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, 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: 310,498,000 shares on November 5, 1999.
This document consists of 18 pages, including the cover page.
<PAGE>
TABLE OF CONTENTS
Page
No.
THE SERVICEMASTER COMPANY (Registrant) -
PART I. FINANCIAL INFORMATION
Consolidated Statements of Income for the three and
nine months ended September 30, 1999 and September 30, 1998 2
Consolidated Statements of Financial Position
as of September 30, 1999 and December 31, 1998 3
Consolidated Statements of Cash Flows for the nine months
ended September 30, 1999 and September 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 16
Signature 17
1
<PAGE>
PART I. FINANCIAL INFORMATION
THE SERVICEMASTER COMPANY
CONSOLIDATED STATEMENTS OF INCOME
(IN THOUSANDS, EXCEPT PER SHARE DATA)
<TABLE>
<CAPTION>
Three Months Ended Nine Months Ended
September 30, September 30,
1999 1998 1999 1998
--------------- -------------- ---------------- --------------
<S> <C> <C> <C> <C>
OPERATING REVENUE .................................. $ 1,584,225 $ 1,273,093 $ 4,236,361 $ 3,499,508
OPERATING COSTS AND EXPENSES:
Cost of services rendered
and products sold .................................. 1,224,340 956,375 3,292,992 2,702,538
Selling and administrative expenses ................ 226,898 202,870 589,615 499,554
Other, net (1) ..................................... -- -- 85,500 --
----------- ----------- ----------- -----------
Total operating costs and expenses ................. 1,451,238 1,159,245 3,968,107 3,202,092
----------- ----------- ----------- -----------
OPERATING .......................................... 132,987 113,848 268,254 297,416
Income
NON-OPERATING EXPENSE (INCOME):
Interest ........................................... 30,083 22,404 80,921 71,044
expense
Interest and investment income ..................... (10,125) (3,092) (19,395) (11,916)
----------- ----------- ----------- -----------
INCOME BEFORE INCOME TAXES ......................... 113,029 94,536 206,728 238,288
Provision for income taxes ......................... 46,392 38,184 86,447 96,262
----------- ----------- ----------- -----------
NET INCOME ......................................... $ 66,637 $ 56,352 $ 120,281 $ 142,026
=========== =========== =========== ===========
PER SHARE
Basic (1) (2) (3) ............................... $ .21 $ .19 $ .39 $ .49
=========== =========== =========== ===========
Diluted (1) (2) (3) ............................. $ .21 $ .19 $ .38 $ .48
=========== =========== =========== ===========
DIVIDENDS PER SHARE (3) ........................... $ .09 $ .08 $ .27 $ .24
=========== =========== =========== ===========
</TABLE>
(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:
<TABLE>
<CAPTION>
Three Months Ended Nine Months Ended
September 30, September 30,
1999 1998 1999 1998
-------------- ------------- ------------- ------------
<S> <C> <C> <C> <C>
Net income before non-recurring items, net ............... $ 66,637 $ 56,352 $ 171,581 $ 142,026
Per share before non-recurring items, net:
Basic ................................................. $ .21 $ .19 $ .56 $.49
========== ========== =========== ===========
Diluted ............................................... $ .21 $ .19 $ .55 $.48
========== ========== =========== ===========
</TABLE>
(2) Basic earnings per share are calculated based on 311,158 shares and 294,686
shares for the three months ended September 30, 1999 and 1998, respectively and
307,106 shares and 286,938 shares for the nine months ended September 30, 1999
and 1998, respectively. Diluted earnings per share are calculated based on
317,502 shares and 304,464 shares for the three months ended September 30, 1999
and 1998, respectively and 314,589 shares and 296,603 shares for the nine months
ended September 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
2
<PAGE>
THE SERVICEMASTER COMPANY
CONSOLIDATED STATEMENTS OF FINANCIAL POSITION
(IN THOUSANDS)
<TABLE>
<CAPTION>
As of
September 30, December 31,
1999 1998
------------ -------------
ASSETS
CURRENT ASSETS:
<S> <C> <C>
Cash and cash equivalents............................................ $ 21,722 $ 66,400
Marketable securities................................................ 55,190 54,022
Receivables, less allowances of $39,246
and $38,988, respectively......................................... 598,909 372,375
Inventories.......................................................... 76,171 49,770
Prepaid expenses and other assets.................................... 175,664 127,635
------------ -------------
Total current assets............................................. 927,656 670,202
------------ -------------
PROPERTY AND EQUIPMENT:
At cost........................................................... 650,791 441,209
Less: accumulated depreciation................................... 330,507 229,049
------------ -------------
Net property and equipment....................................... 320,284 212,160
------------ -------------
INTANGIBLE ASSETS, PRIMARILY TRADE NAMES AND GOODWILL,
net of accumulated amortization of $319,718
and $272,254, respectively........................................ 2,406,923 1,884,002
NOTES RECEIVABLE, LONG-TERM SECURITIES, AND OTHER ASSETS............. 136,521 148,487
------------ -------------
Total assets..................................................... $ 3,791,384 $ 2,914,851
============ =============
</TABLE>
<TABLE>
<CAPTION>
LIABILITIES AND SHAREHOLDERS' EQUITY
CURRENT LIABILITIES:
<S> <C> <C>
Accounts payable..................................................... $ 136,600 $ 110,523
Income taxes payable................................................. 36,197 84,165
Accrued liabilities.................................................. 311,054 302,424
Deferred revenues.................................................... 237,996 204,969
Current portion of long-term obligations............................. 44,725 51,616
------------ -------------
Total current liabilities........................................ 766,572 753,697
------------ -------------
LONG-TERM DEBT....................................................... 1,687,831 1,076,167
OTHER LONG-TERM OBLIGATIONS.......................................... 112,183 128,501
COMMITMENTS AND CONTINGENCIES .......................................
SHAREHOLDERS' EQUITY:
Common stock $0.01 par value, authorized 1 billion shares; issued
and outstanding 311,390 and 298,030 shares, respectively......... 3,114 2,980
Additional paid-in capital........................................... 1,035,811 788,124
Retained earnings.................................................... 217,049 179,840
Accumulated other comprehensive income............................... (2,957) 3,911
Restricted stock..................................................... (2,778) (3,383)
Treasury stock....................................................... (25,441) (14,986)
------------ -------------
Total shareholders' equity....................................... 1,224,798 956,486
------------ -------------
Total liabilities and shareholders' equity...................... $ 3,791,384 $ 2,914,851
============ =============
</TABLE>
SEE NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
3
<PAGE>
THE SERVICEMASTER COMPANY
CONSOLIDATED STATEMENTS OF CASH FLOWS
(IN THOUSANDS)
<TABLE>
<CAPTION>
Nine Months Ended
September 30,
1999 1998
------------ ------------
<S> <C> <C>
CASH AND CASH EQUIVALENTS AT JANUARY 1................................ $ 66,400 $ 64,876
CASH FLOWS FROM OPERATIONS:
NET INCOME............................................................ 120,281 142,026
Adjustments to reconcile net income
to net cash flows from operations:
Depreciation and amortization.................................. 94,759 79,137
Non-recurring items (pretax)................................... 85,500 -
Change in working capital, net of acquisitions:
Receivables.................................................. (106,890) (84,901)
Inventories and other current assets......................... (26,856) (8,011)
Accounts payable............................................. (21,705) 9,527
Deferred revenues............................................ 9,429 3,380
Accrued liabilities.......................................... (31,110) (21,150)
Deferred 1998 tax payment.................................... (78,478) -
Deferred income taxes........................................ 24,073 88,736
Other, net........................................................ (335) (3,127)
------------- -------------
NET CASH PROVIDED FROM OPERATIONS..................................... 68,668 205,617
------------- ------------
NET CASH PROVIDED FROM OPERATIONS EXCLUDING ALL TAXES (MEMO) 209,520 213,143
CASH FLOWS FROM INVESTING ACTIVITIES:
Business acquisitions, net of cash acquired....................... (452,441) (171,640)
Property additions................................................ (71,875) (58,921)
Sale of equipment and other assets............................... 4,796 3,775
Proceeds from the sale of businesses.............................. 68,490 -
Payments to sellers of acquired businesses........................ (9,589) (7,830)
Notes receivable and financial investments........................ (16,751) (3,920)
Net purchases of investment securities............................ (6,500) (5,802)
------------- ------------
NET CASH USED FOR INVESTING ACTIVITIES................................ (483,870) (244,338)
------------- ------------
CASH FLOWS FROM FINANCING ACTIVITIES:
Borrowings, net................................................... 1,164,916 253,567
Payments of borrowings and other obligations...................... (692,665) (373,727)
Shareholders' dividends........................................... (83,072) (58,316)
Purchase of ServiceMaster stock................................... (35,174) (12,237)
Proceeds from employee share plans................................ 16,019 7,302
Proceeds from stock offering...................................... - 208,770
Other............................................................. 500 5,194
--- ------
NET CASH PROVIDED FROM FINANCING ACTIVITIES........................... 370,524 30,553
------------- ------------
CASH DECREASE DURING THE PERIOD....................................... (44,678) (8,168)
------------- ------------
CASH AND CASH EQUIVALENTS AT SEPTEMBER 30............................. $ 21,722 $ 56,708
============= ============
</TABLE>
SEE NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
4
<PAGE>
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 September 30, 1999 and December 31, 1998, and
the results of operations for the three month and nine month periods ended
September 30, 1999 and 1998, and the cash flows for the nine months ended
September 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 September 30, 1999 Ended September 30, 1998
------------------------------- ------------------------------
(IN THOUSANDS, EXCEPTPER SHARE DATA) Income Shares EPS Income Shares EPS
<S> <C> <C> <C> <C> <C> <C>
Basic earnings per share $66,637 311,158 $.21 $56,352 294,686 $.19
Effect of dilutive securities -options - 6,344 ==== - 9,778 =====
---------- ---------- ---------- --------
Diluted earnings per share $66,637 317,502 $.21 $56,352 304,464 $.19
======= ======= ==== ======= ======= =====
</TABLE>
5
<PAGE>
<TABLE>
<CAPTION>
Nine Months Nine Months
Ended September 30, 1999 Ended September 30, 1998
------------------------------- ------------------------------
(IN THOUSANDS, EXCEPT PER SHARE DATA) Income Shares EPS Income Shares EPS
<S> <C> <C> <C> <C> <C> <C>
Basic earnings per share $120,281 307,106 $.39 $142,026 286,938 $.49
Effect of dilutive securities: ===== =====
Options - 7,483 - 9,300
Convertible debentures - - 32 365
---------- ---------- ---------- ----------
Diluted earnings per share $120,281 $314,589 $.38 $142,058 296,603 $.48
========== ========== ===== ========== ========= =====
</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 nine months ended September 30,
1999 and 1998 is presented in the following table. The $7 million increase in
interest and investment income resulted primarily from additional gains relating
to finacial investments. The significant increase in income taxes paid in 1999
reflects the payment of the 1998 federal tax obligation and 1999 estimated
income tax payments.
<TABLE>
<CAPTION>
(IN THOUSANDS) 1999 1998
--------- -----------
Cash paid or (received for):
<S> <C> <C>
Interest expense............................................ $ 84,135 $ 78,995
Interest and investment income.............................. $ (13,054) $ (6,597)
Income taxes................................................ $ 140,852 $ 7,526
</TABLE>
NOTE 7: Total comprehensive income was $63.9 million and $52.6 million for the
three months ended September 30, 1999 and 1998, respectively, and $113.4 million
and $138.9 million for the nine months ended September 30, 1999 and 1998,
respectively. Total comprehensive income includes net income, changes in
unrealized gains on marketable securities and translation balances.
NOTE 8: In the second quarter the Company sold its Premier business unit for $76
million 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 9: 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.
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 and nine months ended September 30
are as follows:
6
<PAGE>
<TABLE>
<CAPTION>
THREE MONTHS
ENDED SEPTEMBER 30,
- ----------------------------------------------------------------------------------------------------------------------------------
(IN THOUSANDS)
CONSUMER &
COMMERCIAL MANAGEMENT OTHER
1999 SERVICES SERVICES OPERATIONS CONSOLIDATED
- -------------------------------------------------- ----------------- ----------------- -------------- ---------------
<S> <C> <C> <C> <C>
Revenue $ 943,585 $ 481,948 $ 158,692 $1,584,225
Operating Income $ 106,880 $ 19,829 $ 6,278 $ 132,987
Total Assets $3,298,910 $ 215,949 $ 276,525 $3,791,384
1998
- --------------------------------------------------
Revenue $ 589,710 $ 522,983 $ 160,400 $1,273,093
Operating Income $ 85,845 $ 20,916 $ 7,087 $ 113,848
Total Assets $2,175,220 $ 249,440 $ 458,804 $2,883,464
</TABLE>
<TABLE>
<CAPTION>
NINE MONTHS
ENDED SEPTEMBER 30,
- ----------------------------------------------------------------------------------------------------------------------------------
(IN THOUSANDS)
CONSUMER &
COMMERCIAL MANAGEMENT OTHER
1999 SERVICES SERVICES OPERATIONS CONSOLIDATED
- -------------------------------------------------- ----------------- ----------------- -------------- ---------------
<S> <C> <C> <C> <C>
Revenue $2,316,436 $1,451,334 $ 468,591 $4,236,361
Operating Income $ 295,679 $ 106,483 $ (133,908) $ 268,254
Operating Income Excluding Non-Recurring Items $ 295,679 $ 56,383 $ 1,692 $ 353,754
1998
- --------------------------------------------------
Revenue $1,534,921 $1,504,727 $ 459,860 $3,499,508
Operating Income $ 226,582 $ 57,065 $ 13,769 $ 297,416
</TABLE>
NOTE 10: In the first quarter of 1999, the Company announced that it was
undertaking a strategic review and assessment of its Diversified Health Services
business due to changes in government reimbursement and compliance policies and
the resulting financial difficulties of a number of its customers. Based on this
review, the Company determined to reduce the scope of services offered
substantially and, 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. The after-tax components of the charge consisted
of: the write-down of impaired assets primarily goodwill ($51 million), the
write-down of receivables, loans and investments in nursing homes and contracts
($19 million), and the provision for losses on contractual arrangements and exit
costs of certain ancillary services ($11 million). Approximately $2 million of
this provision was utilized in the third quarter. The Company believes the
remaining $9 million is adequate. The results of operations of the Diversified
Health Services business were not material to the Company's financial results
for the periods presented.
NOTE 11: 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.
NOTE 12: In June 1996, Ray D. Martin, a former salesman employed by
ServiceMaster's Management Services unit filed a lawsuit in the Circuit Court of
Fulton County, Georgia (Civ. Action File No. 96VS114677J), which as originally
filed contended that the Company had not paid him the full amount of commission
due to him on a sale in which he was involved. The Company believed that the
commission was not payable under the
7
<PAGE>
Company's commission policies and procedures. The amount then in issue was
approximately $180,000. In the course of the pre-trial proceedings, the trial
court entered a default judgment against the Company. Consequently, the Company
was not permitted to defend its position and the only issue left to be
considered at the trial was the question of damages. In addition, the trial
court then permitted the plaintiff to amend his complaint to include a tort
claim, which allowed for the levying of punitive damages. However, the trial
court did not permit the Company to file an answer to the amended complaint or
otherwise to make the point that there is no basis for a tort claim in the
circumstances of this case. On September 29, 1999, the trial court entered final
judgement for the plaintiff in a total amount of $136,259,417. Under Georgia
law, that judgment will accrue post-judgment interest at a statutory rate of 12%
per annum, except for the portion of the judgment ($77,189) that represents
pre-judgment interest. On October 14, 1999, the Company filed a motion for
judgment notwithstanding the verdict or, in the alternative, for a new trial
and/or remittitur. The Company believes that the award of $135 million in
punitive damages is not supportable by the facts of the case or by applicable
state law. The Company is not presently able to reasonably estimate the ultimate
outcome of this case, and accordingly, no expense for this judgment has been
recorded. In the event that the adverse judgment is sustained after all appeals
(which is not anticipated by the Company), it would be likely that the Company's
results of operations for a particular year may be materially adversely
affected. However, the Company believes that the ultimate outcome of this
litigation is not expected to have a material adverse effect on the Company's
financial condition.
8
<PAGE>
THE SERVICEMASTER COMPANY
MANAGEMENT DISCUSSION AND ANALYSIS
RESULTS OF OPERATIONS
THIRD QUARTER 1999 COMPARED TO THIRD QUARTER 1998
Revenues increased 24 percent over the third quarter of 1998 to $1.6 billion,
reflecting strong growth from both base operations and acquisitions.
Approximately six percent of the revenue increase resulted from internal growth
and small roll-up acquisitions in established businesses while the entry into
the landscaping, HVAC, and plumbing markets provided 25 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
increased 17 percent over the prior year. Margins decreased to 8.4 percent of
revenue from 8.9 percent in 1998, because newer initiatives in landscaping,
HVAC, and plumbing reported margins below the Company average. Operating margins
before these platforms would have been flat even though a severe drought in the
Mid Atlantic and Northeast regions of the country in 1999 reduced margins in
TruGreen-ChemLawn, the Company's largest operating unit. Diluted earnings per
share increased 11% to $.21 compared to $.19 last year. Net income of $66.6
million grew 18%, a faster rate than earnings per share due to an increase in
shares outstanding resulting from the impact of shares issued for acquisitions.
Even despite the severe weather conditions this year, the Company expects net
income growth for the year to be in the range of 17 percent to 19 percent and
earnings per share growth to be in the 10 percent to 12 percent range. The
Company has launched two new business initiatives, the first of which will focus
on expanding the Company's core service capabilities to the consumer market,
providing an e-commerce alternative for selling, and providing and bundling our
service offering and related products. The other initiative will focus on
expanding our outsourcing, site service and information resources to the
business and commercial market. The Company expects earnings per share to
continue to grow at double digit rates for the next two years, but less than
historical levels because of the investments that the Company will be making to
support these initiatives which are likely to be $.03 to $.05 per share in 2000.
The Consumer and Commercial Services business unit reported revenue of $944
million, an increase of 60 percent, resulting from double-digit growth at each
of the companies and the successful integration of new businesses. Operating
income increased 25% to $106.9 million. TruGreen reported a substantial increase
in revenues and a more modest growth in profits, reflecting the impact of severe
weather conditions on the lawn care operations partially offset by increases
from the landscape initiative. The lawn care operations reported modest revenue
growth but lower profits due to the effects of the extreme drought in the
Northeast and the Mid Atlantic regions of the country. The profit reduction was
primarily a result of lower employee productivity as the drought impaired the
Company's ability to complete its expected level of services. TruGreen LandCare,
the Company's commercial landscape operations, reported significant increases in
revenue and profits reflecting strong internal growth and the successful
integration of acquisitions. Terminix achieved double-digit increases in
revenues and profits resulting from strong customer demand for termite baiting
systems, improved margins reflecting strong growth in higher margin termite
renewal contracts as well as the integration of acquisitions. American Home
Shield had strong growth in revenues and profits with double-digit increases in
warranty contracts sold through all distribution channels, which include real
estate, customer renewals, and direct-to-consumer sales. The combined Rescue
Rooter and American Residential Services (ARS) operations reported substantial
growth in revenue and profits, reflecting double-digit internal growth in the
Rescue Rooter operations and the addition of ARS, which continues to meet
management's expectations. The franchise operations, Residential/Commercial and
Merry Maids, reported double-digit growth in revenues and profits as a result of
the continued strong growth of company owned operations and increased licenses
sales.
9
<PAGE>
The Management Services business unit reported revenue of $482 million and
operating income of $19.8 million, both down from prior year levels reflecting
the disposition of two businesses. Revenues from continuing operations grew two
percent as strong growth in the Business & Industry market was partially offset
by a decrease in the larger Healthcare market. Operating income from continuing
operations increased four percent reflecting strong overhead cost controls.
Cost of services rendered and products sold increased 28 percent due primarily
to acquisitions and general business growth, and increased as a percentage of
revenue to 77.3 percent from 75.1 percent in 1998. The acquisitions related to
the landscaping, HVAC and plumbing initiatives have significantly impacted this
comparison because their cost of services as a percentage of revenue is higher
than the average for the enterprise. Excluding these platforms, cost of services
rendered and products sold decreased as a percentage of revenue to 74.1 percent
from 74.8 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 business 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 revenues.
Selling and administrative expenses increased 12 percent due to general business
growth and acquisitions, and decreased as a percentage of revenue to 14.3
percent from 15.9 percent in 1998. The platform initiatives noted above have a
lower selling and administrative expense as a percentage of revenue than the
Company average. Excluding these initiatives, selling and administrative
expenses increased as a percentage of revenue to 17.2 percent from 16.3 percent
in 1998, 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 increase in interest and investment
income primarily resulted from additional gains realized on financial
investments. The tax provision reflects a higher effective tax rate compared to
last year, primarily due to the non-deductibility of goodwill from several large
acquisitions completed in 1999.
NINE MONTHS ENDED SEPTEMBER 30, 1999 AS COMPARED TO SEPTEMBER 30, 1998
Revenues for the nine months increased 21 percent over 1998 to $4.2 billion,
reflecting strong base business growth and the effect of acquisitions.
Approximately 7 percent of the growth came from internal sources and small
roll-up acquisitions in existing service lines with another 19 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 non-recurring unusual
items increased 19 percent, while operating margins decreased to 8.4 percent of
revenue from 8.5 percent in 1998. The decrease in operating margins reflects the
impact of the newer initiatives that have operating margins below the Company
average. Diluted earnings per share for the nine months, excluding non-recurring
items, increased 15 percent to $.55 compared to $.48 last year. On this same
basis, net income grew 21 percent to $171.6 million from $142.0 million. Net
income grew at a faster rate than earnings per share due to an increase in
shares outstanding resulting from the equity offering in May 1998 and shares
issued for acquisitions. In the second quarter, 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 from ongoing operations by $51 million
($85.5 million pretax). As a result of these items, for the nine months, the
Company reported net income of $120.3 million and diluted earnings per share of
$.38.
The Consumer and Commercial Services business unit achieved a 51 percent
increase in revenue to $2.3 billion and operating income of $295.7 million, 30
percent higher than last year. The profit growth of the segment reflected both
acquisitions and internal growth. The TruGreen-ChemLawn lawn care operations
reported modest revenue growth but lower profits due to the severe weather
conditions
10
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experienced this year including the worst summer drought on record in the
Northeast and Mid Atlantic states. TruGreen-LandCare, the Company's commercial
landscape operations, achieved significant increases in both revenue and profits
reflecting strong internal growth and the impact of acquisitions, including
LandCare USA, which was completed in March. Terminix reported double digit
revenue growth and a very strong increase in profits reflecting strong growth in
higher margin termite completions and renewal contracts, improved branch
efficiencies as well as the integration of acquisitions. American Home Shield
reported double-digit growth in both revenues and profits with excellent
increases in direct-to-consumer sales and renewal sales. The combined Rescue
Rooter and ARS operations reported significant increases in revenues and
profits, reflecting the acquisition of ARS in April and solid internal growth in
the Rescue Rooter business. The franchise operations, Residential/Commercial and
Merry Maids, reported strong revenue and profit growth for the nine months with
good growth and productivity improvements at the company owned operations as
well as increased franchise licenses sales.
The Management Services business unit reported revenue of $1.5 billion and
operating income of $106.5 million for the nine months. In the second quarter,
the segment recorded a significant gain related to the sale of two of its
business units. Revenues and operating income from continuing operations
increased three 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 nine 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 higher
profits, as 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. Through the first nine months, all three markets had a
higher base of annualized revenue than the beginning of the year levels.
Cost of services rendered and products sold increased 22 percent for the nine
months, primarily due to acquisitions and general business growth. Cost of
services increased as a percentage of revenue to 77.7 percent in 1999 from 77.2
percent in 1998. As discussed in the three month comparison, the platform
acquisitions in landscaping, HVAC and plumbing have affected this comparison.
Excluding these initiatives, cost of services rendered and products sold
decreased as a percentage of revenue to 75.7 percent from 77.0 percent in 1998.
This decrease primarily reflects the changing mix of the business as Consumer
and Commercial Services increase in size in relationship to the overall business
of the Company. The Consumer and Commercial Services business 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 for the nine months increased 18 percent due
to general business growth and acquisitions, and decreased as a percentage of
revenue to 13.9 percent in 1999 from 14.3 percent in 1998. Excluding the
platform initiatives, selling and administrative expenses increased as a
percentage of revenue to 15.9 percent from 14.5 percent in 1998, primarily due
to the changing business mix of the Company noted above.
The increase in interest expense for the nine 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
levels primarily due to additional gains realized on financial investments. The
tax provision reflects a higher effective tax rate compared to last year, and
resulted from increased non-deductible intangible amortization expense.
FINANCIAL POSITION
Net cash provided from operations for the nine months of $68.7 million was
significantly below 1998. The decrease primarily reflects the deferral of the
1998 federal tax payment until March of 1999 and estimated payments on the
Company's 1999 earnings. Excluding all tax payments, cash provided from
11
<PAGE>
operations in 1999 of $209.5 million was slightly below the 1998 level of $213.1
million. Working capital needs increased over 1998, reflecting the growth in the
Company's seasonal businesses, especially landscaping operations, which
experienced a significant increase in receivables. 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 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 earlier in the year, but are directly associated with revenues realized
in subsequent quarters of the current year. These costs are then amortized over
the balance of the current lawn care production season, as the related revenues
are recognized. In addition, prepaid expenses have increased due to the deferral
of contract acquisition costs at American Home Shield, which have grown in
relation to the increased volume of warranty contracts written.
Deferred revenues also increased reflecting strong growth at American Home
Shield, increases in customer prepayments for 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 for the first nine months of 1999 were approximately $843
million ($618 million of which was from the LandCare USA and American
Residential Services acquisitions). Approximately one-third of the acquisition
payments were in the form of shares. Intangible assets, primarily goodwill,
increased $523 million from year-end, reflecting the effect of the acquisitions,
which included $260 million from 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 and 1999 tax payments, 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 were 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 at September 30, 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 $83
million, or $.27 per share for the nine months ended September 30, 1999. The
increase from the prior year reflects a 13 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.
12
<PAGE>
In October 1999, the Company announced that its Board of Directors authorized
the repurchase of $150 million of shares over time in the open market or in
privately negotiated transactions.
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 and has dealt with the Y2K problem either
through system upgrades, which were planned to occur in the normal course of
business, or by putting 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 called 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.
Since early 1998, the Company has monitored its progress on the Y2K program on a
consolidated basis. In 1998, the Company 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 were developed for the mission critical and critical matters,
with milestones established for each plan. This program has enabled management
to measure the progress made in respect of each plan against the work schedule
established for that plan. Although these plans encompass many separately
identifiable items, from a ServiceMaster enterprise standpoint, nine projects
(the "Key Projects") were identified by management as either mission critical or
critical and as requiring a measurable amount of attention to remediate. At
November 12, 1999, eight of these Key Projects had been completed and the ninth
of these Key Project will be completed by the end of November 1999. Thus, by
November 30, 1999, all Key Projects will have been completed in accordance with
their scheduled completion dates and well in advance of December 31, 1999.
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. This committee has provided status reports to the Board of Directors on a
regular basis.
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. These companies had extensive branch networks,
which operated on a variety of different platforms. The Company has remediated
these branches by implementing a common operating system, where possible by year
end, and by 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.
13
<PAGE>
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, including 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-LandCare 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
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 Y2K ready. For those units of the
Company which sell franchises and which provide software to the franchisees,
such software is already, or soon is either fully Y2K ready or, 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 expects all of its internal key IT
and non-IT systems to be Y2K ready before the end of the year 1999. If it
appears that timely delivery of any Key Projects becomes questionable, the
Company will put in place the appropriate contingency plans.
The Company 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
fully completed by the end of November 1999, 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.
14
<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.
15
<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 November 15, 1999, these
proceedings included a number of general liability actions and regulatory
proceedings and a very small number of environmental proceedings, none of which
was material to ServiceMaster's financial condition or results of operations.
RAY D. MARTIN V. SERVICEMASTER. In June 1996, Ray D. Martin, a former
salesman employed by ServiceMaster's Management Services unit, filed a lawsuit
in the State Court of Fulton County, Georgia (Civ. Action File No. 96VS114677J),
which as originally filed contended that the Company had not paid him the full
amount of commission due him on a sale in which he was involved. In the course
of the pre-trial proceedings, the trial court entered a default judgment against
the Company (thereby leaving under the court's orders only the question of
damages to be considered at the trial). On September 13, 1999, the jury awarded
the plaintiff compensatory damages of approximately $1,000,000 and on September
14, 1999, a jury awarded the plaintiff punitive damages and fees of $135
million. On September 29, 1999, the trial court entered final judgment for the
plaintiff on the basis of these verdicts in a total amount of $136,259,417.
Under Georgia law, that judgment will accrue post-judgment interest at a
statutory rate of 12% per annum, except for the portion of the judgment
($77,189) that represents pre-judgment interest. On October 14, 1999, the
Company filed a motion for judgment notwithstanding the verdict or, in the
alternative, for a new trial and/or remittitur. ServiceMaster believes it likely
that the judgment will be reversed or substantially reduced by the trial court
or, if necessary, by an appellate court.
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.
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 15, 1999
THE SERVICEMASTER COMPANY
(Registrant)
By: /s/Steven C. Preston
-------------------------------
Steven C. Preston
Executive Vice President and Chief Financial Officer
17
<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 15, 1999
THE SERVICEMASTER COMPANY
(Registrant)
By:
--------------------------
Steven C. Preston
Executive Vice President and Chief Financial Officer
18
<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, 1999 and is qualified in its entirety by reference to such financial
statements.
</LEGEND>
<MULTIPLIER> 1,000
<S> <C> <C>
<PERIOD-TYPE> 9-MOS 9-MOS
<FISCAL-YEAR-END> DEC-31-1999 DEC-31-1998
<PERIOD-START> JAN-01-1999 JAN-01-1998
<PERIOD-END> SEP-30-1999 SEP-30-1998
<CASH> 21,722 56,708
<SECURITIES> 55,190 58,808
<RECEIVABLES> 638,155 432,917
<ALLOWANCES> 39,246 33,377
<INVENTORY> 76,171 49,950
<CURRENT-ASSETS> 927,656 702,200
<PP&E> 650,791 427,994
<DEPRECIATION> 330,507 226,048
<TOTAL-ASSETS> 3,791,384 2,883,464
<CURRENT-LIABILITIES> 766,572 674,554
<BONDS> 1,687,831 1,177,334
0 0
0 0
<COMMON> 3,114 2,969
<OTHER-SE> 1,221,684 899,018
<TOTAL-LIABILITY-AND-EQUITY> 3,791,384 2,883,464
<SALES> 0 0
<TOTAL-REVENUES> 4,236,361 3,499,508
<CGS> 0 0
<TOTAL-COSTS> 3,292,992 2,702,538
<OTHER-EXPENSES> 675,115 499,554
<LOSS-PROVISION> 0 0
<INTEREST-EXPENSE> 80,921 71,044
<INCOME-PRETAX> 206,728 238,288
<INCOME-TAX> 86,447 96,262
<INCOME-CONTINUING> 120,281 142,026
<DISCONTINUED> 0 0
<EXTRAORDINARY> 0 0
<CHANGES> 0 0
<NET-INCOME> 120,281 142,026
<EPS-BASIC> 0.39 0.49
<EPS-DILUTED> 0.38 0.48
</TABLE>
