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 September 30, 1998
_____ 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)
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
shares: 297,306,636 shares on November 6, 1998.
This document consists of 18 pages, including the cover page.
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TABLE OF CONTENTS
THE SERVICEMASTER COMPANY (Registrant) -
Page
No.
----
Part I. Financial Information
- ------- ---------------------
Consolidated Statements of Income for the three and
nine months ended September 30, 1998 and September 30, 1997 2
Consolidated Statements of Financial Position
as of September 30, 1998 and December 31, 1997 3
Consolidated Statements of Cash Flows for the nine months
ended September 30, 1998 and September 30, 1997 4
Notes to Consolidated Financial Statements 5
Management Discussion and Analysis of Financial Position
and Results of Operations 7
Part II. Other Information
- -------- -----------------
Item 1: Legal Proceedings 15
Item 5: Other Information
Acquisition of LandCare USA 15
Signature 17
1
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<TABLE>
<CAPTION>
PART I. FINANCIAL INFORMATION
THE SERVICEMASTER COMPANY
Consolidated Statements of Income
(In thousands, except per share data)
Three Months Ended Nine Months Ended
September 30, September 30,
1998 1997 1998 1997
---- ---- ---- ----
<S> <C> <C> <C> <C>
Operating Revenue........................... $ 1,273,093 $ 1,090,114 $ 3,499,508 $ 2,918,044
Operating Costs and Expenses:
Cost of services rendered
and products sold.......................... 956,375 832,665 2,702,538 2,243,344
Selling and administrative expenses......... 202,870 159,434 499,554 419,648
----------- ----------- ----------- -----------
Total operating costs and expenses.......... 1,159,245 992,099 3,202,092 2,662,992
----------- ----------- ----------- -----------
Operating Income............................ 113,848 98,015 297,416 255,052
Non-operating Expense (Income):
Interest expense............................ 22,404 22,566 71,044 53,758
Interest and investment income.............. (3,092) (5,096) (11,916) (10,409)
Minority interest........................... - 2,033 - 6,196
----------- ----------- ----------- -----------
Income before Income Taxes.................. 94,536 78,512 238,288 205,507
Provision for income taxes
(pro forma in 1997) (1).................... 38,184 31,719 96,262 83,025
----------- ----------- ----------- -----------
Net Income (pro forma in 1997) (1).......... $ 56,352 $ 46,793 $ 142,026 $ 122,482
=========== =========== =========== ===========
Per Share (1) (2) (3)
Basic (pro forma in 1997).................. $.19 $.17 $.49 $.42
==== ==== ==== ====
Diluted (pro forma in 1997)................ $.19 $.16 $.48 $.41
==== ==== ==== ====
Cash Distributions (3)...................... $.08 $.08 $.24 $ .23 1/8
==== ==== ==== =========
(1) The Company converted from partnership to corporate form on December 26,
1997. The results shown above for the periods ended September 30, 1997 have been
restated to adjust the actual historical information to a basis that assumes
that reincorporation had occurred as of the beginning of that year. Actual net
income, as previously reported (i.e., excluding the effects of pro forma federal
and state income taxes), was $75,759 and $198,326 for the three months and nine
months ended September 30, 1997, respectively (basic and diluted net income per
share were $.28 and $.26 for the three months ended, and $.68 and $.66 for the
nine months ended September 30, 1997, respectively).
(2) Basic earnings per share are calculated based on 294,686 shares and 273,061
shares for the three months ended September 30, 1998 and 1997, respectively and
286,938 shares and 289,855 shares for the nine months ended September 30, 1998
and 1997, respectively. Diluted earnings per share are calculated based on
304,464 shares and 287,876 shares for the three months ended September 30, 1998
and 1997, respectively and 296,603 shares and 303,366 shares for the nine months
ended September 30, 1998 and 1997, respectively.
(3) On July 24, 1998, the Board of Directors of the Company declared a
three-for-two share split effective August 26, 1998, for shareholders of record
on August 12, 1998. All shares and per share data have been restated for all
periods presented to reflect the three-for-two share split.
See Notes to Consolidated Financial Statements
</TABLE>
2
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<TABLE>
<CAPTION>
THE SERVICEMASTER COMPANY
Consolidated Statements of Financial Position
(In thousands)
As of
September 30, December 31,
1998 1997
-------------- -------------
Assets
Current Assets:
<S> <C> <C>
Cash and cash equivalents............................................ $ 56,708 $ 64,876
Marketable securities................................................ 58,808 59,248
Receivables, less allowances of $33,377
and $32,221, respectively........................................... 399,540 299,138
Inventories.......................................................... 49,950 48,157
Prepaid expenses and other assets.................................... 137,194 122,665
------------ -------------
Total current assets............................................. 702,200 594,084
------------ -------------
Property and Equipment:
At cost............................................................. 427,994 362,653
Less: accumulated depreciation..................................... 226,048 204,383
------------ -------------
Net property and equipment....................................... 201,946 158,270
------------ -------------
Intangible assets, primarily trade names and goodwill,
net of accumulated amortization of $258,658
and $218,293, respectively.......................................... 1,822,088 1,563,309
Notes receivable, long-term securities, and other assets............. 157,230 159,561
------------ -------------
Total assets..................................................... $ 2,883,464 $ 2,475,224
============ =============
Liabilities and Shareholders' Equity
Current Liabilities:
Accounts payable..................................................... $ 98,662 $ 84,673
Accrued liabilities.................................................. 342,781 270,667
Deferred revenues.................................................... 186,898 181,298
Current portion of long-term obligations............................. 46,213 21,539
------------ -------------
Total current liabilities........................................ 674,554 558,177
------------ -------------
Long-Term Debt....................................................... 1,177,334 1,247,845
Other Long-Term Obligations.......................................... 129,589 144,764
Commitments and Contingencies .......................................
Shareholders' Equity:
Common stock $0.01 par value, authorized 1 billion shares; issued
and outstanding 296,902 and 279,944 shares, respectively............ 2,969 2,799
Additional paid-in capital........................................... 784,124 518,491
Retained earnings.................................................... 148,710 65,000
Restricted stock..................................................... (3,604) (4,270)
Treasury stock....................................................... (30,212) (57,582)
------------ -------------
Total shareholders' equity....................................... 901,987 524,438
------------ -------------
Total liabilities and shareholders' equity....................... $ 2,883,464 $ 2,475,224
============ =============
See Notes to Consolidated Financial Statements
</TABLE>
3
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<TABLE>
<CAPTION>
THE SERVICEMASTER COMPANY
Consolidated Statements of Cash Flows
(In thousands)
Nine Months Ended
September 30,
1998 1997
------------ ------------
<S> <C> <C>
Cash and Cash Equivalents at January 1................................ $ 64,876 $ 72,009
Cash Flows from Operations:
Net Income............................................................ 142,026 198,326
Adjustments to reconcile net income
to net cash provided from operations:
Depreciation................................................... 38,772 33,899
Amortization................................................... 40,365 35,939
Change in working capital, net of acquisitions:
Receivables.................................................. (84,901) (44,306)
Inventories and other current assets......................... (8,011) (18,332)
Accounts payable............................................. 9,527 (1,595)
Deferred revenues............................................ 3,380 10,983
Accrued liabilities and taxes................................ 67,586 18,901
Other, net..................................................... (3,127) (652)
------------- ------------
Net Cash Provided from Operations..................................... 205,617 233,163
------------- ------------
Cash Flows from Investing Activities:
Business acquisitions, net of cash acquired....................... (171,640) (184,608)
Property additions................................................ (58,921) (39,480)
Payments to sellers of acquired businesses........................ (7,830) (3,306)
Net purchases of investment securities........................... (5,802) (4,088)
Notes receivable and financial investments........................ (3,920) (10,855)
Sale of equipment and other assets................................ 3,775 3,197
------------- ------------
Net Cash Used for Investing Activities................................ (244,338) (239,140)
------------- ------------
Cash Flows from Financing Activities:
Proceeds from stock offering...................................... 208,770 -
Payments of borrowings and other obligations...................... (373,727) (47,876)
Borrowings, net................................................... 253,567 771,386
Distributions to shareholders and shareholders' trust............. (58,316) (93,520)
Proceeds from employee share option plans......................... 7,302 6,101
Purchase of ServiceMaster shares.................................. (12,237) (646,876)
Other............................................................. 5,194 (542)
------------- ------------
Net Cash Provided from (Used for) Financing Activities................ 30,553 (11,327)
------------- ------------
Cash Decrease during the Period....................................... (8,168) (17,304)
------------- ------------
Cash and Cash Equivalents at September 30............................. $ 56,708 $ 54,705
============= ============
See Notes to Consolidated Financial Statements
</TABLE>
4
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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 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, 1997. In the opinion of the
Company, all adjustments necessary to present fairly the financial position of
The ServiceMaster Company as of September 30, 1998 and December 31, 1997, and
the results of operations for the three month and nine month periods ended
September 30, 1998 and 1997, and the cash flows for the nine months ended
September 30, 1998 and 1997, 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: For interim accounting purposes, certain costs directly associated with
the generation of lawn care revenues are initially deferred and recognized as
expense as the related revenues are recognized. All such costs are fully
recognized within the fiscal year in which they are incurred.
Note 4: On July 24, 1998, the Company's Board of Directors declared a three-for
two share split effective August 26, 1998, for shareholders of record on August
12, 1998. All share and per share data have been restated for all periods
presented to reflect this three-for two split.
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.
<TABLE>
<CAPTION>
Three months Three months
ended September 30, 1998 ended September 30, 1997
-------------------------------- --------------------------------
Pro forma
(in thousands, except per share data) Income Shares EPS Income Shares EPS
------ ------ --- --------- ------ ---
<S> <C> <C> <C> <C> <C> <C>
Basic earnings per share $ 56,352 294,686 $ 0.19 $ 46,793 273,061 $ 0.17
====== ======
Effect of dilutive securities, net of tax:
Options 9,778 9,374
Convertible debentures 277 5,441
---------- --------- ---------- ---------
Diluted earnings per share $ 56,352 304,464 $ 0.19 $ 47,070 287,876 $ 0.16
========== ========= ====== ========== ========= ======
</TABLE>
5
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<TABLE>
<CAPTION>
Nine months Nine months
ended September 30, 1998 ended September 30, 1997
----------------------------------- --------------------------------
Pro forma
(in thousands, except per share data) Income Shares EPS Income Shares EPS
------ ------ --- --------- ------ ---
<S> <C> <C> <C> <C> <C> <C>
Basic earnings per share $ 142,026 286,938 $ 0.49 $ 122,482 289,855 $ 0.42
====== ======
Effect of dilutive securities, net of tax:
Options 9,423 8,070
Convertible debentures 32 242 831 5,441
------------ ---------- ----------- ---------
Diluted earnings per share $ 142,058 296,603 $ 0.48 $ 123,313 303,366 $ 0.41
============ ========== ======= =========== ========= ======
</TABLE>
Note 6: In the Consolidated Statements of Cash Flows and on the Balance Sheet,
the caption Cash and Cash Equivalents includes investments in short-term,
highly-liquid securities having a maturity of three months or less. Supplemental
information relating to the Consolidated Statements of Cash Flows for the nine
months ended September 30, 1998 and 1997 is presented in the following table.
The increase in interest paid in 1998 from 1997 is primarily due to overall
higher debt balances throughout the nine month period (relating to the first
quarter impact of the April 1997 WMX share repurchase) as well as the timing of
payments on the public debt. The cash paid increase was greater than the growth
in interest expense recognized in the income statement. This disparity
represented the change in timing of payments and is reflected in the change of
working capital in the cash flow statement. Immaterial amounts of taxes were
paid in the nine months ended September 30, 1998 and 1997 due to the Company's
partnership status in 1997 and a one year deferral of tax payments in 1998.
<TABLE>
<CAPTION>
(In thousands)
1998 1997
---------- ----------
Cash paid or received for:
<S> <C> <C>
Interest expense............................................ $ 78,995 $ 46,577
Interest and dividend income................................ $ 6,597 $ 6,117
</TABLE>
Note 7: Effective January 1, 1998, the Company adopted Statement of Financial
Accounting Standards No. 130, "Reporting Comprehensive Income". This statement
establishes standards for reporting and display of comprehensive income and its
components in financial statements. Total comprehensive income which included
primarily net income and unrealized gains on marketable securities was $52.6
million and $49.1 million for the three months ended September 30, 1998 and
1997, respectively, and $138.9 million and $122.7 million for the nine months
ended September 30, 1998 and 1997, respectively.
In 1998, Statement of Position No. 98-1, "Accounting for the Costs of Computer
Software Developed or Obtained for Internal Use", and Statement of Position No.
98-5, "Reporting on the Costs of Start Up and Preoperating Activities", were
issued. The Company intends to adopt these policies beginning in 1999 as
required by the Statements. The Company does not expect the adoption of these
statements to have a material impact to the financial statements.
In June 1998, the Financial Accounting Standards Board issued a Statement of
Financial Accounting Standards No. 133, "Accounting for Derivative Instruments
and Hedging Activities". The Company intends to adopt this Statement in January
2000 as required by the Statement. Adoption of this Statement is not expected to
have a material impact on the Company's financial statements.
6
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THE SERVICEMASTER COMPANY
MANAGEMENT DISCUSSION AND ANALYSIS
RESULTS OF OPERATIONS
THIRD QUARTER 1998 COMPARED TO THIRD QUARTER 1997
- -------------------------------------------------
Revenues increased 17 percent to $1.3 billion in the third quarter of 1998,
through a combination of acquisitions and solid growth from base operations.
Approximately 8 percent of the revenue increase resulted from internal growth
and small rollup acquisitions in existing service lines, primarily lawn care and
pest control, with another 6 percent coming from platform and other acquisitions
in plumbing and landscaping. The remaining 3 percent of the revenue growth
represented the formation of ServiceMaster Employer Services through an
acquisition of a professional employer organization in August of 1997. This
service line has a significant impact on revenues and margins, because the
entire payroll of the employees for whom services are provided is recognized
both as revenue and operating cost. As a result, the margins are low in this
business and reduce the Company's consolidated operating income margin.
Operating income increased 16 percent to $113.8 million while margins decreased
to 8.9 percent of revenue from 9.0 percent in 1997. Operating margins excluding
Employer Services increased to 9.7 percent of revenue from 9.5 percent in 1997,
reflecting improved operating efficiencies and the continued growth of the
higher margin businesses. Third quarter diluted earnings per share increased 19
percent to $.19 compared to pro forma diluted earnings per share of $.16 for
1997. On this same basis, net income grew 20 percent, from $46.8 million to
$56.4 million. Net income grew at a slightly faster rate than earnings per share
due to an increase in shares outstanding resulting from the Company's equity
offering in May 1998.
The Consumer Services business unit achieved strong double digit increases in
revenues and profits with good growth reflected at all of the companies. Strong
growth from both internal sources and acquisitions, including the commercial
landscape businesses and the Rescue Rooter plumbing business, contributed to an
overall 19 percent increase in revenues. TruGreen-ChemLawn achieved revenue and
profit growth reflecting solid increases in customer counts and the integration
of the commercial landscape acquisitions. Severe weather conditions in many
regions of the country resulted in some production revenues being deferred into
the fourth quarter along with the recognition of certain deferred seasonal
expenses. In August, the Company acquired Ruppert Landscape Company, one of the
largest commercial landscaping companies. On November 2, the Company announced a
definitive agreement to purchase LandCare USA which the Company believes, when
combined with TruGreen-ChemLawn's existing landscape operations, will create the
largest commercial landscape company in America. This acquisition, which is
subject to the approval of a majority of LandCare's shareholders, is expected to
be completed by the end of the first quarter of 1999 and will provide
TruGreen-ChemLawn with opportunities to broaden its service capabilities, expand
market opportunity and develop strong geographic footholds in major cities
across America. Terminix achieved strong double digit growth in revenues and
profits reflecting excellent growth in termite completions which benefited from
favorable weather conditions, strong growth in the higher margin renewal
business, and double digit growth in pest control revenue. On October 12, the
Company announced
7
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the acquisition of the pest control business of National Britannia. The
acquisition of National Britannia, which is the third largest pest control
company in the United Kingdom, further strengthens the Company's ability to
grow and develop its Terminix business in Europe and continues the strategy
of the enterprise to expand its global presence. American Home Shield
continued to experience strong momentum and very good volume increases with
double digit growth in real estate sales, direct to consumer sales, and
renewals. This volume increase was partially affected by increased service
orders relating to expensive air conditioning repairs due to the extreme heat
experienced in many parts of the country. Residential/Commercial and Merry
Maids, the franchise operations, achieved strong profit growth reflecting
continued margin improvements in company-owned operations and strong cost
controls. Rescue Rooter achieved good results reflecting strong growth from
internal sources and the benefits of marketing and productivity improvements.
Traditional Management Services, excluding Diversified Health Services, reported
solid revenue growth from acquisitions and internal sources and a slight
increase in profits. The traditional Healthcare market had revenues consistent
with last year but lower profits due to industry pressures which continue to
affect the margins in the acute care sector of the business. Education achieved
increases in revenues and profits resulting from improved customer retention,
increased contract margins and good cost controls. The Business & Industry group
reported strong growth in revenues and profits reflecting solid increases in
automotive services and the successful integration of acquisitions.
The Diversified Health Services businesses reported a decrease in profits
primarily due to operating losses in the home health care business. Changes in
government reimbursement programs have negatively impacted home health care as
well as other Diversified Health Services businesses. During the quarter, the
Company wrote down certain assets in Diversified Health Services against
previously established reserves which included $5 million relating to the home
health business. The Company is currently reviewing its long-term strategic
objectives with respect to home health care and intends to finalize this review
by the end of the year. The Company's investment in the home health business is
approximately $30 million.
Cost of services rendered and products sold increased 15 percent due to general
business growth, but decreased as a percentage of revenue to 75.1 percent in
1998 from 76.4 percent in 1997. This decrease primarily reflects the changing
mix of the business as Consumer Services increases in size in relationship to
the overall business of the Company as well as productivity improvements and the
successful integration of acquisitions at Consumer Services. The Consumer
Services companies generally operate at higher gross margin levels than the
other businesses but also incur somewhat higher selling and administrative
expenses as a percentage of revenues.
Selling and administrative expenses increased 27 percent due to general business
growth and increased as a percentage of revenue to 15.9 percent in 1998 from
14.6 percent in 1997. This increase as a percentage of revenue is primarily due
to the changing mix of the company noted above.
Interest and investment income decreased reflecting a gain in 1997 on an
international joint venture.
8
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NINE MONTHS 1998 COMPARED TO NINE MONTHS 1997
- ---------------------------------------------
Revenues for the nine months increased 20 percent to $3.5 billion over 1997 due
to acquisitions and growth in base operations. Approximately 5 percent of the
revenue increase resulted from platform acquisitions with another 8 percent
reflecting internal growth and small rollups in existing service lines. The
remaining 7 percent of revenue growth resulted from the newly acquired
professional employer organization. Operating income increased 17 percent to
$297.4 million while margins decreased to 8.5 percent of revenue from 8.7
percent in 1997. Operating margins excluding Employer Services increased to 9.2
percent of revenue from 8.9 percent in 1997, reflecting continued growth of
higher margin businesses, productivity improvements and the successful
integration of acquisitions. Diluted earnings per share for the nine months
increased 17 percent to $.48 compared to pro forma diluted earnings per share of
$.41 for 1997. On this same basis, net income grew 16 percent, to $142.0 million
from $122.5 million.
The Consumer Services business unit achieved a 20 percent increase in revenue
and excellent profit growth reflecting good growth at all of the companies.
TruGreen-ChemLawn reported double digit increases in revenues and profits
reflecting solid base business growth and the entry into the commercial
landscape market. As a result of the extreme heat during the summer months, some
production was deferred into the fourth quarter as well as the recognition of
certain deferred seasonal expenses. Terminix reported strong growth in revenues
and profits reflecting double digit increases in all areas of the business,
including termite completions, termite renewals and pest control as well as
margin improvements from increased efficiencies and favorable weather. Growth in
initial termite treatments was supported by strong customer acceptance of the
non-invasive baiting treatment system. American Home Shield reported excellent
volume growth with double digit increases in real estate sales, direct to
consumer sales, and renewals. Residential/Commercial and Merry Maids achieved
good revenue growth and strong increases in profits despite an extremely tight
labor market, reflecting operational improvements and strong cost controls.
Rescue Rooter achieved good results with strong increases from internal sources
and improving margins.
Traditional Management Services, excluding Diversified Health Services, reported
revenue growth primarily related to acquisitions as well as modest base business
increases. Profits for the nine months were below the prior year level as
increases in Education and Business & Industry were offset by reduced
profitability in the Healthcare market. The traditional Healthcare market
reported a slight decline in revenues with lower profits than last year due to
continued industry pressures resulting in reduced margins and increased
investments in the business. Education achieved strong profit growth due to
increased sales, improvements in retention and the favorable effect of
eliminating costs incurred last year related to unwinding a large contract. The
Business & Industry group reported strong revenue growth primarily reflecting
acquisitions with improved contract sales in the base business.
For the nine months, Diversified Health Services reported profits below last
year primarily reflecting operating losses in the home health care business.
Changes in Medicare reimbursement levels have significantly impacted the
operating results of the home health operations as well as other Diversified
Health
9
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Services lines. In light of these government changes and the industry
transition, the Company is reviewing its long-term strategic objectives with
respect to home health care in the fourth quarter. The Company's investment in
the home health business is approximately $30 million.
Cost of services rendered and products sold increased 20 percent due to general
business growth and the addition of Employer Services. Cost of services
increased as a percentage of revenue to 77.2 percent in 1998 from 76.9 percent
in 1997. Excluding Employer Services, cost of services increased 12 percent and
decreased as a percentage of revenue to 75.8 from 76.5 in 1997. This decrease
primarily reflects the changing mix of the business as Consumer Services becomes
a greater percentage of the overall business of the Company as well as
productivity improvements and the successful integration of acquisitions.
Selling and administrative expenses increased 19 percent due to general business
growth and acquisitions and slightly decreased as a percent of revenue to 14.3
percent from 14.4 percent.
Interest expense increased as compared to prior year primarily due to increased
debt outstanding throughout the nine months relating to the repurchase of
ServiceMaster shares held by WMX and acquisitions partially offset by the
issuance of shares in the May public offering. Interest and investment income
increased due to the growth in the investment portfolio of American Home Shield
and recognized gains on sales of marketable securities partially offset by a
gain in 1997 on an international joint venture.
FINANCIAL POSITION
- ------------------
Net cash provided from operations of $205.6 million represents a slight decrease
compared to the first nine months of 1997, reflecting the timing of certain
items. Federal taxes on the Company's earnings, while accrued in the
consolidated income statement will not have to be paid until the first quarter
of 1999. At that time, the Company will be responsible for its 1998 obligation
and will begin making estimated payments for 1999 as well. Some of the tax
expense will be deferred for a longer period of time due to the significant
timing differences between book and tax basis.
Since the Company is able to defer its 1998 tax payment, the cash flow is
comparable to last year when the Company was in partnership form and paid an
immaterial amount of federal taxes. The decline in cash from operations was
primarily due to the acceleration of customer prepayments at TruGreen-ChemLawn
into the fourth quarter of 1997 due to a successful pre-season selling campaign
and the current year funding of early seasonal investments for the acquired lawn
care operations, which the Company did not incur in 1997. In addition, cash from
operations for the nine months was negatively impacted by the timing of
semi-annual interest payments reflecting the refinancing of debt in late 1997.
In addition to the interest payments, there were other timing issues relating to
certain large expense items, such as advertising and payroll tax payments and
the recognition of certain deferred expenses in TruGreen-ChemLawn. Management
believes that funds generated from operations and other existing resources will
continue to be adequate to satisfy the ongoing working capital needs of the
Company.
10
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The increase in accounts and notes receivable over year end levels reflects
general business growth, increased seasonal build-ups in the Consumer Services
segment, and acquisitions. The increase in inventories is a result of normal
seasonal build-ups in the pest control and lawn care businesses.
Prepaids and other assets have increased from year end because of seasonality in
the lawn care and pest control businesses. The lawn care operation defers
certain marketing costs that are incurred early in the year but are directly
associated with revenues that are 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, prepaid
expenses have also increased due to the deferral of contract acquisition costs
at American Home Shield which have grown as a result of the increased volume of
warranty contracts written. Deferred revenues also increased reflecting the
strong growth in warranty contracts written at American Home Shield.
Property and equipment increased due to general business growth and
acquisitions. Capital expenditures grew primarily due to growth in the business
and investments in computer system/technology upgrades throughout the
organization including automatic dialers at TruGreen-ChemLawn. The Company has
no material commitments at this time.
Intangible assets increased from year end primarily reflecting the impact of
acquisitions, which included Rescue Rooter, Ruppert Landscape Company and
several other commercial landscape companies and other smaller Consumer and
Management Services companies. Through the nine months, approximately $323
million of companies were purchased with $172 million representing cash
consideration and the remaining amount representing shares issued and seller
financed debt.
Accrued liabilities increased from year end reflecting seasonal activity at
Consumer Services and an increase in income taxes payable. The tax liability
represents taxes payable on 1998 earnings for which payment has been deferred
until first quarter 1999.
Debt levels decreased reflecting the use of proceeds from the equity offering to
pay down debt offset in part by acquisitions and capital spending. The Company
is a 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.
Total shareholders' equity increased to $902.0 million in 1998 from $524.4
million at December 31, 1997 reflecting the public equity offering, strong
growth in earnings and shares issued for acquisitions, which were partially
offset by shareholder distributions and share repurchases. The equity offering
was completed in the second quarter and resulted in the sale of approximately 21
million shares (11 million of newly issued shares and 10 million of shares sold
by existing shareholders) at $19.17 a share. The net proceeds to the Company was
approximately $209 million and was used to reduce outstanding debt.
11
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Cash distributions paid directly to shareholders for the nine months ended
September 30, 1998, totaled $69 million or $.24 per share. Total cash
distributions paid to shareholders was consistent with the prior year primarily
reflecting a 4 percent increase in per share distributions offset by the April
1997 repurchase of ServiceMaster shares from WMX. In 1997 total distributions
included payments to the shareholder trust of $25 million while in 1998 a tax
refund was recorded related to the final trust tax filing which reduced reported
distributions by $10 million.
YEAR 2000 STATUS
- ----------------
Year 2000 Compliance. Certain computer programs use two digits rather than four
to define the applicable year and consequently may not function properly beyond
the year 1999 unless they are remediated. In addition, some computer programs
are unable to recognize the year 2000 as a leap year. These problems may also
exist in chips embedded in various types of equipment. The Company has long been
aware of this Year 2000 (Y2K) problem. The Company is dealing with the Y2K
problem in part through system upgrades, which were planned to occur in the
normal course of business. In other cases, the Company has put programs into
place which the Company believes will result in the completion of necessary
remediation efforts prior to the year 2000.
State of Readiness. The Company has initiated a program (the "Y2K program") to
address Y2K issues as they affect the Company's information technology (IT)
systems, electronic data interfaces and its non-IT hardware. The Y2K program was
set up to use the following steps as appropriate: inventory - assessment -
planning - renovation - testing - implementation. In addition, the program calls
for inquiries of the Company's major suppliers of goods and services to
determine their Y2K status and a review of the Company's relationships with its
customers to determine if the Company has any responsibility for the status of
the customers' IT and/or non-IT systems and hardware.
In 1998, the Company began to monitor its progress on the Y2K program on a
consolidated basis and completed an inventory which covered both IT and non-IT
items for all operating companies and administrative units within the
ServiceMaster enterprise. All items in the inventory were placed in one of four
categories: mission critical, critical, important and ordinary within the
context of the operating company or administrative unit involved. (A "mission
critical" or "critical" designation for an item within an operating company or
administrative unit does not necessarily hold the same level of criticality from
the perspective of the entire ServiceMaster enterprise).
Remediation plans have been developed for the mission critical and critical
matters, with milestones established for each plan which enable management to
measure the progress made in respect of a plan against the work schedule
established for that plan. Although these plans encompass many separately
identifiable items, from a ServiceMaster enterprise standpoint, there are nine
projects (the "Key Projects") which management has identified as either mission
critical or critical and which will require a measurable amount of attention to
remediate. Although all of the Key Projects are scheduled for completion before
the end of the year 1999, most of the Key Projects are scheduled for completion
by June 30, 1999. As of October 31, 1998, work on each of the Key Projects
12
<PAGE>
was on schedule and the Company believes that all Key Projects will be
completed in accordance with their scheduled completion dates.
The Company has utilized the services of an outside consultant for the Y2K
program to help identify Y2K issues and to develop a system to closely monitor
remediation work. In early 1998, the Company established a Y2K committee in the
parent unit with responsibility for monitoring the Y2K program in each of the
Company's operating units and for providing status reports to the Board of
Directors.
Year 2000 Costs. Several of the Key Projects are upgrades of systems which the
Company would have undertaken irrespective of the Y2K problem. In some cases,
including a new accounting and financial reporting system for the parent company
and its Management Services subsidiary, work on these systems has been
accelerated in view of Y2K issues. Other upgrades or new systems were already
scheduled for completion prior to the year 2000, such as a new support system
for the Company's American Home Shield subsidiary and a new accounting and
billing system for the recently developed commercial landscape business within
the Company's TruGreen-ChemLawn subsidiary. References to "Year 2000 costs" in
this report do not include the costs of projects for which no acceleration is
occurring due to Y2K issues.
The Company's Year 2000 costs to date are not material to the Company's
financial position and the Company does not expect its future Year 2000 costs to
be material to the Company's results of operations or financial position. All
Year 2000 costs (as well as the costs of installing the system upgrades referred
to above) have been, and are expected to continue to be, funded with cash from
operations.
Year 2000 Risks. The Company believes that its greatest Year 2000 compliance
risk, in terms of magnitude of risk, is that key third party suppliers of goods
or services may fail to complete their own remediation efforts in a timely
manner and thereby provoke an interruption in the ability of one or more of the
operating segments of the Company to provide uninterrupted services to their
customers. Utility services (electrical, water and gas), telephone service,
banking services and, to a much lesser degree, the delivery of chemical products
are the critical items in this regard. Based on the Company's inquiries to its
providers of goods and services and on the basis of the Company's general
knowledge of the state of readiness of the utility companies and banks with
which it does business, the Company does not expect to suffer any material
interruption in the services on which the Company depends.
The Company has reviewed its agreements with its customers, including
particularly the customers of its Management Services units for whom such units
provide facility management services. The Company is satisfied that it is not
responsible, contractually or otherwise, for the Y2K readiness of the customer's
IT and non-IT systems and hardware, and the Company is in the process of
notifying all of its customers to this effect where, in the Company's judgment,
the nature of the customers' business or facility warranted such notices.
Where the Company uses its own software in the course of providing management
services, the Company is responsible to make such software Y2K compliant. The
Company is confident that such software is already, or soon will
13
<PAGE>
be, Y2K compliant. For those units of the Company which sell franchises
and which provide software to the franchisees, such software is already, or
soon will be, fully Y2K compliant or, alternatively, provision has been
made for making available to franchisees software from third-party
developers from whom appropriate Y2K compliance assurances have been or will be
received.
Contingency Plans. At this time, the Company fully expects all of its internal
key IT and non-IT systems to be Y2K compliant well in advance of the end of the
year 1999. If it appears that timely delivery of any Key Projects becomes
questionable, the Company will immediately develop appropriate contingency
plans.
The Company presently expects that its significant providers of goods and
services are or will be Y2K compliant by the end of the year 1999. The Company
will continue to make inquires of its key suppliers for the purpose of testing
this expectation. Insofar as the Company is exposed to risks originating in Y2K
problems at key suppliers, the Company will utilize short-term solutions, but no
practical long-term contingency plans for these external Y2K problems are
possible.
Although the Company believes that critical remediation efforts will be
completed prior to the Year 2000, the untimely completion of these efforts
could, in certain circumstances, have a material adverse effect on the
operations of the Company.
14
<PAGE>
PART II. OTHER INFORMATION
Item 1: Litigation
Two lawsuits have been filed in Texas against ServiceMaster, ServiceMaster's
American Home Shield subsidiary ("AHS") and AHS' Texas subsidiary ("AHS-Texas")
in which four plaintiffs claim that AHS-Texas violated certain provisions of two
Texas consumer protection statutes in the course of soliciting new and renewal
service contracts. The plaintiffs have requested the court to permit the
lawsuits to be maintained as class actions on behalf of all customers who
purchased service contracts since late 1993. Theoretically, this would place
some 300,000 contracts in issue. The plaintiffs have further claimed that the
number of contracts in issue times a statutory penalty of $1,000 per contract
represents the measure of damages. ServiceMaster believes that AHS-Texas
accurately represented the coverage provided in its service agreements and that
the changes in the wording of its renewal contracts were routine updates or
clarifications. In this regard, it is noteworthy that most of the AHS-Texas
contract forms were reviewed and approved by the Texas Real Estate Commission
before the forms were distributed. In any and all events, no material actual
damages have been suffered by anyone in this matter. Furthermore, ServiceMaster
believes that the lawsuits can not be sustained as class actions and that the
statutes in question were not intended to be applied in the manner advocated by
the plaintiffs (and in fact can not be so applied under the federal
constitution). Accordingly, ServiceMaster believes that the ultimate outcome of
these cases will not be material to ServiceMaster's financial condition or
results of operations.
Item 5: Other Matters
ServiceMaster has entered into a merger agreement with LandCare USA, Inc.
("LandCare") dated as of November 1, 1998 under which, subject to the
satisfaction of certain conditions, LandCare will merge with a ServiceMaster
acquisition subsidiary (the "Merger") and thereby become a wholly owned
subsidiary of ServiceMaster and each outstanding share of common stock of
LandCare will convert into a fraction of a share of ServiceMaster common stock.
The conversion ratio depends upon the average market price of ServiceMaster's
common stock for twenty consecutive trading days ending shortly before the
meeting at which LandCare's stockholders vote on the Merger and upon the number
of LandCare shares of common stock issued before the Merger is consummated.
ServiceMaster estimates that the number of ServiceMaster shares issued in the
Merger will increase the number of ServiceMaster shares outstanding by about
five percent.
Completion of the Merger is subject to several conditions, including the
approval of the Merger by the holders of at least a majority of the shares of
LandCare common stock outstanding on the record date for the LandCare
stockholders meeting. Key members of LandCare's management and certain other
LandCare stockholders have agreed to vote their LandCare shares in favor of the
Merger. These shares represent about 30% of the LandCare common stock
outstanding on November 1, 1998. The parties expect that the LandCare
stockholders meeting will be held in mid-February 1999. Information regarding
15
<PAGE>
the Merger will be provided to LandCare stockholders in a proxy
statement/prospectus prepared by ServiceMaster and LandCare. No vote by
ServiceMaster's stockholders is required.
LandCare was formed in June 1998 through the affiliation of seven commercial
landscaping companies serving separate regional markets across the United
States. It is currently one of the leading commercial landscaping companies in
the country. Since the completion of an initial public offering of its common
stock in June 1998, LandCare's common stock has been listed on the New York
Stock Exchange.
In accordance with the Private Securities Litigation Reform Act of 1995, the
Company notes that statements that look forward in time, which include
everything other than historical information, involves risks and uncertainties
that may affect the Company's actual results of operations. Factors which could
cause actual results to differ materially include the following (among others):
weather conditions adverse to certain of the Company's Consumer Services
businesses, labor shortages, the entry of additional competitors in any of the
markets served by the Company, consolidation of hospitals in the healthcare
market, the condition of the U.S. economy, the inability of key suppliers to
achieve timely Y2K compliance in their delivery systems or the inability of the
Company to make its own systems Y2K compliant, and other factors listed from
time to time in the Company's filings with the Securities and Exchange
Commission.
16
<PAGE>
SIGNATURE
Pursuant to the requirements of the Securities Exchange Act of 1934, the
Registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
Date: November 16, 1998
THE SERVICEMASTER COMPANY
(Registrant)
By: /s/Steven C. Preston
---------------------------------------------------
Steven C. Preston
Executive Vice President and Chief Financial Officer
17
<PAGE>
<TABLE> <S> <C>
<ARTICLE> 5
<LEGEND>
THIS SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION
EXTRACTED FROM SERVICEMASTER'S QUARTERLY REPORT TO SHAREHOLDERS
FOR THE PERIOD ENDED SEPTEMBER 30, 1998 AND IS QUALIFIED IN ITS
ENTIRETY BY REFERENCE TO SUCH FINANCIAL STATEMENTS.
</LEGEND>
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<NAME> THE SERVICEMASTER COMPANY
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<FISCAL-YEAR-END> DEC-31-1998 DEC-31-1997
<PERIOD-START> JAN-01-1998 JAN-01-1997
<PERIOD-END> SEP-30-1998 SEP-30-1997
<CASH> 56,708 54,705
<SECURITIES> 58,808 55,800
<RECEIVABLES> 432,917 357,896
<ALLOWANCES> 33,377 33,750
<INVENTORY> 49,950 49,449
<CURRENT-ASSETS> 702,200 580,145
<PP&E> 427,994 351,770
<DEPRECIATION> 226,048 195,965
<TOTAL-ASSETS> 2,883,464 2,322,212
<CURRENT-LIABILITIES> 674,554 509,558
<BONDS> 1,177,334 1,221,386
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<TOTAL-REVENUES> 3,499,508 2,918,044
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