before Income Taxes and Extraordinary Item .............. 87,551 114,715 127,410 176,555
Provision for income taxes...................................... 36,838 48,400 53,473 74,186
----------- ----------- ----------- -----------
Income before Extraordinary Item................................ 50,713 66,315 73,937 102,369
Extraordinary Item - gain on repurchase of bonds, net of
$4.2 million in income taxes (1)............................. - - (6,003) -
----------- ----------- ----------- -----------
Net Income ..................................................... $ 50,713 $ 66,315 $ 79,940 $ 102,369
============ ============ ============ ============
Per Share:(2)
Basic earnings per share, before extraordinary item............. $.17 $.22 $.25 $.34
Extraordinary gain on repurchase of bonds(1).................... - - .02 -
------------ ------------ ------------ ------------
Basic earnings per share........................................ $.17 $.22 $.27 $.34
============ ============ ============ ============
Diluted earnings per share, before extraordinary item........... $.17 $.21 $.25 $.33
Extraordinary gain on repurchase of bonds(1).................... - - .02 -
------------ ------------ ------------ ------------
Diluted earnings per share...................................... $.17 $.21 $.27 $.33
============ ============ ============ ============
Dividends per share............................................. $.10 $.09 $.20 $.18
============ ============ ============ ============
(1) In the first quarter of 2001, the Company paid approximately $35 million to
purchase $45 million, a portion, of its public debt securities. As a result, the
Company recognized an extraordinary gain on the early extinguishment of debt.
(2) Basic earnings per share are calculated based on 298,547 shares and 304,391
shares for the three months ended June 30, 2001 and 2000, respectively, and
298,170 shares and 305,030 shares for the six months ended June 30, 2001 and
2000, respectively. Diluted earnings per share are calculated based on 310,764
shares and 308,475 shares for the three months ended June 30, 2001 and 2000,
respectively, and 310,300 shares and 309,307 shares for the six months ended
June 30, 2001 and 2000, respectively.
See Notes to Consolidated Financial Statements
2
THE SERVICEMASTER COMPANY
Consolidated Statements of Financial Position
(In thousands)
As of
Assets June 30, December 31,
2001 2000
------------ -------------
Current Assets:
Cash and cash equivalents ....................................................... $ 32,529 $ 44,386
Marketable securities ........................................................... 60,537 56,531
Receivables less allowance of $39,054 and $37,970, respectively ................. 533,558 556,941
Inventories ..................................................................... 101,035 88,152
Prepaid expenses and other assets ............................................... 251,042 168,403
Deferred taxes and tax receivables .............................................. 49,562 70,346
----------- -----------
Total current assets ..................................................... 1,028,263 984,759
----------- -----------
Property and Equipment:
At cost ...................................................................... 684,352 681,569
Less: accumulated depreciation ............................................... 393,688 375,585
----------- -----------
Net property and equipment ................................................. 290,664 305,984
----------- -----------
Intangible assets, primarily trade names and goodwill,
net of accumulated amortization of $464,699 and $422,899, respectively ........ 2,615,827 2,521,633
Notes receivable, long-term securities, and other assets ........................ 157,413 155,292
----------- -----------
Total assets ............................................................. $ 4,092,167 $ 3,967,668
=========== ===========
Liabilities and Shareholders' Equity
Current Liabilities:
Accounts payable ................................................................ $ 150,124 $ 147,788
Income taxes payable ............................................................ 51,184 1,235
Accrued liabilities ............................................................. 294,976 291,852
Deferred revenues ............................................................... 394,004 325,246
Current portion of long-term obligations ........................................ 326,146 61,360
----------- -----------
Total current liabilities ................................................ 1,216,434 827,481
----------- -----------
Long-Term Debt .................................................................. 1,376,947 1,756,757
Deferred Tax Liability .......................................................... 114,073 115,150
Other Long-Term Obligations ..................................................... 101,651 100,759
Minority Interest ............................................................... 108,172 5,933
Commitments and Contingencies
Shareholders' Equity:
Common stock $0.01 par value, authorized 1 billion shares; issued
and outstanding 299,656 and 298,474 shares, respectively ................... 2,997 2,985
Additional paid-in capital ...................................................... 1,023,742 1,030,399
Retained earnings ............................................................... 321,355 301,207
Accumulated other comprehensive income .......................................... (14,139) (2,832)
Restricted stock ................................................................ (1,543) (1,829)
Treasury stock .................................................................. (157,522) (168,342)
----------- -----------
Total shareholders' equity ............................................... 1,174,890 1,161,588
----------- -----------
Total liabilities and shareholders' equity ............................... $ 4,092,167 $ 3,967,668
=========== ===========
See Notes to Consolidated Financial Statements
3
THE SERVICEMASTER COMPANY
Consolidated Statements of Cash Flows
(In thousands)
Six Months Ended
June 30,
2001 2000
--------------- ---------------
Cash and Cash Equivalents at January 1 ............................................. $ 44,386 $ 59,834
Cash Flows from Operations:
Net Income ......................................................................... 79,940 102,369
Adjustments to reconcile net income to net cash flows from operations:
Depreciation ............................................................... 38,112 39,286
Amortization ............................................................... 41,800 36,714
Tax refund from prior years payments .......................................... 21,000 22,000
Deferred income taxes ......................................................... 48,752 64,410
Change in working capital, net of acquisitions:
Receivables ............................................................ (70,988) (84,678)
Sale of receivables .................................................... 100,000 --
Inventories and other current assets ................................... (92,950) (76,408)
Accounts payable ....................................................... 2,164 1,551
Deferred revenues ...................................................... 69,250 43,355
Accrued liabilities .................................................... 8,997 (24,569)
Other, net ................................................................ 704 (1,256)
--------- ---------
Net Cash Provided from Operations .................................................. 246,781 122,774
--------- ---------
Memo: Net Cash Provided from Operations (Excluding Sale of Receivables) .......... 146,781 122,774
Cash Flows from Investing Activities:
Property additions ........................................................... (31,986) (39,068)
Sale of equipment and other assets ........................................... 8,070 2,937
Business acquisitions, net of cash acquired .................................. (21,065) (113,510)
Proceeds from business sales and minority interests .......................... 12,542 17,331
Notes receivable, financial investments and securities ....................... (23,003) (16,841)
--------- ---------
Net Cash Used for Investing Activities ............................................. (55,442) (149,151)
--------- ---------
Cash Flows from Financing Activities:
Net borrowings (payments) .................................................... (147,313) 119,212
Purchase of ServiceMaster stock .............................................. (1,308) (55,704)
Shareholders' dividends ...................................................... (59,792) (55,217)
Other ........................................................................ 5,217 5,729
--------- ---------
Net Cash Provided from (Used for) Financing Activities ............................. (203,196) 14,020
--------- ---------
Cash Decrease during the Period .................................................... (11,857) (12,357)
--------- ---------
Cash and Cash Equivalents at June 30 ............................................... $ 32,529 $ 47,477
========= =========
See Notes to Consolidated Financial Statements
4
THE SERVICEMASTER COMPANY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 1: The consolidated financial statements include the accounts of
ServiceMaster and its significant subsidiaries, collectively referred to as "the
Company". Intercompany transactions and balances have been eliminated in
consolidation.
NOTE 2: The consolidated financial statements included herein have been prepared
by the Company pursuant to the rules and regulations of the Securities and
Exchange Commission. Certain information and footnote disclosures normally
included in financial statements prepared in accordance with generally accepted
accounting principles have been condensed or omitted pursuant to such rules and
regulations. However, the Company believes that the disclosures are adequate to
make the information presented not misleading. It is suggested that these
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, 2000. In the
opinion of the Company, all adjustments necessary to present fairly the
financial position of The ServiceMaster Company as of June 30, 2001 and December
31, 2000, and the results of operations for the three and six month periods
ended June 30, 2001 and 2000, and the cash flows for the six months ended June
30, 2001 and 2000 have been included. The preparation of the financial
statements requires management to make certain estimates and assumptions
required under generally accepted accounting principles which may differ from
the actual results. The results of operations for any interim period are not
necessarily indicative of the results which might be obtained for a full year.
NOTE 3: In December 1999, the Staff of the Securities and Exchange Commission
issued Staff Accounting Bulletin (SAB) No. 101, "Revenue Recognition," which
provides additional guidance in applying generally accepted accounting
principles for revenue recognition in financial statements. The Company's
interpretation of the requirements of SAB No. 101 resulted in changes to the
Company's accounting policies for revenue recognition on sales of its termite
baiting contracts. These changes were adopted in the fourth quarter of 2000,
however, as required by SAB No. 101, the impact of adoption was retroactively
recorded as of January 1, 2000 which required the second quarter and six month
2000 financial information to be restated to incorporate this accounting change.
NOTE 4: In June 2001, the Financial Accounting Standards Board issued Statement
of Financial Accounting Standards No. 141, "Business Combinations" (SFAS 141)
and No. 142, "Goodwill and Other Intangible Assets" (SFAS 142). SFAS 141
requires all business combinations initiated after June 30, 2001, to be
accounted for using the purchase method. SFAS 142 requires that for fiscal years
beginning after December 31, 2001 existing goodwill will no longer be subject to
amortization. Rather goodwill will be subject to at least an annual assessment
for impairment by applying a fair-value-based test. The Company has not yet
determined the effect of applying the impairment provisions of SFAS 142.
Goodwill amortization expense which would be eliminated under SFAS 142 was $.04
per diluted share for both the three month periods ended June 30, 2001 and 2000
and $.08 per diluted share for both the six month periods ended June 30, 2001
and 2000.
NOTE 5: Basic earnings per share includes no dilution from options, debentures
or other financial instruments and is computed by dividing income available to
common stockholders by the weighted average number of shares outstanding.
Diluted earnings per share reflects the potential dilution of convertible
securities and options to purchase common stock. The following chart reconciles
both the numerator and the denominator of the basic earnings per share
computation to the numerator and denominator of the diluted earnings per share
computation.
5
(In thousands, except per share data) Three Months Three Months
Ended June 30, 2001 Ended June 30, 2000
------------------------------ ------------------------------
Income Shares EPS Income Shares EPS
------ ------ --- ------ ------ ---
Basic earnings per share ...................... $50,713 298,547 $0.17 $ 66,315 304,391 $0.22
===== =====
Effect of dilutive securities, net of tax:
Options .............................. - 4,060 - 4,084
Convertible securities ............... 1,191 8,157 - -
-------- ------- --------- --------
Diluted earnings per share .................... $51,904 310,764 $0.17 $ 66,315 308,475 $0.21
======= ======= ===== ========= ======= =====
Six Months Six Months
Ended June 30, 2001 Ended June 30, 2000
------------------------------ ------------------------------
Income Shares EPS Income Shares EPS
------ ------ --- ------ ------ ---
Basic earnings per share ...................... $79,940 298,170 $0.27 $ 102,369 305,030 $0.34
===== =====
Effect of dilutive securities, net of tax:
Options .............................. - 3,973 - 4,277
Convertible securities ............... 2,383 8,157 - -
-------- ------- --------- --------
Diluted earnings per share .................... $82,323 310,300 $0.27 $ 102,369 309,307 $0.33
======= ======= ===== ========= ======= =====
NOTE 6: In the Consolidated Statements of Cash Flows, the caption Cash and Cash
Equivalents includes investments in short-term, highly-liquid securities having
a maturity of three months or less. Supplemental information relating to the
Consolidated Statements of Cash Flows for the six months ended June 30, 2001 and
2000 is presented in the following table. The increase in interest paid in 2001
is primarily due to the timing of payments resulting from refinancing a portion
of floating rate borrowings in the public bond market in the second quarter last
year. Tax payments in 2001 include a $21 million tax refund related to tax
over-payments in 2000. This is comparable to 2000 when the Company received a
similar tax refund in the first quarter.
(in thousands)
2001 2000
------------ ------------
Cash paid or (received for):
Interest expense............................... $ 64,845 $ 61,154
Interest and dividend income................... $ (4,366) $ (5,177)
Income taxes................................... $ (12,277) $ (10,200)
NOTE 7: Total comprehensive income was $49.3 million and $69.0 million for the
three months ended June 30, 2001 and 2000, respectively, and $68.6 million and
$112.7 million for the six months ended June 30, 2001 and 2000, respectively.
Total comprehensive income includes primarily net income, changes in unrealized
gains and losses on marketable securities and translation balances.
NOTE 8: At the end of the first quarter of 2001, the Company entered into an
agreement to sell, on a revolving basis, certain of its accounts receivable to a
wholly-owned, bankruptcy-remote subsidiary, ServiceMaster Funding Company LLC
which 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 Company 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. Amounts sold to
the purchasers under this agreement include certain of the accounts receivable
from the Company's Management Services, TruGreen and Terminix business units.
The agreement is a 364-day facility renewable at the option of the purchasers.
Through June 30, 2001, $768 million of net accounts receivable had been sold to
ServiceMaster Funding Company LLC. The amount of the retained interest in the
receivables was $68 million as of June 30, 2001 and is classified as accounts
receivable in the Consolidated Statements of
6
Financial Position. ServiceMaster Funding Company LLC in turn sold $700 million
of receivables to Falcon Asset Securitization Corporation under this agreement.
Approximately $600 million of these receivables have been collected. The $100
million of cash proceeds relating to outstanding receivables sold under this
agreement was used to pay down bank revolving credit debt.
The retained interest in the accounts receivable sold are valued at the carrying
amount of the retained accounts receivable net of applicable loss reserves,
which approximates fair value. Management monitors the change in the outstanding
retained interest and makes adjustments to its carrying amount based on actual
and projected losses. Any changes in interest rates would only have a minimal
impact on the value of the residual interest due to the short-term nature of the
receivables.
The Company, as agent for the purchaser, retains servicing responsibilities for
the sold receivables. The fees received by the Company for these services during
the quarter and six months ended June 30, 2001, were at fair market value,
therefore, no related assets or liabilities have been recorded. The discount on
the Company's sale of receivables totaled $1.8 million for the quarter and the
six months ended June 30, 2001 and is included in "Minority interest and other
expense (income), net" in the Consolidated Statements of Income.
NOTE 9: The Company has a bank revolving credit facility which expires April,
2002. Because the facility is scheduled to mature within the next twelve months,
outstanding amounts under the facility as of June 30, 2001 have been classified
as current debt maturities. The Company expects to enter into a replacement
facility in an amount that is expected to meet its bank revolving credit
facility needs prior to the maturity of the existing facility.
NOTE 10: The business of the Company is primarily conducted through four
operating segments: TruGreen, Terminix, Home Maintenance and Improvement, and
Management Services. In accordance with Statement of Financial Accounting
Standards No. 131 (SFAS 131), the Company's reportable segments are strategic
business units that offer different services. The TruGreen unit provides
residential and commercial lawn care and landscaping services through the
TruGreen ChemLawn and TruGreen LandCare companies. The Terminix unit provides
domestic termite and pest control services to residential and commercial
customers. The Home Maintenance and Improvement unit includes American
Residential Services, American Home Shield, ServiceMaster Clean and Merry Maids.
This unit provides heating, ventilation and air conditioning, plumbing, and
cleaning services to residential and commercial customers as well as home
warranties to consumers. The Management Services unit provides a variety of
supportive management services to health care, education and commercial
accounts.
The Other Operations unit includes entities that are managed separately from the
four major units and aggregated together in accordance with SFAS 131 due to
their size or developmental nature. This unit includes the Company's
international operations which include Terminix Europe; ServiceMaster Employer
Services, a professional employer organization that provides clients with
administrative processing of payroll, workers' compensation insurance, health
insurance, unemployment insurance and other employee benefit plans;
ServiceMaster Home Service Center (formerly WeServeHomes.com), a joint venture
initiative that is developing a full service, cross-selling marketing arm for
the enterprise; the Company's headquarters operations; and certain non-core
businesses that have been sold or discontinued. Segment information as of and
for the three months and six months ended June 30, 2001 and 2000 is presented on
the following page.
7
(In thousands) THREE MONTHS THREE MONTHS SIX MONTHS SIX MONTHS
ENDED JUNE 30, ENDED JUNE 30, ENDED JUNE 30, ENDED JUNE 30,
2001 2000 2001 2000
------------------------------------------------------------------------------------------------------------------------------------
OPERATING REVENUE:
TruGreen ................................. $ 475,059 $ 468,707 $ 733,379 $ 731,763
Terminix ................................. 227,321 200,063 421,991 364,996
Home Maintenance
and Improvement ...................... 353,220 317,069 644,233 573,949
Management Services ...................... 480,932 471,802 954,162 941,081
Other Operations ......................... 112,409 157,054 224,838 343,790
----------- ----------- ----------- -----------
TOTAL OPERATING REVENUE .................. $ 1,648,941 $ 1,614,695 $ 2,978,603 $ 2,955,579
----------- ----------- ----------- -----------
OPERATING INCOME:
TruGreen ................................. $ 48,162 $ 58,716 $ 65,119 $ 90,955
Terminix ................................. 34,623 30,555 60,029 51,082
Home Maintenance
and Improvement ...................... 32,920 30,527 52,937 49,574
Management Services ...................... 13,759 14,734 28,450 31,210
Other Operations ......................... (10,995) 5,685 (18,925) 4,268
----------- ----------- ----------- -----------
TOTAL OPERATING INCOME ................... $ 118,469 $ 140,217 $ 187,610 $ 227,089
----------- ----------- ----------- -----------
CAPITAL EMPLOYED:
TruGreen ................................. $1,458,529 $1,563,610
Terminix ................................. 593,783 521,708
Home Maintenance
and Improvement ...................... 677,263 627,158
Management Services ...................... 74,050 138,096
Other Operations ......................... 182,530 315,063
---------- ----------
TOTAL CAPITAL EMPLOYED ................... $2,986,155 $3,165,635
---------- ----------
IDENTIFIABLE ASSETS:
TruGreen ................................. $1,595,735 $1,711,622
Terminix ................................. 797,145 705,658
Home Maintenance
and Improvement ...................... 1,042,942 967,010
Management Services ...................... 148,233 237,478
Other Operations ......................... 508,112 555,351
---------- ----------
TOTAL IDENTIFIABLE ASSETS ................ $4,092,167 $4,177,119
---------- ----------
8
MANAGEMENT DISCUSSION AND ANALYSIS
RESULTS OF OPERATIONS
SECOND QUARTER 2001 COMPARED TO SECOND QUARTER 2000
Revenue for the second quarter totaled $1.65 billion, two percent above the
prior year. After adjusting for the impact of sold or discontinued businesses,
revenue growth was four percent. Operating income decreased 16 percent to $118.5
million, with margins decreasing to 7.2 percent from 8.7 percent. The decline in
operating income reflects growth in operating earnings in the Terminix and Home
Maintenance and Improvement segments which were offset primarily by lower
earnings in the TruGreen and Other Operations segments. Diluted earnings per
share for the quarter declined to $.17 from $.21 and net income decreased to
$50.7 million from $66.3 million.
As a result of the challenges in the TruGreen segment, combined with concerns
about the near-term U.S. economic outlook, the Company has reduced its earnings
outlook for 2001 to be in the range of $.51 to $.55 per share. The Company has
implemented cost reduction measures at the corporate center and in each of its
businesses to address these challenges.
The TruGreen segment includes lawn care operations performed under the TruGreen
ChemLawn brand name and landscaping services provided under the TruGreen
LandCare brand name. This segment reported revenue of $475 million, an increase
of one percent from $469 million in the prior year. Operating income decreased
to $48 million from $59 million last year. Revenues in the lawn care business
increased over the prior year, reflecting the impact of price increases, growth
in ancillary services, and the delay of first quarter production into the second
quarter. These factors were partially offset by a decrease in customer counts.
Projected sales which management believed were delayed due to adverse weather in
March and April were below expectations in the second quarter. Margins in the
lawn care operations declined, partially impacted by costs incurred to support a
higher expected demand for services. The Company has put in place a new
marketing team that will examine the effectiveness of its telemarketing and
customer acquisition capabilities. Revenue in the landscaping business was lower
than the prior year, reflecting management's focus to reposition the business
portfolio to increase its concentration on more predictable maintenance services
and less on construction services. In addition, management has been enforcing
stricter profitability standards on contract sales and renewals. The
implementation of a branch level construction project management system in the
landscape operations was completed in the second quarter. This process included
a thorough assessment of all construction contracts on the books and resulted in
the recording of an expense to reflect the amount of anticipated losses from
unprofitable construction accounts. The impact of that expense, along with the
comparison to a more profitable construction business last year, resulted in
significantly lower margins in the consolidated landscape operations. The
Company has closed four low-performing and non-profitable construction branches
and continues to evaluate potential additional branches. Capital employed
decreased seven percent primarily reflecting improved working capital management
as well as the sale of a portion of this segment's accounts receivable.
9
The Terminix segment, which includes the domestic termite and pest control
services, reported a 14 percent increase in revenue to $227 million from $200
million in 2000 and operating income growth of 13 percent to $35 million from
$31 million last year. This strong growth reflects the continued migration of
the customer base to termite baiting systems, improved customer retention, and
the impact of price increases. In January 2001, the Company acquired the Allied
Bruce Terminix companies, the Company's largest Terminix franchise and the
fourth largest pest control company in the United States. Approximately one-half
of the revenue and operating income growth for the quarter reflected the impact
of the Allied Bruce acquisition which continues to exceed management's
expectations. Margins for the quarter were down slightly, reflecting improved
branch-level margins offset by a higher level of incentive program expense than
the same quarter last year. Capital employed increased 14 percent primarily due
to acquisitions, offset in part by higher prepaid contracts and improved working
capital management.
The Home Maintenance and Improvement segment includes heating, ventilation, air
conditioning (HVAC), and plumbing services provided under the American
Residential Services (ARS), Rescue Rooter, and AMS (for commercial accounts)
brand names; home systems and appliance warranty contracts offered through
American Home Shield; and the franchised operations, ServiceMaster Clean and
Merry Maids. The segment achieved revenues of $353 million, an increase of 11
percent from $317 million last year, reflecting double-digit growth in all
businesses in this segment. The combined ARS operations achieved double-digit
revenue growth, reflecting continuing strength in the commercial operations, the
impact of acquisitions, and price increases. These factors were partially offset
by reduced residential service call volume for both plumbing and HVAC services
reflecting the adverse effect of a cool May and June which dampened demand.
American Home Shield reported double-digit increases in all major distribution
channels which will continue to support revenue growth in the future as revenue
on these contracts is recognized. The franchise operations achieved double-digit
revenue growth supported by strong disaster restoration growth at ServiceMaster
Clean and growth in branch operations at Merry Maids. Operating income for this
segment increased eight percent to $33 million compared to $31 million in the
prior year. Operating income grew at a lesser rate than revenue primarily due to
a higher level of direct and indirect support costs that were in place at ARS in
anticipation of stronger sales. These factors were partially offset by lower
service costs from reduced claim activity at American Home Shield and operating
efficiencies in the franchise operations. Management of ARS has taken action to
reduce branch operating costs and bring margins in line, primarily targeting
direct and indirect labor. Capital employed in this unit increased eight
percent, primarily reflecting acquisitions at ARS.
The Management Services segment serves institutional healthcare, education and
commercial facilities. The segment reported revenue of $481 million, an increase
of two percent compared to $472 million last year, reflecting growth in both the
healthcare and business and industry markets. Operating income decreased seven
percent to $14 million from $15 million in the prior year. Several large account
terminations last year as well as an unprofitable account in SiteServices that
was terminated in the second quarter this year contributed to the reduced
profits. Capital employed decreased 46 percent primarily reflecting the
securitization of a significant portion of this segment's receivables as well as
a strong reduction in working capital.
Other Operations consists of the Company's international operations which
include Terminix Europe; ServiceMaster Employer Services (the professional
employer organization); ServiceMaster Home Service Center (formerly
WeServeHomes.com); the Company's headquarters operations; and certain non-core
businesses that have been sold or discontinued. During the quarter,
WeServeHomes.com was renamed the ServiceMaster Home Service Center and
repositioned to focus more heavily on membership programs and additional
distribution channels. Revenues and capital employed in the Other Operations
segment declined, reflecting the impact of sold or discontinued operations. The
decrease in operating income primarily
10
reflects the impact of one-time or transitional items that improved the results
last year including the resolution of a foreign license agreement and the
benefit of a marketing arrangement that is no longer in place. In addition, the
current year includes increased expenses related to ServiceMaster Home Service
Center, ServiceMaster Employer Services, and various enterprise initiatives.
Throughout 2000 and until May 2001, the operating losses of ServiceMaster Home
Service Center had been allocated to the Company's minority partner in
ServiceMaster Home Service Center, Kleiner Perkins, and were offset through
minority interest income below the operating income line. In May 2001, the
cumulative operating losses of ServiceMaster Home Service Center began exceeding
the funding provided by Kleiner Perkins. As a result, the operating losses since
May have been absorbed in the accompanying financial statements without an
offset at the minority interest income line.
Cost of services rendered and products sold increased three percent for the
quarter and increased as a percentage of revenue to 76.8 percent in 2001 from
75.9 percent in 2000. Selling and administrative expenses increased six percent
and increased as a percentage of revenue to 16.0 percent from 15.4 percent in
2000.
Interest expense decreased from the prior year, primarily due to reduced debt
levels from improved cash flows and the sale of certain of the Company's
accounts receivable. Interest income decreased primarily due to a lower level of
investment gains realized on the American Home Shield investment portfolio.
Minority interest and other expense/income reflected $6 million more expense
than last year due to: lower minority interest income related to the
ServiceMaster Home Service Center venture, minority interest expense related to
the equity security issued in the Allied Bruce acquisition, and the discount
from the Company's sale of receivables.
As discussed last quarter, the Company is undertaking an in-depth strategic
review of its portfolio of businesses with the focus on shareholder value
creation and strategic alignment. Management intends to take steps over the next
few quarters to implement the vision as it emerges. Last quarter, the Company
also announced that it will be implementing operational imperatives to focus on
ways to improve customer retention, the quality of service and employee loyalty.
The Company expects to implement Six Sigma later this year, with a broadening
rollout of the program expected to occur over a twelve to twenty-four month
period. Six Sigma is a continuous improvement methodology that will be used by
the Company to discover ways to better serve customers and improve productivity.
The Company is also in the final stages of a decision about a common methodology
to use across the entire enterprise to measure customer and employee
satisfaction. The Company's goal is to have a baseline established by year end
and roll it out to all the branches and facilities during 2002.
SIX MONTHS ENDED JUNE 30, 2001 AS COMPARED TO JUNE 30, 2000
-----------------------------------------------------------
Revenues for the six months increased one percent to $3.0 billion. Revenue
growth was four percent, after adjusting for the impact of sold or discontinued
businesses. Operating income decreased 17 percent to $187.6 million, with
margins decreasing to 6.3 percent from 7.7 percent. As was the case in the
second quarter, the decline in operating income for the six months reflected
strong growth in the Terminix and Home Maintenance and Improvement segments
offset primarily by lower operating earnings in the TruGreen and Other
Operations segments. Diluted earnings per share for the six months declined from
$.33 to $.27 and net income decreased from $102.4 million to $79.9 million. The
2001 results include a $.02 per share, or $6 million after-tax, extraordinary
gain recorded in the first quarter resulting from the repurchase of certain
ServiceMaster corporate bonds. Excluding this extraordinary item, net income and
diluted earnings per share were $73.9 million and $.25, respectively.
The TruGreen segment reported revenues of $733 million, consistent with last
year. Operating income decreased to $65 million from $91 million last year.
Revenues in the lawn care business
11
increased modestly over the prior year, reflecting the realization of price
increases and growth in ancillary services, partially offset by a decrease in
customer counts. The lawn care operations' first quarter results were impacted
by winter weather conditions that persisted much later in 2001 than in the prior
year, resulting in reduced production levels and lower margins from sub-optimal
labor utilization and fixed cost leverage. In addition, management was
optimistic that the selling season, which had been delayed due to adverse
weather in March and April, was going to rebound in May and June. However,
second quarter sales were below expectations and margins in the lawn care
operations were unfavorably impacted by a cost structure that was in place to
support a higher anticipated level of demand. Landscaping services revenues
decreased modestly compared to last year, reflecting management's decision to
enforce stricter profitability standards on contract sales and renewals. As
discussed in the three month comparison, management is also actively
repositioning its business portfolio to concentrate on more predictable
maintenance services and less on construction services. Operating margins in the
landscaping operations were lower due to expenses recorded in the second quarter
this year to accrue for estimated losses on many construction contracts, as well
as the impact of integration challenges that had not yet begun to emerge in the
prior year period. Management has taken measures such as establishing stronger
pricing guidelines, instituting branch level operating controls and conducting
increased training for region and branch managers, which it believes will
enhance future operating performance.
The Terminix segment reported a 16 percent increase in revenues to $422 million
from $365 million in 2000 and operating income growth of 18 percent to $60
million from $51 million last year. The growth at Terminix reflected both the
acquisition of Allied Bruce, which accounted for approximately one-half of the
revenue and operating growth for the six months, and strong growth in both new
termite contracts and termite renewals. The margin improvement reflects the
continued increased mix of higher margin termite renewals, the impact of price
increases, as well as ongoing productivity improvements and overhead
efficiencies.
The Home Maintenance and Improvement segment achieved revenues of $644 million,
an increase of 12 percent from $574 million last year. Operating income
increased seven percent to $53 million compared with $50 million in the prior
year. The combined ARS operations achieved double-digit revenue growth,
reflecting continuing strength in the commercial operations, acquisitions, as
well as price increases. For the six months, residential plumbing and HVAC
services showed solid growth reflecting strong increases in the first quarter,
partially offset by lower than expected demand in the second quarter, which the
Company believes is due to cooler weather conditions and softening economic
environment. American Home Shield reported double-digit revenue growth
continuing its strong growth across all major distribution channels. The
franchise operations, ServiceMaster Clean and Merry Maids, achieved double-digit
growth, reflecting the benefit of successful marketing programs, national
account relationships, and employee retention initiatives.
The Management Services segment reported revenue growth of one percent to $954
million and operating income of $28 million, a nine percent decrease compared to
last year. The decrease in profits reflects the impact of account terminations
last year in the healthcare and education markets and an unprofitable
SiteService account, which was terminated in the second quarter this year.
Revenues in the Other Operations segment declined reflecting the impact of sold
or discontinued operations. Operating income declined as a result of certain
favorable non-recurring items last year including a benefit resulting from the
resolution of a foreign license agreement, a marketing arrangement that is no
longer in place, higher expenses this year in certain business operations
including the ServiceMaster Home Service Center venture, and the impact of
discontinued operations. As noted in the three month comparison, beginning in
May 2001, the operating losses of ServiceMaster Home Service Center were no
longer allocated to the Company's minority
12
partner, Kleiner Perkins. Consequently, the consolidated results for the six
months ended June 30, 2001 include operating losses of ServiceMaster Home
Services Center since May without an offset at the minority interest income
line.
Cost of services rendered and products sold increased one percent for the six
months and increased as a percentage of revenue to 78.5 percent in 2001 from
78.2 percent in 2000. Selling and administrative expenses increased eight
percent and increased as a percentage of revenue to 15.2 percent from 14.2
percent in 2000.
Interest expense decreased from the prior year, primarily due to lower debt
levels reflecting strong cash flows and the use of funds received on the sale of
receivables to pay down revolving bank credit debt. Interest income decreased
primarily reflecting a reduced level of investment gains realized on the
American Home Shield investment portfolio. Minority interest and other
expense/income was $7 million below the comparable period last year due to:
minority interest expense related to the equity security issued in the Allied
Bruce acquisition, the discount from the Company's sale of receivables, and
reduced minority interest income related to the ServiceMaster Home Service
Center venture.
FINANCIAL POSITION
Net cash provided from operations of $247 million was $125 million higher than
the first six months of 2000. The significant increase reflects the sale of $100
million of accounts receivable through the Company's securitization program and
lower working capital usage which provided $57 million in cash flow. Cash from
operations excluding the benefit from the sale of receivables increased 20
percent to the highest level in the Company's history for the first half of the
year. This result was due to strong working capital management, reflecting
improved receivable collections and days sales outstanding in the landscape
operations and growth in customer prepayments in the lawn care operations, and
the Terminix and American Home Shield companies. Management believes that funds
generated from operations and other existing resources will continue to be
adequate to satisfy ongoing working capital needs of the Company.
Debt levels decreased primarily reflecting the proceeds from the accounts
receivable securitization financing program and strong cash flows. As a result
of the ongoing cash flow strength of the Company, debt levels have been reduced
over the last four consecutive quarters to the lowest level in two years. The
Company is party to a number of long-term debt agreements which require it to
maintain compliance with certain financial covenants, including limitations on
indebtedness, restricted payments, fixed charge coverage ratios, and net worth.
The Company is in compliance with the covenants related to these debt
agreements.
The Company has a bank revolving credit facility which is scheduled to mature
within the next twelve months. The outstanding amounts under the facility have
been classified as current debt maturities even though the Company expects to
enter into a replacement facility that is expected to meet its credit needs.
Accounts receivable decreased from year-end levels, reflecting the sale of
receivables through the securitization financing program and improved
collections and days sales outstanding at several companies. Inventories
increased over year-end levels as a result of normal seasonal build-ups in the
lawn care operations.
Prepaids and other assets have increased from year-end reflecting the
seasonality in the lawn care operations and the increased volume of contracts
written at Terminix and American Home Shield. The lawn care operations defer
marketing and other costs that are incurred earlier in the year, but are
directly associated with revenues realized in subsequent quarters of the current
year. These costs are then amortized over the balance of the current lawn care
production season, as the related revenues are recognized. In addition, the
Company capitalizes sales commission and
13
other direct contract acquisition costs relating to termite baiting and pest
contracts as well as home warranty agreements.
Deferred revenues grew significantly reflecting increases in customer
prepayments for lawn care services and termite renewals and strong growth in
warranty contracts written at American Home Shield.
Capital expenditures which include recurring capital needs and information
technology projects are below prior year levels reflecting fewer large-scale
technology projects. The Company has no material capital commitments at this
time.
The increase in the minority interest liability primarily reflects the
acquisition of the Allied Bruce Terminix Companies, in which the consideration
included an equity interest in the Terminix subsidiary which is exchangeable
into eight million ServiceMaster common shares.
In February 2001, Kleiner Perkins, the Company's minority partner in
ServiceMaster Home Service Center (formerly WeServeHomes.com), exercised a
warrant to purchase additional capital stock for $5 million, and the Company
purchased additional capital stock for $10 million. The Company currently has an
81 percent ownership interest in ServiceMaster Home Service Center and Kleiner
Perkins has an 18 percent interest. Kleiner Perkins also has a warrant to
purchase additional capital stock for $6.5 million.
Total shareholders' equity was $1.2 billion at June 30, 2001, approximately the
same level as year end, reflecting earnings offset by cash dividends. Cash
dividends paid directly to shareholders totaled $60 million, or $.20 per share,
for the six months ended June 30, 2001. In July 2000, the Company announced that
its Board of Directors authorized $350 million for a share repurchase program.
The Company purchased approximately $136 million of its shares in 2000
subsequent to the authorization. The Company has not undertaken material share
repurchases in 2001. Decisions relating to any future share repurchases will
take various factors into consideration such as the Company's commitment to
maintain investment grade ratings, general business conditions, and other
strategic investment opportunities.
In June 2001, the Financial Accounting Standards Board issued Statement of
Financial Accounting Standards No. 141, "Business Combinations" and No. 142,
"Goodwill and Other Intangible Assets". See Note 4 to the Consolidated Financial
Statements for additional discussion of these statements.
THE COMPANY NOTES THAT STATEMENTS THAT LOOK FORWARD IN TIME, WHICH INCLUDE
EVERYTHING OTHER THAN HISTORICAL INFORMATION, INVOLVE RISKS AND UNCERTAINTIES
THAT AFFECT THE COMPANY'S RESULTS OF OPERATIONS. FACTORS WHICH COULD CAUSE
ACTUAL RESULTS TO DIFFER MATERIALLY FROM THOSE EXPRESSED OR IMPLIED IN A
FORWARD-LOOKING STATEMENT INCLUDE THE FOLLOWING (AMONG OTHERS): WEATHER
CONDITIONS ADVERSE TO CERTAIN OF THE COMPANY'S CONSUMER AND COMMERCIAL SERVICES
BUSINESSES; THE ENTRY OF ADDITIONAL COMPETITORS IN ANY OF THE MARKETS SERVED BY
THE COMPANY; LABOR SHORTAGES; CONSOLIDATION OF HOSPITALS IN THE HEALTHCARE
MARKET; THE COST AND LENGTH OF TIME TO INTEGRATE ACQUIRED BUSINESSES; UNEXPECTED
CHANGES IN OPERATING COSTS; THE CONDITION OF THE U.S. ECONOMY; AND OTHER FACTORS
DISCUSSED ABOVE LISTED FROM TIME TO TIME IN THE COMPANY'S FILINGS WITH THE
SECURITIES AND EXCHANGE COMMISSION.
14
PART II. OTHER INFORMATION
ITEM 1: LEGAL PROCEEDINGS
In the ordinary course of conducting its business activities, ServiceMaster
becomes involved in judicial, administrative and regulatory proceedings which
involve both private parties and governmental authorities. As of August 1, 2001,
these proceedings included general and commercial liability actions and a small
number of environmental proceedings.
RAY D. MARTIN V. SERVICEMASTER. In June 1996, Ray D. Martin, a former
salesman employed by ServiceMaster Management Services, filed a lawsuit in the
State Court of Fulton County, Georgia (Civ. Action File No. 96VS114677J). The
complaint, as originally filed, contended that ServiceMaster had not paid Mr.
Martin the full amount of commission due to him on a sale in which he was
involved. In the course of the pre-trial proceedings, the trial court entered a
default judgment against ServiceMaster, thereby leaving only the question of
damages to be considered at the trial. At trial in September 1999, a jury
awarded the plaintiff compensatory damages and fees of approximately $1 million
and punitive damages of $135 million. In October 1999, ServiceMaster filed a
motion for judgment notwithstanding the verdict or, in the alternative, for a
new trial. On June 1, 2000 the trial court entered a new judgment in the amount
of $461,440 in compensatory damages and $45 million in punitive damages, as well
as amounts for attorneys' fees and interest. ServiceMaster appealed and Mr.
Martin cross-appealed. The appeals have been fully briefed. ServiceMaster
believes that the award of $45 million in punitive damages is not supported by
the facts of the case or by applicable state law and that the judgment will be
reversed by the court of appeals. The court of appeals must issue its decision
by the end of the 2001. Under Georgia law, a judgment accrues interest at the
rate of 12% per annum. ServiceMaster continues to be unable to reasonably
estimate the ultimate outcome of this case, and accordingly, minimal expense has
been recorded. If the existing judgment is sustained, or if the original
judgment is reinstated (which is not anticipated by ServiceMaster), then it
would be likely that ServiceMaster's results of operations for a particular year
may be materially adversely affected. However, ServiceMaster believes, based on
advice from legal counsel, that the ultimate outcome of this litigation is not
expected to have a material adverse effect on ServiceMaster's financial
condition or results of operations.
ITEM 2: CHANGES IN SECURITIES AND USE OF PROCEEDS
(c) On May 10, 2001, ServiceMaster sold to Jonathan P. Ward, President and Chief
Executive Officer of ServiceMaster, a 5.50% convertible debenture due May 10,
2011 with a face amount equal to $1,083,000. The debenture becomes convertible
into 20,000 shares of common stock of ServiceMaster on December 31 of each of
the years 2001 through 2005. The debenture was sold pursuant to the exemption
from registration provided by section 4(2) of the Securities Act of 1933.
ServiceMaster financed 50% of the purchase price of the debenture with a full
recourse loan of $541,500 to Mr. Ward.
15
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
(a) The 2001 Annual Meeting of Shareholders was held on April 27, 2001.
(b) The following persons are elected as Class of 2004 directors:
Name Votes For Votes Withheld Broker Non-Votes
----------- -------------- ----------------
Brian Griffiths 249,427,709 4,545,584 N/A
Sidney E. Harris 249,883,276 4,090,017 N/A
James D. McLennan 250,077,132 3,896,161 N/A
C. William Pollard 244,464,129 9,509,164 N/A
Donald G. Soderquist 249,463,277 4,510,016 N/A
No votes were cast for any other nominee for directors. The Class of 2002
directors continuing in office are Paul W. Berezny, Carlos H. Cantu, Vincent C.
Nelson, Charles W. Stair, and Jonathan P. Ward. The Class of 2003 continuing in
office are: Glenda A. Hatchett, Herbert P. Hess, Michele M. Hunt, Dallen W.
Peterson, and David K. Wessner.
A vote was taken to approve the 2001 Directors Stock Plan as follows:
For Against Abstain Broker Non-votes
----------- ----------- ----------- ----------------
169,737,530 26,984,461 2,235,884 55,015,418
A vote was taken to ratify the selection of Arthur Andersen LLP to serve as the
Company's independent auditor for 2001 as follows:
For Against Abstain Broker Non-votes
----------- ----------- --------- ------------------
244,881,556 8,288,928 802,809 N/A
No other matters were submitted to shareholders.
16
ITEM 6(A): EXHIBITS
Exhibit No. Description of Exhibit
----------- -----------------------
10.1 Letter Agreement with Carlos Cantu dated as of June 1, 2001
10.2 Letter Agreement with Charles Stair dated as of July 1, 2001
ITEM 6(B): REPORTS ON FORM 8-K
The Company did not file any current reports on Form 8-K during the quarter
ended June 30, 2001.
17