<PAGE>
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
__X__ QUARTERLY REPORT UNDER SECTION 13 OR 15(d) OF
THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended June 30, 1999
_____ 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: 311,933,000 shares on August 10, 1999.
This document consists of 20 pages, including the cover page.
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TABLE OF CONTENTS
Page
No.
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THE SERVICEMASTER COMPANY (Registrant) -
Part I. Financial Information
- ------- ---------------------
Consolidated Statements of Income for the three and
six months ended June 30, 1999 and June 30, 1998 2
Consolidated Statements of Financial Position
as of June 30, 1999 and December 31, 1998 3
Consolidated Statements of Cash Flows for the six months
ended June 30, 1999 and June 30, 1998 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 18
Signature 19
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 Six Months Ended
June 30, June 30,
1999 1998 1999 1998
-------------------------------------- --------------------------------------
<S> <C> <C> <C> <C>
Operating Revenue............................... $ 1,537,074 $ 1,244,627 $ 2,652,136 $ 2,226,415
Operating Costs and Expenses:
Cost of services rendered
and products sold............................ 1,168,837 951,366 2,068,652 1,746,163
Selling and administrative expenses............. 226,098 179,466 362,717 296,684
Other, net (1).................................. 85,500 - 85,500 -
-------------- -------------- -------------- --------------
Total operating costs and expenses.............. 1,480,435 1,130,832 2,516,869 2,042,847
-------------- -------------- -------------- --------------
Operating Income................................ 56,639 113,795 135,267 183,568
Non-operating Expense (Income):
Interest expense................................ 28,890 24,545 50,838 48,640
Interest and investment income.................. (5,649) (5,389) (9,270) (8,824)
-------------- -------------- -------------- --------------
Income before Income Taxes...................... 33,398 94,639 93,699 143,752
Provision for income taxes...................... 15,363 38,235 40,055 58,078
-------------- -------------- -------------- --------------
Net Income...................................... $ 18,035 $ 56,404 $ 53,644 $ 85,674
============== ============== ============== ==============
Per Share
Basic (1)(2)(3).............................. $.06 $.20 $.18 $.30
==== ==== ==== ====
Diluted (1)(2)(3)............................ $.06 $.19 $.17 $.29
==== ==== ==== ====
Dividends Per Share............................ $.09 $.08 $.18 $.16
==== ==== ==== ====
(1) In the second quarter of 1999, the Company realized an after-tax gain of $30
million ($50.1 million pretax) relating to the sales of its Premier automotive
business and its remaining 15 percent interest in ServiceMaster Energy
Management, and recorded a one-time after-tax charge of $81 million ($135.6
million pretax) relating to its Diversified Health Services business. Excluding
the impact of these items, net income and earnings per share were as follows:
Three Months Ended Six Months Ended
June 30, June 30,
1999 1998 1999 1998
-------------------------------------- --------------------------------------
Net income before non-recurring items, net....... $ 69,335 $ 56,404 $ 104,944 $ 85,674
Per share before non-recurring items, net:
Basic......................................... $.22 $.20 $.34 $.30
==== ==== ==== ====
Diluted....................................... $.22 $.19 $.34 $.29
==== ==== ==== ====
(2) Basic earnings per share are calculated based on 310,431 shares and 286,778
shares for the three months ended June 30, 1999 and 1998, respectively and
305,047 shares and 283,001 shares for the six months ended June 30, 1999 and
1998, respectively. Diluted earnings per share are calculated based on 318,179
shares and 296,441 shares for the three months ended June 30, 1999 and 1998,
respectively and 313,099 shares and 292,610 shares for the six months ended June
30, 1999 and 1998, respectively.
(3) All share and per share data reflect the three-for-two share split effective
August 26, 1998.
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
June 30, December 31,
1999 1998
------------ -------------
Assets
Current Assets:
<S> <C> <C>
Cash and cash equivalents............................................ $ 53,934 $ 66,400
Marketable securities................................................ 55,713 54,022
Receivables, less allowances of $43,608
and $38,988, respectively......................................... 575,120 372,375
Inventories.......................................................... 82,586 49,770
Prepaid expenses and other assets.................................... 217,231 127,635
------------ -------------
Total current assets............................................. 984,584 670,202
------------ -------------
Property and Equipment:
At cost........................................................... 629,912 441,209
Less: accumulated depreciation................................... 320,265 229,049
------------ -------------
Net property and equipment....................................... 309,647 212,160
------------ -------------
Intangible assets, primarily trade names and goodwill,
net of accumulated amortization of $297,070
and $272,254, respectively........................................ 2,370,531 1,884,002
Notes receivable, long-term securities, and other assets............. 144,417 148,487
------------ -------------
Total assets..................................................... $ 3,809,179 $ 2,914,851
============ =============
Liabilities and Shareholders' Equity
Current Liabilities:
Accounts payable..................................................... $ 157,490 $ 110,523
Income taxes payable................................................. 45,487 84,165
Accrued liabilities.................................................. 342,205 302,424
Deferred revenues.................................................... 254,346 204,969
Current portion of long-term obligations............................. 46,283 51,616
------------ -------------
Total current liabilities........................................ 845,811 753,697
------------ -------------
Long-Term Debt....................................................... 1,644,961 1,076,167
Other Long-Term Obligations.......................................... 125,043 128,501
Commitments and Contingencies .......................................
Shareholders' Equity:
Common stock $0.01 par value, authorized 1 billion shares; issued
and outstanding 311,452 and 298,030 shares, respectively......... 3,115 2,980
Additional paid-in capital........................................... 1,026,398 788,124
Retained earnings.................................................... 179,873 179,840
Accumulated other comprehensive income............................... (252) 3,911
Restricted stock..................................................... (2,981) (3,383)
Treasury stock....................................................... (12,789) (14,986)
------------ -------------
Total shareholders' equity....................................... 1,193,364 956,486
------------ -------------
Total liabilities and shareholders' equity....................... $ 3,809,179 $ 2,914,851
============ =============
See Notes to Consolidated Financial Statements
</TABLE>
3
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<TABLE>
<CAPTION>
THE SERVICEMASTER COMPANY
Consolidated Statements of Cash Flows
(In thousands)
Six Months Ended
June 30,
1999 1998
------------ ------------
<S> <C> <C>
Cash and Cash Equivalents at January 1................................ $ 66,400 $ 64,876
Cash Flows from Operations:
Net Income............................................................ 53,644 85,674
Adjustments to reconcile net income
to net cash flows from operations:
Depreciation and amortization.................................. 55,305 47,916
Non-recurring items, net....................................... 51,300 -
Change in working capital, net of acquisitions:
Receivables.................................................. (85,602) (61,538)
Inventories and other current assets......................... (69,372) (54,687)
Accounts payable............................................. 16,335 11,197
Deferred revenues............................................ 27,473 29,682
Accrued liabilities.......................................... 59,149 48,350
Deferred 1998 tax payment.................................... (78,478) -
Other, net..................................................... (1,948) 779
------------- ------------
Net Cash Provided from Operations..................................... 27,806 107,373
------------- ------------
Cash Flows from Investing Activities:
Business acquisitions, net of cash acquired....................... (419,034) (144,053)
Property additions................................................ (50,203) (40,241)
Sale of equipment and other assets................................ 2,861 2,814
Proceeds from the sale of businesses.............................. 68,260 -
Payments to sellers of acquired businesses........................ (6,506) (5,130)
Notes receivable and financial investments........................ (16,606) (2,657)
Net purchases of investment securities............................ (6,577) (2,133)
------------- ------------
Net Cash Used for Investing Activities................................ (427,805) (191,400)
------------- ------------
Cash Flows from Financing Activities:
Borrowings, net................................................... 666,639 185,571
Payments of borrowings and other obligations...................... (223,936) (293,632)
Shareholders' dividends........................................... (54,985) (34,718)
Purchase of ServiceMaster stock................................... (12,354) (4,019)
Proceeds from employee share plans................................ 11,669 5,877
Proceeds from stock offering...................................... - 209,391
Other............................................................. 500 3,005
------------- ------------
Net Cash Provided from Financing Activities........................... 387,533 71,475
------------- ------------
Cash Decrease during the Period....................................... (12,466) (12,552)
------------- ------------
Cash and Cash Equivalents at June 30.................................. $ 53,934 $ 52,324
============= ============
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, 1998. In the opinion of the
Company, all adjustments necessary to present fairly the financial position of
The ServiceMaster Company as of June 30, 1999 and December 31, 1998, and the
results of operations for the three month and six month periods ended June 30,
1999 and 1998, and the cash flows for the six months ended June 30, 1999 and
1998 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 June 30, 1999 Ended June 30, 1998
------------------------------- ------------------------------
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 $ 18,035 310,431 $0.06 $ 56,404 286,778 $0.20
===== =====
Effect of dilutive securities - options - 7,748 - 9,663
---------- --------- ---------- ---------
Diluted earnings per share $ 18,035 318,179 $0.06 $ 56,404 296,441 $0.19
========== ========= ===== ========== ========= =====
</TABLE>
5
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<TABLE>
<CAPTION>
Six Months Six Months
Ended June 30, 1999 Ended June 30, 1998
------------------------------- ------------------------------
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 $ 53,644 305,047 $0.18 $ 85,674 283,001 $0.30
===== =====
Effect of dilutive securities, net of tax:
Options - 8,052 - 9,244
Convertible debentures - - 32 365
---------- --------- ---------- ---------
Diluted earnings per share $ 53,644 313,099 $0.17 $ 85,706 292,610 $0.29
========== ========= ===== ========== ========= =====
</TABLE>
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, 1999 and
1998 is presented in the following table. The significant increase in income
taxes paid in 1999 reflects the payment of the 1998 federal tax obligation.
<TABLE>
<CAPTION>
(In thousands) 1999 1998
--------- ---------
Cash paid or (received for):
<S> <C> <C>
Interest expense............................................ $ 44,850 $ 44,475
Interest and dividend income................................ $ (4,148) $ (4,268)
Income taxes................................................ $ 85,829 $ 6,920
</TABLE>
Note 7: Total comprehensive income was $17.9 million and $54.9 million for the
three months ended June 30, 1999 and 1998, respectively, and $49.5 million and
$86.3 million for the six months ended June 30, 1999 and 1998, respectively.
Total comprehensive income includes net income, changes in unrealized gains on
marketable securities and translation balances.
Note 8: On April 27, 1999, the Company acquired American Residential Services
(ARS), establishing the Company as one of the nation's leading providers of
heating, ventilation, and air conditioning services. The Company acquired ARS
for approximately $285 million in cash and assumed debt. The acquisition has
been accounted for using the purchase method and the results of ARS have been
included in the Company's financial statements since the date of acquisition.
The excess of the consideration paid over the fair value of the business of $213
million was recorded as goodwill and is being amortized on a straight-line basis
over 40 years. This allocation of purchase price is preliminary and subject to
change as additional information is obtained related to the fair values of the
acquired net assets.
Note 9: In the second quarter, the Company sold its Premier business unit, which
provides cleaning and maintenance services to the automotive industry, to Durr
AG of Germany. In addition, the Company sold its remaining 15 percent interest
in ServiceMaster Energy Management to its partner Texas Utilities. These sales
resulted in after-tax gains totaling approximately $30 million ($50 million
pretax).
Note 10: The business of the Company is primarily conducted through the
ServiceMaster Consumer and Commercial Services and ServiceMaster Management
Services operating units. The Consumer and Commercial Services unit provides a
variety of specialty services to residential and commercial customers. The
Management Services unit provides a variety of supportive management services to
health care, education, and commercial accounts. The Company derives
substantially all of its revenues from customers in the United States with less
than five percent generated in foreign markets.
6
<PAGE>
The Other Operations group includes primarily ServiceMaster Employer Services, a
professional employer organization that provides clients with administrative
processing of payroll, insurance, and other employee benefit programs, and
Diversified Health Services which provides services and products to the long
term care industry, and the Company's headquarters operation. Segment
information as of and for the three months ended and six months ended June 30
are as follows:
<TABLE>
<CAPTION>
Three Months
Ended June 30,
- ----------------------------------------------------------------------------------------------------------------------------------
(In thousands)
Consumer &
Commercial Management Other
1999 Services Services Operations Consolidated
- -------------------------------------------------- ----------------- ----------------- -------------- ---------------
<S> <C> <C> <C> <C>
Revenue $ 910,874 $ 468,174 $ 158,026 $ 1,537,074
Operating Income $ 126,258 $ 67,452 $ (137,071) $ 56,639
Operating Income Excluding Non-Recurring Items $ 126,258 $ 17,352 $ (1,471) $ 142,139
Total Assets $ 3,303,016 $ 216,116 $ 290,047 $ 3,809,179
1998
- --------------------------------------------------
Revenue $ 581,319 $ 507,856 $ 155,452 $ 1,244,627
Operating Income $ 91,200 $ 17,833 $ 4,762 $ 113,795
Total Assets $ 2,086,989 $ 240,443 $ 476,788 $ 2,804,220
Six Months
Ended June 30,
- ----------------------------------------------------------------------------------------------------------------------------------
(In thousands)
Consumer &
Commercial Management Other
1999 Services Services Operations Consolidated
- -------------------------------------------------- ----------------- ----------------- -------------- ---------------
Revenue $ 1,372,851 $ 969,386 $ 309,899 $ 2,652,136
Operating Income $ 188,799 $ 86,654 $ (140,186) $ 135,267
Operating Income Excluding Non-Recurring Items $ 188,799 $ 36,554 $ (4,586) $ 220,767
1998
- --------------------------------------------------
Revenue $ 945,211 $ 981,744 $ 299,460 $ 2,226,415
Operating Income $ 140,737 $ 36,149 $ 6,682 $ 183,568
</TABLE>
Note 11: The long term care industry has recently undergone a dramatic
transition period, largely as a result of changes in government reimbursement
and compliance policies. The Company's Diversified Health Services unit manages
long term care facilities and, in a number of cases, has helped finance these
facilities generally in return for a long term management contract and a share
in the market appreciation of the facility. The division also provides a number
of ancillary services and products, including rehabilitation therapy, medical
supplies, pharmacy, and design and build services. Last quarter, the Company
announced that it was undertaking a strategic review and assessment of its
Diversified Health Services business due to changes in reimbursement and
compliance policies and the resulting financial difficulties of a number of its
customers. Based on the review of the business and the credit risks involved,
the Company has determined to reduce the scope of services offered
substantially, including ancillary services, and eliminate all future credit
extension agreements. As a result, in the second quarter the Company recorded an
after-tax charge of $81 million for the restructuring and write-down of assets
relating to Diversified Health Services. Approximately $12 million of the charge
relates to provisions for future expected cash expenditures.
7
<PAGE>
The following summarizes the components of the charge:
(After-tax, in millions)
Write-down of receivables,
loans, and investments in nursing homes $19
Provision for losses on contractual provisions
and exit costs of certain ancillary services 11
Write-down of impaired assets,
primarily goodwill 51
---
Total $81
===
The write-down of receivables, loans, and investments in nursing homes is
largely due to the deterioration in the financial viability of the customers
resulting from Medicare changes. The majority of the write-down relates to seven
troubled homes. As noted above, the Company has also taken a charge to provide
for losses and exposures relating to exiting contracts and services. The Company
has exited or will exit a number of client arrangements in which customers are
not paying Diversified Health Services and the prospect of collection is low.
The Company is sensitive to the need to provide quality patient care throughout
the transition period of the Company's exit in these contracts.
Given the uncertainty in the industry and the Company's decision to reduce the
size and scope of Diversified Health Services, the Company took a charge to
write-down the assets of Diversified Health Services. The Company reviewed the
expected cash flows from the business, which were less than the carrying value
of the assets, and accordingly, recorded an impairment charge.
Note 12: In June 1998, the Financial Accounting Standards Board issued a
Statement of Financial Accounting Standards No. 133, "Accounting for Derivative
Instruments and Hedging Activities". This Statement was subsequently amended to
defer its effective date. The Company intends to adopt this Statement in January
2001 as required by the amended Statement. Adoption of this Statement is not
expected to have a material impact on the Company's financial statements.
8
<PAGE>
THE SERVICEMASTER COMPANY
MANAGEMENT DISCUSSION AND ANALYSIS
RESULTS OF OPERATIONS
SECOND QUARTER 1999 COMPARED TO SECOND QUARTER 1998
- ---------------------------------------------------
Revenues increased 23 percent over the second quarter of 1998 to $1.5 billion,
reflecting strong growth from both base operations and acquisitions.
Approximately eight percent of the revenue increase resulted from internal
growth and small roll-up acquisitions in established businesses while the newer
initiatives including landscaping, plumbing, and HVAC provided 22 percent of the
growth. This growth was partially offset by the sale of Premier and
ServiceMaster Energy Management and the wind-down of the Home Health Care
business. Operating income before non-recurring unusual items increased 25
percent over the prior year, while margins increased to 9.2 percent of revenue
from 9.1 percent in 1998. The operating margin improvement reflects continued
strong growth in the higher margin Consumer and Commercial Services segment
offset in part by acquiring businesses with margins below the Company average.
Net income before non-recurring unusual items, increased 23 percent to $69.3
million from $56.4 million in 1998. Diluted earnings per share before
non-recurring items increased 16 percent to $.22. Earnings per share grew at a
lower rate than net income due to the equity offering in May 1998 and the impact
of shares issued in acquisitions. During the quarter the Company realized an
after-tax gain of $30 million, relating to the sale of its Premier automotive
business and the sale of its remaining 15 percent interest in ServiceMaster
Energy Management. In addition, the Company recorded a one-time after-tax charge
of $81 million relating to its Diversified Health Services business. These items
reduced net income from ongoing operations by $51 million ($85.5 million
pretax). As a result, the Company reported net income of $18 million, with
diluted earnings per share of $.06.
The Consumer and Commercial Services business unit reported revenue of $911
million, an increase of 57 percent, and operating income of $126.3 million, 38
percent higher than last year. The segment's profit growth included double digit
growth in the established businesses, as well as contributions from landscaping,
plumbing, and HVAC initiatives. TruGreen-ChemLawn achieved solid revenue and
profit growth for the quarter reflecting continued strong momentum in the
commercial landscape operations. The landscape operations, TruGreen Landcare,
has achieved significant increases through acquisitions but has also realized
strong internal growth. Over the next twelve months, the Company intends to
implement a new operating system which may provide margin improvements in the
future. Solid sales of add-on lawn care services and growth in commercial
accounts helped support somewhat weaker growth in residential lawn care
services. Terminix achieved excellent growth in revenues and profits due to
strong increases in termite completions and renewals, improved branch
efficiencies and the successful integration of acquisitions. Growth in new
termite customers reflects a continued strong demand of the termite baiting
systems. American Home Shield achieved double digit growth in revenues and
profits, reflecting increases in warranty contracts sold through all
distribution channels. The combined Rescue Rooter and American Residential
Services (ARS) operations reported strong growth in revenue and profits,
reflecting continued productivity improvements in the plumbing operation and
good initial results from the integration of the businesses.
9
<PAGE>
The franchise operations, Residential/Commercial and Merry Maids, reported
strong growth in revenues and profits as a result of the continued strong growth
of company owned operations, increased licenses sales, and productivity
initiatives.
The Management Services business unit reported revenue of $468 million and
operating income of $67.5 million. In the second quarter, the segment recorded a
$30 million after-tax gain ($50 million pretax) resulting from the sales of its
Premier automotive unit and its remaining 15 percent interest in ServiceMaster
Energy Management. Revenues from continuing operations grew two percent to $468
million as strong sales in the Education and Business & Industry markets were
partially offset by a decrease in the larger Healthcare market. Operating income
from continuing operations increased six percent, as a result of strong overhead
cost controls. All these markets ended the quarter with a higher base of
annualized revenue than the beginning of the year levels.
On April 21, 1999, the Company sold its Premier business unit to Durr AG of
Germany for $76 million. Premier provides cleaning services for paint booths and
other related maintenance services in the automotive industry. The Company
believes that alliances or significant incremental investments would have been
required to remain competitive in this industry. The sale of Premier allowed
ServiceMaster to realize the significant appreciation in its investment and to
reinvest the proceeds in initiatives more central to the Company's core
strategies. The sale resulted in an after-tax gain of approximately $25 million
($42 million pretax). Also in the quarter, the Company sold its remaining 15
percent interest in ServiceMaster Energy Management to its partner, Texas
Utilities, which resulted in an after-tax gain of $5 million ($8 million
pretax).
In the first quarter of this year, the Company announced that it was undertaking
a strategic review and assessment of the services comprising the Diversified
Health Services operation. Diversified Health Services provides general
management services for long term care facilities, as well as a number of
ancillary services, including rehabilitation therapy, medical supplies,
pharmacy, and design and build services. In addition, the Company has provided
financing to certain facilities. As a result of the review, the Company recorded
an after-tax charge of $30 million in the second quarter relating to customer
receivables, loans, and other investments, as well as provisions for contractual
commitments. An after-tax charge of $51 million was also recorded for the
write-down of goodwill relating to these businesses. Of the total charges, only
$12 million will result in future cash payments. Following these actions, the
scope and services offered, including ancillary services, will be substantially
reduced and all future credit extension agreements will be eliminated.
Cost of services rendered and products sold increased 23 percent due primarily
to general business growth and acquisitions, but decreased as a percentage of
revenue to 76.0 percent from 76.4 percent in 1998. This decrease primarily
reflects the changing business mix of the business as Consumer and Commercial
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 and Commercial Services. The Consumer and
10
<PAGE>
Commercial Services businesses generally operate at higher gross margin levels
than the rest of the business, but also incur somewhat higher selling and
administrative expenses as a percentage of revenues.
Selling and administrative expenses increased 26 percent due to general business
growth and acquisitions, and increased as a percentage of revenue to 14.7
percent from 14.4 percent in 1998. This increase as a percentage of revenue is
primarily due to the changing business mix of the company noted above.
Interest expense increased over the prior year primarily due to increased debt
levels associated with acquisitions. The tax provision reflects a higher
effective tax rate compared to last year, primarily due to the non-deductibility
of goodwill for several large acquisitions completed in 1999.
SIX MONTHS ENDED JUNE 30, 1999 AS COMPARED TO JUNE 30, 1998
- -----------------------------------------------------------
Revenues for the six months increased 19 percent over 1998 to $2.7 billion,
reflecting strong base business growth and the effect of acquisitions.
Approximately 8 percent of the growth came from internal sources and small
roll-up acquisitions in existing service lines with another 15 percent increase
resulting from the newer initiatives in landscaping, plumbing, and HVAC. As
noted in the three month comparison, this growth was offset by the sale and
exiting of certain businesses. Operating income, excluding the non-recurring
unusual items noted in the three month discussion, increased 20 percent, while
margins increased to 8.3 percent of revenue from 8.2 percent in 1998. Operating
margins improved due to the change in business mix, as Consumer and Commercial
Services comprises a higher percentage of the consolidated operating income.
Diluted earnings per share for the six months, excluding non-recurring items,
were $.34 compared to diluted earnings per share of $.29 last year, an increase
of 17 percent. On this same basis, net income grew 22 percent to $104.9 million
from $85.7 million. Net income grew at a faster rate than earnings per share due
to an increase in shares outstanding, as a result of the equity offering and
shares issued for acquisitions. As discussed in the three month comparison, the
Company realized after-tax gains totaling $30 million relating to the sales of
businesses and recorded an after-tax charge of $81 million relating to its
Diversified Health Services business. These items reduced net income form
ongoing operations by $51 million ($85.5 million pretax). As a result of these
items, for the six months, the Company reported net income of $53.6 million and
diluted earnings per share of $.17.
The Consumer and Commercial Services business unit achieved a 45 percent
increase in revenue to $1.4 billion and operating income of $188.8 million, 34
percent higher than last year. The segment's profit growth included double digit
increases at all companies, reflecting acquisitions and internal growth.
TruGreen-ChemLawn reported double digit increases in both revenue and profits as
solid growth in its lawn care operations was complimented by excellent growth in
the newer commercial landscape initiative. Approximately one-half of the
segment's 45 percent growth in revenue came from the entry into the commercial
landscape business. With the acquisition of LandCare USA, which was completed in
March, the Company became the largest provider of commercial landscape services
in the country. The acquisition provides TruGreen-ChemLawn the opportunity to
integrate its traditional lawn care services with
11
<PAGE>
landscape maintenance. Terminix achieved very strong revenue and profit
growth for the six months, reflecting strong growth in all service lines and
continued strong customer reception of the newer termite baiting systems.
American Home Shield reported double digit growth in both revenues and profits
with strong increases in direct-to-consumer sales and renewal sales. Rescue
Rooter reported significant increases in revenues and profits, reflecting
the acquisition of ARS in April and solid growth in the established business.
ARS provides comprehensive maintenance and repair services for HVAC, plumbing,
electrical and other systems, and major appliances in homes and commercial
buildings. The acquisition of ARS establishes the Company as one of the
country's leading providers of heating, ventilation, and air conditioning
services and will complement the Company's plumbing business. The franchise
operations, Residential/Commercial and Merry Maids operations reported strong
revenue and profit growth for the six months as a result of increased franchise
licenses sales and the benefit of productivity initiatives at the branches.
The Management Services business unit reported revenue of $969 million and
operating income of $86.7 million for the first six months. As discussed in the
three month comparison, the segment recorded a significant gain related to the
sale of two of its business units. Revenues and operating income from continuing
operations increased four percent and five percent, respectively. This growth
reflects the benefit of acquisitions made in April 1998 and overhead efficiency
gains throughout the business unit. For the six months, the traditional
Healthcare market reported a decrease in revenue and profits, reflecting the
termination of large accounts in the latter part of 1998. The Education
market reported slightly higher profits, as good sales activity and
controlled overhead spending offset margin declines from certain contract
renegotiations. The Business & Industry group achieved strong growth in revenues
and profits, reflecting the successful integration of acquisitions and base
business growth.
Cost of services rendered and products sold increased 18 percent, primarily due
to general business growth and acquisitions. Cost of services decreased as a
percentage of revenue to 78.0 percent in 1999 from 78.4 percent in 1998. This
decrease primarily reflects the changing mix of the business as Consumer and
Commercial Services increases in size in relationship to the overall business of
the Company. The Consumer and Commercial Services businesses generally operates
at higher gross margin levels than the rest of the business but also incur
somewhat higher selling and administrative expenses as a percentage of revenue.
Selling and administrative expenses increased 22 percent due to general business
growth and acquisitions, and increased as a percentage of revenue to 13.7
percent in 1999 from 13.3 percent in 1998. This increase as a percentage of
revenue is primarily attributable to the changing business mix of the Company
noted above.
The increase in interest expense for the six months is due to increased debt
levels associated with acquisitions, partially offset by proceeds from the May
1998 equity offering. Interest and investment income increased over prior year
primarily due to increased gains realized on sales of marketable securities from
the American Home Shield portfolio. The tax provision reflects a higher
effective tax rate compared to last year, which reflects increased
non-deductible intangible amortization expense.
12
<PAGE>
FINANCIAL POSITION
- ------------------
Net cash provided from operations of $28 million was significantly below the
first six months of 1998. The decrease primarily reflects the deferral of the
1998 federal tax payment until March of 1999. Federal taxes of $78 million on
the Company's 1998 earnings were accrued for in the financial statements in
1998, but not paid until the first quarter of 1999. Excluding this tax payment,
cash provided from operations was comparable to 1998 at $106 million. (Some of
the tax expense in 1998 and 1999 will be deferred for longer periods of time due
to the significant timing difference between book and tax basis.) Due to the
seasonality of the lawn care, landscape, and pest control operating cycles, the
Company's working capital needs are higher during the first half of the year and
have a significant impact on funds provided from operations. Working capital
needs increased in the first six months of 1999 over 1998, reflecting the
significant growth in the Company's seasonal businesses, especially landscaping
operations which primarily experienced increases in receivables and in inventory
levels. 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.
Accounts and notes receivable grew over year end levels, reflecting general
business growth, increased seasonal activity in the Consumer and Commercial
Services segment, and acquisitions, primarily LandCare and ARS. Inventories also
increased over year end levels as a result of normal seasonal build-ups in the
lawn care business and acquisitions.
Prepaids and other assets have increased from year end because of seasonality in
the lawn care business and acquisitions in the landscape and plumbing
operations. The lawn care operation defers certain marketing costs that are
incurred during the first six months, 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.
Deferred revenues also grew significantly, reflecting strong growth at American
Home Shield, increases in customer prepayments for lawn care and pest control
services, and the acquisition of ARS. Accrued liabilities and payables increased
from year end, primarily due to the acquisition activity and seasonality of the
business.
Property and equipment increased due to general business growth and
acquisitions, primarily LandCare and ARS. Capital expenditures grew, reflecting
increased investments in technology throughout the organization, business
growth, and recurring capital needs. The Company has no material capital
commitments at this time.
Total acquisitions in the first half of the year were approximately $789 million
($603 million of which was from the LandCare USA and American Residential
Services acquisitions). Approximately one-third of the acquisitions were in the
form of shares. Intangible assets increased $487 million from year end,
reflecting the effect of the acquisitions, which included $260 million from
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<PAGE>
LandCare, $213 million from ARS and various smaller acquisitions in the Consumer
and Commercial Services segment.
Debt levels increased due to the seasonal nature of the Company's operating cash
flows and the 1998 tax payment, combined with the effects of acquisitions and
property additions. 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.
In August 1999, the Company completed a senior unsecured debt offering of $250
million, 7.875 percent notes priced to yield 7.98 percent and due August 15,
2009. The net proceeds will be used to repay a portion of the Company's
borrowings under its revolving bank credit facility, thereby, reducing the
Company's exposure to short term interest rate fluctuations.
Total shareholders' equity increased to $1.2 billion in 1999 from $956 million
at December 31, 1998, reflecting earnings growth as well as the shares issued
for acquisitions, partially offset by cash dividends and treasury share
repurchases. Cash dividends paid directly to shareholders totaled $55 million or
$.18 per share. The increase from the prior year reflects a 12 percent increase
in the dividend rate per share and an increase in shares outstanding, primarily
resulting from the May 1998 equity offering and shares issued in acquisitions.
YEAR 2000 READINESS DISCLOSURE
- ------------------------------
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 and services. 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
14
<PAGE>
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 have required 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 were completed by June 30,
1999. As of August 10, 1999, work on each of the Key Projects not already
completed was on schedule and the Company believes that all Key Projects will be
completed in accordance with their scheduled completion dates.
The Company 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.
In addition to the Key Projects, remediation plans were developed for LandCare
USA, Inc. and American Residential Services, which were acquired in March and
April of 1999, respectively. In both cases, the companies have extensive branch
networks, which operate on a variety of different platforms. The Company intends
to remediate these branches by implementing a common operating system where
possible by year end, and implementing Y2K upgrades to the existing systems in
the other branches. At this time, the Company does not expect Y2K problems to
occur as a result of the 1999 acquisitions which will have a material adverse
effect on the ServiceMaster enterprise.
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 its results of operations or
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
15
<PAGE>
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 risk in respect of the
Year 2000 problem, 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 certain products are the critical items
in this regard. Based on the Company's inquiries to its providers of goods and
services as well as 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 and its customers depend.
The Company has reviewed its agreements with certain of 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 has notified 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 ready. The
Company is confident that such software is already, or soon will be, Y2K ready.
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 ready
or, alternatively, provision has been made for making available to franchisees
software from third-party developers from whom appropriate Y2K 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 ready 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 ready 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 its own critical remediation efforts will be
completed prior to the Year 2000, the untimely completion of Y2K remediation
efforts by third parties could, in certain circumstances, have a material
adverse effect on the operations of the Company.
16
<PAGE>
Definition. As used in this Year 2000 Readiness Disclosure Statement, the term
"year 2000 ready" or "Y2K ready" when used with reference to a item of software
or equipment means the capability of the software or equipment to process
correctly (including calculating, comparing, sequencing, displaying, or
storing), transmit, or receive date data from, into, and between the 20th and
21st centuries, and during the years 1999 and 2000, and to make leap year
calculations, provided that all products used with the software or equipment
properly exchange accurate date data with it.
17
<PAGE>
PART II. OTHER INFORMATION
Item 1: Legal Proceedings
In the ordinary course of its business activities, ServiceMaster becomes
involved in judicial and administrative proceedings that involve both private
parties and governmental authorities. As of August 13, 1999, these proceedings
included a number of general liability actions and a very small number of
environmental proceedings, none of which was material to ServiceMaster's
financial condition or results of operations.
American Home Shield of Texas Litigation. A lawsuit was filed in November
1997 in the District Court of Harris County, Texas against ServiceMaster,
ServiceMaster's American Home Shield subsidiary ("AHS") and AHS' Texas
subsidiary ("AHS-Texas") in which the plaintiffs claimed that AHS-Texas violated
certain provisions of two Texas consumer protection statutes in the course of
soliciting new and renewal home systems and appliance warranty contracts
("warranty contracts") (Kortz et. al. v. American Home Shield of Texas, et. al.,
originally filed under the name Lugrin et. al. v. American Home Shield of Texas,
et. al). A second lawsuit making similar allegations was filed in the same court
(Thorn v. American Home Shield of Texas, et. al) but this second lawsuit was
abated to the extent that any issues therein overlapped with issues litigated in
the Lugrin case. In April 1999, AHS-Texas filed an interlocutory appeal of the
District Court's certification of two sub-classes in the Lugrin case. While this
appeal was pending the Texas Legislature enacted H.B. No. 1521 and, on June 19,
1999, the Governor of Texas signed this legislation into law. H.B. No. 1521,
which was effective immediately, amends the private right of action under one of
the two statutes upon which plaintiffs base their claims by removing a statutory
$1,000 penalty provision. The enactment of H.B. 1521 has the effect of requiring
the plaintiffs in the Lugrin and Thorn cases to prove that they were actually
harmed in order to recover damages. ServiceMaster believes that the plaintiffs
have not been harmed by the conduct that they have alleged and, in any event,
that the AHS-Texas warranty contracts comply with Texas law. Accordingly,
ServiceMaster believes that the ultimate outcome of the Lugrin and Thorne cases
will not be material to ServiceMaster's financial condition or results of
operations.
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, involve 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 and Commercial
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.
18
<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: August 13, 1999
THE SERVICEMASTER COMPANY
(Registrant)
By: /s/Steven C. Preston
----------------------------------------------------
Steven C. Preston
Executive Vice President and Chief Financial Officer
19
<PAGE>
<TABLE> <S> <C>
<ARTICLE> 5
<LEGEND>
THIS SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION EXTRACTED FROM THE
SERVICEMASTER QUARTERLY REPORT TO SHAREHOLDERS FOR THE PERIOD ENDED
JUNE 30, 1999 AND IS QUALIFIED IN ITS ENTIRETY BY REFERENCE TO SUCH
FINANCIAL STATEMENTS.
</LEGEND>
<MULTIPLIER> 1000
<S> <C> <C>
<PERIOD-TYPE> 6-MOS 6-MOS
<FISCAL-YEAR-END> DEC-31-1999 DEC-31-1998
<PERIOD-START> JAN-01-1999 JAN-01-1998
<PERIOD-END> JUN-30-1999 JUN-30-1998
<CASH> 53,934 52,324
<SECURITIES> 55,713 65,580
<RECEIVABLES> 618,728 418,921
<ALLOWANCES> 43,608 37,576
<INVENTORY> 82,586 55,135
<CURRENT-ASSETS> 984,584 733,392
<PP&E> 629,912 432,802
<DEPRECIATION> 320,265 240,730
<TOTAL-ASSETS> 3,809,179 2,804,220
<CURRENT-LIABILITIES> 845,811 681,245
<BONDS> 1,644,961 1,173,159
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0 0
<COMMON> 3,115 1,964
<OTHER-SE> 1,190,249 818,173
<TOTAL-LIABILITY-AND-EQUITY> 3,809,179 2,804,220
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<TOTAL-REVENUES> 2,652,136 2,226,415
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<TOTAL-COSTS> 2,068,652 1,746,163
<OTHER-EXPENSES> 448,217 296,684
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<INTEREST-EXPENSE> 50,838 48,640
<INCOME-PRETAX> 93,699 143,752
<INCOME-TAX> 40,055 58,078
<INCOME-CONTINUING> 53,644 85,674
<DISCONTINUED> 0 0
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